Navigators Group Inc. And Operating Subsidiaries

Navigators Group Inc. AndOperating SubsidiariesPrimary Credit Analyst:Blake Mock, New York (1) 212-438-7278; [email protected]

Secondary Contact:Taoufik Gharib, New York (1) 212-438-7253; [email protected]

Table Of Contents

Major Rating Factors

Rationale

Factors Specific To Holding Company

Outlook

Competitive Position: Strong Brand Name And Underwriting Expertise In

Marine Business

Management And Corporate Strategy: A Focus On Underwriting

Discipline And Reduced Volatility

Enterprise Risk Management: Adequate, But Slow To Develop

Accounting

Operating Performance: Continued Large Losses And Modest Reserve

Development Partially Offset By Growth

Investments And Liquidity: Conservative Strategy And Liquid Investment

Portfolio

Capitalization: Strong Despite Operating Losses And Repurchases

Financial Flexibility: Low Leverage For The Rating

Related Criteria And Research

June 15, 2012

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Navigators Group Inc. And OperatingSubsidiaries

Major Rating Factors

Strengths:

• Strong competitive position in the marine insurance market

• Strong capitalization supported by retained earnings

• Strong financial flexibility with strong leverage ratios

Weaknesses:

• Volatile operating performance

• High dependence on reinsurance

• Growth and diversification strategy, increasing the importance of enterprise

risk management

Holding Company:Navigators Group Inc.

Counterparty Credit Rating

Local Currency

BBB/Negative/--

Operating Companies Covered ByThis Report

Financial Strength Rating

Local Currency

A/Negative/--

Rationale

The counterparty credit rating on Navigators Group Inc. (NASDAQ: NAVG) and the insurer financial strength

ratings on its core operating subsidiaries, Navigators Insurance Co. and Navigators Specialty Insurance Co.

(collectively, Navigators), reflect the group's strong competitive position in the marine insurance market, strong

capitalization, and strong financial flexibility. Offsetting these factors are volatile earnings performance, a high

dependence on reinsurance, and an organic growth and diversification strategy.

Navigators has a strong competitive position and brand name in the marine insurance segment of the

property/casualty (P/C) industry. The group has solid underwriting expertise in its specialized niche and is one of the

leading underwriters in the U.S. and global marine insurance markets. Navigators Insurance Companies' marine

division has ranked as a top 10 carrier by gross premium written (GPW) over the past 10 years in the U.S.

Navigators' Lloyd's Syndicate, of which it owns 100% of the stamp capacity, primarily writes marine and energy

related lines in the U.K. The company has diversified into other commercial specialty lines and distributes its

products through global, national, and regional brokers.

Consolidated risk-adjusted capitalization was strong and redundant at the rating level at year-end 2011. This

measure included a one-in-250-year net probable maximum loss (PML) that captures the group's catastrophe

exposure. Strong capitalization remains despite a 3.1% year-over-year drop, to $803.4 million from $829.4 million,

in shareholder equity, which was mainly a result of $91 million in share repurchases.

Navigators' financial flexibility is "strong", with strong leverage (15.2% (including operating leases) as of Dec. 31,

2011, and March 31, 2012) and good interest coverage (3.5x as of Dec. 31, 2011, and 6.7x as of Dec. 31, 2010).

The decrease in interest coverage from 6.7x as of year-end 2010 was the result of lower net income, while interest

expense remained at $8.2 million. Interest coverage was 4.8x in first-quarter 2012.

Navigators produced a combined ratio of 104.7% in 2011 mostly on large losses and related reinsurance

reinstatement premiums in the on- and off-shore energy business in the first quarter and adverse development in the

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management and professional liability business. The adverse development was mainly related to public company

directors and officers liability (D&O) from the 2009 and 2010 accident years. This was an increase in the combined

ratio from 101.3% in 2010, affected again by large losses and reinsurance reinstatement premiums in offshore

energy (including Deepwater Horizon). Return on revenue (ROR) of 4.1% in 2011 was down from 9.1% in 2010.

The decrease was due to the losses above and a reduction in investment income due to a low interest rate

environment and investment expense of $4.7 million related to a final legal settlement with Equitas.

The company's operating performance improved in the first three months of 2012. It reported a combined ratio of

100.1%, compared with a combined ratio of 117.4% during the same period in first-quarter 2011. The

improvement from first-quarter 2011 resulted primarily from a decreased loss ratio. The results also include $18.3

million net losses and reinstatement premiums associated with the grounding of Costa Concordia, decreased

investment income, and an additional investment expense of $4.5 million taken on the Equitas settlement.

The group's business model historically has relied on reinsurance. However, reinsurance utilization has decreased

steadily from a high of 55.1% in 2004 to 32.0% in 2011. Reinsurance utilization increases recoverability risk and

dependence on the reinsurance pricing cycle. Reinsurance recoverables to shareholders' equity is high, but lower

than historically. At the end of 2011, recoverables constituted 110.7% of shareholder equity. This ratio has

gradually decreased from more than 200% following Hurricanes Katrina, Rita, and Wilma in 2005. Navigators'

strong and long-standing relationships with its reinsurers (most of which are highly rated) helps mitigate credit risk.

Also, the company has collateral in place to offset some of its potential recoverability risk.

The group has historically relied on its marine and energy business, so it has undertaken a geographic and product

growth strategy to diversify its exposure. Marine and energy will remain core product lines, however. Navigators

has diversified to other lines of business, such as management and professional liability, casualty and assumed

reinsurance.

