Fitch Updates Liberty Mutual’s Asbestos Charge

October 21, 2003

Fitch Ratings commented that following a review of Liberty Mutual Insurance Co.’s (Liberty) public disclosures regarding the completion of the insurance company’s ‘grounds up’ asbestos reserve study, the ‘A-‘ Insurer Financial Strength Rating, ‘BBB-‘ surplus note rating and Negative Rating Outlook remain unchanged.

The net asbestos reserve charge of $331 million, and moderate improvement in operating results during the first nine months of 2003, are consistent with the expectations Fitch had reportedly built into its negative rating outlook assigned in July 2003.

While Fitch is encouraged that Liberty has undertaken a grounds up review of its asbestos exposure, several aspects of the study are reportedly worthy of note.

Fitch believes the level of public disclosure was somewhat limited compared to that of several other prominent insurers that have undergone similar studies.

Fitch also noted that Liberty Mutual’s “settlement adjusted” survival ratio of 15x-16x is considerably below that of some other companies that have completed recent grounds up reserve studies. Finally, Fitch noted that the study was not conducted by one of the large, established actuarial firms that have produced the global asbestos estimates that have reportedly become the industry standard.

For stress test purposes, Fitch will continue to impose a traditional survival ratio target of roughly 12x for Liberty compared to its industry benchmark of 16x. The lower target for Liberty reflects consideration for management’s aggressive claim settlement practices, small account focus and limited excess exposure. Using the 12X target, Liberty’s pro-forma 2002 three year survival ratio (adjusted for the recent reserve charge, but not for settlements as per above) of 8.3x indicates a possible further reserving shortfall of up to $500 million.

Additionally, concerns that contributed to Fitch’s negative rating outlook persist.

Namely, Fitch reportedly believes that Liberty demonstrates moderate risk-adjusted capitalization. This is based on concerns as to the quality of reported capital in light of the adequacy of reserves related to the workers’ compensation and general liability lines of business, as well as heavy use of retroactive reinsurance to boost capital levels that will result in a decline of future investment income.

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