Note 5. Reserves for Losses and Loss Adjustment Expenses

Insurance companies and Lloyd’s syndicates are required to maintain reserves for unpaid losses and unpaid loss adjustment expenses for all lines of business. These reserves are intended to cover the probable ultimate cost of settling all losses incurred and unpaid, including those incurred but not reported. The determination of reserves for losses and LAE for insurance companies such as Navigators Insurance Company and Navigators Specialty Insurance Company, and Lloyd’s corporate members such as Navigators Corporate Underwriters Ltd. is dependent upon the receipt of information from the agents and brokers which produce the insurance business for us. Generally, there is a lag between the time premiums are written and related losses and loss adjustment expenses are incurred, and the time such events are reported to the agents and brokers and, subsequently, to Navigators Insurance Company, Navigators Specialty Insurance Company, Navigators Corporate Underwriters Ltd.

Case reserves are established by our Insurance Companies and Syndicate 1221 for reported claims when notice of the claim is first received. Reserves for such reported claims are established on a case-by-case basis by evaluating several factors, including the type of risk involved, knowledge of the circumstances surrounding such claim, severity of injury or damage, the potential for ultimate exposure, experience with the line of business, and the policy provisions relating to the type of claim. Reserves for IBNR are determined in part on the basis of statistical information, in part on industry experience and in part on the judgment of our senior corporate officers. Indicated reserves are calculated by our actuaries using several standard actuarial methodologies, including the paid and incurred loss development and the paid and incurred Bornheutter-Ferguson loss methods. Additional analyses, such as frequency/severity analyses, are performed for certain books of business. To the extent that reserves are deficient or redundant, the amount of such deficiency or redundancy is treated as a charge or credit to earnings in the period in which the deficiency or redundancy is recognized.

Total loss reserves are estimates of what the insurer or reinsurer expects to pay on claims, based on facts and circumstances then known. It is possible that the ultimate liability may exceed or be less than such estimates. In setting our loss reserve estimates, we review statistical data covering several years, analyze patterns by line of business and consider several factors including trends in claims frequency and severity, changes in operations, emerging economic and social trends, inflation and changes in the regulatory and litigation environment. Using the aforementioned actuarial methods and different underlying assumptions, our actuaries produce a number of point estimates for each class of business. After reviewing the appropriateness of the underlying assumptions, management selects the carried reserve for each class of business. We do not calculate a range of loss reserve estimates. We believe that ranges may not be a true reflection of the potential volatility between carried loss reserves and the ultimate settlement amount of losses incurred prior to the balance sheet date. The numerous factors that contribute to the inherent uncertainty in the process of establishing loss reserves include: interpreting loss development activity, emerging economic and social trends, inflation, changes in the regulatory and judicial environment and changes in our operations, including changes in underwriting standards and claims handling procedures. During the loss settlement period, which, in some cases, may last several years, additional facts regarding individual claims may become known and, accordingly, it often becomes necessary to refine and adjust the estimates of liability on a claim upward or downward. Such estimates are regularly reviewed and updated and any resulting adjustments are included in the current year’s income statement. Even then, the ultimate liability may exceed or be less than the revised estimates. The reserving process is intended to provide implicit recognition of the impact of inflation and other factors affecting loss payments by taking into account changes in historical payment patterns and perceived probable trends. There is generally no precise method for the subsequent evaluation of the adequacy of the consideration given to inflation, or to any other specific factor, because the eventual deficiency or redundancy of reserves is affected by many factors, some of which are interdependent. To the extent that reserves are deficient or redundant, the amount of such deficiency or redundancy is treated as a charge or credit to earnings in the period in which the deficiency or redundancy is recognized.

