[LETTERHEAD OF THE NAVIGATORS GROUP, INC.]
VIA EDGAR
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Securities and Exchange Commission
Division of Corporation Finance
100 F Street, NE
Washington, D.C. 20549
Attn: Mr. Jim B. Rosenberg
Senior Assistant Chief Accountant
January 4, 2008
Re: The Navigators Group, Inc. (the "Company")
Form 10-K for fiscal year ended December 31, 2006 (File No. 0-15886)
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Dear Mr. Rosenberg:
This letter is in response to the Division of Corporation Finance's
comment letter dated November 29, 2007, in which you requested additional
information based on your review of the Company's annual report on Form
10-K for the year ended December 31, 2006 (the "2006 10-K"). The comments
included in your letter are repeated below, and our response immediately
follows each comment. Any information in the responses below that the
Company has indicated will be included in its Form 10-K for the fiscal
year ended December 31, 2007 (the "2007 10-K") will be updated to reflect
the year-end numbers when the 2007 10-K is filed.
In connection with the filing of our responses to your comments, the
Company acknowledges that:
o the Company is responsible for the adequacy and accuracy of the
disclosure in the 2006 10-K;
o staff comments or changes to disclosure in response to staff
comments do not foreclose the Securities and Exchange Commission
(the "Commission") from taking any action with respect to the 2006
10-K; and
o the Company may not assert staff comments as a defense in any
proceeding initiated by the Commission or any person under the
federal securities laws of the United States.
1
Form 10-K for fiscal year ended December 31, 2006
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Management's Discussion and Analysis ("MD&A") of Financial Condition and
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Results of Operations
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Results of Operations and Overview
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Net Losses and Loss Adjustment Expenses Incurred, page 54
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1. We believe your disclosure in MD&A regarding the estimation of the
reserve for losses and loss adjustment expenses could be improved to
better explain the judgments and uncertainties surrounding this
estimate and the potential impact on your financial statements. We
believe in order to meet the principal objectives of MD&A this
disclosure should enable the investor to understand 1) management's
method for establishing the estimate; 2) whether and if so to what
extent and why you have adjusted your assumptions used to determine the
estimate from the assumptions used in the immediately preceding period
and 3) the potential variability in the most recent estimate and the
impact this variability may have on reported results, financial
condition and liquidity. Please keep these points in mind in providing
us your responses to the comments listed below. Notwithstanding your
responses to comments two and three of our letter dated December 8,
2005, please revise your disclosure to provide the following
information for each material line of business and also consider
providing any additional information to achieve this objective.
a. Although you identify some of the actuarial methods you utilize, you
do not appear to describe these methods nor explain in what
circumstances you apply each method. Please describe the methods you
used to determine your reserve for losses and loss adjustment
expenses. Please ensure this description:
1. Explains how the methods you use for your short-tail business
differ from the methods you use for your long-tail business.
2. Identifies the unique development characteristics of each
material short-tail and long-tail line of business.
3. Describes the method you use to calculate the IBNR reserve for
each material line of business. For example, we understand
that some companies may calculate this reserve by estimating
the ultimate unpaid liability first and then reducing that
amount by cumulative paid claims and by case reserves, but
there may be other methods as well.
4. Describes the extent of your procedures for determining the
reserve for loss and loss adjustment expense on both an annual
and interim reporting basis.
Response:
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The 2007 10-K will reflect the following paragraphs in the MD&A in
the section Operating Expenses--Net losses and Loss Adjustment Expenses
Incurred:
2
The Company's actuaries generally calculate the IBNR loss reserves
for each line of business by underwriting year for major products
principally using two standard actuarial methodologies which are
projection or extrapolation techniques: the loss ratio method and the
Bornheutter-Ferguson method. The loss ratio method is used to calculate
the IBNR for the most current underwriting year while the
Bornheutter-Ferguson method is used to calculate the IBNR for all prior
underwriting years, except as otherwise described below. Such
methodologies are supplemented in most instances by the loss development
method and the frequency/severity method which are used to analyze and
better comprehend loss development patterns and trends in the data when
making selections and judgments under the loss ratio method and the
Bornheutter-Ferguson method. In utilizing these methodologies, each of
which is generally applicable to both long-tail and short-tail lines of
business and all of which are described below, to develop our IBNR loss
reserves, a key objective of our actuaries is to identify aberrations and
systemic changes occurring within historical experience and accurately
adjust for them so that the future can be projected more reliably. This
process requires the substantial use of informed judgment and is
inherently uncertain.
