UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934

The Navigators Group, Inc.

(Exact name of Registrant as specified in its charter)

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

(212) 244-2333

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

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

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

Large accelerated filer þ   Accelerated filer o   Non-accelerated filer o

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

The number of common shares outstanding as of October 19, 2007 was 16,858,267.

 

 

THE NAVIGATORS GROUP, INC. AND SUBSIDIARIES

INDEX

		Page No.
Part I. FINANCIAL INFORMATION:
Item 1. Financial Statements
Consolidated Balance Sheets
September 30, 2007 (Unaudited) and December 31, 2006			3
Consolidated Statements of Income (Unaudited)
Three Months Ended September 30, 2007 and 2006			4
Nine Months Ended September 30, 2007 and 2006			5
Consolidated Statements of Stockholders’ Equity (Unaudited)
September 30, 2007 and 2006			6
Consolidated Statements of Comprehensive Income (Unaudited)
Three Months Ended September 30, 2007 and 2006			7
Nine Months Ended September 30, 2007 and 2006			8
Consolidated Statements of Cash Flows (Unaudited)
Nine Months Ended September 30, 2007 and 2006			9
Notes to Interim Consolidated Financial Statements (Unaudited)			10
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			20
Item 3. Quantitative and Qualitative Disclosures About Market Risk			58
Item 4. Controls and Procedures			58
Part II. OTHER INFORMATION
Item 1. Legal Proceedings			59
Item 1A. Risk Factors			59
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			59
Item 3. Defaults Upon Senior Securities			59
Item 4. Submissions of Matters to a Vote of Security Holders			60
Item 5. Other Information			60
Item 6. Exhibits			60
Signature			61
Index of Exhibits			62
Exhibit 11.1
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

Part 1. Financial Information

THE NAVIGATORS GROUP, INC. AND SUBSIDIARIES

		September 30,				December 31,
		2007				2006
		(Unaudited)
ASSETS
Investments and cash:
Fixed maturities, available-for-sale, at fair value (amortized cost: 2007, $1,458,458; 2006, $1,263,284)		$	1,454,684			$	1,258,717
Equity securities, available-for-sale, at fair value (cost: 2007, $57,697; 2006, $31,879)			63,858				37,828
Short-term investments, at cost which approximates fair value			215,117				176,961
Cash			4,906				2,404
Total investments and cash			1,738,565				1,475,910
Premiums in course of collection			186,865				163,309
Commissions receivable			2,429				3,647
Prepaid reinsurance premiums			194,742				179,493
Reinsurance receivable on paid losses			84,043				108,878
Reinsurance receivable on unpaid losses and loss adjustment expenses			837,545				911,439
Net deferred income tax benefit			31,360				30,422
Deferred policy acquisition costs			54,752				41,700
Accrued investment income			15,548				13,052
Goodwill and other intangible assets			8,237				8,012
Other assets			20,906				20,824
Total assets		$	3,174,992			$	2,956,686
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Reserves for losses and loss adjustment expenses		$	1,645,542			$	1,607,555
Unearned premium			484,507				415,096
Reinsurance balances payable			179,892				194,266
Senior notes			123,644				123,560
Federal income tax payable			7,688				3,934
Payable for securities purchased			27,550				166
Accounts payable and other liabilities			79,693				60,766
Total liabilities			2,548,516				2,405,343
Stockholders’ equity:
Preferred stock, $.10 par value, authorized 1,000,000 shares, none issued			—				—
Common stock, $.10 par value, shares authorized: 50,000,000 for 2007 and 2006; issued and outstanding: 16,856,267 for 2007 and 16,735,898 for 2006			1,686				1,674
Additional paid-in capital			290,955				286,732
Retained earnings			328,544				259,464
Accumulated other comprehensive income			5,291				3,473
Total stockholders’ equity			626,476				551,343
Total liabilities and stockholders’ equity		$	3,174,992			$	2,956,686

See accompanying notes to interim consolidated financial statements.

THE NAVIGATORS GROUP, INC. AND SUBSIDIARIES

		Three Months Ended
		September 30,
		2007				2006
		(Unaudited)
Gross written premium		$	245,961			$	221,667
Revenues:
Net written premium		$	159,102			$	119,037
(Increase) in unearned premium			(3,064	)			(3,341	)
Net earned premium			156,038				115,696
Commission income			117				639
Net investment income			17,930				14,691
Net realized capital gains (losses)			(66	)			(151	)
Other income (expense)			298				(884	)
Total revenues			174,317				129,991
Operating expenses:
Net losses and loss adjustment expenses incurred			88,019				64,456
Commission expense			19,676				13,769
Other operating expenses			27,902				22,683
Interest expense			2,216				2,214
Total operating expenses			137,813				103,122
Income before income tax expense			36,504				26,869
Income tax expense (benefit):
Current			11,520				8,126
Deferred			(49	)			410
Total income tax expense			11,471				8,536
Net income		$	25,033			$	18,333
Net income per common share:
Basic		$	1.49			$	1.10
Diluted		$	1.47			$	1.09
Average common shares outstanding:
Basic			16,843				16,685
Diluted			16,996				16,827

See accompanying notes to interim consolidated financial statements.

THE NAVIGATORS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
($ and shares in thousands, except net income per share)

		Nine Months Ended
		September 30,
		2007				2006
		(Unaudited)
Gross written premium		$	823,371			$	737,816
Revenues:
Net written premium		$	493,471			$	391,711
(Increase) in unearned premium			(52,770	)			(57,752	)
Net earned premium			440,701				333,959
Commission income			1,011				2,465
Net investment income			51,476				41,244
Net realized capital gains (losses)			975				(767	)
Other income (expense)			(26	)			(654	)
Total revenues			494,137				376,247
Operating expenses:
Net losses and loss adjustment expenses incurred			248,950				193,200
Commission expense			54,425				41,098
Other operating expenses			82,799				61,018
Interest expense			6,646				4,034
Total operating expenses			392,820				299,350
Income before income tax expense			101,317				76,897
Income tax expense (benefit):
Current			34,301				27,492
Deferred			(2,064	)			(2,551	)
Total income tax expense			32,237				24,941
Net income		$	69,080			$	51,956
Net income per common share:
Basic		$	4.11			$	3.12
Diluted		$	4.07			$	3.09
Average common shares outstanding:
Basic			16,796				16,664
Diluted			16,967				16,812

See accompanying notes to interim consolidated financial statements.