While Navigators is addressing issues regarding earnings volatility, risk controls, and managerial turnover,

execution risks remain. Its offshore energy business has experienced large losses, while its U.S. D&O liability

business has experienced volatile earnings over past three years. The company has implemented a quota share

offshore energy reinsurance program and reunderwritten its U.S. D&O book. Navigators has experienced significant

growth in new product offerings and operational changes in the past year. Its risk profile has changed significantly

due to the growth in the assumed reinsurance business. Growth in new products and markets increases the

importance of enterprise risk management (ERM) and risk controls. We have maintained our "adequate" view of

the firm's ERM, but expect Navigators to further develop its ERM framework in light of its changing risk profile. In

particular, we see potential weakness in operational, reserving, and emerging risk controls. Navigators is also in the

process of replacing key senior executives.

Factors Specific To Holding Company

We rate the holding company, Navigators Group Inc., three notches lower than its core subsidiaries. The

three-notch difference, which is the standard notching, reflects the holding company's dependence on dividends from

its operating entities to meet its debt-service obligations and the regulatory restrictions that limit the free flow of

funds within the organization. In 2011, Navigators paid $45 million in dividends to its parent company.

Historically, the parent has not received the full amount of allowable dividends. In 2011, Navigators' statutory

dividend capacity without regulatory approval was about $59 million. As of Dec. 31, 2011, Navigators had $8.3


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Navigators Group Inc. And Operating Subsidiaries

million of marketable assets on its parent's balance sheet mainly as a result of share repurchases in 2011 and prior.

The company repurchased $91 million of its common shares in 2011 under its board authorized stock repurchase

program. It announced the expiration of the plan at the end of 2011.

The company's debt leverage was strong in 2011 and first-quarter 2012. Interest coverage was good in 2011 and

first-quarter 2012. Navigators has not declared or paid any cash dividends on its common stock.

Table 1

The Navigators Group Inc. -- Financial Statistics

--Year ended Dec. 31--

Q1 2012 Q1 2011 2011 2010 2009 2008 2007

EBITDA interest coverage (x)* 4.8 (2.5) 3.5 6.7 9.5 10.8 13.9

EBITDA fixed-charge coverage (x)* 4.8 (2.5) 3.5 6.7 9.5 10.8 13.9

Debt leverage (%)* 15.00 14.95 15.21 14.87 14.88 17.69 18.19

Financial leverage (%)* 15.00 14.95 15.21 14.87 14.88 17.69 18.19

*Includes operating leases.

Outlook

The outlook is negative. In 2012, we expect Navigators to generate a combined ratio in the 97%-100% range and a

return on revenue of 8%. However, we do anticipate improvements in ERM, including strengthening of operational,

reserving, and emerging risk controls as Navigators continues to expand by product and geography. We believe the

company's capital adequacy likely will remain strong in 2012. This strong capital position mitigates its credit risk

exposure from its reinsurers. We expect financial leverage to remain below 20% and interest coverage to remain

above 3x.

We could lower the rating one notch over the next 12 months if the company does not meet our stated performance

expectations for its combined ratio and ROR, or if its financial position weakens due to significant adverse reserve

development. If Navigators is successful at addressing issues regarding earnings volatility, risk controls, and

managerial turnover, we may revise the outlook to stable.

Competitive Position: Strong Brand Name And Underwriting Expertise In MarineBusiness

Navigators has a strong expertise and competitive position in the marine insurance segment of the P/C industry and

has grown into a global, diversified specialty insurance writer.

Table 2

The Navigators Group Inc. -- Business Statistics


(Mil. $) Q1 2012 Q1 2011 2011 2010 2009 2008 2007

Gross premiums written 343.1 296.3 1,108.2 987.2 1,044.9 1,084.9 1,070.7

Change in gross premiums written (%) 15.82 9.68 12.26 (5.52) (3.69) 1.33 10.29

Net premiums written 243.0 193.1 753.8 653.9 701.3 661.6 645.8

Change in net premiums written (%) 25.88 1.99 15.27 (6.75) 5.99 2.45 24.00


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Table 2

The Navigators Group Inc. -- Business Statistics (cont.)

Reinsurance utilization 29.17 34.83 31.98 33.76 32.89 39.02 39.69

Net premiums written by line of business (%)

Marine 17.64 28.08 22.64 23.10 24.43 22.30 18.16

Property/casualty 47.12 32.58 38.97 30.25 32.40 39.50 46.70

Professional liability 9.81 7.05 10.35 12.30 11.29 9.64 9.15

Insurance companies total 74.57 67.71 71.95 65.66 68.12 71.44 74.02

Lloyd's operations (%)

Marine 19.97 25.73 18.20 22.84 22.27 20.07 17.12

Property/casualty 3.66 4.34 7.46 8.27 6.43 4.95 5.24

Professional liability 1.80 2.22 2.38 3.24 3.18 3.54 3.62

Lloyd's operations total 25.43 32.29 28.05 34.34 31.88 28.56 25.98

In the past decade, Navigators has significantly increased its premium volume, benefiting from the hard markets

following Sept. 11, 2001, and the hurricanes of 2005. Navigators has significantly expanded its commercial casualty

writing and, most recently, its assumed reinsurance products. Specifically, over the past decade, it has added D&O

liability (in 2001), excess casualty (2004), primary casualty and inland marine (2006), environmental (2008),

architect and engineering (2009), and assumed reinsurance (2010). Accordingly, GPW totaled $1.1 billion in 2011,

up 12.3% from 2010 as growth in the reinsurance and primary and excess casualty businesses more than offset the

sell of its middle-market business to Tower Insurance Co. Nav Re was up $101.5 million in its first full year of

operations. The Nav Re division writes accident and health, agriculture, Latin America P/C, and professional

reinsurance. The casualty book grew more than $56 million due to production from the expansion of the

underwriting team and changes in the competitive landscape for excess casualty. These results were partially offset

by lower production in the professional liability business on a continued shift to excess layers on U.S. D&O

business. In 2011, net premium written (NPW) increased 15.3% as less premium was ceded due to the change in

Nav Re's business mix.

