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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended
December 31, 2003

Commission File No. 0-15886

THE NAVIGATORS GROUP, INC.
(Exact name of the Registrant as specified in its charter)

Company's telephone number, including area code: (212) 244-2333

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.10 Par Value

                                                                                                               (Title of Class)

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K ý

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes ý    No o

The aggregate market value of voting stock held by non-affiliates as of June 30, 2003 was $127,123,000.

The number of common shares outstanding as of March 1, 2004 was 12,553,865.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Company's 2004 Proxy Statement are incorporated by reference in Part III, Items 10, 11, 12, 13 and 14 of this Form 10-K.

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TABLE OF CONTENTS

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Note on Forward-Looking Statements

    Some of the statements in this Annual Report on Form 10-K are "forward-looking statements" as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements are derived from information that we currently have and assumptions that we make. We cannot assure that anticipated results will be achieved, since results may differ materially because of both known and unknown risks and uncertainties which we face. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Factors that could cause actual results to differ materially from our forward-looking statements include, but are not limited to, the factors discussed in the "Risk Factors" section of this Form 10-K as well as:

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



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



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



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



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



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unexpected turnover of our professional staff;



•

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



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



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weather-related events and other catastrophes (including acts of terrorism) impacting our insureds and/or reinsurers;



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



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



•

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



•

other risks that we identify in future filings with the Securities and Exchange Commission.

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

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Part I

Item 1. BUSINESS

General

    The accompanying consolidated financial statements consisting of the accounts of The Navigators Group, Inc., a Delaware holding company established in 1982, and its twelve active wholly owned subsidiaries are prepared on the basis of accounting principles generally accepted in the United States of America ("GAAP"). The Company consists of insurance company operations, insurance underwriting agencies and operations at Lloyd's of London. The terms "we", "us", "our" or "the Company" as used herein means The Navigators Group, Inc. and its subsidiaries, unless the context otherwise requires. The term "Parent Company" is used to mean The Navigators Group, Inc. without its subsidiaries. All significant intercompany transactions and balances have been eliminated.

    We are an international insurance holding company focusing on specialty products for niches within the overall property/casualty insurance market. Our largest product line and most long-standing area of specialization is ocean marine insurance. We have also developed niches in specialty lines of business and professional liability insurance. We base our strategy of developing specialty niches of business on the presence of what we perceive to be market opportunities for insurance products, our access to appropriately experienced personnel to manage a particular niche business and our estimation of the likelihood of that niche business producing profitable results. We conduct our insurance operations through five wholly owned underwriting agencies (the "Navigators Agencies") which underwrite on behalf of two wholly owned domestic insurance companies (Navigators Insurance Company and NIC Insurance Company, collectively referred to herein as the "Insurance Companies"), as well as three unaffiliated insurers that participate in the marine business written by the Navigators Agencies. In addition to business that we underwrite in our insurance company subsidiaries, we also participate in the Lloyd's of London market primarily through our ownership of Navigators Underwriting Agency, Ltd. ("NUAL") which manages the Lloyd's Syndicate 1221.

Marine Insurance

    Our marine insurance business is conducted both through our Insurance Companies and through our Lloyd's operations. Navigators Insurance Company obtains marine business through participation with three other unaffiliated insurers in a marine insurance pool managed by the Navigators Agencies. Navigators Insurance Company has participated in this marine insurance pool since 1983, when the company was formed. The composition of the pool and the level of participation of each member changes from time to time. Navigators Insurance Company's net participation in the marine pool for 2002 and 2001 was 75%. Navigators Insurance Company had a 70% participation in the marine pool for 2003 until it consummated a commutation agreement with one of the pool members, which retroactively increased our participation in the pool for 2003 to 80%. Somerset Insurance Ltd., a Bermuda corporation of which our Chairman and a member of his family own, in the aggregate, 98% of the outstanding voting stock, continued to reinsure the portion of the amount commuted that it previously reinsured. This portion constituted approximately 3.1% of Navigators Insurance Company's participation in the pool for the 2003 underwriting year which amounted to $2.3 million of gross written premium. Somerset Insurance Ltd. will not be providing reinsurance to the Company for the 2004 underwriting year. Net recoverable balances due to Navigators Insurance Company from Somerset Insurance Ltd. at December 31, 2003 of $3.5 million were fully collateralized by a funded trust account held by an independent third party. The Navigators Agencies generally receive commissions equal to 7.5% of the gross premium earned on marine insurance and are entitled to receive a 20% profit commission on the net underwriting profits of

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the pool. The Navigators Agencies' offices writing ocean marine business are located in major insurance or port locations in Chicago, Houston, London, Oakland, New York, San Franciso and Seattle.