THE NAVIGATORS GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
($ in thousands)

		Nine Months Ended
		September 30,
		2007				2006
		(Unaudited)
Preferred Stock
Balance at beginning and end of period		$	—			$	—
Common stock
Balance at beginning of year		$	1,674			$	1,662
Shares issued under stock plans			12				8
Balance at end of period		$	1,686			$	1,670
Additional paid-in capital
Balance at beginning of year		$	286,732			$	282,463
Employee stock plans			441				761
Shares issued under stock plans			3,782				2,392
Balance at end of period		$	290,955			$	285,616
Retained earnings
Balance at beginning of year		$	259,464			$	186,901
Net income			69,080				51,956
Balance at end of period		$	328,544			$	238,857
Accumulated other comprehensive income (loss)
Net unrealized gains (losses) on securities, net of tax
Balance at beginning of year		$	849			$	(884	)
Change in period			686				707
Balance at end of period			1,535				(177	)
Cumulative translation adjustments, net of tax
Balance at beginning of year			2,624				96
Net adjustment for period			1,132				1,453
Balance at end of period			3,756				1,549
Balance at end of period		$	5,291			$	1,372
Total stockholders’ equity at end of period		$	626,476			$	527,515

See accompanying notes to interim consolidated financial statements.

THE NAVIGATORS GROUP, INC. AND SUBSIDIARIES

		Three Months Ended
		September 30,
		2007				2006
		(Unaudited)
Net income		$	25,033			$	18,333
Other comprehensive income:
Change in net unrealized gains on securities, net of tax expense of $6,446 and $9,371 in 2007 and 2006, respectively(1)			12,154				17,249
Change in foreign currency translation gains, net of tax expense of $178 and $135 in 2007 and 2006, respectively			331				252
Other comprehensive income			12,485				17,501
Comprehensive income		$	37,518			$	35,834
(1) Disclosure of reclassification amount, net of tax:
Unrealized holding gains arising during period		$	12,105			$	17,145
Less: reclassification adjustment for net realized capital (losses) included in net income			(49	)			(104	)
Change in net unrealized gains on securities		$	12,154			$	17,249

See accompanying notes to interim consolidated financial statements.

THE NAVIGATORS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
($ in thousands)

		Nine Months Ended
		September 30,
		2007				2006
		(Unaudited)
Net income		$	69,080			$	51,956
Other comprehensive income:
Change in net unrealized gains on securities, net of tax expense of $311 and $462 in 2007 and 2006, respectively(1)			686				707
Change in foreign currency translation gains, net of tax expense of $610 and $782 in 2007 and 2006, respectively			1,132				1,453
Other comprehensive income			1,818				2,160
Comprehensive income		$	70,898			$	54,116
(1) Disclosure of reclassification amount, net of tax:
Unrealized holding gains arising during period		$	1,312			$	187
Less: reclassification adjustment for net realized capital capital gains (losses) included in net income			626				(520	)
Change in net unrealized gains on securities		$	686			$	707

See accompanying notes to interim consolidated financial statements.

THE NAVIGATORS GROUP, INC. AND SUBSIDIARIES

		Nine Months Ended
		September 30,
		2007				2006
		(Unaudited)
Operating activities:
Net income		$	69,080			$	51,956
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation & amortization			2,532				1,990
Net deferred income tax expense (benefit)			(2,064	)			(2,551	)
Net realized capital (gains) losses			(975	)			767
Changes in assets and liabilities:
Reinsurance receivable on paid and unpaid losses and LAE			111,379				(21,429	)
Reserve for losses and LAE			19,306				11,677
Prepaid reinsurance premiums			(12,558	)			(42,139	)
Unearned premium			63,504				95,977
Premiums in course of collection			(19,151	)			(17,056	)
Commissions receivable			1,247				1,004
Deferred policy acquisition costs			(12,052	)			(11,764	)
Accrued investment income			(2,650	)			(1,721	)
Reinsurance balances payable			(18,297	)			13,684
Federal income tax			3,193				2,138
Other			28,842				5,561
Net cash provided by operating activities			231,336				88,094
Investing activities:
Fixed maturities, available-for-sale
Redemptions and maturities			127,639				95,288
Sales			136,046				111,643
Purchases			(455,845	)			(388,126	)
Equity securities, available-for-sale
Sales			17,436				3,431
Purchases			(41,294	)			(12,121	)
Change in payable for securities			27,176				78
Net change in short-term investments			(34,867	)			(30,675	)
Purchase of property and equipment			(7,149	)			(3,559	)
Net cash (used in) investing activities			(230,858	)			(224,041	)
Financing activities:
Net proceeds from senior notes			—				123,511
Proceeds of stock issued from employee stock purchase plan			606				536
Proceeds of stock issued from exercise of stock options			1,406				601
Net cash provided by financing activities			2,012				124,648
Effect of exchange rate changes on foreign currency cash			12				25
Increase (decrease) in cash			2,502				(11,274	)
Cash at beginning of year			2,404				13,165
Cash at end of period		$	4,906			$	1,891
Supplemental disclosures of cash flow information:
Federal, state and local income tax paid		$	31,144			$	19,857
Interest paid			4,375				4,715
Issuance of stock to directors			181				140

See accompanying notes to interim consolidated financial statements.

