Note 14. Dividends and Statutory Financial Information

The Parent Company has not paid or declared any cash dividends on common stock. There are no regulatory restrictions on the ability of the Parent Company to pay dividends. While there is no intention to pay cash dividends on the common stock, future declarations, if any, are at the discretion of our Board of Directors. The amounts of such dividends will be dependent, upon other factors such as, our results of operations and cash flow, financial condition and business needs, restrictive covenants under our credit facility that require us to maintain certain consolidated tangible net worth, the capital and surplus requirements of our subsidiaries, and applicable insurance regulations that limit the amount of dividends that may be paid by our regulated insurance subsidiaries. Refer to Note 8, Credit Facility, for additional information on the restrictions of our credit facility that limit the amount of dividends that may be paid by our subsidiaries.

The amount and nature of net assets that are restricted from payment of dividends as of December 31, 2012 and 2011 are presented in the following table:


	As of December 31,
In thousands	2012		2011
Restricted Net Assets:
Insurance Companies:
Fixed maturities at fair value (amortized cost: 2012, $9,607, 2011, $10,163)	$	11,728	$	12,489
Short term investments, at cost which approximates fair value		290		290
Cash		5,208		1,206

Total Insurance Companies ⁽¹⁾		17,226		13,985
Lloyd’s Operations:
Fixed maturities at fair value (amortized cost: 2012, $419,271, 2011, $386,275)		428,142		386,608
Short term investments, at cost which approximates fair value		72,984		59,928
Cash		849		1,938

Total Lloyd’s Operations ⁽²⁾		501,975		448,474

Total Restricted Net Assets	$	519,201	$	462,459

(1)–

The restricted net assets for the Insurance Companies primarily consist of fixed maturities on deposit with various state insurance departments. As of December 31, 2012 restricted net assets in the form of cash include approximately $4.0 million in collateral held in trust in connection with the commercial surety business. The remaining cash as of December 31, 2012 and 2011, as presented in the table above, was on deposit with a U.K. bank to comply with the regulatory requirements of the Financial Services Authority for the underwriting activities of the U.K. Branch.

(2)–

The restricted net assets for the Lloyd’s Operations consists of fixed maturities and cash held in trust for the benefit of syndicate policyholders and short term investments primarily consisting of overseas deposits in various countries with Lloyd’s to support underwriting activities in those countries.

In addition to the Company’s restricted net assets provided in the table above, there are regulatory limitations on the payment of dividends by our subsidiaries, discussed below, and the Company’s letter of credit facility is secured by all of the common stock of Navigators Insurance Company.

Insurance Companies

Navigators Insurance Company may pay dividends to the Parent Company out of its statutory earned surplus pursuant to statutory restrictions imposed under the New York insurance law. As of December 31, 2012, the maximum amount available for the payment of dividends by Navigators Insurance Company in 2013 without prior regulatory approval is $68.3 million. Navigators Insurance Company paid $15.0 million, $45.0 million and $40.0 million in dividends to the Parent Company in 2012, 2011 and 2010, respectively.

The Insurance Companies’ statutory net income as filed with the regulatory authorities for 2012, 2011 and 2010 was $28.6 million, $16.3 million and $85.7 million, respectively. The statutory capital and surplus as filed with the regulatory authorities was $682.9 million and $662.2 million as of December 31, 2012 and 2011, respectively.

The NAIC has codified statutory accounting practices (“SAP”) for insurance enterprises. As a result of this process, the NAIC issued a revised Statutory Accounting Practices and Procedures Manual that became effective January 1, 2001, and is updated each year. We prepare our statutory basis financial statements in accordance with the most recently updated statutory manual subject to any deviations prescribed or permitted by the New York Insurance Commissioner. The significant differences between SAP and GAAP, as they relate to our operations, are as follows: (1) acquisition and commission costs are expensed when incurred, while under GAAP these costs are deferred and amortized as the related premium is earned; (2) bonds are stated at amortized cost, while under GAAP bonds are classified as available-for-sale and reported at fair value, with unrealized gains and losses recognized in other comprehensive income as a separate component of stockholders’ equity; (3) certain deferred tax assets are not permitted to be included in statutory surplus, while under GAAP deferred taxes are provided to reflect all temporary differences between the carrying values and tax basis of assets and liabilities; (4) unearned premiums and loss reserves are reflected net of ceded amounts, while under GAAP the unearned premiums and loss reserves are reflected gross of ceded amounts; (5) agents’ balances over ninety days due are excluded from the balance sheet, and uncollateralized amounts due from unauthorized reinsurers are deducted from surplus, while under GAAP they are restored to the balance sheet, subject to the usual tests regarding recoverability.