    Within Navigators Insurance Company's ocean marine business, there are a number of different product lines. The largest is marine liability, which protects business from liability to third parties for bodily injury or property damage stemming from their marine-related operations, such as terminals, marinas and stevedoring. We insure the physical damage to offshore oil platforms along with other offshore operations related to oil exploration and production. Another significant product line is bluewater hull, which provides coverage to the owners of ocean-going vessels against physical damage to the vessels. We also underwrite insurance for harbor craft and other small craft such as fishing vessels, providing physical damage and third party liability coverage. We underwrite cargo insurance, which provides coverage for physical damages to goods in the course of transit, whether by water, air or land.

    We participate in the marine and related insurance lines of the Lloyd's market through NUAL, which manages Lloyd's Syndicate 1221. The majority of Lloyd's Syndicate 1221's capacity is provided by Millennium Underwriting Ltd. and Navigators Corporate Underwriters Ltd., which are wholly owned subsidiaries of NUAL. We provided 97.4%, 68.1% and 67.4% of Syndicate 1221's capacity for the 2003, 2002 and 2001 underwriting years, respectively. In 2003, we provided a larger percentage of the gross capacity and reinsured 15.4% of our Syndicate 1221 capacity through the utilization of quota share reinsurance agreements with third parties who provide letters of credit used as collateral at Lloyd's. Our share of the premiums, losses and expenses from Lloyd's Syndicate 1221 are included in our consolidated results. The largest product line within our Lloyd's marine business is currently cargo, and the other primary lines include marine liability, offshore energy, bluewater hull, and assumed reinsurance of other marine insurers on an excess of loss basis. We have also developed a regional agency operation, Pennine Underwriting Limited, that generates cargo and engineering business in the Manchester, Leeds and Basingstoke areas of the United Kingdom that are not traditionally served by Lloyd's of London.

Specialty

    Navigators Specialty, a division of one of the Navigators Agencies which was acquired in 1999, primarily writes general liability insurance focusing on small general and artisan contractors and other targeted commercial risks, mostly in California. We have developed underwriting and claims expertise in this niche which we believe has allowed us to minimize our exposure to many of the large losses sustained in the past several years by other insurers, including losses stemming from coverages provided to larger contractors who work on condominiums, cooperative developments and other large housing developments. Many former competitors that lacked the expertise to selectively underwrite in this niche have been forced to withdraw from the market in the past several years, at a time when demand for coverage has remained, giving us the opportunity to selectively expand our underwriting in this area. As part of assessing the profit potential of the various lines of our business, as well as the overall amount of business that we are prepared to write in this specific line, in early 2003 we began to reduce the number of policies covering small artisan contractors, and to redirect our capacity to general contractors as well as to medium-sized artisan contractors. This shift in our business mix is consistent with our approach of emphasizing underwriting profit over market share.

    Beginning in late 2002, Navigators Specialty began producing surety business from our Midwest office. Surety bonds guarantee the performance of a specific contractual or statutory obligation, such as completion of a contractor's work on a publicly funded project. Our surety focus is on providing bid, performance and payment bonds for small to medium size contractors generally requiring bonds for individual projects of $2 million or less. In addition, we write surety bonds to guarantee obligations outside of the construction industry, such as travel agents' bonds, property brokers' bonds, notary bonds,

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miscellaneous bonds, and license and permit bonds. We have hired a group of experienced surety underwriters in our Midwest office who focus exclusively on this business.

    Also in late 2002, Navigators Specialty began to write commercial multiple peril and commercial automobile insurance business from our Midwest office. Our commercial multi-peril products include general liability and a small amount of property insurance. We do not underwrite workers compensation coverage. We generally avoid writing property risks in areas with high exposure to earthquake or windstorm losses, such as California and Florida. In 2002, we also began underwriting personal umbrella insurance. This product is typically purchased by individuals who seek higher limits of liability than are provided in their homeowners or personal automobile policies. When personal umbrella coverage is desired and these two primary coverages are placed with different insurers, there is a need to place the personal umbrella insurance policy on a stand-alone basis.