THE NAVIGATORS GROUP, INC. AND SUBSIDIARIES

Notes to Interim Consolidated Financial Statements
(Unaudited)

Note 1. Accounting Policies

The interim consolidated financial statements are unaudited but reflect all adjustments which, in the opinion of management, are necessary to provide a fair statement of the results of The Navigators Group, Inc. and its subsidiaries for the interim periods presented on the basis of U.S. generally accepted accounting principles (“GAAP” or “U.S. GAAP”). All such adjustments are of a normal recurring nature. All significant intercompany transactions and balances have been eliminated. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported revenues and expenses during the reporting periods. The results of operations for any interim period are not necessarily indicative of results for the full year. The terms “we”, “us”, “our” and “the Company” as used herein mean The Navigators Group, Inc. and its subsidiaries, unless the context otherwise requires. The term “Parent” or “Parent Company” is used to mean The Navigators Group, Inc. without its subsidiaries. These financial statements should be read in conjunction with the consolidated financial statements and notes contained in the Company’s 2006 Annual Report on Form 10-K. Certain amounts for the prior year have been reclassified or restated to conform to the current year’s presentation.

Note 2. Reinsurance Ceded

The Company’s ceded earned premiums were $102.1 million and $106.0 million for the three months ended September 30, 2007 and 2006, respectively, and were $316.1 million and $330.5 million for the nine months ended September 30, 2007 and 2006, respectively. The Company’s ceded incurred losses were $54.5 million and $61.4 million for the three months ended September 30, 2007 and 2006, respectively, and were $156.9 million and $186.2 million for the nine months ended September 30, 2007 and 2006, respectively.

Note 3. Segment Information

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

The Company classifies its business into two underwriting segments consisting of the Insurance Companies and the Lloyd’s Operations, which are separately managed, and a Corporate segment. Segment data for each of the two underwriting segments include allocations of revenues and expenses of the Navigators Agencies’ (as defined below) and the Parent Company’s expenses and related income tax amounts.

We evaluate the performance of each segment based on its underwriting and net income results. The Insurance Companies’ and the Lloyd’s Operations’ results are measured by taking into account net earned premium, net losses and loss adjustment expenses (“LAE”), commission expense, other operating expenses, commission income and other income or expense. The Corporate segment consists of the Parent Company’s investment income, interest expense and the related tax effect. Each segment also maintains its own investments, on which it earns income and realizes capital gains or losses. Our underwriting performance is evaluated separately from the performance of our investment portfolios.

Our Insurance Companies consist of Navigators Insurance Company, including its United Kingdom Branch (the “U.K. Branch”), and Navigators Specialty Insurance Company (formerly NIC Insurance Company). Navigators Insurance Company, our largest insurance subsidiary, has been active since 1983. It specializes principally in underwriting marine insurance and related lines of business, specialty liability insurance and professional liability insurance. Navigators Specialty Insurance Company, a wholly owned subsidiary of Navigators Insurance Company, began operations in 1990. It underwrites specialty and professional liability insurance on an excess and surplus lines basis fully reinsured by Navigators Insurance Company. The Lloyd’s Operations primarily underwrite marine and related lines of business at Lloyd’s of London (“Lloyd’s”) through Lloyd’s Syndicate 1221 (“Syndicate 1221”). Our Lloyd’s Operations include Navigators Underwriting Agency Ltd. (“NUAL”), a Lloyd’s underwriting agency which manages Syndicate 1221. We participate in the capacity of Syndicate 1221 through two wholly-owned Lloyd’s corporate members. The Navigators Agencies are wholly-owned insurance underwriting management companies which produce, manage and underwrite insurance and reinsurance for the Company. All segments are evaluated based on their GAAP results.

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

Financial data by segment for the three and nine months ended September 30, 2007 and 2006 were as follows:

		Three Months Ended September 30, 2007
		Insurance				Lloyd’s
		Companies				Operations				Corporate				Total
		($ in thousands)
Gross written premium		$	178,058			$	67,903							$	245,961
Net written premium			109,677				49,425								159,102
Net earned premium			109,060				46,978								156,038
Net losses and LAE			(59,816	)			(28,203	)							(88,019	)
Commission expense			(13,086	)			(6,590	)							(19,676	)
Other operating expenses			(21,157	)			(6,745	)							(27,902	)
Commission income and other income (expense)			304				111								415
Underwriting profit			15,305				5,551								20,856
Net investment income			14,816				2,609			$	505				17,930
Net realized capital gains (losses)			41				(107	)			—				(66	)
Interest expense			—				—				(2,216	)			(2,216	)
Income (loss) before income taxes			30,162				8,053				(1,711	)			36,504
Income tax expense (benefit)			9,193				2,877				(599	)			11,471
Net income (loss)		$	20,969			$	5,176			$	(1,112	)		$	25,033
Identifiable assets (1)		$	2,292,811			$	793,661			$	65,950			$	3,174,992
Loss and LAE ratio			54.8	%			60.0	%							56.4	%
Commission expense ratio			12.0	%			14.0	%							12.6	%
Other operating expense ratio (2)			19.1	%			14.1	%							17.6	%
Combined ratio			85.9	%			88.1	%							86.6	%

