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LIBERTY MUTUAL HOLDING COMPANY INC.
<br />Notes to Consolidated Financial Statements
<br />(dollars in millions, except per share amounts)
<br />(unaudited)
<br />(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
<br />Basis of Preaentadon
<br />The accompanying consolidated financial statements include the accounts of Liberty Mutual Holding Company Inc. and its subsidiaries (collectively "LMHC" or the
<br />"Company'. Certain reclassifications have been made to the 2006 and 2005 consolidated financial statements to conform with the 2007 presentation. All material
<br />intercompany transactions and balances have been eliminated.
<br />The accompanying consolidated financial statements have been prepazed in conformity with accounting principles generally accepted in the United States ("GAAP'~.
<br />The preparation of finanual statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets
<br />and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the
<br />reporting period. The Company's principal estimates include (1) unpaid losses and loss expense reserves, including asbestos and environmental reserves, (2) allowance
<br />for uncollectible reinsurance and polityholder receivables, (3) fair value determination and other than temporary impairments of the investment portfolio, (4) deferred
<br />acquisition costs, (5) the valuation of goodwill and intangible assets, and (6) valuation allowance on deferced taxes. While management believes that the amounts
<br />included in the consolidated financial statements reflect their best estimates and assumptions, these amounts ultimately could be materially different from the amounts
<br />curcendy provided for in the consolidated financial statements.
<br />Adoption of New Accounting Standards
<br />Lffective December 31, 2007, the Company adopted Statement of Financial Accounting Standards No. 158, "Employers' Acrounting for D~ned Benefit Pennon and Other
<br />Portretirement Plans, au Amendment of FASB Statements Na. 87, 88, 106 and 132(R)"("SFAS 158'x. This statement requires the Company to (a) recognize the funded status
<br />of its pension, supplemental pension and postretirement benefit plans on the consolidated balance sheet as an asset or liability, measured as the difference between plan
<br />assets at fair value and the benefit obligation as of the employer's fiscal year end, with a corresponding adjustment co accumulated other comprehensive income (AOCI),
<br />net of tax; and to (b) recognize as a component of AOCI, net of tax, actuarial gains or losses or prior service cost or credit that arise during the period but are not
<br />recognized as a component of net periodic benefit cost. Consistent with the provisions of SFAS 158, these amounts will be subsequently recognized in the income
<br />statement pursuant to the Company's historical accounting potty Eor amortizing such amounts with a corresponding offset to AOCI. The provisions of SFAS 87 and
<br />SPAS 106 continue to apply in measuring plan assets and benefit obligations, as of the date of fiscal year-end statement of financial position, and in determining net
<br />periodic benefit cost. The provisions of SFAS 158 are not to be applied retrospectively. The adoption of SFAS 158 as of December 31, 2007 decreased other assets by
<br />$245, increased other liabilities by $198, increased deferred tax assets by $155, and decreased accumulated other comprehensive income, a component of polityholders'
<br />equity by $288, net of tax. Adoption of SFAS 158 did not affect the Company's result of operation or liquidity as SFAS 158 does not affect the determination of net
<br />periodic benefit costs.
<br />Effective January 1, 2007, the Company adopted Statement of Financial Accounting Standards No. ] 55, "Acrounting for Certain Hybrid Financial Inttrumentt - an Amendment
<br />of FASB Statements No. 133 and 140" ("SFAS 155'x. SFAS 155 nullifies the guidance in the FASB's Derivatives Implementation Group Issue Dl "Application of Statement
<br />133 to Beneficial Interrtu in SecuritiZed Atret.~', which had deferced the bifurcation requirements of Statement of Financial Accounting Standards No. 133, "Acrounting for
<br />Derivative In.rtrumentr and Hedging Artivitie.~' ("SFAS 133'x, for certain beneficial interests in securirized financial assets. SFAS 155 requires beneficial interests in securitized
<br />financial assets be analyzed to determine whether they are freestanding derivatives or hybrid instruments that contain an embedded derivative requiring bifurcation.
<br />SFAS 155 is effective for all financial instruments acquired, issued or subject to a re-measurement (new basis) event occurring after the beginning of an entity's fiscal year
<br />that begins after September 15, 2006. In January 2007, the FASB issued Derivative Implementation Group Issue No. B40, "Embedded DerivativetApplication afParagrapb
<br />13(b) to SecuritiZed Interertr in Prepayable FinanrialA.rreh" ("DIG B40'~. DIG B40 provided limited exemption from bifurcation of embedded derivatives as required by
<br />paragraph 13(b) of SFAS 133. Management has concluded the exemption applies for the Company's investment in its mortgage backed securities, and as a result, SPAS
<br />155 did not impact the Company's consolidated fmancial statements.
<br />Lffective January 1, 2007, the Company adopted the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants' ("AcSEC'~
<br />Statement of Position No. OS-1, 'Arrounting by Inrurante Enterpriau for Deferred Acquisition Corti m Connection urtb Modifications or Excbanget of Insurance Contrails" ("SOP OS-
<br />1'~. SOP OS-1 provides guidance on accounting by insurance enterprises for deferred acquisition costs on internal replacements of insurance and investment contracts
<br />other than those specifically described in FASB Statement No. 97, `Arrounting and Reporting by Iaruraare Enterpriser jor Certain Lang-Duration ConMaili and for Realized taint
<br />and L.atrer from the Sak of Invettmentr" ("SFAS 97'x. As defined by SOP OS-1, an internal replacement is a modification in product benefits, features, rights, or coverage
<br />that occurs by exchange of a contract for a new contract, or by amendment, endorsement, rider, or by election of a feature or coverage within an existing contract. The
<br />adoption of SOP OS-1 did not impact the Company's consolidated financial statements.
<br />Effective January 1, 2007, the Company adopted Interpretation No. 48, "Arrounting for Uncertainty in Inrome Taxe1 an Interpretation of FASB Statement No. 109" ("FIN 48'~
<br />issued by the FASB in June 2006. FIN 48 requires companies to recognize the tax benefits of uncertain tax positions only where the position is "more likely than not"
<br />to be sustained assuming examination by tax authorities. The amount recognized is the amount that represents the largest amount of tax benefit that is greater than 50%
<br />likely of being ultimately realized. A liability is recognized for any benefit claimed, or expected to be claimed, in a tax return in excess of the benefit recorded in the
<br />financial statements, along with any interest and penalty (if applicable) on the excess. FIN 48 requires a tabular reconciliation of the change in the aggregate
<br />unrecognized tax benefits claimed, or expected to be claimed, in tax returns and disclosure relating to accrued interest and penalties for unrecognized tax benefits.
<br />Discussion is also required for those uncertain tax positions where it is reasonably possible that the estimate of the tax benefit will change significantly in the next 12
<br />months. As a result of the adoption, the Company recognized a decrease of approximately $11 in the liability for unrecognized tax benefits, which was accounted for as
<br />an increase to retained earnings.
<br />As of the date of adoption of FIN 48, the total amount of unrecognized tax benefits was approximately $107, including approximately $85 related to tax positions that
<br />would impact the annual effective rate. The Company recognizes interest and penalties related to unrecognized tax benefits in Federal and foreign income tax expense
<br />and had approximately $39 accrued as of]anuary 1, 2007. The Company has not had any material changes to the unrecognized benefits within the last 12 months since
<br />the adoption date.
<br />The IRS is curcentiy reviewing the Company's federal tax returns for the 1999 through 2005 tax years. Any adjustments that might result from the IRS examination of
<br />these income tax returns are not expected to have a material impact on the financial position, liquidity or results of operations of the Company.
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