Professional Liability

    We commenced underwriting professional liability insurance in the fourth quarter of 2001 after attracting a team of experienced professionals. This business is produced through Navigators Pro, a division of one of the Navigators Agencies. We believe that a compelling market opportunity exists in this line due to public perception of diminished stockholder value resulting from numerous high profile financial and accounting scandals that have resulted in earnings restatements. This has resulted in increased class action litigation activity involving potential large losses related to alleged mismanagement by directors and officers. Our principal product in this business is directors and officers liability, which we offer for both privately held and small to mid-size publicly traded corporations. With respect to public corporations, we currently target corporations with a market capitalization of $2 billion or less for this business. In addition, we provide fiduciary liability and crime insurance to our directors and officers liability clients. In 2002, we began offering employment practices liability, lawyers professional liability and miscellaneous professional liability coverages. Our current target market for lawyers professional liability is law firms comprised of 75 or fewer attorneys.

Engineering and Construction

    The Lloyd's operations write engineering and construction business consisting of coverage for construction projects including damage to machinery and equipment and loss of use due to delays. We believe this coverage, together with the cargo coverage provided through our Lloyd's operations marine business, provides our policyholders with risk management protection for key exposures throughout a project's construction and operation.

Onshore Energy

    The Lloyd's operations also write onshore energy insurance which principally focuses on the oil and gas, chemical and petrochemical industries with coverages primarily for property damage and business interruption.

Reinsurance Ceded

    We utilize reinsurance principally to reduce our exposure on individual risks, to protect against catastrophic losses, to maintain desired ratios of net written premium to statutory surplus and to stabilize loss ratios.

    Reinsurance does not discharge the original insurer from its primary liability to the policyholder. The ceding company is required to pay the losses even if the assuming company fails to meet its obligations under the reinsurance agreement.

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

    An allowance was established for any amounts considered to be uncollectible. At December 31, 2003, 2002 and 2001, we had an allowance for uncollectible reinsurance of $33,068,000, $8,534,000 and $6,905,000, respectively. The 2003 allowance included a charge of $25,700,000 for uncollectible reinsurance as a result of loss reserves established for asbestos exposures on marine and aviation business written mostly prior to 1986. Charges for uncollectible reinsurance amounts recorded to incurred losses were $27,551,000, $1,632,000 and $320,000 for 2003, 2002 and 2001, respectively.

    The following table lists our 10 largest reinsurers measured by the amount of reinsurance recoverable for ceded losses, ceded loss adjustment expense and ceded unearned premium (constituting approximately 54.6% of the total recoverables) together with the reinsurance recoverables and collateral at December 31, 2003, and the reinsurers' rating from the indicated rating agency:

    Collateral includes letters of credit, ceded balances payable and other balances held by the Company.

Loss Reserves

    Insurance companies and Lloyd's syndicates are required to maintain reserves for unpaid losses and unpaid loss adjustment expenses for all lines of business. These reserves are intended to cover the probable ultimate cost of settling all losses incurred and unpaid, including those incurred but not reported. The determination of reserves for losses and loss adjustment expenses ("LAE") for insurance companies such as Navigators Insurance Company and NIC Insurance Company, and Lloyd's corporate members such as Navigators Corporate Underwriters Ltd. and Millennium Underwriting Ltd. is dependent upon the receipt of information from the pools and syndicates in which such companies participate. Generally, there is a lag between the time

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premiums are written and related losses and loss adjustment expenses are incurred, and the time such events are reported to the pools and syndicates and, subsequently, to Navigators Insurance Company, NIC Insurance Company, Navigators Corporate Underwriters Ltd. and Millennium Underwriting Ltd.

    Loss reserves are established by our Insurance Companies and Lloyd's Syndicate 1221 for reported claims when notice of the claim is first received. Reserves for such reported claims are established on a case-by-case basis by evaluating several factors, including the type of risk involved, knowledge of the circumstances surrounding such claim, severity of injury or damage, the potential for ultimate exposure, experience with the insured and the broker on the line of business, and the policy provisions relating to the type of claim. Reserves for incurred but not reported losses ("IBNR") are determined in part on the basis of statistical information, in part on the basis of industry experience and in part on the basis of the judgment of our senior corporate officers. To the extent that reserves are deficient or redundant, the amount of such deficiency or redundancy is treated as a charge or credit to earnings in the period in which the deficiency or redundancy is recognized.