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

		Nine Months Ended September 30, 2007
		Insurance				Lloyd’s
		Companies				Operations				Corporate				Total
		($ in thousands)
Gross written premium		$	585,492			$	237,879							$	823,371
Net written premium			355,798				137,673								493,471
Net earned premium			320,607				120,094								440,701
Net losses and LAE			(184,881	)			(64,069	)							(248,950	)
Commission expense			(38,072	)			(16,353	)							(54,425	)
Other operating expenses			(60,983	)			(21,816	)							(82,799	)
Commission income and other income (expense)			889				96								985
Underwriting profit			37,560				17,952								55,512
Net investment income			42,910				7,167			$	1,399				51,476
Net realized capital gains (losses)			1,118				(143	)			—				975
Interest expense			—				—				(6,646	)			(6,646	)
Income (loss) before income taxes			81,588				24,976				(5,247	)			101,317
Income tax expense (benefit)			25,267				8,806				(1,836	)			32,237
Net income (loss)		$	56,321			$	16,170			$	(3,411	)		$	69,080
Identifiable assets (1)		$	2,292,811			$	793,661			$	65,950			$	3,174,992
Loss and LAE ratio			57.7	%			53.3	%							56.5	%
Commission expense ratio			11.9	%			13.6	%							12.3	%
Other operating expense ratio (2)			18.7	%			18.1	%							18.6	%
Combined ratio			88.3	%			85.0	%							87.4	%

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

The Insurance Companies’ net earned premium includes $12.6 million and $12.9 million of net earned premium from the U.K. Branch for the three months ended September 30, 2007 and 2006, respectively, and $45.0 million and $34.2 million of net earned premium from the U.K. Branch for the nine months ended September 30, 2007 and 2006, respectively.

Note 4. Comprehensive Income

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

Note 5. Stock-Based Compensation

Stock based compensation is expensed as stock awards granted under the Company’s stock plans vest with the expense being included in other operating expenses for the periods indicated. The amount charged to expense for stock grants was $1.4 million and $1.8 million for the three months ended September 30, 2007 and 2006, respectively, and $3.8 million and $3.1 million for the nine months ended September 30, 2007 and 2006, respectively. The amount charged to expense for stock options was $140,000 and $292,000 for the three months ended September 30, 2007 and 2006, respectively, and $441,000 and $761,000 for the nine months ended September 30, 2007 and 2006, respectively. Stock appreciation rights resulted in an expense of $29,000 and $541,000 for the three months ended September 30, 2007 and 2006, respectively, and an expense of $652,000 and $563,000 for the nine months ended September 30, 2007 and 2006, respectively.

The Company expensed $45,000 and $48,000 for the three months ended September 30, 2007 and 2006, respectively, and $115,000 and $104,000 for the nine months ended September 30, 2007 and 2006, respectively, related to its Employee Stock Purchase Plan.

In addition, $50,000 and $46,000 was expensed in each of the three month periods ended September 30, 2007 and 2006, and $150,000 and $133,000 was expensed in each of the nine month periods ended September 30, 2007 and 2006 for stock issued annually to non-employee directors as part of their directors’ compensation for serving on the Company’s Board of Directors.

Note 6. Application of New Accounting Standards

In February 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 155, Accounting for Certain Hybrid Financial Instruments. SFAS No. 155 amends SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, and allows an entity to re-measure at fair value a hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation from the host, if the holder irrevocably elects to account for the whole instrument on a fair value basis. Subsequent changes in the fair value of the instrument would be recognized in earnings. SFAS No. 155 also removed an exception included in an interpretation of SFAS No. 133 (Implementation Issue No. B39) that kept holders of mortgage-backed securities from testing for the need to bifurcate the value embedded in mortgage-backed securities related to the ability to prepay. Such exception was subsequently reinstated on a limited basis. SFAS No. 155 is effective for financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The Company’s adoption of SFAS No. 155 at January 1, 2007 did not have a material effect on its financial condition or results of operations.

In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”), an interpretation of FASB Statement No. 109, Accounting for Income Taxes. FIN 48, which was effective in the first quarter of 2007, established the threshold for recognizing the benefits of tax-return positions in the financial statements as more-likely-than-not to be sustained by the taxing authorities, and prescribed a measurement methodology for those positions meeting the recognition threshold. The Company’s adoption of FIN 48 at January 1, 2007 did not have a material effect on its financial condition or results of operations.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in GAAP, and enhances disclosures about fair value measurements. SFAS No. 157, which becomes effective on January 1, 2008, applies when other accounting pronouncements require fair value measurements; it does not require new fair value measurements. The Company has not yet determined the estimated impact on its financial condition or results of operations, if any, of adopting SFAS No. 157.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, which permits entities to choose to measure many financial instruments and certain warranty and insurance contracts at fair value on a contract-by-contract basis. SFAS No. 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007 (January 1, 2008 for calendar-year-end companies). The Company has not yet determined the estimated impact on its financial condition or results of operations, if any, of adopting SFAS No. 159.

Note 7. Lloyd’s Syndicate

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

Syndicate 1221’s stamp capacity is £140.0 million ($278.2 million) in 2007 compared to £123.5 million ($224.8 million) in 2006. Stamp capacity is a measure of the amount of premium a Lloyd’s syndicate is authorized to write based on a business plan approved by the Council of Lloyd’s. Syndicate 1221’s capacity is expressed net of commission (as is standard at Lloyd’s). The Syndicate 1221 premium recorded in the Company’s financial statements is gross of commission. The Company participates for 100% of Syndicate 1221’s capacity for both the 2007 and 2006 underwriting years. The Lloyd’s Operations included in the consolidated financial statements represent the Company’s participation in Syndicate 1221.

The Company provides letters of credit to Lloyd’s to support its Syndicate 1221 capacity. If the Company increases its participation or if Lloyd’s changes the capital requirements, the Company may be required to supply additional letters of credit or other collateral acceptable to Lloyd’s, or reduce the capacity of Syndicate 1221. The letters of credit are provided through a credit facility with a consortium of banks which expires March 31, 2009. If the banks decide not to renew the credit facility, the Company will need to find other sources to provide the letters of credit or other collateral in order to continue to participate in Syndicate 1221. The bank facility is collateralized by all of the common stock of Navigators Insurance Company.