The following table summarizes the Company’s reserves for losses and LAE activity for the years ended December 31, 2012, 2011 and 2010:


	Year Ended December 31,
In thousands	2012			2011			2010
Net reserves for losses and LAE at beginning of year	$	1,237,234		$	1,142,542		$	1,112,934
Provision for losses and LAE for claims occurring in the current year		542,724			474,852			434,957
Increase (decrease) in estimated losses and LAE for claims occurring in prior years		(45,291	)		2,145			(13,802	)

Incurred losses and LAE		497,433			476,997			421,155
Losses and LAE paid for claims occurring during:
Current year		(110,373	)		(73,242	)		(76,982	)
Prior years		(407,385	)		(309,063	)		(314,565	)

Losses and LAE payments		(517,758	)		(382,305	)		(391,547	)

Net reserves for losses and LAE at end of year		1,216,909			1,237,234			1,142,542
Reinsurance recoverables on unpaid losses and LAE		880,139			845,445			843,296

Gross reserves for losses and LAE at end of year	$	2,097,048		$	2,082,679		$	1,985,838

The segment and line of business breakdowns of prior period net reserve deficiencies (redundancies) for the years ended December 31, 2012, 2011 and 2010 are as follows:


	Year Ended December 31,
In thousands	2012			2011			2010
Insurance Companies:
Marine	$	(10,010	)	$	1,348		$	(4,155	)
Property Casualty		4,293			(6,828	)		(14,923	)
Professional Liability		7,613			17,582			13,623

Insurance Companies	$	1,896		$	12,102		$	(5,455	)
Lloyd’s Operations:
Marine		(30,735	)		(10,311	)		(3,152	)
Property Casualty		(6,890	)		(5,434	)		(5,236	)
Professional Liability		(9,562	)		5,788			41

Lloyd’s		(47,187	)		(9,957	)		(8,347	)

Total deficiencies (redundancies)	$	(45,291	)	$	2,145		$	(13,802	)

The Insurance Companies recorded $1.9 million net prior period reserve deficiencies. The Marine business had $10.0 million of net reserve redundancies, which were primarily driven by:

•

an IBNR adjustment of 4.0 million to reflect the actual emergence of claims for underwriting year “(UY)” 2010, which was more favorable than the expected emergence.

•

case reserve releases of $3.4 million due to the favorable settlement of several large losses; and

•

a favorable IBNR adjustment of $2.6 million attributable to changes in our assumptions for salvage and subrogation from our short tail marine lines that was based on our observation of a consistent and persistent historical pattern of favorable savings attributable to salvage and subrogation.

The Marine reserve redundancies were partially offset by net reserve deficiencies of $7.6 million from the small lawyer and accountants lines within our Professional Liability business. This deficiency was primarily driven by IBNR increases of $3.4 million made to recognize the severity impact of several large losses that caused the actual claims emergence for these lines to exceed the expected emergence pattern. We also incurred net reserve deficiencies of $4.3 million within our Property Casualty segment which were primarily attributable to two large hemophiliac claims from UY 2011 arising from our A&H business.

Our Lloyd’s Operations recorded $47.2 million of net prior period reserve redundancies across all businesses and divisions. In connection with the Company’s implementation of the Solvency II technical provisions in its Lloyd’s operation, the Company’s actuaries undertook a comprehensive review during 2012 of the historical claims emergence patterns for all lines of business underwritten through Syndicate 1221. As a result of this review, the Company updated the loss emergence patterns used to project ultimate losses for all such lines of business, aligning these loss emergence factors with the historical median. This caused a reduction in ultimate loss estimates for all Lloyd’s segments other than certain lines of business in Property Casualty segment, which increased. The Lloyd’s Operation also experienced significant reserve redundancies in several large claims. The amount of reserve redundancies attributable to these settlements was $5.0 million, consisting of $4.1 million from the Lloyd’s Marine business and $0.9 million from Lloyd’s Professional Liability business. A summary of the resulting prior period redundancies for each business within our Lloyd’s Operations by prior UY is set forth below:


In thousands	Marine		Property Casualty		Professional Liability		Total
2010		3,492		378		1,157		5,027
2009		14,792		4,170		6,072		25,034
2008 and Prior		12,451		2,342		2,333		17,126

Total Redundancy	$	30,735	$	6,890	$	9,562	$	47,187

The following is a discussion of relevant factors impacting our $2.1 million net reserve deficiencies for the year ended December 31, 2011:

The adverse development of $1.3 million for our Insurance Companies Marine business was driven by $4.0 million of unfavorable loss emergence in Inland Marine in accident years 2009 and 2010 which was offset by $2.7 million favorable development in Ocean Marine. The Ocean Marine development was driven by $5.8 million of favorable development in accident years 2008 to 2010 and was partially offset by $3.2 million of adverse development for accident years 2007 and prior. Ocean Marine’s favorable development was driven by the Craft, protection and indemnity, and Transport classes with partial offsets from the Specie and Liability classes.