    Loss reserves are estimates of what the insurer or reinsurer expects to pay on claims, based on facts and circumstances then known. It is possible that the ultimate liability may exceed or be less than such estimates. In setting our loss reserve estimates, we review statistical data covering several years, analyze patterns by line of business and consider several factors including trends in claims frequency and severity, changes in operations, emerging economic and social trends, inflation and changes in the regulatory and litigation environment. Based on this review, we make a best estimate of our ultimate liability. We do not establish a range of loss estimates around the best estimate we use to establish our reserves and loss adjustment expenses. During the loss settlement period, which, in some cases, may last several years, additional facts regarding individual claims may become known and, accordingly, it often becomes necessary to refine and adjust the estimates of liability on a claim upward or downward. Such estimates are regularly reviewed and updated and any resulting adjustments are included in the current year's income statement. Even then, the ultimate liability may exceed or be less than the revised estimates. The reserving process is intended to provide implicit recognition of the impact of inflation and other factors affecting loss payments by taking into account changes in historical payment patterns and perceived probable trends. There is generally no precise method for the subsequent evaluation of the adequacy of the consideration given to inflation, or to any other specific factor, because the eventual deficiency or redundancy of reserves is affected by many factors, some of which are interdependent.

    Navigators Insurance Company increased its gross and net asbestos reserves for losses by approximately $77.6 million and $31.6 million, respectively, in the fourth quarter of 2003. As a result, gross and net incurred losses increased by the amount of the respective reserve increase. The $31.6 million of net asbestos losses includes $25.7 million of uncollectible reinsurance.

    The reserve action was the result of a review of asbestos-related exposures conducted by the Company. The Company's management was notified in late January 2004 that an asbestos claim would likely have to be settled for a significantly greater amount than previously anticipated. As a result of the unexpected adverse development on this individual claim, the Company retained a leading independent consulting firm in this area to assist in the identification of its potential exposure to asbestos claims from policies written directly as well as those reinsured to Navigators Insurance Company from prior members of the Company's insurance pools. The Company's increased reserves relate primarily to policies underwritten by the Navigators Agencies in the late 1970's and first half of the 1980's on behalf of members of the pool, consisting of excess liability on marine related business and aviation products liability, including policies subsequently assumed by Navigators Insurance Company pursuant to reinsurance arrangements with pool members who exited the pool. Following the Company's and the independent consulting firm's recent review, the Company determined to increase its gross and net loss reserves for asbestos exposure to $78.5 million and $32.1 million, respectively, at December 31, 2003.

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    Another factor related to reserve development is that we record those premiums which are reported to us through the end of each calendar year and accrue estimates for amounts where there is a time lag between when the policy is bound and the recording of the policy. A substantial portion of the estimated premium is from international business where there can be significant time lags. To the extent that the actual premium varies from estimates, the difference, along with the related loss reserves are recorded in current operations.

    The following table presents an analysis of losses and loss adjustment expenses for each year in the three-year period ended December 31, 2003:

    The segment breakdown of prior year reserve deficiency (redundancy) was as follows:

    The $61.5 million deficiency recorded in 2003 for claims occurring in prior years for the Insurance Companies includes approximately $32.5 million recorded for asbestos and environmental exposures (consisting of $31.1 million in marine business and $1.4 million in run-off business), $22.2 million recorded for specialty business mostly for our California contractors liability business, approximately $4.0 million for marine business and $2.8 million for other run-off business (the latter three being unrelated to the asbestos and environmental exposures). The additional asbestos and environmental reserves include $25.7 million of uncollectible reinsurance.

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    Approximately $6.7 million of the $7.0 million deficiency recorded in 2002 related to the Insurance Companies which resulted from adverse development in our specialty business, predominantly from our California contractors' liability business. The $9.9 million deficiency recorded in 2001 for the Lloyd's operations was due to an increase in premium estimates and related reserves for prior years and strengthening the Lloyd's reserves related to the 1999 underwriting year. The $4.5 million prior year redundancy recorded in 2001 for the Insurance Companies was mostly related to marine business.