Note 8. Income Taxes

We are subject to the tax regulations of the United States and foreign countries in which we operate. The Company files a consolidated federal tax return, which includes all domestic subsidiaries and the U.K. Branch. The income from the foreign operations is designated as either U.S. connected income or non-U.S. connected income. Lloyd’s is required to pay U.S. income tax on U.S. connected income written by Lloyd’s syndicates. Lloyd’s and the IRS have entered into an agreement whereby the amount of tax due on U.S. connected income is calculated by Lloyd’s and remitted directly to the IRS. These amounts are then charged to the corporate members in proportion to their participation in the relevant syndicates. The Company’s corporate members are subject to this agreement and will receive United Kingdom (“U.K.”) tax credits for any U.S. income tax incurred up to the U.K. income tax charged on the U.S. connected income. The non-U.S. connected insurance income would generally constitute taxable income under the Subpart F income section of the Internal Revenue Code since less than 50% of Syndicate 1221’s premium is derived within the U.K. and would therefore be subject to U.S. taxation when the Lloyd’s year of account closes. Taxes are accrued at a 35% rate on our foreign source insurance income and foreign tax credits, where available, are utilized to offset U.S. tax as permitted.

The Company’s effective tax rate for Syndicate 1221 taxable income could substantially exceed 35% to the extent the Company is unable to offset U.S. taxes paid under Subpart F tax regulations with U.K. tax credits on future underwriting year distributions. U.S. taxes are not accrued on the earnings of the Company’s foreign agencies as these earnings are not subject to the Subpart F tax regulations. These earnings are subject to taxes under U.K. tax regulations at a 30% rate. We have not provided for U.S. deferred income taxes on the undistributed earnings of our non-U.S. subsidiaries since these earnings are intended to be permanently reinvested in our non-U.S. subsidiaries. A finance bill was enacted in the U.K. on July 19, 2007 that reduces the U.K. corporate tax rate from 30% to 28% effective April 1, 2008. The effect of such tax rate change was not material.

As discussed in Note 6 included herein, the Company adopted FIN 48 on January 1, 2007. FIN 48 applies to all tax positions accounted for under SFAS No. 109.  FIN 48 defines the confidence level that a tax position must meet in order to be recognized in the financial statements.  The tax position must be more-likely-than-not to be sustained by the relevant taxing authority which means a likelihood of more than 50%.  If the more-likely-than-not threshold can not be reached, the benefit should not be reflected in the financial statements.  However, a company should recognize the largest amount of the tax benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with the taxing authorities.  The determination of the 50% threshold is highly judgmental and depends on the individual facts and circumstances.  A tax benefit taken in the tax return but not in the financial statements is known as an ‘unrecognized tax benefit’. The Company had no unrecognized tax benefits at either January 1, 2007 or at September 30, 2007 and does not anticipate any significant unrecognized tax benefits within the next twelve months.

The Company is currently not under examination by any major U.S. or foreign tax authority and is generally subject to U.S. Federal, state, local, or foreign tax examinations by tax authorities for years 2003 and subsequent. The Company’s policy is to record interest and penalties related to unrecognized tax benefits to income tax expense. The Company did not incur any interest or penalties related to unrecognized tax benefits for the nine month periods ended September 30, 2007 and 2006.

The Company had state and local deferred tax assets amounting to potential future tax benefits of $7.4 million and $6.0 million at September 30, 2007 and December 31, 2006, respectively. Included in the deferred tax assets are net operating loss carryforwards of $3.8 million and $4.8 million at September 30, 2007 and December 31, 2006, respectively. A valuation allowance was established for the full amount of these potential future tax benefits due to the uncertainty associated with their realization.

Note 9. Commitments and Contingencies

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

On November 22, 2006, the Company filed a demand for arbitration in New York against Equitas, a lead reinsurer participating in excess of loss reinsurance agreements, with respect to unsatisfied loss payment recovery demands that the Company has previously presented to Equitas (the “Equitas Arbitration”). The recovery demands are for the 2005 settlement of two class action lawsuits involving large asbestos claims (together, the “2005 Settled Claims”), which 2005 Settled Claims are being paid through 2007. Equitas has not indicated any dispute with respect to recoveries on related pro rata reinsurance agreements for such 2005 Settled Claims or with respect to excess of loss or pro rata reinsurance for the 2004 Settled Claim referred to below. The aggregate amount of excess of loss recoveries due from Equitas for ceded paid and unpaid losses on the 2005 Settled Claims is approximately $2.7 million.

The Company filed its demand for arbitration against Equitas in accordance with the applicable provisions of the excess of loss reinsurance agreements. The Company believes that the refusal of Equitas to satisfy the Company’s payment demands is without merit and it intends to vigorously pursue collection of its reinsurance recovery. While it is too early to predict with any certainty the outcome of the Equitas Arbitration, the Company believes that the ultimate outcome would not be expected to have a significant adverse effect on its results of operations, financial condition or liquidity, although an unexpected adverse resolution of the Equitas Arbitration could have a material adverse effect on the Company’s results of operations in a particular fiscal quarter or year.

(b) Whenever a member of Lloyd’s is unable to pay its debts to policyholders, such debts may be payable by the Lloyd’s Central Fund. If Lloyd’s determines that the Central Fund needs to be increased, it has the power to assess premium levies on current Lloyd’s members up to 3% of a member’s underwriting capacity in any one year. The Company does not believe that any assessment is likely in the foreseeable future and has not provided any allowance for such an assessment. However, based on the Company’s 2007 capacity at Lloyd’s of £140 million, the September 30, 2007 exchange rate of £1 equals $2.04 and assuming the maximum 3% assessment, the Company would be assessed approximately $8.6 million.

Note 10. Senior Notes due May 1, 2016

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

The Senior Notes, the Company’s only senior unsecured obligation, will rank equally with future senior unsecured indebtedness. The Company may redeem the Senior Notes at any time and from time to time, in whole or in part, at a “make-whole” redemption price. The terms of the Senior Notes contain various restrictive business and financial covenants typical for debt obligations of this type, including limitations on mergers, and liens or dispositions of the common stock of certain subsidiaries. As of September 30, 2007, the Company was in compliance with all such covenants.

