[LETTERHEAD OF THE NAVIGATORS GROUP, INC.]
VIA EDGAR
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
February 1, 2008
Re: The Navigators Group, Inc. (the "Company")
Form 10-K for fiscal year ended December 31, 2006 (File
No. 0-15886)
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"), and to the subsequent comments
provided to us by Mark Brunhofer of the Division of Corporation Finance in a
telephone discussion on January 28, 2008. The comments included in your letter,
and the additional comments provided to us by Mr. Brunhofer in our telephone
discussion, 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
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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.
Form 10-K for fiscal year ended December 31, 2006
- -------------------------------------------------
Management's Discussion and Analysis ("MD&A") of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations 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.
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Response:
--------
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:
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
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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.
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.
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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 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
immediately 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
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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 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
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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.
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
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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.
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.
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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 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:
--------
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.
3. (Additional comment provided on January 28, 2008) We acknowledge
your response to our previous comment in 1.c. Please elaborate on
your favorable underwriting experience, the legislative changes
and the re-evaluation of your claim reserving practices
identified in the fourth paragraph (below) of your proposed
revised disclosure related to your contractors liability
reserves. Please quantify the impact of each of these
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factors where possible and fully describe how these factors
impacted your prior period reserve estimates.
4. (Additional comment provided on January 28, 2008) In addition,
please elaborate on the favorable development identified in your
professional liability business in the sixth paragraph (below) of
your proposed disclosure in response to comment 1.c. In this
regard, please discuss whether the favorable development is a
result of lower frequency, severity or a combination of both.
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 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 frequency and severity trends for 2003 to 2006 compared to
expectations. Our actuaries believe that the favorable loss frequency
trends result primarily from a number of underwriting and coverage changes
since 2002, including the
10
migration to non-admitted business from admitted business in 2003, which
allowed the Company to exclude certain previously permitted exposures (for
example, exposure to construction work performed prior to the policy
inception), and withdrawals from certain contractor classes previously
underwritten. Our actuaries believe that the favorable loss severity trends
result primarily from improved claim practices coupled with a California
legislative change, effective in mid-2002, which provides for an
alternative dispute resolution system with respect to construction defect
claims and is intended to avoid or mitigate costly litigation and claims
settlements. While our actuaries were unable to precisely quantify the
impact of each of the foregoing factors, such factors were judgmentally
taken into account in recording such prior years' savings for contractors
liability business by evaluating actual loss development compared to
expected loss development coupled with 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 the Company's limited
claims history. Such industry experience is heavily influenced by the
historical frequency and severity of large securities class action
lawsuits. 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 made to recognize
both the low level of open claim counts and the lack of claim severity
compared to expectations at the time the reserves were initially
established using industry experience.
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 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.
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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:
--------
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 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.
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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
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:
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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.
Sensitivity Analysis
September 30, 2007
($ in thousands, except per share)
Reasonably Likely Range of Deviation
------------------------------------
Total Redundancy Deficiency
Net Loss ---------- ----------
Reserves Amount % Amount %
-------- ------ -- ------ ---
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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 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:
--------
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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.
(Additional comment provided on January 28, 2008) Please revise your
proposed disclosure in response to our previous comment 4 (above) to
disclose the significant assumptions underlying your prepayment estimates
as required by paragraph 19 of Statement of Financial Accounting Standards
No. 91.
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.
The projected principal cash flows are based on certain prepayment
assumptions which are generated using a prepayment model. The prepayment
model uses a number of factors to estimate prepayment activity including
the current levels of interest rates (refinancing incentive), time of year
(seasonality), economic activity (including housing turnover), and term and
age of the underlying collateral (burnout, seasoning). 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
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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.
We will include the following disclosure in "Item 1 - Description of
Business - Investments" section of our 2007 10-K.
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 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 are included in net investment income for the current
period being reported. The adjustments decreased net investment income and
net income by immaterial amounts in 2007, 2006 and 2005.
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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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