    The following table presents the development of the loss and loss adjustment expenses reserves for 1993 through 2003. The line "Net reserves for losses and loss adjustment expenses" reflects the net reserves at the balance sheet date for each of the indicated years and represents the estimated amount of losses and loss adjustment expenses arising in all prior years that are unpaid at the balance sheet date. The "Reserves re-estimated" lines of the table reflect the re-estimated amount of the previously recorded reserves based on experience as of the end of each succeeding year. The estimate changes as more information becomes known about the frequency and severity of claims for individual years. The "Cumulative redundancy (deficiency)" lines of the table reflect the cumulative amounts developed as of successive years with respect to the aforementioned reserve liability. The cumulative redundancy or deficiency represents the aggregate change in the estimates over all prior years.

    The table allocates losses and loss adjustment expenses reported and recorded in subsequent years to all prior years starting with the year in which the loss was incurred. For example, assume that a loss occurred in 1995 and was not reported until 1997, the amount of such loss will appear as a deficiency in both 1995 and 1996. Conditions and trends that have affected development of the liability in the past may not necessarily occur in the future. Accordingly, it may not be appropriate to extrapolate future redundancies or deficiencies based on the table.

    As part of our risk management process, we purchase reinsurance to limit our liability on individual risks and to protect against catastrophic loss. We purchase both quota share reinsurance and excess of loss reinsurance. Quota share reinsurance is often utilized on the lower layers of risk and excess of loss reinsurance is used above the quota share reinsurance to limit our net retention per risk. Net retention means the amount of losses that we keep for our own account. Once our initial reserve is established and our net retention is exceeded, any adverse development will directly affect the gross loss reserve, but would generally have no impact on our net retained loss. Generally our limits of exposure are known with greater certainty when estimating our net loss versus our gross loss. This situation tends to create greater volatility in the deficiencies and redundancies of the gross reserves as compared to the net reserves.

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    The increases to the net asbestos reserves of $31.6 million and the gross asbestos reserves of $77.6 million in the fourth quarter of 2003 are included in the net and gross cumulative deficiency figures, respectively, in each of the years shown in the table since the asbestos losses were prior to 1993.

    The following discussion in this paragraph excludes the increases to the asbestos reserves. We had a net cumulative redundancy in seven of the last ten years, meaning our initial net reserve estimates for each of those years have not been increased in the aggregate upon re-estimation in subsequent calendar years. We have, however, experienced a net cumulative deficiency in the latest three years as well as gross cumulative deficiencies in all of the ten years. The 1993 gross cumulative deficiencies resulted primarily from the 1989 Exxon Valdez loss. The gross cumulative deficiencies for 1994 and 1995 resulted primarily from the 1994 Northridge Earthquake loss, the 1989 Exxon Valdez loss and a large marine liability claim reported in 1999 affecting years 1994 through 1998. The 1996 gross cumulative deficiency resulted from adverse development in several lines of business. The 1997 gross cumulative deficiency resulted from adverse development in the onshore energy business and from one large 1989 claim from a run-off book of business which also adversely affected years prior to 1997. The gross cumulative deficiency in 1998 resulted from the two marine liability claims mentioned, a large energy claim incurred in 1998 and reported in 1999 and reserve strengthening in our Lloyd's operations. The 2000 gross and net adverse development resulted from our Lloyd's operations establishing reserves against premiums from prior years' which were received in excess of our original premium estimates and strengthening the Lloyd's reserves related to the 1999 underwriting year. The net reserve deficiency for the 2001 year resulted primarily from adverse development in the specialty liability line of business. The gross deficiency in the 2001 year resulted primarily from the adverse development in the specialty liability and marine lines of business. The gross and net reserve deficiency for 2002 resulted primarily from reserve strengthening for specialty business written in prior years. The adverse development on our gross reserves has been mostly reinsured through excess of loss reinsurance treaties. As a result of these reinsurance arrangements, while our gross losses and related reserve deficiencies and redundancies are very sensitive to adverse developments such as those described above, our net losses and related reserve deficiencies and redundancies tend to be less sensitive to such developments.

    Our loss reserves include amounts related to short tail and long tail classes of business. Short tail business means that claims are generally reported quickly upon occurrence of an event, making estimation of loss reserves less complex. Our longer tail business includes our specialty liability and professional liability insurance. For the long tail lines, significant periods of time, ranging up to several years or more, may elapse between the occurrence of the loss, the reporting of the loss and the settlement of the claim. The longer the time span between the incidence of a loss and the settlement of the claim, the more likely the ultimate settlement amount can vary from the original estimate.