The interest expense for the three and nine months ended September 30, 2007 was $2.2 million and $6.6 million, respectively. The interest expense from the April 17, 2006 issuance date to September 30, 2006 was $4.0 million. The fair value, which is based on the quoted market price at September 30, 2007, was $127.8 million.

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

Note on Forward-Looking Statements

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

	•		the effects of domestic and foreign economic conditions, and conditions which affect the market for property and casualty insurance;
	•		changes in the laws, rules and regulations which apply to our insurance companies;
	•		the effects of emerging claim and coverage issues on our business, including adverse judicial or regulatory decisions and rulings;
	•		the effects of competition from banks and other insurers and the trend toward self-insurance;
	•		risks that we face in entering new markets and diversifying the products and services we offer;
	•		unexpected turnover of our professional staff;
	•		changing legal and social trends and inherent uncertainties in the loss estimation process that can adversely impact the adequacy of loss reserves and the allowance for reinsurance recoverables, including our estimates relating to ultimate asbestos liabilities and related reinsurance recoverables;
	•		risks inherent in the collection of reinsurance recoverable amounts from our reinsurers over many years into the future based on the reinsurers’ financial ability and intent to meet such obligations to the Company;
	•		risks associated with our continuing ability to obtain reinsurance covering our exposures at appropriate prices and/or in sufficient amounts and the related recoverability of our reinsured losses;
	•		weather-related events and other catastrophes (including acts of terrorism) impacting our insureds and/or reinsurers, including, without limitation, the impact of Hurricanes Katrina, Rita, and Wilma and the possibility that our estimates of losses from Hurricanes Katrina, Rita and Wilma will prove to be materially inaccurate;
	•		our ability to attain adequate prices, obtain new business and retain existing business consistent with our expectations;
	•		the possibility of downgrades in our claims-paying and financial strength ratings significantly adversely affecting us, including reducing the number of insurance policies we write generally, or causing clients who require an insurer with a certain rating level to use higher-rated insurers;
	•		the inability of our internal control framework to provide absolute assurance that all incidents of fraud or unintended material errors will be detected and prevented;

	•		the risk that our investment portfolio suffers reduced returns or investment losses which could reduce our profitability; and
	•		other risks that we identify in future filings with the Securities and Exchange Commission (the “SEC”), including without limitation the risks described under the caption “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2006.

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

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

Overview

We are an international insurance holding company focusing on specialty products for niches within the overall property/casualty insurance market. The Company’s underwriting segments consist of insurance company operations and operations at Lloyd’s of London. Our largest product line and most long-standing area of specialization is ocean marine insurance. We have also developed specialty niches in professional liability insurance and in specialty liability insurance primarily consisting of contractors liability and excess liability coverages. We conduct operations through our Insurance Companies and our Lloyd’s Operations. The Insurance Companies consist of Navigators Insurance Company, which includes our U.K. Branch, and Navigators Specialty Insurance Company, which underwrites specialty and professional liability insurance on an excess and surplus lines basis fully reinsured by Navigators Insurance Company. Our Lloyd’s Operations include NUAL, a Lloyd’s underwriting agency which manages Syndicate 1221. We participate in the capacity of Syndicate 1221 through two wholly-owned Lloyd’s corporate members.

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

The discussions that follow include tables, which contain both our consolidated and segment operating results for the three and nine month periods ended September 30, 2007 and 2006. In presenting our financial results we have discussed our performance with reference to underwriting profit or loss and the related combined ratio, both of which are non-GAAP measures of underwriting profitability. We consider such measures, which may be defined differently by other companies, to be important in the understanding of our overall results of operations. Underwriting profit or loss is calculated from net earned premium, less the sum of net losses and LAE, commission expense, other operating expenses and commission income and other income (expense). The combined ratio is derived by dividing the sum of net losses and LAE, commission expense, other operating expenses and commission income and other income (expense) by net earned premiums. A combined ratio of less than 100% indicates an underwriting profit and over 100% indicates an underwriting loss.

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

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

Over the past several years, we have experienced generally beneficial market changes in our lines of business. As a result of several large industry losses in the second quarter of 2001, the marine insurance market began to experience diminished capacity and rate increases, initially in the offshore energy line of business. The marine rate increases began to level off in 2004 and into 2005. As a result of the substantial insurance industry losses resulting from Hurricanes Katrina and Rita, the marine insurance market experienced diminished capacity and rate increases through the end of 2006, particularly for the offshore energy risks located in the Gulf of Mexico. Since the end of 2006, competitive market conditions returned as available capacity has increased. The 2007 average renewal rates for our Insurance Companies’ marine business decreased approximately 1.7% for the third quarter and were flat for the nine month period, including offshore energy average renewal rates which decreased approximately 3.6% for the third quarter and increased approximately 1.4% for the nine month period. The 2007 average renewal rates for our Lloyd’s Operations marine business decreased approximately 3.3% for the third quarter and were flat for the nine month period, including offshore energy average renewal rates which decreased approximately 6.4% for the third quarter and 3.5% for the nine month period.

Specialty liability losses in 2001 to 2003, particularly for the contractors liability business, also resulted in diminished capacity in the market in which we compete, as many former competitors who lacked the expertise to selectively underwrite this business have been forced to withdraw from the market resulting in approximate rate increases of 13% in 2004 and 49% in 2003. This was followed by a slight decline in rates of approximately 1% in 2005. The 2006 year average renewal rates for the contractors liability business declined approximately 6%, primarily due to additional competition in the marketplace. This decline continued into the 2007 third quarter and nine month period with average renewal rates declining approximately 15.3% and 11.4%, respectively. We expect these competitive conditions to continue during 2007 resulting in continuing declines in pricing for contractors liability and excess liability business.