There are instances in which facts and circumstances require a
deviation from the general process described above. Two such instances
relate to the IBNR loss reserve processes for our 2005 Hurricanes Katrina
and Rita losses and our asbestos exposures, where extrapolation techniques
are not applied, except in a limited way, given the unique nature of
hurricane losses and limited population of marine excess policies with
potential asbestos exposures. In such circumstances, inventories of the
policy limits exposed to losses coupled with reported losses are analyzed
and evaluated principally by claims personnel and underwriters to
establish IBNR loss reserves. At September 30, 2007, the gross and net
loss reserve amounts of our 2005 Hurricanes Katrina and Rita losses were
$188.3 million and $5.3 million, respectively, and the gross and net loss
reserve amounts for our asbestos exposures were $23.9 million and $17.4
million, respectively.
A brief summary of each actuarial method discussed above follows:
Loss ratio method: This method is based on the assumption that
ultimate losses vary proportionately with premiums. Pursuant to the loss
ratio method, IBNR loss reserves are calculated by multiplying the earned
premium by an expected ultimate loss ratio to estimate the ultimate losses
for each underwriting year, then subtracting the reported losses,
consisting of paid losses and case loss reserves, to determine the IBNR
loss reserve amount. The ultimate loss ratios applied are the Company's
best estimates for each underwriting year and are generally determined
after evaluating a number of factors which include: information derived by
underwriters and actuaries in the initial pricing of the business, the
ultimate loss ratios established in the prior accounting period and the
related judgments applied, the ultimate loss ratios of previous
underwriting years, premium rate changes, underwriting and coverage
changes, changes in terms and conditions, legislative changes, exposure
trends, loss development trends, claim frequency and severity trends, paid
claims activity, remaining open case reserves and industry data where
deemed appropriate. Such factors are also evaluated when selecting
ultimate loss ratios and/or loss development factors in the methods
described below.
3
Bornheutter-Ferguson method: The Bornheutter-Ferguson method
calculates the IBNR loss reserves as the product of the earned premium, an
expected ultimate loss ratio, and a loss development factor that
represents the expected percentage of the ultimate losses that have been
incurred but not yet reported. The loss development factor equals one
hundred percent less the expected percentage of losses that have thus far
been reported, which is generally calculated as an average of the
percentage of losses reported for comparable reporting periods of prior
underwriting years. The expected ultimate loss ratio is generally
determined in the same manner as in the loss ratio method.
Loss development method: The loss development method, also known as
the chainladder or the link-ratio method, develops the IBNR loss reserves
by multiplying the paid or reported losses by a loss development factor to
estimate the ultimate losses, then subtracting the reported losses,
consisting of paid losses and case loss reserves, to determine the IBNR
loss reserves. The loss development factor is the reciprocal of the
expected percentage of losses that have thus far been reported, which is
generally calculated as an average of the percentage of losses reported
for comparable reporting periods of prior underwriting years.
Frequency/severity method: The frequency/severity method calculates
the IBNR loss reserves by separately projecting claim count and average
cost per claim data on either a paid or incurred basis. It estimates the
expected ultimate losses as the product of the ultimate number of claims
that are expected to be reported and the expected average amount of these
claims.
An annual loss reserve study is conducted by the Company's actuaries
for each major line of business employing the methodologies as described
above with the timing of such studies varying throughout the year.
Additionally, a review of the emergence of actual losses relative to
expectations for each line of business, generally derived from the annual
reserve study, is conducted each quarter to determine whether the
assumptions used in the reserving process continue to form a reasonable
basis for the projection of liabilities for each product line. Such
reviews may result in maintaining or revising assumptions regarding future
loss development based on various quantitative and qualitative
considerations. If actual loss activity differs from expectations, an
upward or downward adjustment to loss reserves may occur. As time passes,
estimated loss reserves for an underwriting year will be based more on
historical loss activity and loss development patterns rather than on
assumptions based on underwriters' input, pricing assumptions or industry
experience.
The following discusses the method used for calculating the IBNR for
each line of business and key assumptions used in applying the actuarial
methods described.
Marine: Generally, two key assumptions are used by our actuaries in
setting IBNR loss reserves for major products in this line of business.