    Specialty Liability and Professional Liability.    Substantially all of our specialty liability business involves general liability policies which generate third party liability claims that are long tail in nature. A significant portion of our general liability reserves relate to California construction defect claims. Reserves and claim frequency on this business may be impacted by legislation recently implemented in California, which generally provides consumers who experience construction defects a method other than litigation to obtain construction defect repairs. This legislation may impact claim severity, frequency and length to settlement assumptions underlying our reserves. Accordingly, our ultimate liability may exceed or be less than current estimates due to this variable, among others. As of December 31, 2003, we had 1,566 open claims on our general liability policies included in our specialty business. During 2003, 2,074 new claims were reported.

    The professional liability class generates third party claims, which also are longer tail in nature. The professional liability policies provide coverage on a claims-made basis, whereby coverage is generally provided only for those claims that are made during the policy period. Our professional liability business is relatively immature, with our first writing of the business in late

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2001. Accordingly, given the relative immaturity of this business, it will take some time to better understand the reserve trends on this business. Our professional liability loss estimates are based on expected losses, actual reported losses, evaluation of loss trends, industry data, and the legal, regulatory and current risk environment because anticipated loss experience in this area is less predictable due to the small number of claims and/or erratic claim severity patterns. We believe that we have made a reasonable estimate of the required loss reserves for professional liability. The expected ultimate losses may be adjusted up or down as the accident years mature. As of December 31, 2003, we had 134 open claims for professional liability coverage. During 2003, 185 new claims were reported.

    The following tables set forth our net loss and LAE loss reserves for our Specialty liability and professional liability businesses for the periods indicated:

    Asbestos and Environmental Liability.    Our exposure to asbestos and environmental liability principally stems from marine liability insurance written on an occurrence basis during the mid-1980s. In general, our participation on such risks is in the excess layers, which requires the underlying coverage to be exhausted prior to coverage being triggered in our layer. In many instances we are one of many insurers who participate in the defense and ultimate settlement of these claims, and we are generally a minor participant in the overall insurance coverage and settlement. Further, since most of our policies were issued after the industry was apprised of asbestos exposures, many of the policies on which we participate have exclusions that may preclude coverage. In addition, many of our asbestos and environmental claims have been inactive for several years.

    In the fourth quarter of 2003, Navigators Insurance Company increased its gross and net asbestos reserves for losses by $77.6 million and $31.6 million, respectively. As a result, gross and net incurred losses increased by the amount of the respective reserve increase. The $31.6 million of net asbestos losses includes $25.7 million of uncollectible reinsurance.

    The reserve action was the result of a review of asbestos-related exposures conducted by the Company. The Company's management was notified in late January 2004 that an asbestos claim would likely have to be settled for a significantly greater

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amount than previously anticipated. As a result of the unexpected adverse development on this individual claim, the Company retained a leading independent consulting firm in this area to assist in the identification of its potential exposure to asbestos claims from policies written directly as well as those reinsured to Navigators Insurance Company from prior members of the Company's insurance pools. The Company's increased reserves relate primarily to policies underwritten by the Navigators Agencies in the late 1970's and first half of the 1980's on behalf of members of the pool, consisting of excess liability on marine related business and aviation products liability, including policies subsequently assumed by Navigators Insurance Company pursuant to reinsurance arrangements with pool members who exited the pool. Following the Company's and the independent consulting firm's recent review, the Company determined to increase its gross and net loss reserves for asbestos exposure to $78.5 million and $32.1 million, respectively, at December 31, 2003.

    The following tables set forth our gross and net loss and LAE reserves, and claim counts for our asbestos and environmental exposures, which we believe is subject to uncertainties greater than those presented by other types of claims:

*

Includes a charge for uncollectible reinsurance of approximately $25.7 million in the 2003 fourth quarter.

    Our management believes that the reserves for losses and loss adjustment expenses are adequate to cover the ultimate cost of losses and loss adjustment expenses on reported and unreported claims.

    Additional information regarding our loss reserves can be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations and Overview—Operating Expenses—Net Losses and Loss

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Adjustment Expenses Incurred," "Business—Reserves," and Note 6 to our consolidated audited financial statements, all of which are included herein.