In the professional liability market, the enactment of the Sarbanes-Oxley Act of 2002, together with financial and accounting scandals at publicly traded corporations and the increased frequency of securities- related class action litigation, has led to heightened interest in professional liability insurance generally. Average professional liability renewal premium rates decreased approximately 5.8% and 6.6% in the 2007 third quarter and nine month period, respectively, compared to relatively level renewal rates in 2006 and 2005 after decreasing approximately 3% in 2004 which followed substantial renewal rate increases in 2003 and 2002, particularly for D&O insurance. The D&O insurance premium renewal rates decreased approximately 7.7% and 8.6% in the 2007 third quarter and nine month period, respectively, after decreases of approximately 2% in 2005 and 10% in 2004. We anticipate continuing declines in 2007 pricing given the overall favorable industry underwriting results since 2002 for the professional liability lines of business.

Our business is cyclical and influenced by many factors. These factors include price competition, economic conditions, interest rates, weather-related events and other catastrophes including natural and man-made disasters (for example hurricanes and terrorism), state regulations, court decisions and changes in the law. The incidence and severity of catastrophes are inherently unpredictable. Although we will attempt to manage our exposure to such events, the frequency and severity of catastrophic events could exceed our estimates, which could have a material adverse effect on our financial condition. Additionally, because our insurance products must be priced, and premiums charged, before costs have fully developed, our liabilities are required to be estimated and recorded in recognition of future loss and settlement obligations. Due to the inherent uncertainty in estimating these liabilities, we cannot assure you that our actual liabilities will not exceed our recorded amounts.

Catastrophe Risk Management

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

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

The Company has significant catastrophe exposures throughout the world with the largest catastrophe exposure for offshore energy risks due to hurricanes in the Gulf of Mexico. Based on an assessment made through the end of the 2007 third quarter, the Company believes that its estimated probable maximum pre-tax gross and net loss exposure in a theoretical one in two hundred and fifty year hurricane event in the Gulf of Mexico would approximate $212 million and $30 million, respectively, including the cost of reinsurance reinstatement premiums. There are a number of significant assumptions and related variables related to such an estimate including the size, force and path of the hurricane, the various types of the insured risks exposed to the event at the time the event occurs and the estimated costs or damages incurred for each insured risk. There can be no assurances that the gross and net loss amounts that the Company could incur in such an event or in any hurricanes that may occur in the Gulf of Mexico would not be materially higher than the estimates discussed above given the significant uncertainties with respect to such an estimate.

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

Critical Accounting Policies

It is important to understand our accounting policies in order to understand our financial statements. Management considers certain of these policies to be critical to the presentation of the financial results, since they require management to make significant estimates and assumptions. These estimates and assumptions affect the reported amounts of assets, liabilities, revenues, expenses, and related disclosures at the financial reporting date and throughout the reporting period. Certain of the estimates result from judgments that can be subjective and complex and consequently actual results may differ from these estimates, which would be reflected in future periods.

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

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

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

Written and Unearned Premium. Written premium is recorded based on the insurance policies that have been reported to us and the policies that have been written by agents but not yet reported to us. We must estimate the amount of written premium not yet reported based on judgments relative to current and historical trends of the business being written. Such estimates are regularly reviewed and updated and any resulting adjustments are included in the current year’s results. An unearned premium reserve is established to reflect the unexpired portion of each policy at the financial reporting date.

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

A portion of the Company’s premium is estimated for unreported premium, mostly for the marine business written by our U.K. Branch and Lloyd’s Operations. We generally do not experience any significant backlog in processing premiums. Such premium estimates are generally based on submission data received from brokers and agents and recorded when the insurance policy or reinsurance contract is written or bound. The estimates are regularly reviewed and updated taking into account the premium received to date versus the estimate and the age of the estimate. To the extent that the actual premium varies from the estimates, the difference, along with the related loss reserves and underwriting expenses, is recorded in current operations.

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

Impairment of Investment Securities. Impairment of investment securities results in a charge to operations when a market decline below cost is other-than-temporary. Management regularly reviews our fixed maturity and equity securities portfolios to evaluate the necessity of recording impairment losses for other-than-temporary declines in the fair value of investments. In general, we focus our attention on those securities whose market value was less than 80% of their cost or amortized cost, as appropriate, for six or more consecutive months. Factors considered in evaluating potential impairment include, but are not limited to, the current fair value as compared to cost or amortized cost of the security, as appropriate, the length of time the investment has been below cost or amortized cost and by how much, our intent and ability to retain the investment for a period of time sufficient to allow for an anticipated recovery in value, specific credit issues related to the issuer and current economic conditions. Other-than-temporary impairment losses result in a permanent reduction of the cost basis of the underlying investment. Significant changes in the factors we consider when evaluating investments for impairment losses could result in a significant change in impairment losses reported in the consolidated financial statements.

As mentioned above, the Company considers its intent and ability to hold a security until the value recovers as part of the process of evaluating whether a security’s unrealized loss represents an other-than- temporary decline. The Company’s ability to hold such securities is supported by sufficient cash flow from its operations and from maturities within its investment portfolio in order to meet its claims payment and other disbursement obligations arising from its underwriting operations without selling such investments. With respect to securities where the decline in value is determined to be temporary and the security’s value is not written down, a subsequent decision may be made to sell that security and realize a loss. Subsequent decisions on security sales are made within the context of overall risk monitoring, changing information, market conditions and assessing value relative to other comparable securities. Management of the Company’s investment portfolio is outsourced to third party investment managers. While these investment managers may, at a given point in time, believe that the preferred course of action is to hold securities with unrealized losses that are considered temporary until such losses are recovered, the dynamic nature of the portfolio management may result in a subsequent decision to sell the security and realize the loss, based upon a change in market and other factors described above. The Company believes that subsequent decisions to sell such securities are consistent with the classification of the Company’s portfolio as available for sale.