The company underwrites business through its two U.S. insurance subsidiaries on admitted and nonadmitted bases

and through its Lloyd's Syndicate 1221. Within the U.S. and Lloyd's divisions there are marine, P/C, and

professional liability business lines. In 2011, the U.S. subsidiaries generated the majority (71%) of the group's GPW.

The remaining 29% was from its Lloyd's operations. On a consolidated basis, Navigators' marine insurance remains

its largest line of business and its longest-standing area of specialization. In 2011, GPW included 36% marine

insurance, 51% P/C (U.S. primary and excess casualty, engineering, energy, and assumed reinsurance), and 13%

professional liability.

Navigators Marine

Navigators has been writing marine business since inception. Ocean marine is its largest product line and

longest-standing area of specialization. The distribution platform is the brokerage market, with Aon Corp., Willis

Group Holdings PLC, and Marsh Inc. producing the majority of premiums. Navigators has a diverse portfolio of

marine insurance products. Through its marine business, Navigators' GPW increased by 2.4% to $228.5 million in

2011--21% of the group's business, resulting primarily from increases in inland marine, protection and indemnity

(P&I), and transport of 10.5%, 17.3%, and 11.5%, respectively. The increases were a combination of increased

production and increased renewal rates on each line.


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As part of its diversification strategy, Navigators began writing primary marine P&I in 2004 through its U.K.

branch for non-U.S. flag vessels, mostly for small accounts that are not traditionally covered by P&I clubs. This

complements Navigators' marine liability business, which is generally written on an excess basis. In 2006,

Navigators established a U.S. inland marine division with a focus on traditional products (builders' risk and

contractors' tools and equipment), with limited exposure to the Gulf of Mexico and Florida.

Navigators Property Casualty

In 2011, Navigators P/C generated 40% of the group's premiums. GPW increased 42.4% from 2010 to $445.3,

primarily from growth in assumed reinsurance and U.S. excess casualty. Navigators P/C offers a diverse range of

specialty commercial insurance. Nav Re is the most recent addition, with its first full year of operations in 2011.

Nav Re specializes in reinsurance for agriculture, accident and health, Latin America property, and, most recently,

professional liability.

Navigators has grown its excess casualty division and umbrella line of business offering such products to a broad

range of industries. Navigators offers contractors' liability insurance focusing on small general and artisan

contractors. Its primary casualty division focuses on construction business east of the Rocky Mountains and

nonconstruction risks nationwide. Navigators has further diversified its P/C products to include products liability

insurance, life sciences firms, and environmental liability coverage.

Navigators Professional Liability

Navigators Professional Liability (Nav Pro) began underwriting primarily D&O insurance. It offers D&O to both

private and small to midsize public companies with market capitalization of $2 billion or less, written on primary

and excess bases. It provides maximum gross limits of $25 million for international business and $15 million for

U.S. business, with an average gross limit of $6.7 million. Professional liability comprises of various E&O lines such

as miscellaneous professional, small lawyers, and real estate professional liability.

In 2011, Nav Pro's GPW decreased 11.7% to $114.6 million. Average renewal rates decreased by a marginal 1.4%

after decreases of 4% in 2010, however, the decrease in GPW was mainly due to a continued reduction in the U.S.

business as a result of a shift in its D&O business to excess layers. The current mix of the business is 60% E&O and

40% D&O due to the recent expansion and contraction, respectively.

In 2010, Navigators adjusted its risk tolerances for the D&O book to account for an increased frequency of

merger-related litigation. Subsequently, the company adjusted its retentions on primary public D&O policies and is

shifting its focus to excess layers. As D&O policies are written on a claims-made basis, the strategy may take a few

years to be fully realized, however, early indicators of results in the D&O business suggest dramatic improvement in

accident-year 2011 from the prior two years.

The decreases in D&O in 2011 were partially offset by a 37.6% increase in the E&O book driven by real estate

professional liability. The E&O business has also evolved since early 2009, when Navigators combined its small

lawyers professional liability book with Brown & Brown. Navigators also began re-underwriting its large lawyer's

book, which resulted in a reduction in its market presence in this niche.

Lloyd's Syndicate 1221

Navigators controls 100% of the stamp capacity of Syndicate 1221. The group continues to benefit from a strong

presence in the marine market and access to Lloyd's global licensing arrangements. Through these arrangements,

Navigators has a presence in emerging markets such as Brazil and China. In 2011, the syndicate's stamp capacity,


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net of commissions, increased to £175 million ($271 million) compared with £168 million ($264 million) in 2010

and £124 million (or $194 million) in 2009. Syndicate 1221 is one of the largest marine-focused syndicates at

Lloyd's. Navigators Underwriting Agency Ltd. manages Syndicate 1221, which produced $319.8 million, or 29%,

of Navigators' total 2011 GPW--virtually flat y/y.

The marine business GPW decreased to $167.6 million in 2011 from $182.7 million in 2010, mostly on a reduction

in cargo and hull, partially offset by an increase in war premiums. Lloyd's marine average renewal rates increased

1% in 2011, compared with an increase of 3% in 2010. The P/C GPW increased to $115.1 million in 2011 from

$94.8 million in 2010 due to increased production and rates in the onshore energy, engineering, and construction

businesses.