The first assumption is that our historical experience regarding paid and
reported losses for each product where we have sufficient history can be
relied on to predict future loss activity. The second assumption is that
our underwriters' assessments as to potential loss exposures are reliable
indicators of the level of our expected loss activity. The specific loss
reserves for
4
marine are then analyzed separately by product based on such assumptions,
except where noted below, with the major products including marine
liability, offshore energy, cargo, protection and indemnity ("P&I"),
transport and bluewater hull.
The claims emergence patterns for various marine product lines vary
substantially. Our largest marine product line is marine liability, which
has one of the longer loss development patterns. Marine liability protects
an insured's business from liability to third parties stemming from their
marine-related operations, such as terminal operations, stevedoring and
marina operations. Since marine liability claims generally involve a
dispute as to the extent and amount of legal liability that our insured
has to a third party, these claims tend to take a longer time to develop
and settle. Other longer-tail marine product lines include P&I insurance,
which provides coverage for third party liability as well as injury to
crew for vessel operators, and transport insurance, which provides both
property and third party liability on a primary basis to businesses such
as port authorities, marine terminal operators and others engaged in the
infrastructure of international transportation. Offshore energy provides
physical damage coverage to offshore oil platforms along with offshore
operations related to oil exploration and production. The significant
offshore energy claims are generally caused by fire or storms, and thus
tend to be large, infrequent, quickly reported, but occasionally not
quickly settled because the damage is often extensive but not always
completely known. Other marine product lines have considerably shorter
periods in which losses develop and settle. Ocean cargo insurance, for
example, provides physical damage coverage to goods in the course of
transit by water, air or land. By their nature, cargo claims tend to be
reported quickly as losses typically result from an obvious peril such as
fire, theft or weather. Similarly, bluewater hull insurance provides
coverage against physical damage to ocean-going vessels. Such claims for
physical damage generally are discovered, reported and settled quickly.
The Company currently has extensive experience for all of these products
and thus the IBNR loss reserves for all of the marine products are
determined using the key assumptions and actuarial methodologies described
above. Prior to 2007, however, as discussed below, the Company did not
have sufficient experience in the transport product line and instead used
its hull and liability products loss development experience as a key
assumption in setting the IBNR loss reserves for its transport product.
Specialty: The reserves for specialty are established separately by
product with the major product being contractors liability insurance.
Other products include commercial middle markets, personal umbrella,
primary casualty and excess casualty. Our actuaries generally utilize two
key assumptions in this line of business: first, that our historical loss
development patterns are reasonable predictors of future loss patterns and
second, that our claims personnel's assessment of our claims exposures and
our underwriters' assessment of our expected losses are reliable
indicators of our loss exposure. However, this line of business includes a
number of newer products where there is insufficient Company historical
experience to project loss reserves and/or loss development is sparse or
erratic, which makes extrapolation techniques for those products extremely
difficult to apply, and in those circumstances we typically rely more on
industry data and our underwriters' input in setting assumptions for our
IBNR loss reserves as opposed to historical loss development patterns. In
addition, as discussed in
5
more detail below with respect to construction defect reserves, our
actuaries may take other market trends or events into account in setting
IBNR loss reserves.
The substantial majority of the specialty loss reserves are for the
contractors liability business, which insures mostly general and artisan
contractors. Contractor liability claims are categorized into two claim
types: construction defect and other general liability. Other general
liability claims typically derive from workplace accidents or from
negligence alleged by third parties, and take a long time to report and
settle. Construction defect claims involve the discovery of damage to
buildings that was caused by latent construction defects. These claims
take a very long time to report and to settle compared to other general
liability claims. Since construction defect claims report much later than
other contractor liability claims, they are analyzed separately in the
annual loss reserve study.
The Company has extensive history in the contractors liability
business upon which to perform actuarial analyses and does use the key
assumption noted above relating to its own historical experience as a
reliable indicator of the future for this product. However, there is
inherent uncertainty in the loss reserve estimation process for this line
of business given both the long-tail nature of the liability claims and
the continuing underwriting and coverage changes, claims handling and
reserve changes, and legislative changes that have occurred over a several
year period. Such factors are judgmentally taken into account in this line
of business in specific periods. The underwriting and coverage changes
include the migration to a non-admitted business from admitted business in
2003, which allowed the Company to exclude certain exposures previously
permitted (for example, exposure to construction work performed prior to
the policy inception), withdrawals from certain contractor classes
previously underwritten and expansion into new states beginning in 2005.