Investment managers are required to notify management of rating agency downgrades of securities in their portfolios as well as any potential investment valuation issues at the end of each quarter. Investment managers are also required to notify management to the extent the investment manager is contemplating a transaction or transactions that may result in a realized loss above a certain threshold. Additionally, investment managers are required to notify management if they are contemplating a transaction or transactions that may result in any realized loss up until a certain period beyond the close of a quarterly accounting period.

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

Translation of Foreign Currencies. Financial statements of subsidiaries expressed in foreign currencies are translated into U.S. dollars in accordance with SFAS No. 52, Foreign Currency Translation, issued by the FASB. Under SFAS 52, functional currency assets and liabilities are translated into U.S. dollars using period end rates of exchange and the related translation adjustments are recorded as a separate component of accumulated other comprehensive income. Statement of income amounts expressed in functional currencies are translated using average exchange rates.

Results of Operations

The following is a discussion and analysis of our consolidated and segment results of operations for the three and nine month periods ended September 30, 2007 and 2006. All earnings per share data is presented on a per diluted share basis.

Net income for the three months ended September 30, 2007 was $25.0 million or $1.47 per share compared to $18.3 million or $1.09 per share for the three months ended September 30, 2006. Included in these results were net realized capital gains (losses) of $0.00 per share and $(0.01) per share for the three months ended September 30, 2007 and 2006, respectively.

Net income for the nine months ended September 30, 2007 was $69.1 million or $4.07 per share compared to $52.0 million or $3.09 per share for the nine months ended September 30, 2006. Included in these results were net realized capital gains (losses) of $0.04 per share and $(0.03) per share for the nine months ended September 30, 2007 and 2006, respectively.

The combined ratios, which consist of the sum of the loss and LAE ratio and the expense ratio for each period, for the 2007 third quarter and nine month period were 86.6% and 87.4%, respectively, compared to 87.4% for the 2006 third quarter and 87.9% for the first nine months of 2006. The combined ratios for the 2007 third quarter and nine month period were reduced by 7.8 and 6.7 loss ratio points, respectively, for net loss reserve redundancies of $12.2 million and $29.6 million, respectively, relating to prior periods. The combined ratios for the 2006 third quarter and nine month period were reduced by 5.1 and 3.8 loss ratio points, respectively, for net loss reserve redundancies of $6.0 million and $12.7 million, respectively, relating to prior periods. The net paid loss and LAE ratios for the 2007 third quarter and nine month period were 29.6% and 31.1%, respectively, compared to 35.9% for the 2006 third quarter and 34.6% for the first nine months of 2006.

The 2007 third quarter and nine month period included incurred losses of $2.0 million or 1.3 loss ratio points and $5.6 million or 1.3 loss ratio points for U.K. flood losses. Approximately $4.0 million was recorded for property losses and $1.6 million for cargo losses for the two events that occurred in the 2007 second and third quarters.

Cash flow from operations was $231.3 million for the first nine months of 2007 compared to $88.1 million for the comparable period in 2006. The positive cash flow contributed to the growth in invested assets and net investment income.

Consolidated stockholders’ equity increased 14% to $626.5 million or $37.17 per share at September 30, 2007 compared to $551.3 million or $32.94 per share at December 31, 2006. The increase was primarily due to net income of $69.1 million for the first nine months of 2007.

Revenues. Gross written premium increased to $246.0 million and $823.4 million in the third quarter and first nine months of 2007, respectively, from $221.7 million and $737.8 million in the third quarter and first nine months of 2006, increases of 11% and 12%, respectively. The growth in the 2007 gross written premium generally reflects a combination of business expansion in both new and existing lines of business, partially offset by the effect of premium rate changes on renewal policies on certain lines of business. As discussed below under Lloyd’s Operations Gross Written Premium, the 2007 third quarter and nine month period gross written premium excludes advance premium, however advance premium was recorded as gross written premium in our Lloyd’s Operations in the 2006 third quarter and nine month period. The inclusion or exclusion of advance premium in gross written premium has no impact on revenues or net income for either accounting period since premiums are earned commencing with the effective date of an insurance policy.

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

The following tables set forth our gross and net written premium and net earned premium by segment and line of business for the periods indicated:

		Three Months Ended September 30,
		2007																2006
		Gross								Net				Net				Gross								Net				Net
		Written								Written				Earned				Written								Written				Earned
		Premium				%				Premium				Premium				Premium				%				Premium				Premium
		($ in thousands)
Insurance Companies:
Marine		$	53,040				21.5	%		$	24,207			$	29,520			$	54,116				24.3	%		$	24,566			$	29,291
Specialty			95,627				38.9	%			68,441				62,796				85,675				38.7	%			52,923				45,234
Professional Liability			24,546				10.0	%			14,447				14,184				22,848				10.3	%			13,450				10,938
Other			4,845				2.0	%			2,582				2,560				1,034				0.5	%			249				31
Insurance Companies Total			178,058				72.4	%			109,677				109,060				163,673				73.8	%			91,188				85,494
Lloyd’s Operations:
Marine			50,060				20.3	%			37,373				41,607				44,962				20.3	%			23,743				29,126
Professional Liability			9,639				3.9	%			8,692				4,587				9,015				4.1	%			3,381				1,525
Other			8,204				3.4	%			3,360				784				3,803				1.7	%			725				(449	)
Lloyd’s Operations Total			67,903				27.6	%			49,425				46,978				57,780				26.1	%			27,849				30,202
Intercompany elimination			—				0.0	%			—				—				214				0.1	%			—				—
Total		$	245,961				100.0	%		$	159,102			$	156,038			$	221,667				100.0	%		$	119,037			$	115,696