In response to opportunities in the international market, Syndicate 1221 began writing professional liability in

second-quarter 2005 to further establish its presence in the London market. GPW was $37.1 million in 2011, down

16% from $44.2 million in 2010 due to restructuring of the international E&O business in ways similar to the U.S.

This book is split between international D&O (75% of GPW) and E&O (25%). Lloyd's professional liability

premiums were flat in 2010 after increasing 13.3% in 2009. In fourth-quarter 2008, Navigators hired an

experienced team of international excess D&O underwriters to be part of the Lloyd's operation. The team focuses

on excess D&O layers for companies outside the U.S.

Prospective

We expect GPW will increase in 2012 as Navigators maintains its underwriting discipline in existing lines, while

continuing the expansion of its products into new markets and the broadening of its distribution channels. We

expect the company to grow mainly from selected lines within its P/C segment, particularly Nav Re. Marine GPW

could experience a decline in 2012 due to a competitive environment, however, large events such as the grounding of

Costa Concordia could have a positive affect on pricing. Similarly, contractors' liability in Navigators' construction

business could continue to decrease due to a weak housing market.

Management And Corporate Strategy: A Focus On Underwriting Discipline AndReduced Volatility

Navigators benefits from a management team with extensive industry experience. Its strategic planning process is

enhanced by strong participation at the executive level. Management remains focused on underwriting, as the

company continues to build other supporting functions to keep pace with growth. While there has recently been

executive turnover at the Chief Financial Officer and Chief Actuary positions, we expect successful replacement and

integration of the new team in the near future.

Historically, Navigators depended heavily on its marine business, but the group has diversified its geographic and

product offerings to reduce its exposure to niche insurance cycles. Nevertheless, the marine business will remain a

core product line. In 1997, Navigators opened its U.K. branch to underwrite U.K. and European business. Similarly,

in 1998, the group acquired its Lloyd's Managing General Agency to access Lloyd's global markets. In 1999,

Navigators purchased an agency that had written its construction liability insurance since 1995. As the P/C market

hardened after Sept. 11, 2001, Navigators expanded into new products in 2001, such as professional liability

through Navigators Pro, and later targeted specialty niches such as on- and offshore energy, personal umbrella, and

primary and excess casualty. The company has expanded since 2008 by opening new offices and launching products

such as environmental, life sciences, and assumed reinsurance coverage. Navigators hired personnel to enter new


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lines of business and markets and to expand its current underwriting teams. The company will continue to enter new

geographic markets with its existing products while broadening its distribution channels.

While we view continued entrance into and exit out of lines of business unfavorably, we feel Navigators approaches

underperformance objectively. Navigators relies on an experienced management team that's willing to reduce

top-line growth and exit certain lines of business if rates and conditions are unfavorable. In 2009, the company

demonstrated prudent cycle management as it reduced its Gulf of Mexico windstorm offshore energy exposures to

maintain underwriting discipline in light of unfavorable terms and conditions. In the same year, it exited personal

umbrella business. The company did not have the personal lines expertise or the scale within this line to make it

worthwhile to continue to write this business. It also re-staffed and re-underwrote its E&O business to better align

its writings with its risk tolerances. In 2010 Navigators began the re-underwriting process of its D&O business

adding new models and risk tolerances to manage exposure by geography, industry, and attachment points. During

first-quarter 2011, the company entered into a transaction with Tower Insurance Co. of New York, a subsidiary of

Tower Insurance Co., to sell the renewal rights for the middle-market commercial package and commercial

automobile business underwritten through its Nav Pac division. The firm has also exited certain lines of business

because of tough market conditions.

As a specialty insurance writer in potentially volatile lines of business, Navigators continues to depend on and

develop its reinsurance program in order to reduce volatility in earnings. Notably, in 2011 the company

implemented a quota share structure for the offshore energy business.

Operational management

The group conducts its operations through its insurance companies and Lloyd's operations. The insurance

companies consist of Navigators Insurance Co., its subsidiary; Navigators Specialty Insurance Co., an excess and

surplus lines writer; and its U.K. branch. The company's Lloyd's syndicate 1221 complements its U.S. operations

and provides a global platform for the group. Navigators uses Lloyd's paper as its preferred vehicle for global

expansion.

Navigators is focusing on controlling costs in the near term through operational enhancements, improved premium

billing and collections, more-efficient policy processing, and advancements to its information technology

infrastructure.

Financial management

We expect the company to remain focused on underwriting profit with an average 12%-13% return on equity

throughout market cycles. Financial management is reasonable and appropriate for the current rating level, with an

overall conservative investment strategy. Both financial leverage and double leverage are significantly better than our

threshold for a 'BBB' counterparty credit rating.

Enterprise Risk Management: Adequate, But Slow To Develop

We consider Navigator's ERM to be "adequate". Our view is influenced by scores of "adequate" for all the

components of the ERM framework. We consider insurance risk (underwriting, pricing, and cycle management) as

significant risks for Navigators. Reinsurance risk (credit/counterparty risk) is also crucial, given the fact that the

business mandates big line sizes and reinsurance is crucial in managing its losses. Navigators' has an increasingly

complex risk profile as it seeks to diversify away from its marine niche into specialty and catastrophe oriented lines.


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The combined ratio in the past couple of years has been high and this, along with the firm's expansion into severity

oriented lines, may cause volatility to be high.