Claims changes include bringing the claim handling in-house in 1999 and
changes in case reserving practices in 2003 and 2006. A California
legislative change, the effects of which are yet to be fully understood by
the industry, with respect to reserves and claim frequency for
construction defect repairs, became effective July 1, 2002 with a sunset
provision effective January 1, 2011. The law provides for an alternative
dispute resolution system that attempts to involve all parties to a claim
at an early stage. The legislation may be impacting claim severity,
frequency and the length of settlement which may ultimately be different
than historical loss development assumptions employed in our loss reserve
process.
Most recently, in setting the IBNR loss reserves for construction
defect claims, the Company's actuaries have begun to consider a new
qualitative factor based on their evolving concern with the recent decline
in home values caused by the sub-prime home mortgage crisis and its
possible impact on the frequency and severity of construction defect
claims. As a result, the Company's actuaries acknowledge this uncertainty
and anticipate claims arising from alleged construction defects
contributing to housing value declines on policies written on newly
constructed homes in our portfolio. We believe our reserves remain
adequate to address such potential exposure, but we can give no assurances
with respect thereto.
6
The commercial middle markets business consists of general
liability, auto liability and property exposures for a variety of
commercial middle market businesses, principally hospitality,
manufacturing and garages. Commencing in 2007, our actuaries are
segmenting and analyzing the components of the loss development for this
business among the property, liability and auto exposures which had been
previously combined.
Personal umbrella coverage is purchased by individuals who seek
higher limits of liability than are provided in their homeowners or
personal automobile policies. Losses tend to be large and infrequent, and
often result from automobile accidents. They are reserved primarily using
the Company's historical loss experience.
Primary casualty insurance provides primary general liability
coverage principally to corporations in the construction and manufacturing
sector. Excess casualty insurance is purchased by corporations which seek
higher limits of liability than are provided in their primary casualty
policies. Neither product line has a significant amount of loss activity
reported to date. Because the Company has limited historical experience in
these products, the IBNR loss reserves for both of these products
currently are established using the loss ratio method primarily based on
our underwriters' input and industry loss experience.
Professional liability: The professional liability policies mainly
provide coverage on a claims-made basis mostly for a one-year period. The
reserves for professional liability are analyzed separately by product
with the major products being directors and officers ("D&O") liability
coverage and errors and omissions ("E&O") liability coverage for lawyers
and other professionals.
The losses for D&O business are generally very large and infrequent,
and typically involve securities class actions. D&O claims report
reasonably quickly, but may take several years to settle. While the
Company has been writing D&O business since 2001, the limited claim
history is generally insufficient to establish IBNR loss reserves using
Company data. As a result, the Company principally employs assumptions
based on industry experience coupled with input from its underwriters and
its claims staff's assessment of potential exposure to establish IBNR loss
reserves. Another key assumption with respect to establishing IBNR loss
reserves for D&O business is that such industry experience is
representative of our future potential loss development with respect to
trends in class action activity, such as the impact of stock option
backdating, IPO laddering and, most recently, the sub-prime mortgage
crisis. As time passes, for a given underwriting year, additional weight
is given to assumptions relating to our actual experience and claims
outstanding.
The E&O IBNR loss reserve process is similar to the process for D&O,
with the exception of a particular book of business of the U.K. Branch
written from 2004 through 2006. For the U.K Branch E&O business, we assume
the claims, while similar in nature to the claims in the U.S. E&O
business, are larger, more frequent and have a longer loss development
pattern. The IBNR loss reserves for the U.K. Branch E&O business are
determined judgmentally after reviewing recent loss activity relative to
the remaining in-force policy count and the loss activity for similar
insureds.
7
Other: Loss reserves for other include inland marine business and
European property business written by the U.K. Branch. Both businesses
were started in 2006. The Company has limited loss history and relies
primarily on assumptions based on underwriters' input and industry
experience. Also included are loss reserves for aviation, property and
assumed reinsurance business in runoff since 1999, which are periodically
monitored and evaluated by claims and actuarial personnel.
Lloyd's Operations: Reserves for the Company's Lloyd's Operations
are reviewed separately for the marine and professional liability lines by
product. The major marine products are marine liability, offshore energy,
cargo, specie and marine reinsurance, and the major products for
professional liability are international D&O and international E&O.