Our Insurance Companies Property Casualty business experienced $6.8 million of favorable development overall which was driven by favorable development of $8.4 million from Offshore Energy across several accident years and was partially offset by adverse development from runoff Liquor Liability in accident years 2008 and 2009.

Our Insurance Companies Professional Liability business had overall adverse development of $17.6 million, which consisted of adverse development of $14.5 million and $3.1 million from Management Liability and Errors and Omissions, respectively. The Management Liability development was primarily driven by coverage of Public companies for accident years 2009 and 2010. The Errors and Omissions development was driven by Small Lawyer Professional Liability and Miscellaneous Professional Liability classes for accident year 2010.

Our Lloyd’s operations experienced $10.0 million of favorable development. This was driven by favorable development of $10.3 million and $5.5 million from the Marine and Nav Tech divisions respectively, which was partially offset by $5.8 million of unfavorable development from Professional Liability. The favorable development in Marine was primarily from the Cargo, Liability and Specie classes for accident years 2008 and prior. The favorable development in Nav Tech was from Offshore Energy primarily in accident years 2007 to 2009. The adverse development in Professional Liability was mostly from Errors and Omissions in accident years 2006 to 2008.

The following is a discussion of relevant factors impacting our $13.8 million net reserve redundancies for the year ended December 31, 2010:

The Insurance Companies recorded $4.2 million of net prior year favorable development for the marine business, of which $2.6 million arose in the marine liability business due to favorable loss emergence relative to our expectations and $1.4 million in Hull as we eliminated IBNR in older underwriting years where we determined the year had been fully reported and saw case reserve reductions on a number of claims.

The Insurance Companies recorded $14.9 million of net prior year redundancies for property casualty business in total. The favorable development included:

•

$29.2 million for West Coast contractors’ liability due to an internal actuarial review conducted in 2010 which indicated that loss development on underwriting years 2006 to 2008 has been more favorable than our prior expectations with a partial offset for underwriting years 2004 and prior.

•

$2.9 million of favorable development on our offshore energy (NavTech) book due to favorable claims trends across a number of prior underwriting years.

•

$1.8 million of favorable development on the Somerset Re run-off book of business where we concluded the IBNR was no longer required and $1.5 million on our Agriculture reinsurance book where the reported activity was lower than our initial estimate for the 2009 treaty year.

Partially offsetting these favorable developments were adverse development of:

•

$16.5 million in our Specialty run-off books of business, including $13.3 million in our personal umbrella lines across multiple underwriting years where loss activity has exceeded our expectations and $2.0 million of adverse development in our Liquor business due to reported claim activity.

•

$1.7 million for New York construction liability due to unfavorable loss emergence.

The Insurance Companies recorded $13.6 million of net prior year unfavorable development for professional liability:

•

The directors and officers liability book of business had $15.7 million of adverse development, which was primarily attributable to a severity study of our open claims. This study showed our IBNR to be significantly deficient if current trends continued and we raised our loss estimates for underwriting years 2002 to 2009. This was partially offset by $1.4 million of favorable development on a run-off lawyers book of business written from London where we saw favorable settlements of outstanding claims and $0.7 million of favorable development on other lawyers business mostly due to a favorable claim reserve settlement.

The Lloyd’s Operations recorded $8.3 million in favorable loss development for prior years during 2010. This included favorable development of $3.2 million in Marine, $4.8 million in NavTech, and $0.5 million in all other areas. The Marine favorable development was primarily from the 2007 and 2008 underwriting years and was driven by loss development on these underwriting years being more favorable than our expectations, particularly in marine liability, assumed reinsurance, and specie classes. NavTech’s favorable development was mostly from the 2006 through 2008 underwriting years driven by favorable claims trends in the offshore energy.

Management believes that the reserves for losses and loss adjustment expenses are adequate to cover the ultimate cost of losses and loss adjustment expenses on reported and unreported claims. We continue to review our reserves on a regular basis.