We score Navigator's risk management culture as "adequate". While the ERM steering committee is the main

governance body related to risk management, the firm lacks a formal risk organization that can aggregate and report

on risks in a systematic manner. Our views are affected favorably by a risk register that analyses sensitivity to key

risks and prioritizes and tracks their movement along the dashboard. Offsetting these views is the fact that

Navigators formalized risk appetite is still recent. For the past two years, the chief underwriting officer (CUO) has

served as the chief risk officer (CRO), which could cause role conflicts. While a dedicated CRO has recently been

hired, the new officer will take some time to season and implement practices suitable to Navigators. Given its

product diversification and geographic breadth, and dependence on reinsurance, ERM is of high importance to the

overall rating.

We score the company's investment risk controls as "strong". We regard the firm's conservative composition of the

investment portfolio and a low tolerance for losses coupled with explicit limits for asset class, sectors, and

geographies favorably. While the portfolio is managed externally, Navigators management exercises oversight

through weekly review of transactions, monthly calls with managers, and independent verification of pricing. Our

views are partially offset by reliance on stochastic models. It's also our opinion that, while there is a collegial

approach to new money allocation which is based on performance and the manager's outlooks, this approach

appears a bit less-formalized than some peers.

We score the controls related to underwriting, pricing, and cycle management as "adequate". We view favorably the

governance established through the underwriting advisory committee of the board of directors and process

improvements in some areas. In addition, there are pockets of strength in the niche areas such as marine and energy

that Navigators operates in, and the firm combines this with a thoughtful reinsurance strategy. Our views are

somewhat offset by some recent developments in the professional liability area. We view some of the steps the

company is currently taking as positive, but also, to a certain extent, reflects the reactive nature of management. In

addition, Navigators' expense ratio in a soft cycle puts additional pressure on the combined ratio.

A significant number of initiatives are under way to improve underwriting including exits from Nav Pac and pockets

of D&O segments and adding of new lines such as accident and health reinsurance, Latin American reinsurance, and

a strategy of shifting to excess layers on professional liability lines. These changes indicate the rapidly evolving

nature of the firm's risk profile and the need for enhanced risk controls.

We consider Navigator's reserve risk controls as "weak". Adverse development in the professional liability lines has

exposed some weaknesses in the reserve risk controls. While there is detailed in depth analysis of claims and

monthly claim watch-list reports, we would look for seasoning of some of these processes and a track record of

conservative reserving to revise our score for this category.

We score the catastrophe risk controls at Navigators as "adequate". We view the company's recent adoption of

catastrophe risk tolerances as favorable. However, these tolerance levels are recent and, given the recent nature of

some of these tolerances, we consider the monitoring of risk levels against the tolerances and reporting as relatively

unseasoned. Also, we view the method used to combine the exposures to loss from nonstatic exposures and static

exposures positively. With the growth strategies planned for Nav Re, the catastrophe aggregation management takes

on bigger importance, and our views are positively influenced by the monitoring of occurrence limits and not just


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the modeled PMLs. This risk profile may evolve quickly, and we expect the control environment to sustain this

growth.

We regard Navigator's counterparty/credit risk controls as "adequate". While the company takes on significant

gross exposures, it uses a variety of strategies including reinsurance to reduce this risk. Management designs its

reinsurance structures in a thoughtful manner. Reinsurance purchases are risk attaching and the purchases aim to

reduce per-risk net to achieve tail risk within risk tolerances. Management has the ability to view reinsurance

purchases through an automated system and use of a common platform to buy reinsurance across the group helps

monitor this risk. In addition, the quality of reinsurers is high with 99% of the reinsurers rated 'A-' or better. While

we agree with the necessity for reinsurance and the controls around this, the reinsurance purchases and associated

reinstatement premiums add pressure to the combined ratio.

We consider operational risk controls at Navigators as "weak". The operational risk controls are pressured by the

recent departure of key executives (CFO, Chief Actuary), the temporarily expanded role of the CUO, recently hired

CRO, and the need for integration of systems in new lines of business. Favorable opinions about operational risk

include a strong internal audit function that coordinates well with the ERM function to conduct risk-based audits of

the company.

We consider emerging risk management at Navigators as "weak". Given its concentration in short-tail lines

business, it can react faster to emerging risks and tweak underwriting terms and pricing to respond to them more

quickly than companies that write longer-tailed lines. The company's reinsurance strategy in terms of buying risk

attaching treaties also mitigates emerging risks from past underwriting decisions to a certain extent. However, there

are some lines such as D&O where the company has been quite reactive and there is no formal process for

identifying, prioritizing, or tracking emerging risks.

Our view of Navigators' score for strategic risk management is positively influenced by developments at the Lloyd's

syndicate, with a thoughtful structure that's in place for Solvency II and the capital modeling efforts at the syndicate

level to gauge the firm's economic capital adequacy. However, at a group level, the economic capital modeling

initiatives are in infancy; it has plans to roll out the model by first-quarter 2013. Currently, a variety of regulatory-

and rating agency-based measures are in place and the company uses a variety of modeling results to view capital

requirements for reserve risks (using the Milliman reserve variability model), The firm uses natural catastrophe

modeling in reserve management systems as an input to constrain catastrophe risk to within risk tolerances. While it

provides examples of risk-reward analyses--from investment decisions (using stochastic models for investment

portfolio) and use of analytics for reinsurance purchases and technical pricing models--the firm lacks a systematic

approach by which it can prioritize strategic options in order to optimize risk adjusted returns.

Navigators' is taking significant steps in improving its risk management infrastructure and management's

commitment to understanding and effective use of the models. We expect these initiatives to continue and evolve

with the risk profile for Navigators as the company diversifies.