Investments

    The investments of our insurance company subsidiaries must comply with the insurance laws of New York State, the domiciliary state of Navigators Insurance Company and NIC Insurance Company. These laws prescribe the type, quality and concentration of investments which may be made by insurance companies. In general, these laws permit investments, within specified limits and subject to certain qualifications, in federal, state and municipal obligations, corporate bonds, preferred stocks, common stocks, real estate mortgages and real estate.

    Our insurance company subsidiaries' investments are subject to the direction and control of their respective boards of directors and our finance committee, and are reviewed on a quarterly basis. The investments are managed by outside professional fixed-income and equity portfolio managers. Current investment objectives are to maximize annual after-tax income while preserving and enhancing capital and statutory surplus. The insurance company subsidiaries seek to attain these objectives by investing in municipal bonds, U.S. Government obligations, corporate bonds, mortgage-backed and asset-backed securities and common stocks. Our insurance company subsidiaries' investment guidelines require that at least 90% of the fixed-income portfolio be rated "A-" or better by a nationally recognized rating organization. Up to 25% of the total portfolio may be invested in equity securities that are actively traded on major U.S. stock exchanges. Our insurance company subsidiaries' investment guidelines prohibit investments in derivatives other than as a hedge against foreign currency exposures or the writing of covered call options on the equity portfolio.

    The Lloyd's operations' investments are subject to the direction and control of the board of directors and the investment committee of NUAL, as well as our finance committee, and represent our share of the investments held by Syndicate 1221. These investments must comply with the rules and regulations imposed by Lloyd's of London and by certain overseas regulators. The investments are managed by outside professional fixed-income portfolio managers. The performance of the investment managers is reviewed quarterly. Current investment objectives are to maximize pre-tax income while preserving and enhancing capital. The investment managers for Syndicate 1221 seek to attain these objectives by investing in government obligations, corporate bonds and mortgage-backed and asset-backed securities.

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

A N N U A L   R E P O R T   2 0 0 3  —   15

    The table set forth below reflects investments and income earned thereon for the Company on a consolidated basis and for the Insurance Companies for each of the years in the three year period ended December 31, 2003:

16  —   A N N U A L   R E P O R T   2 0 0 3

    The following tables show our cash and investments as of December 31, 2003 and 2002:

    Fixed maturity securities include bonds, mortgage-backed securities (which include fixed-rate mortgage-backed securities issued by the Government National Mortgage Association, or GNMAs) and asset-backed securities. All fixed maturity and equity securities are carried at fair value. The fair value is based on quoted market prices or dealer quotes provided by independent pricing services.

    At December 31, 2003 and 2002, all fixed-maturity and equity securities held by us were classified as available-for-sale.

A N N U A L   R E P O R T   2 0 0 3  —   17

    We regularly review our fixed maturity and equity securities portfolios to evaluate the necessity of recording impairment losses for other-than-temporary declines in the fair value of investments. In general, we focus our attention on those securities whose market value was less than 80% of their cost or amortized cost, as appropriate, for six or more consecutive months. Other factors considered in evaluating potential impairment include the current fair value as compared to cost or amortized cost, as appropriate, our intent and ability to retain the investment for a period of time sufficient to allow for an anticipated recovery in value, specific credit issues related to the issuer and current economic conditions.

    When a security in our investment portfolio has an unrealized loss that is deemed to be other-than-temporary, we write the security down to fair value through a charge to operations. Significant changes in the factors we consider when evaluating investments for impairment losses could result in a significant change in impairment losses reported in the consolidated financial statements.

    There were no impairment losses recorded in our fixed maturity or equity securities portfolios for the year ended December 31, 2003. During 2002, $2,905,000 of impairment losses were recorded on an asset backed fixed maturity security that was subsequently sold in 2002. During 2001, $1,618,000 of impairment losses were recorded on two asset backed fixed maturity securities that were subsequently sold in 2002. There were no impairment losses recorded on our equity securities portfolio in 2001 or 2002.

    The following table summarizes all securities in an unrealized loss position at December 31, 2003 and December 31, 2002 showing the aggregate fair value and gross unrealized loss by the length of time those securities have continuously been in an unrealized loss position:

18  —   A N N U A L   R E P O R T   2 0 0 3

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

    The following table shows the composition by National Association of Insurance Commissioners ("NAIC") rating and the generally equivalent Standard & Poor's ("S&P") and Moody's ratings of the fixed maturity securities in our portfolio with gross unrealized losses at December 31, 2003. Not all of the securities are rated by S&P and/or Moody's.