The marine liability, offshore energy and cargo products and related
loss exposures are similar in nature to that described for marine business
above. Specie insurance provides property coverage for chattel, such as
jewelry, fine art and cash in transit. Claims tend to be from theft or
damage, and thus are small, quick to report and quick to settle. Marine
reinsurance is a diversified global book of reinsurance, the majority of
which consists of excess of loss reinsurance policies for which claims
activity tends to be large and infrequent with loss development somewhat
longer than for such products written on a direct basis. Marine
reinsurance reinsures liability, cargo, hull and offshore energy exposures
that are similar in nature to the marine business described above.
The process for establishing the IBNR loss reserves for the marine
and professional liability lines of the Lloyd's Operations, and the
assumptions used as part of this process, are similar in nature to the
process employed by the Insurance Companies. Other business for the
Lloyd's Operations includes European property and inland marine products,
each of which is a new line of business where we have limited loss history
and rely primarily on assumptions based on our underwriters' input and
industry loss experience.
The Lloyd's Operations products also include property coverages for
engineering and construction projects and onshore energy business, which
are substantially reinsured. Losses from engineering and construction
projects tend to result from loss of use due to construction delays while
losses from onshore energy business are usually caused by fires or
explosions. Large losses tend to be catastrophic in nature and are heavily
reinsured. IBNR loss reserves for attritional losses are established based
on the Syndicate's extensive loss experience.
b. Describe your policy, if any, for adjusting the reserve for losses
and loss adjustment expenses to an amount that is different than the
amount determined by your actuaries.
1. If such a policy exists, describe the method you used to
determine the adjustment and the extent to which it relies on
objective versus subjective determinations. Such adjustments
may include, but not be
8
limited to, an incremental provision, a reduction in the
liability, or a reversal of a previously recorded adjustment.
2. When such adjustments or reversals are made, include MD&A
disclosure that identifies the amount of the adjustment or
reversal, the method you used to determine it, and the
specific underlying reasons that explain why you believe the
adjustment or reversal is necessary.
Response:
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The Company's practice is to record the amount determined by its
internal actuaries as its reserve for losses and loss adjustment expenses
in its financial statements. Management of the Company does not make
adjustments or reversals of the nature described above in its financial
statements. In the event the Company's practice changes and it makes such
an adjustment or reversal, it will include the information requested in
1.b. above in its MD&A.
c. It appears that your revision of prior year reserves has
significantly increased in 2007 as compared to the rate of revision
in 2006 and 2005 as demonstrated in your SOP 94-5 table on page 10.
The 2007 adjustment of prior year reserves also appears to be
significant to your 2007 net income. Your disclosure of the lines of
business contributing to the 2007 adjustment does not appear to
provide meaningful information to investors. Please revise your
disclosure to explain the reasons for your change in estimate for
your specialty and marine businesses as well as your Lloyd's
Operations:
1. Identify and describe in reasonable specificity the nature and
extent of a) new events that occurred or b) additional
experience/information obtained since the last reporting date
that led to the change in estimates.
2. Ensure your disclosure clarifies the timing of the change in
estimate such as why recognition occurred in the periods that
it did and why recognition in earlier periods was not
required.
Response:
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The 2007 10-K will reflect the following paragraphs in the MD&A in
the section Operating Expenses--Net losses and Loss Adjustment Expenses
Incurred:
As part of our regular review of prior reserves, the Company's
actuaries may determine, based on their judgment, that certain assumptions
made in the reserving process in prior years may need to be revised to
reflect various factors, likely including the availability of additional
information. Based on their reserve analyses, our actuaries may make
corresponding reserve adjustments. As discussed in more detail below, in
2007, prior year reserve redundancies of $29.6 million were recorded.
The relevant factors that can have a significant impact on the
establishment and adjustment of loss and loss adjustment expense reserves
can vary by line of business and
9
from period to period. Following is a discussion of relevant factors
impacting our 2007 loss reserves:
The Insurance Companies recorded $2.9 million of net prior years'
savings for marine business of which $6.0 million of savings was mostly
due to transport business written during 2002 to 2006, offset by $1.5
million of 2005 Hurricanes Katrina and Rita loss development and $1.6
million for uncollectible reinsurance recoverables for asbestos losses.
Prior to 2007, because the Company did not have sufficient experience in
the transport product line, it instead used its hull and liability
products loss development experience as a key assumption in setting the
IBNR loss reserves for its transport product. Commencing in 2007, our
actuaries determined that the Company's loss development experience for
its transport product had become sufficiently credible to begin
establishing transport reserves using such experience, which resulted in
the prior year savings referred to above recorded for this business.