Accounting

We calculate the expense ratio differently than the company. Navigators' definition of the expense ratio is

commission expenses plus other operating expenses, less other income (expense) over net premiums earned. We, on

the other hand, do not offset the numerator by other income (expense), but rather by commission income only--a


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component of other income (expense). We made adjustments for modest reserve deficiency in our analysis of

capitalization.

Operating Performance: Continued Large Losses And Modest ReserveDevelopment Partially Offset By Growth

In 2011, Navigators reported a decline in its operating performance primarily due to three major energy losses,

prior-period reserve development in the professional lines, and continued competitive pricing partially offset by a

decrease in the expense ratio. Navigators' expense ratio decreased as a result of lower reinstatement premiums

relative to the Deepwater Horizon loss in 2010, employee expenses, and relatively lower investment for information

technology.

Table 3

The Navigators Group Inc. -- Operating Statistics


(Mil. $) Q1 2012 Q1 2011 2011 2010 2009 2008 2007

Total revenue 195.1 170.6 756.4 736.8 765.5 722.0 674.7

Underwriting gain or (loss) (0.1) (26.5) (32.7) (8.3) 15.9 38.9 75.1

EBIT 13.2 (10.3) 40.9 107.1 95.3 77.6 148.0

EBIT adjusted 12.3 (8.0) 34.7 70.7 101.4 119.3 148.7

EBITDA 14.3 (9.4) 45.0 111.4 99.9 82.4 151.4

EBITDA adjusted 13.4 (7.0) 38.8 75.1 106.0 124.0 152.1

Pretax operating income (excluding realized capital gains or losses) 9.3 (11.0) 22.7 58.6 89.5 107.0 137.2

Net income 7.9 (7.9) 25.6 69.6 63.2 51.7 95.6

Return on revenue (%) 5.84 (5.25) 4.09 9.07 12.80 16.05 21.65

Return on equity (%)* 3.87 (3.89) 3.14 8.54 8.47 7.65 15.76

Return on assets (%)* 0.84 (0.89) 0.71 1.99 1.86 1.59 3.13

Loss ratio (%) 64.43 76.59 68.97 63.82 63.80 61.05 56.58

Commission expense ratio (%) 15.80 16.82 15.81 16.26 14.46 13.79 12.60

Administrative expense ratio (%) 19.83 23.99 19.96 21.17 19.41 19.12 18.34

Expense ratio (%) 35.63 40.81 35.76 37.43 33.88 32.91 30.95

Combined ratio (%) 100.06 117.40 104.73 101.25 97.68 93.96 87.52

Operating ratio (%) 6.01 (6.16) 4.45 9.61 13.37 17.93 24.21

Net investment income to net premiums earned (%) 6.06 11.24 9.18 10.86 11.05 11.89 11.74

Cash flows

Net cash flow from operating activities 16.4 13.3 118.3 118.2 103.9 245.3 284.6

Net cash flow from investing activities (98.5) 6.9 66.0 (36.5) (92.8) (243.3) (282.2)

Net cash flow from financing activities 0.3 (12.6) (88.8) (50.5) (12.1) (7.6) 2.2

*Annualized one quarter of data.

Current performance

During 2011, pretax operating income (excluding net realized gains/losses) declined to $22.7 million (with a

combined ratio of 104.7%) from $58.6 million in 2010 (combined ratio of 101.3%) mainly as a result of

underwriting losses in its Nav Tech energy division (reported in P/C results) and adverse development in the


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professional liability business. Including realized investment gains/losses, the company reported pretax income of

$32.7 million in 2011, compared with 2010's $98.8 million. Navigators reported $2.1 million in adverse reserve

development in 2011 versus $13.8 million in favorable development in 2010. The company experienced adverse

development in its professional liability business, offset by reserve releases in its P/C business. Navigators' net

investment income declined marginally, to $63.5 million in 2011 from $71.7 million in 2010.

Through March 31, 2012, Navigators' combined ratio decreased to 100.1% from 117.4% during the same period

in 2011. The marine industry experienced one of its largest losses ever with the grounding of the Costa Concordia.

Navigators recorded a net loss $7.5 million and $10.8 million in reinsurance reinstatement premiums. Still

Navigators' performance improved over first-quarter 2011 due to less energy losses. During the same period,

Navigators experienced $6.9 million of favorable prior-year loss reserve development from its NavTech and primary

casualty divisions across multiple years.

Historical

During 2010, pretax operating income (excluding net realized gains/losses) declined to $58.6 million (with a

combined ratio of 101.3%) from $89.5 million in 2009 (combined ratio of 97.7%) mainly as a result of

underwriting losses in its energy and professional liability segments. Including realized investment gains/losses, the

company reported pretax income of $98.8 million in 2010 compared with $86.8 million the year before. Navigators

reported $13.8 million in favorable reserve development in 2010, up from $8.9 million in 2009. The company

experienced reserve deficiencies in the professional liability business, offset by reserve releases in the P/C business,

especially related to its West Coast contractor's liability and marine business. Although Navigators' net investment

income declined marginally, to $71.7 million in 2010 from $75.5 million in 2009, its net realized gains and

other-than-temporary impairments (OTTI) increased significantly, to $40.2 million in 2010 from net realized

investment losses of $2.7 million in 2009.

Prospective

We expect Navigators' 2012 combined ratio in the 97%-100% range. Operating performance should benefit from

the re-underwriting actions taken in 2009 and 2010, and volatility should be reduced due to quota share reinsurance

programs it has put in place.

Investments And Liquidity: Conservative Strategy And Liquid Investment Portfolio

Navigators' investment objective is to maximize total investment return while preserving and enhancing shareholder

value and the statutory surplus of its operating companies. Its secondary objective is to optimize after-tax income.