The NAIC has adopted Risked Based Capital (“RBC”) requirements to elevate the adequacy of statutory capital and surplus in relation to risks associated with: (1) asset risk; (2) insurance risk; (3) interest rate and equity market risk; and (4) business risk. The RBC formula is designated as an early warning tool for the states to identify possible undercapitalized companies for the purpose of initiating regulatory action. In the course of operations, we periodically monitor the RBC level of the Navigators Insurance Company. As of December 31, 2012 and 2011, the Navigators Insurance Company exceeded the company action RBC levels. The RBC ratio of Navigators Insurance Company was approximately 295.1% and 307.8% of the company action level as of December 31, 2012 and 2011, respectively.

As part of its general regulatory oversight process, the New York State Department of Finance conducts detailed examinations of the books, records and accounts of New York insurance companies every three to five years. In 2011, the New York State Department of Finance conducted an examination of Navigators Insurance Company and Navigators Specialty Insurance Company for the years 2005 through 2009. The U.K. Branch is required to maintain certain capital requirements under U.K. regulations and subject to examination by the U.K. Financial Services Authority (FSA).

Lloyd’s Operations

Lloyd’s sets the corporate member’s required capital annually based on Syndicate 1221’s business plans, rating environment, reserving environment and input arising from Lloyd’s discussions with regulatory and rating agencies. The capital requirement of Syndicate 1221, known as Funds at Lloyd’s (the “FAL”), is currently calculated using the internal Lloyd’s risk-based capital model. The FAL may comprise cash, investments and undrawn letters of credit provided by various banks. As of December 31, 2012 and 2011, the FAL requirement set by Lloyd’s for Syndicate 1221 was $223.4 million (£137.1 million) and $223.4 million (£144.1 million) based on its business plans, approved in November 2012 and November 2011, respectively.

The valuation of the assets and letters of credit posted for FAL for Syndicate 1221 as of December 31, 2012 and 2011 was $227.3 million (£139.5 million) and $227.3 million (£146.7) million, respectively.

We prepare our Lloyd’s financial statements in accordance with U.K. GAAP basis. The significant differences between U.K. GAAP and GAAP, as they relate to our operations, are as follows: (1) investments are recorded at fair value with unrealized gains and losses being recorded in income while under GAAP the changes in unrealized gains and losses are recorded through other comprehensive income as a separate component of stockholders’ equity; (2) realized foreign exchange on inter-currency conversions are recorded through the income statement, while under GAAP foreign exchange translation is recorded through other comprehensive income as a separate component of stockholders’ equity; (3) Lloyd’s membership costs are not deferred for U.K. GAAP, while under GAAP a prepaid asset is established and amortized over each year of account.

The primary source of income for NCUL, a corporate member of Lloyd’s and controller of 100% of Syndicate 1221’s stamp capacity, is generated through Syndicate 1221. Syndicate 1221 is subject to oversight by the Council of Lloyd’s. Lloyd’s as a whole is authorized and regulated by the FSA. Syndicate 1221’s income as filed with Lloyd’s for 2012, 2011 and 2010 was $54.9 million, $5.3 million and $6.5 million, respectively. The Syndicate’s capital and surplus as filed with Lloyd’s was $110.0 million (£67.5 million) and $68.2 million (£44.0 million) as of December 31, 2012 and 2011, respectively. The difference between our Syndicate’s capital and surplus and the FAL primarily consists of letters of credit and cash held by our corporate member.

NCUL may pay dividends to the Parent Company up to the extent of available profits that have been distributed from Syndicate 1221. The Syndicate’s capital and surplus as filed with Lloyd’s consists of undistributed profits on closed and open years of account. In connection with the business plan approved in November 2012, NCUL posted all of the available undistributed profits on closed years of $91.1 million (£55.9 million) to support a portion of the FAL requirement and therefore that amount is not available for distribution to NCUL, which ultimately is not available to the Parent in the form of a dividend. As of December 31, 2012, NCUL has the ability to pay dividends of up to $8.6 million (£5.3 million), consisting of previously distributed profits from Syndicate 1221, to the Parent in the form of dividends.

Refer to Note 1, Organization and Summary of Significant Accounting Policies, for additional disclosure on the accounting treatment for Syndicate 1221 as it relates to closed and open years of account.