Moody's expects the majority of the proceeds from the $500 million transaction will be used to refinance higher cost debt and strengthen subsidiary capital levels. In the same action, the rating agency affirmed the A2 insurance financial strength ratings of Liberty Mutual Insurance Company (LMIC) and members of its inter-company pool, as well as the Baa2 rating on the surplus notes issued by LMIC. The outlook for all of Liberty's long-term ratings remains negative.
Moody's noted that the Baa3 rating of the holding company's (LMGI) senior unsecured debt reflects its structural subordination to LMIC's surplus notes. At Baa2, Liberty Mutual's surplus notes reflect Moody's typical three notch spread relative to the company's insurance financial strength rating. Moody's noted that the investment grade rating of LMGI's senior debt considers its sound liquidity profile, which also benefits from unrestricted cash flows and earnings from its service operations within Liberty Corporate Services (LCS). At present, Moody's does not believe that the additional liquidity from LCS is sizable enough to warrant eliminating the 1 notch distinction between the rating of LMGI senior debt and the LMIC surplus notes. Were that liquidity to grow substantially, Moody's might reconsider the notching, particularly if LMGI supplanted LMIC as the primary borrower within the group. In the near term, earnings from LCS should provide adequate coverage of the holding company's prospective interest payment obligations and reduce potential demands for subsidiary dividends, which are constrained by regulation and by Liberty's need to maintain adequate capitalization at it's operating subsidiaries. Notwithstanding this, Moody's noted that the unrestricted dividend capacity of LMGI's insurance subsidiaries increased significantly in 2004, and provides LMGI with relatively strong levels of fixed charge coverage.
Moody's noted that the transaction will increase the group's consolidated financial leverage to around 23% and the rating agency noted that expectations for Liberty's current ratings include a financial leverage profile below 25% with operating earnings coverage of consolidated interest expenses in the 5-6x range. Moody's also noted that the continued negative outlook on Liberty's long-term ratings reflects the group's relatively weak position, within its rating category, on certain key measures of financial performance and capital adequacy. Consistent with Moody's expectations for Liberty's current ratings, the company has recently improved its absolute position with respect to several of these quantitative measures, including core return on earned premium and risk-based capitalization. The US group's statutory surplus increased by over $2.0 billion, to $7.2 billion at the end of 2003, which alleviates some, but not all, of Moody's concerns about capital sufficiency at the group. The rating agency also noted that most of the increase in surplus was due to factors other than operating earnings growth.
According to Moody's, Liberty's current ratings reflect expectations for continued improvements in operating results and capital adequacy; meaningful improvements in these areas would likely stabilize the rating outlook and stasis or deterioration in these measures would likely lead to a downgrade.
The Liberty Mutual Group is a Boston-based mutual holding company that provides personal and commercial insurance products both domestically and internationally. On a GAAP basis, the group reported almost $14 billion in net earned premiums and a 104.4% combined ratio in 2003. As of December 31, 2003, Liberty reported almost $7.4 billion in