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Rating Action:

Moody's affirms Liberty Mutual's ratings; outlook changed to negative

23 Apr 2008
Moody's affirms Liberty Mutual's ratings; outlook changed to negative

Pending acquisition of Safeco Corporation for approximately $6.2 billion.

New York, April 23, 2008 -- Moody's Investors Service has affirmed the debt and insurance financial strength ratings of Liberty Mutual Group Inc. (LMGI) and its subsidiaries following the company's announcement this morning of a definitive agreement to acquire SAFECO Corporation (NYSE: SAF) for approximately $6.2 billion. The outlook for all of Liberty Mutual's long-term ratings has been changed to negative, from stable. The outlook for the company's short-term Prime-2 rating for commercial paper remains stable, based on a guarantee provided by Liberty Mutual Insurance Company (LMIC).

According to Moody's, the ratings were affirmed because the acquisition represents a sound strategic move for Liberty Mutual that will further strengthen the group's Agency Markets franchise and its presence in the California and Pacific Northwest regions, as well as in surety, and that will bring further balance between the group's commercial and personal lines operations. Furthermore, Moody's believes that the limited geographic and agency overlap of the two companies' operations should help to both enhance the combined group's operational platform and to mitigate integration risks post-acquisition. Upon completion of the transaction, Liberty Mutual will become the fifth largest property and casualty insurer in the United States. Moody's added that these positive franchise-related developments will, in its view, be somewhat offset over the near-to-intermediate term by incrementally negative financial considerations driven by the price and funding of the deal.

The rating agency noted that the change to a negative outlook is primarily driven by the decrease in Liberty Mutual's financial flexibility and capital adequacy measures that will result from the significant use of internal resources to finance the acquisition, as well as by increased leverage to tangible capital that will result by the generation of substantial goodwill intangibles given the purchase price. Specifically, Moody's noted that although Liberty Mutual's capital adequacy -- like that of nearly all of its major industry competitors -- has strengthened substantially in recent years through earnings and internal capital generation, as well as through capital-raising initiatives, the group's underwriting leverage will increase -- and its risk-adjusted capital measures will decrease -- substantially following the completion of the acquisition.

Although Moody's currently views Liberty Mutual, like many of its competitors, as having total capital that is in excess of current expectations for the group's rating level, the rating agency believes that at least a portion of this excess capital will be necessary to help insulate the company from the likely effects of the current industry-wide down-cycle over the coming years. Moody's believes that this concern is somewhat tempered by its view that SAFECO's operations have continued to maintain a strong level of capital adequacy at the insurance subsidiaries, and that the combined operation's risk-adjusted capital metrics should benefit incrementally from a broader diversification of risk. With respect to financial flexibility, Moody's noted that the proposed funding for the acquisition, assuming LMGI's issuance of up to $1.5 billion of hybrid securities and debt, will result in a heightened financial leverage profile relative to tangible capital. Moody's noted that although it does not consider LMGI's pro forma financial flexibility and capital adequacy position to be incompatible with the group's current long-term ratings, a further weakening of either of these factors -- or failure to raise capital externally having significant equity-like character in a timely manner -- would likely lead to a downgrade of LMIC's and LMGI's long-term ratings. Consequently, Moody's views Liberty Mutual's financial metrics, pro forma for the pending acquisition and inclusive of the company's plan to raise external capital, to be at the limits for expectations at the current rating level with respect to both capital adequacy and financial flexibility.

Moody's also noted other general risks associated with the pending acquisition and integrating the acquired operations. Specifically, the premium being paid relative to SAFECO's prior market value and book value per share raises questions about future growth rates and expense efficiencies that may or may not be achievable over the intermediate term, given prevailing industrywide cycle trends.

Finally, with respect to Liberty Mutual's notching (i.e. the difference between the group's debt and insurance financial strength ratings), Moody's noted that the expected coverage by Liberty Corporate Services (LCS) of LMGI's debt service requirements -- pro forma for acquisition-related capital raising -- as well as any potential future debt servicing costs will likely be reduced, placing incrementally larger debt servicing requirements on dividend flows from LMIC to LMGI. Although Moody's continues to maintain the existing notching, this analytic issue could be reconsidered over time, should coverage levels by LCS diminish significantly.

The following ratings have been affirmed, with outlooks changed to negative, from stable:

Liberty Mutual Group, Inc. -- guaranteed senior unsecured debt at Baa1 (originally issued by Liberty Mutual Capital Corporation, and subsequently merged into LMGI) based on a guarantee from Liberty Mutual Insurance Company; senior unsecured debt at Baa2; junior subordinated debt at Baa3;

Liberty Mutual Insurance Company -- insurance financial strength at A2; surplus notes at Baa2; long-term issuer credit rating at Baa1;

Ohio Casualty Corporation - senior unsecured debt at Baa2; [Ohio Casualty Corporation's shelf registration has been withdrawn, as have its provisional ratings for senior unsecured debt at (P)Baa2, subordinated debt at (P)Baa3, and preferred stock at (P)Ba1; for the same reason, the provisional ratings of the Ohio Casualty Capital Trusts I and II for preferred securities at (P)Baa3 have also been withdrawn.]

Insurance financial strength ratings at A2 for other members of the Liberty Mutual and affiliated intercompany pool members, including the following:

- American Fire & Casualty Company

- Avomark Insurance Company

- Employers Insurance of Wausau

- First Liberty Insurance Corporation

- Liberty Insurance Company of America

- Liberty Insurance Corporation

- Liberty Insurance Underwriters, Inc.

- Liberty Mutual Fire Insurance Company

- Liberty Mutual Insurance Company

- Liberty Surplus Insurance Corporation

- LM Insurance Corporation

- Ohio Casualty Insurance Company

- Ohio Security Insurance Company

- Wausau Business Insurance Company

- Wausau General Insurance Company

- Wausau Underwriters Insurance Company

- West American Insurance Company

The following rating has been affirmed with a stable outlook:

Liberty Mutual Group, Inc. -- rating at Prime-2 for commercial paper (guaranteed by Liberty Mutual Insurance Company).

Moody's most recent rating action on Liberty Mutual was on May 7, 2007, when the rating agency upgraded Liberty Mutual Group Inc.'s non-guaranteed long-term debt and confirmed its other ratings on the company and its subsidiaries.

Liberty Mutual Group Inc. (LMGI), based in Boston, is a mutual holding company for a diversified global insurance group that provides personal and commercial insurance products both domestically and internationally. The group was the sixth largest property and casualty insurer in the U.S. based on 2007 direct written premium. On a GAAP basis, for the full year 2007, the group reported net earned premiums of $21.9 billion and net income of $1.5 billion. As of December 31, 2007, LMGI reported consolidated GAAP assets of $94.7 billion and policyholders' equity of $12.4 billion.

Moody's insurance financial strength ratings are opinions of the ability of insurance companies to repay senior policyholder claims and obligations. For more information, visit our website at www.moodys.com/insurance.

New York
Alan Murray
VP - Senior Credit Officer
Financial Institutions Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
Robert Riegel
Managing Director
Financial Institutions Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

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