The Insurance Companies recorded $11.5 million of net prior years'
savings for specialty business of which approximately $10.0 million was
for contractors liability business for the years 1998 through 2006 and
approximately $1.5 million was for commercial middle markets business
written in 2003 and 2004. The $10.0 million of the prior years' savings
recorded for contractors liability business was due mostly to continued
favorable loss trends for 2003 to 2006. These trends are attributable to
favorable underwriting and legislative changes coupled with a
re-evaluation of the Company's claim reserving practices based on a
frequency and severity claims analysis conducted in 2007.
The $1.5 million in prior years' savings for the commercial middle
markets business resulted from segmenting and analyzing the components of
the loss development for this business among property, liability and auto
exposures, which had been previously analyzed as a combined single product
line. Development factors were reduced given the shorter tail nature of
the property and auto components, which were a larger percentage of the
mix of the business in this line than previously assumed when the
components were analyzed on a combined basis.
The Insurance Companies have historically reserved for the
professional liability business using ultimate loss ratios based on
industry experience for this line of business given its limited claims
history. During 2007 the Insurance Companies reduced the net reserves for
such claims-made policies compared to year-end 2006 by $7.2 million,
mostly related to policies issued in 2005. The reductions were to
recognize the low level of open claim counts and continued favorable
development compared to expectations at the time the reserves were
initially established.
In 2007, the Insurance Companies recorded approximately $600,000 of
net prior year savings from run-off business, principally resulting from a
review of open claims files in the aviation business that was discontinued
in 1999.
The Lloyd's Operations recorded $7.4 million of net prior year
savings, which included $2.7 million due to a review of the 2005
Hurricanes Katrina and Rita loss
10
estimates, approximately $2.0 million due to a review of open claim files
for the years 1998 to 2001, with the remaining $2.7 million of favorable
development spread across several lines of business, principally for
offshore energy and liability business.
To the extent that reserves are deficient or redundant, the amount
of such deficiency or redundancy is recorded as a charge or credit to
earnings in the period in which the deficiency or redundancy is
identified.
d. Please identify and describe those key assumptions that materially
affect the estimate of the reserve for loss and loss adjustment
expenses. In addition please disclose the following:
1. For each of your key assumptions quantify and explain what
caused them to change from the assumptions used in the
immediately preceding period. Please note that this discussion
should supplement, rather than duplicate the disclosure
provided responsive to Industry Guide 6.
2. Explicitly identify and discuss key assumptions as of December
31, 2007 that are premised on future emergence that are
inconsistent with historical loss reserve development patterns
and explain why these assumptions are now appropriate given
the inconsistency identified.
Response:
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In response to 1(d)(1), please see above our responses to 1(a) for
the identification of the key assumptions that materially affect the
estimate of the reserve for the loss and loss adjustment expenses and 1(c)
for the quantification of the impact of the changes of key assumptions. In
response to 1(d)(2), please see our discussion above in 1(a) pertaining to
the sub-prime home mortgage crisis.
e. In order to show investors the potential variability in the most
recent estimate of your loss reserve, quantify and present
preferably in a tabular format the impact that reasonably likely
changes in the key assumptions identified may have on reported
results, financial position and liquidity. Explain why you believe
the scenarios quantified are reasonably likely. In this regard, your
disclosure of examples of sensitivity in specific instances does not
appear to indicate whether theses hypothetical changes are
reasonably likely to occur and whether there are other key
assumptions that are reasonably likely to change that would also
affect your reserve balances and results of operations.
Response:
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The 2007 10-K will include the following paragraphs in the MD&A in the
section Operating Expenses--Net Losses and Loss Adjustment Expenses Incurred:
The Company's actuaries use various assumptions in determining a best
estimate of reserves for each line of business. The importance of any specific
assumption can vary by both individual product within a line of business and
underwriting year. If actual experience differs
11
from key assumptions used in establishing reserves, there is potential for
significant variation in the development of loss reserves, particularly for
long-tail casualty classes of business.
As discussed above, our actuaries generally apply the loss ratio method to
calculate the IBNR loss reserve for the most current underwriting year while the
Bornhuetter-Ferguson method is used to calculate the IBNR loss reserves for all
prior underwriting years except in certain situations such as when limited or
insufficient historical data is available.
