Unlike more well-known insurers focused on the consumer market, Navigators Group (NAVG) focuses on a limited number of global specialty lines of business such as marine, energy, specialty casualty, and professional liability.

There are two key benefits to focusing on niche, under-served markets characterized by higher severity and lower frequency of loss. First, the company is able to earn higher prices thanks to less competition as a result of the high level of technical expertise required. Second, there are typically fewer regulatory requirements compared to other lines of business, such as workers compensation and personal automobile insurance.

An expansion into other specialty lines such as commercial primary, excess liability, and reinsurance provide even greater diversification. However organic growth is still possible as management said on the most recent conference call that most of its segments outside of marine are not mature and it has less than a 4% share in the marine market despite being one of the largest underwriters.

Risk of rising interest rates is greatly exaggerated
While many investors assume that the end of the 30-year bull market for interest rates will have a negative impact on insurers with large fixed income portfolios, there are two key points to remember. First, insurers can typically hold securities showing unrealized losses to maturity, unlike fixed income mutual funds, who may be forced to sell to meet investor redemptions. Second, insurers such as Navigators Group, with a short duration of only around 3.9 years, can earn higher investment income as maturing funds are reinvested at higher rates.

Underwriting discipline claimed by many, practiced by few
The commitment to underwriting profit instead of high market share or premium growth should not be taken for granted as it is one of the key drivers of long-term profitability. Every insurer claims to maintain discipline in the underwriting process yet few actually practice what they preach. The focus by management on the long term is most likely because they own about 25% of the company. 

The underwriting discipline can be seen in the combined ratio -- that is, the sum of losses and expenses divided by premiums. A ratio less than 100% results in an underwriting profit, while a ratio above leads to a loss. As shown in this chart from a recent company presentation, the combined ratio for Navigators Group is consistently lower than the industry.

There is skill required in walking away from writing business. For example, management said that premium volume was down 5% in the professional liability segment as it shifted away from small law firms toward a broader base of small- to medium-sized professional service firms. While this pressures overall premiums, it's expected to result in a higher-margin portfolio over the next year.

Peer comparisons
Navigators Group trades at a discount to its peer group despite similarly strong financial results. For example, the shares trade at a price-to-book value of only 0.98 with a trailing-12-month return on equity of 8.7% and a combined ratio of 99%. In the quarter ended in September, it posted record quarterly operating earnings thanks to across-the-board favorable underwriting performance.

Markel, another extremely disciplined underwriter, trades at a P/B of 1.25 with a return on equity of 4.7% and a combined ratio of 97%. HCC Insurance trades at a P/B of 1.28, although this higher multiple is deserved given the return on equity of 11.3% and a combined ratio of only 84%. Argo Group International trades at a P/B of 0.81 with a return on equity of 5.9% and a combined ratio of 105%. 

Bottom line
Warren Buffett, who knows a thing or two about insurance, said, "You never know who's swimming naked until the tide goes out." Navigators Group is one of the few companies who truly understands this, which is reflected in the strong financial performance. However, the fact that the market has not yet recognized this provides investors an attractive entry point.