Following a tumultuous 2001, Liberty Mutual Group’s focus in 2002 on the fundamentals of its property and casualty business brought significant growth and improvement in revenue, earnings, cash flow and financial strength.

This focus, driven by sound underwriting and firmer pricing, produced excellent financial results for the Group. Pre-tax income was $593 million on revenues of $14.5 billion, and our business units contributed $1.6 billion in positive cash flow.

In addition to good earnings, we continued to strengthen our loss reserves, an effort we started in 2001 in response to both rising workers compensation loss costs, driven primarily by high medical inflation, and the accelerated pace of asbestos claims.

The good financial performance was broad-based as each of our four major business units – Personal, Commercial, International and Regional Agency – performed well in 2002, and is among the leaders in each of its markets.

After a poor performance in 2001, our Personal Market property and casualty lines addressed changing loss trends and adjusted rates accordingly. These actions, along with a little help from Mother Nature in the form of good weather, resulted in a dramatic turnaround in profitability. Most gratifying was that continued high customer satisfaction and retention accompanied the improved profitability.

As anticipated, our core domestic Commercial Markets businesses are on a firm foundation after several years of tough pricing and underwriting decisions. As a result, 2002 was a tremendous year for these businesses, and we expect more of the same in 2003.

Our four-year-old independent agency business, Regional Agency Markets, now manages more than $3 billion in commercial and personal premium sold entirely through independent agents. With the addition of the OneBeacon book of business, Regional Agency Markets is a true national organization, with seven regional companies serving 5,000 independent agencies and brokers.

Finally, our young and growing international operation is now a $2.5 billion player. We are one of the largest foreign-based property and casualty insurers in South America; we have a growing presence in southern Europe and Southeast Asia; and our global risk business has put together a quality team of experienced underwriters who understand the global market for specialty coverages

Specific international achievements include our expansion into Portugal, making us the ninth-largest, non-life insurer in that nation, and receipt of the Chinese government’s permission to establish an insurance operation in that fast-developing country.

We must consider these achievements, however, against the backdrop of industry-wide trends and concerns – issues with negative implications for the long term, if not addressed aggressively.

Asbestos litigation, for example, is a serious national problem, with the insurance industry, and companies only peripherally associated with asbestos, funding an out-of-control litigation system. Conservative estimates place the ultimate costs to business – as a whole – at close to $250 billion, with the insurance industry’s share estimated at $70 billion. Without significant reform, some companies will not be able to fund this system much longer without significant cutbacks in ongoing operations, and those truly impaired claimants will not receive deserved compensation.

Terrorism risk, both from an exposure and pricing perspective, is another serious problem. In the aftermath of September 11, 2001, the insurance industry, with its capital severely weakened, sought to reduce its exposure to terrorism. The backstop provided by the federal government – The Terrorism Risk Insurance Act of 2002 – is a welcome, albeit partial, solution. It still leaves the insurance industry considerably exposed, most significantly in the out years. We believe that, ultimately, terrorism is an uninsurable risk. Society will have to rely on the Federal Government to provide both physical and financial protection from terrorism.

In a related, but positive note, we are extremely proud of our role as the insurer responsible for the safe cleanup of the World Trade Center site. Thanks to the professionalism of our employees, not one Liberty-insured person involved in the WTC cleanup lost his or her life, or, in fact, was seriously injured.

So, taking these achievements and the external environment into account, what is Liberty Mutual’s competitive position today?

Clearly we are a very different company than we were just a few years ago. We have four diversified business units, each operating with a considerable degree of independence and contributing a substantial share of total revenue. We are the eighth-largest property and casualty insurer in the U.S., and one of the few companies in the U.S. top ten to have significant international operations.

And, while we are as committed as ever to direct selling, we have well-established, multi-channel distribution capabilities that give our customers the flexibility to do business with us their way. This geographic and distribution channel diversification, combined with our reputation for superior customer service, positions us well for new opportunities in an increasingly competitive and consolidating global economy.

But in certain fundamental ways, we are the same company as we were five years ago, or even when founded in 1912. Each of our business units, whether serving a network of insurance agents in Venezuela or monitoring safe work practices for a middle-market manufacturer in Dallas, provides focused and consistent service over long periods of time.

Our business units operate with absolute integrity. They treat you fairly; handle your claims quickly and appropriately; and shape their products and services to benefit you over the long term.

Our employees treat you, and one another, with dignity and respect. In their daily interactions, they appreciate the significance and value of the other person.

Finally, and perhaps most importantly from a business perspective, our businesses aspire to provide consistently superior service at a price that is fair to you, while allowing them a reasonable profit.

As we enter 2003, our status is solid, and our strategy is sound and focused on how to succeed in a highly uncertain geo-political and economic environment.

Most important, we have remarkably talented employees dedicated to helping you manage your personal and business insurance costs and live safer, more secure lives.

As always, I thank you, our customers and policyholders, for the privilege of serving you over the past year, and I thank our Board of Directors and our 29 Advisory Boards for their continued support and guidance. Their collective experience and advice helps keep us focused on serving you.



Edmund F. Kelly
Chairman, President and Chief Executive Officer