Set forth below is a sensitivity analysis that estimates the effect on the
Company's net loss reserve position of using alternative expected loss ratios
for the underwriting years 2000 to 2007 and alternative loss development factors
for the underwriting years 2000 to 2006 rather than those actually used in
determining the Company's best estimates at September 30, 2007. The analysis
addresses each major line of business and underwriting year for which a material
deviation to the Company's overall reserve position is believed reasonably
possible, and uses what the Company believes is a reasonably likely range of
potential deviation for each line of business. The underwriting years prior to
2000 were not included given the maturity of such years and their relatively
small contribution to the overall IBNR loss reserve amount at September 30,
2007. Such underwriting years are therefore deemed to be less likely to cause a
material deviation to the Company's overall loss reserve position. There can be
no assurance, however, that actual reserve development will be materially
consistent with either the original or the adjusted expected loss ratios or loss
development factor assumptions, or with other assumptions made in the reserving
process, or that a material deviation in loss reserves will not occur for
underwriting years prior to 2000.
For the selected alternative expected loss ratios, our actuaries observed
the range of ultimate loss ratios recorded for the underwriting years 2000 to
2006 for each major line of business at September 30, 2007. After evaluating the
range of ultimate loss ratio variances for each underwriting year, our actuaries
judgmentally selected a range of reasonably likely variations from the ultimate
loss ratios recorded for each line of business for each underwriting year out of
the range of reasonably possible variations for each underwriting year.
The reasonably likely ranges of potential deviation in the loss ratios for
each line of business for the 2000 to 2007 underwriting years expressed in loss
ratio points are as follows:
Reasonably Likely Loss Ratio Point Variances:
Decrease Increase
-------- --------
Marine 6 1
Specialty 8 4
Professional Liability 18 12
Lloyd's Operations 9 5
For the selected alternative loss development factors for the 2000 to 2006
underwriting years, our actuaries observed the range of historical loss
development factors recorded for such underwriting years for each major line of
business at September 30, 2007. After evaluating the range of loss development
factor variances for each underwriting year, our actuaries
12
judgmentally selected a range of reasonably likely variations to determine
alternative IBNR loss reserve amounts compared to the amounts recorded for each
line of business for the underwriting years 2000 to 2006 out of the range of
reasonably possible variations for such underwriting years. Such variations
represent the differences in the time that it takes for losses to develop for an
underwriting year.
The reasonably likely ranges of potential deviations in the aggregate or
overall loss development factors for all underwriting years for each line of
business are as follows:
Reasonably Likely Ultimate Loss Development Factor Variances:
Decrease Increase
-------- --------
Marine 12% 12%
Specialty 9% 9%
Professional Liability 6% 8%
Lloyd's Operations 13% 15%
Such sensitivity analysis was performed in the aggregate for all products
in each line of business. The use of aggregate data was considered more stable
and reliable compared to a product-by-product analysis. We cannot assure you,
however, that such use of aggregate data will provide a more accurate range of
the actual variations in loss development. The sensitivity analysis uses loss
ratios and loss development patterns for the 2000 to 2007 underwriting years,
which are believed to be more representative compared to years prior to 2000
given the Company's evolving mix of business, product changes and other factors.
There can be no assurances, however, that the use of such recent history is more
predictive of actual development as compared to employing longer periods of
history. In addition, while the net loss reserves include the net loss reserves
for asbestos exposures, such amounts were excluded from the sensitivity analysis
given the nature of how such reserves are established by the Company. While we
believe such net reserves are adequate, we cannot assure you that material loss
development may not arise in the future from asbestos losses given the complex
nature of such exposures.
A significant factor influencing the results of the sensitivity analysis
has been the generally favorable loss trends experienced in the most recent
three calendar years as evidenced by the recording of net prior year savings
across each line of business. Future loss activity may in fact deviate
substantially from recent experience by becoming less favorable or, in fact,
unfavorable. In such event, future loss activity could lead to smaller than
reasonably likely loss reserve savings or larger than reasonably likely loss
reserve deficiencies as identified below.
The sensitivity analysis also reflects a likely range of impact on
reported financial results by aggregating calculated redundancy amounts and
deficiency amounts for each line of business. The total Company range amounts
below were determined by adding the reasonably likely range amounts for each
line of business, which are uncorrelated to each other, and therefore such
amounts may not be representative of the actual aggregate favorable or
unfavorable loss development amounts that may occur over time.