Navigators follows a conservative investment strategy, with overall portfolio allocation targets of 0%-20% in equity

and 80%-100% in fixed-income securities. The company outsources the management of its invested assets.

Navigators' finance committee oversees these invested assets and manages them according to investment guidelines

and benchmarks that the company has established. Navigators reviews and evaluates portfolio compliance and

performance monthly in addition to weekly transaction reviews.


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Table 4

The Navigators Group Inc. -- Investment Statistics


(Mil. $) Q1 2012 Q1 2011 2011 2010 2009 2008 2007

Total invested assets 2,294.4 2,144.7 2,233.5 2,154.3 2,056.6 1,917.7 1,767.3

Change in total invested assets (%) 6.98 4.36 3.67 4.75 7.24 8.51 19.74

Net investment income 11.1 17.1 63.5 71.7 75.5 76.6 70.7

Net investment income to total revenue (%) 5.69 10.05 8.40 9.73 9.86 10.60 10.47

Net investment yield (%)* 2.00 3.13 2.89 3.40 3.80 4.15 4.36

Realized capital gains or (losses) 1.8 (1.4) 10.0 40.2 (2.7) (38.3) 2.0

Total yield (%)* 2.33 2.88 3.35 5.31 3.67 2.08 4.48

Portfolio composition (% of invested assets)

Fixed maturities available for sale 84.71 86.03 84.53 87.37 88.33 85.72 86.14

Short term investments 8.85 7.90 5.47 7.10 8.60 11.51 9.66

Equity securities available for sale 4.46 4.24 4.29 4.05 3.04 2.70 3.80

Cash 1.98 1.83 5.70 1.47 0.02 0.08 0.40


Invested assets totaled $2.23 billion in 2011, an increase of 3.7% from $2.15 billion in 2010. This resulted from

strong operating cash flows and realized and unrealized gains of $39.4 million. Despite a larger invested asset base,

investment income (excluding realized gains or losses) decreased 11.4% to $63.5 million at year-end 2011 because

of low yields and an investment expense accrual of $4.7 million related to a settlement with Equitas. Navigators

would go on to increase the accrual by $4.5 million in first-quarter 2012, for a total final settlement expense of $9.2

million.

Navigators' investment portfolio consisted of $1.89 billion in fixed maturities as of Dec. 31, 2011, constituting 85%

of the investment portfolio. The fixed-maturity portfolio is highly rated, with an average credit rating of 'AA' and an

average duration of 3.6 years. The duration is still slightly higher than the mean duration of its reserve balance of

2.5 years, however, this is more closely matched than the 4.4 years at year-end 2010. The company has a significant

amount of residential mortgage-backed securities (RMBS), collateralized mortgage obligations, commercial

mortgage-backed securities (CMBS), and asset-backed securities (30% of the total investment portfolio).

Nonetheless, the RMBS and CMBS securities are highly rated. The remaining investment portfolio consists of cash

and short-term investments (11.2%) and a diverse equity portfolio (4.3%).

Liquidity

We view Navigators' liquidity as "strong", supported by $118 million of net operating cash flows in 2011.

Furthermore, the company benefits from a very liquid investment portfolio, including $250 million in cash and

short-term investments as of Dec. 31, 2011, and highly rated fixed-income securities. Besides Navigators' projected

claims payments, expected liquidity needs in 2012 include $8 million in interest payments on its 7% senior notes

and $9.2 million in operating leases. At year-end 2011, the holding company's liquid assets dropped to $8.3 million.

These have, however, improved to $18 million as of March 31, 2012. We expect Navigators to increase its cash on

hand through earnings coming off a year of large share repurchases. We expect Navigators to have adequate

liquidity to meet its obligations based on its holding-company invested assets and strong operating cash flows.


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Capitalization: Strong Despite Operating Losses And Repurchases

Navigators' consolidated GAAP (generally accepted accounting principles) capitalization at year-end 2011 was

strong and includes a one-in-250-year net PML that captures the group's catastrophe exposure. Risk-adjusted

capitalization remains redundant at the rating level. Shareholder equity decreased by a modest 3.1% to $803 million

at year-end 2011 mostly due to share repurchases. Shareholder equity has since increased to $818 million as of

March 31, 2012, on operating earnings and gains on investments. Given the uncertainty of Navigators' loss-reserve

estimates for its long-tail specialty and professional liability business, we believe such a high level of capital is

appropriate for the rating.

Table 5

The Navigators Group Inc. -- Capital Adequacy And Flexibility Statistics


(Mil. $) Q1 2012 Q1 2011 2011 2010 2009 2008 2007

Shareholders' equity 818.2 815.2 803.4 829.4 801.5 689.3 662.1

Change in shareholders' equity (%) 0.37 1.46 (3.13) 3.47 16.28 4.11 20.09

Total capital 932.5 929.3 917.7 943.5 915.5 813.1 785.8

Change in total capital (%) 0.34 1.27 (2.73) 3.05 12.60 3.48 16.43

Operating leverage (%) 29.70 23.69 93.82 78.85 87.49 95.98 97.54

Net loss reserves to shareholders' equity (%) 144.86 138.11 148.54 130.93 129.31 135.30 113.65

Net loss reserves to net premiums written (%)* 121.91 143.87 158.32 166.05 147.80 140.96 116.52

Common stock to shareholders' equity (%) 12.52 11.15 11.93 10.52 7.81 7.51 10.16

Reinsurance recoverables (on paid losses) toshareholders' equity (%)

6.32 7.11 5.45 6.83 9.55 9.75 14.32

Reinsurance recoverables (on unpaid losses) toshareholders' equity (%)

104.71 106.14 105.23 101.68 100.73 123.86 121.05

Total reinsurance recoverables to shareholders' equity(%)

111.02 113.24 110.68 108.51 110.27 133.61 135.37

Interest expense 2.0 2.0 8.2 8.2 8.5 8.9 8.9


Prospective

We believe Navigators' capitalization likely will remain strong in 2012 and that its total adjusted capital will cover

its risk-based capital needs, including severity risk associated with the company's core marine insurance business, the

risk associated with expanding and entering into new lines, and the credit risk exposure to reinsurers.

