A:
I think the 1" is the minimum required. I would hesitate to put this with just 1/8" on the sides, although the side clearance might just be to help with installation, not really required for ventilation.
I would not remove drywall to get additional clearance - the most you are going to get is about 1/2". Drilling holes isn't going to help either - you need space for hot air to escape, so holes in the drywall aren't going to help.
The additional vertical clearance may compensate for the lack of rear clearance, but you would need to consult with someone more knowledgeable to be sure.
I would check with LG to see if the clearances are enough and more importantly if it will affect the warranty in any way. One reason for getting this fridge is it has a 10 year compressor warranty.