13
Sensitivity Analysis
September 30, 2007
($ in thousands, except per share)
Total Reasonably Likely Range of Deviation
Net Loss Redundancy Deficiency
Reserves Amount % Amount %
-------- ------ - ------ -
Insurance Companies:
Marine $191,105 $11,946 6% $7,557 4%
Specialty 320,103 27,018 8% 18,189 6%
Professional Liability 68,119 6,500 10% 6,171 9%
Other 25,017
----------------------------------------------
Total Insurance Companies 604,344 45,464 6% 31,917 4%
Lloyd's Operations:
Marine and Other 203,653 19,801 10% 13,916 7%
----------------------------------------------
Total Company $807,997 $65,265 8% $45,833 6%
==============================================
Increase (decrease) to net income:
Amount $42,422 ($29,791)
========== =========
Per share (1) $2.50 ($1.76)
========== =========
(1) Used 16,967,000 average diluted shares outstanding for the nine months
ended September 30, (2007.)
2. On page 59 you disclose the use of outside actuaries who perform annual
loss reserve studies you use to judge the reasonableness of your
recorded loss reserves. Your reference to these outside actuaries
suggests that you are placing reliance on them, which the staff
believes requires that the firm's name be included in the '34 Act
filing. Additionally, if the Form 10-K is incorporated by reference
into a '33 Act registration statement, a consent from the actuaries
must be provided in the '33 Act registration statement. Please advise.
Response:
---------
We will omit the reference to the use of outside actuaries in future
Form 10-K filings.
Notes to Consolidated Financial Statements
- ------------------------------------------
Note 3. Segment Information, page F-17
- --------------------------------------
3. Please revise your disclosure to provide your revenue for each group of
similar products and services or tell us where you made this disclosure in
your financial
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statements. Please see paragraph 37 of SFAS 131. It appears that you
should disclose the components of revenue in the financial statement at
least at the level you disclose in MD&A on page 50.
Response:
---------
We will include premium revenue information in tabular format from
our MD&A in our Note 3 - Segment Information to the Notes to Consolidated
Financial Statements for each year presented in our 10-K commencing with
the 2007 10-K.
Note 1. Organization and Summary of Significant Accounting Policies
- -------------------------------------------------------------------
Investments, page F-10
- ----------------------
4. It is apparent that you invest significantly in mortgage and
asset-backed securities. Please revise your accounting policy note to
include a discussion of the accounting treatment applied to your
investments in mortgage and asset backed securities. Specifically
indicate how you handle differences in actual prepayment assumptions
from your original estimates. Separately reference for us in your
response the authoritative literature you rely upon to support your
accounting.
Response:
---------
We will include the following disclosure in Note 1 - Organization
and Summary of Significant Accounting Policies under "Investments" to the
Notes to Consolidated Financial Statements in our 2007 10-K.
The accounting treatment applied to the Company's investments in
mortgage-backed and asset-backed securities is in accordance with
Statement of Financial Accounting Standards No. 91, "Accounting for
Nonrefundable Fees and Costs Associated with Originating or Acquiring
Loans and Initial Direct Costs of Leases". Anticipated prepayments and
expected maturities are utilized in applying the interest rate method to
our mortgage-backed and asset-backed securities. An effective yield is
calculated based on projected principal cash flows at the time of original
purchase. The effective yield is used to amortize the purchase price of
the security over the security's expected life. Book values are adjusted
to reflect the amortization of premium or accretion of discount on a
monthly basis.
Prepayment assumptions associated with the mortgage-backed and
asset-backed securities are reviewed on a periodic basis. When changes in
prepayment assumptions are deemed necessary as the result of actual
prepayments differing from anticipated prepayments, securities are
revalued based upon the new prepayment assumptions utilizing the
retrospective adjustment method, whereby the effective yield is
recalculated to reflect actual payments to date and anticipated future
payments. The net investment in such securities is adjusted to the amount
that would have existed had the new effective yield been applied since the
acquisition of the security. Such adjustments, if any, are included in net
investment income for the current period being reported.
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We welcome the opportunity to discuss any of the information
included herein should you desire. If you have any questions or comments
concerning this response letter, please contact the undersigned at
914-933-6025 (phone), 914-933-6033 (fax) or bwiley@navg.com.
Sincerely yours,
/s/ Bradley D. Wiley
------------------------------
Bradley D. Wiley
Senior Vice President,
Financial Compliance
Officer and Chief Risk Officer
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