Reserves

We view Navigators' reserve position as modestly deficient. The company internally monitors its reserves each

quarter and the results are independently evaluated by an outside actuarial firm twice a year. Navigators' reserve

risk is increasing since its risk profile is gradually changing as it adds more casualty product lines to its book of

business. The net loss reserve balance of $1.2 billion as of Dec. 31, 2011, constituted 149% of shareholder equity.

Navigators has had a track record of favorable reserve development over the past five years--except for 2011, when

it saw a $2.1 million strengthening, mainly the result of $17.6 million adverse development from its U.S.

professional liability business. The development was mainly attributable to public company D&O liability coverage

for accident-years 2009 and 2010. Other adverse development included $1.3 million in its U.S. marine line, which


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was partially offset by favorable development of $6.8 million in U.S. P/C, mostly from the offshore energy line over

several accident years and $10.0 million in the Lloyd's operations driven by the marine and Nav Tech divisions.

Reserve development of $13.8 million in 2010 was up from $8.9 million in 2009.

Following a thorough analysis in fourth-quarter 2003, Navigators incurred gross and net losses for asbestos of $78

million and $32 million, respectively. The development related primarily to policies underwritten by Navigators

agencies in the late 1970s and the first half of the 1980s, consisting of excess liability on marine business and

aviation products liability. Subsequently, the company significantly reduced the loss reserves because of settlements

with insureds and recoveries from reinsurers. Asbestos reserves to total reserves and to capital are lower than in

previous years and have been declining since 2003.

Reinsurance

Navigators' business model depends highly on reinsurance. The company's reinsurance strategy is to reduce its

exposure to individual risks, protect against catastrophic losses, and stabilize its loss ratios. Navigators' reinsurance

utilization rate decreased marginally in 2011, to 32.0% from 33.8% in 2010 on a shift toward business lines with

lower cessions, such as the Nav Re division. We believe this shift will continue in 2012, slightly offset by an increase

in quota share structures on offshore energy and other lines.

The company's reinsurance recoverables to shareholder equity is high, but generally declining since 2005. At

year-end 2011, reinsurance recoverables constituted 110.7% of shareholder equity compared with more than 200%

in 2005 after hurricanes Katrina, Rita, and Wilma. A mitigating factor to the recoverability risk is that Navigators

has strong and long-standing relationships with its reinsurers, most of them are rated at least 'A-' (99% of net

recoverables at year-end 2011). Furthermore, the company had $177 million in collateral at year-end 2011 to offset

some of its potential recoverability risk.

Financial Flexibility: Low Leverage For The Rating

We view Navigators' financial flexibility as "strong". The company can access both the equity and debt markets

through its publicly traded parent company. The group successfully raised $124 million and $111 million in capital

from secondary public common stock offerings in 2005 and 2003, respectively. In 2006, the group drew down $125

million in senior unsecured notes due in May 2016 from its existing universal shelf that expired in July 2009. Its

current $500 million universal shelf registration, which was due to expire in July 2012, has been successfully

renewed for a term of three years. The company's debt-to-capital ratio of 15% (including operating leases) at

year-end 2011 should not constrain its ability to issue more debt, if needed.

Navigators has access to a $165 million letter of credit (LOC) facility, which it primarily uses to support its Lloyd's

operations; the prior credit facility that expired on April 1, 2011, provided $140 million in LOCs. Liquid invested

assets and holding company investments also support Navigators' strong financial flexibility.

Table 6

The Navigators Group Inc. -- Reserve Development And Combined Ratio


(Mil. $) Q1 2012 Q1 2011 2011 2010 2009 2008 2007

(Favorable)/unfavorable reserve development (6.9) 3.4 2.1 (13.8) (8.9) (50.7) (47.0)

Accident year combined ratio (%) 103.83 115.17 104.43 103.34 98.98 101.84 95.33


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Table 6

The Navigators Group Inc. -- Reserve Development And Combined Ratio (cont.)

Calendar year combined ratio (%) 100.06 117.40 104.73 101.25 97.68 93.96 87.52

Related Criteria And Research

• Navigators Group Inc. And Core Subsidiaries Ratings Affirmed On Strong Capitalization; Outlook Remains

Negative, May 30, 2012

• Evaluating Insurers' Competitive Position, April 22, 2009

• Analysis of Nonlife Insurance Operating Performance, April 22, 2009

Ratings Detail (As Of June 15, 2012)

Holding Company: Navigators Group Inc.

Issuer Credit Rating

Local Currency BBB/Negative/--

Senior Unsecured BBB

Operating Companies Covered By This Report

Navigators Insurance Co.


Local Currency A/Negative/--

Counterparty Credit Rating


Navigators Specialty Insurance Co.



Issuer Credit Rating


Domicile New York

*Unless otherwise noted, all ratings in this report are global scale ratings. Standard & Poor's credit ratings on the global scale are comparable across countries. Standard

& Poor's credit ratings on a national scale are relative to obligors or obligations within that specific country.


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Navigators Group Inc. And Operating Subsidiaries

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