NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
1.
Statement of
Accounting Principles
The
accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with U.S. generally accepted accounting principles and
include all normal recurring adjustments which Aon Corporation (Aon or the
Company) considers necessary for a fair presentation. Operating results for
the third quarter and nine months ended September 30, 2007 are not necessarily
indicative of results that may be expected for the year ending December 31,
2007.
Refer to the consolidated financial statements and notes in the Annual
Report on Form 10-K for the year ended December 31, 2006 for additional details
of Aons financial position, as well as a description of Aons accounting
policies, which have been continued without material change, except as
described in Note 13.
2.
New
Accounting Pronouncements
In February 2007, the Financial Accounting Standards Board (FASB)
issued Statement No. 159,
The Fair Value Option for
Financial Assets and Financial Liabilities,
which permits entities
to choose to measure many financial instruments and certain other items at fair
value. FASB Statement No. 159 is effective for fiscal years beginning after
November 15, 2007. The impact of FASB Statement No. 159 on Aon has not yet been
determined.
3.
Stock Compensation Plans
Aons Stock Incentive Plan (as amended and restated) provides for the
grant of non-qualified and incentive stock options, stock appreciation rights,
restricted stock and restricted stock units (RSUs). The annual rate at which
awards are granted each year is based upon financial and competitive business
conditions.
Compensation expense
Stock based compensation expense recognized during 2007 and 2006, which
includes RSUs, stock options, performance plan awards and stock purchases
related to the Employee Stock Purchase Plan, are based on the value of the
portion of share-based payment awards that is ultimately expected to vest
during the period. Stock-based compensation expense recognized in Aons
condensed consolidated statements of income includes compensation expense for
share-based payment awards granted prior to, but not yet vested as of December
31, 2005 based on the grant date fair value estimated in accordance with the
pro forma provisions of FASB Statement No. 123, and compensation expense for
the share-based payment awards granted subsequent to December 31, 2005 based on
the grant date fair value estimated in accordance with the provisions of FASB
Statement No. 123(R). Because stock-based compensation expense recognized is
based on awards ultimately expected to vest, it has been reduced for estimated
forfeitures. FASB Statement No. 123(R) requires forfeitures to be estimated at
the time of grant and revised, if necessary, in subsequent periods if actual
forfeitures differ from those estimates.
The following table summarizes stock-based compensation expense related
to all share-based payments, which is included in compensation and benefits in
the accompanying condensed consolidated statements of income (in millions):
5
|
|
Three months ended
September 30,
|
|
Nine months ended
September 30,
|
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
RSUs
|
|
$
|
26
|
|
$
|
22
|
|
$
|
86
|
|
$
|
73
|
|
Performance plans
|
|
13
|
|
7
|
|
45
|
|
19
|
|
Stock options
|
|
5
|
|
5
|
|
18
|
|
18
|
|
Employee stock purchase plan
|
|
1
|
|
1
|
|
3
|
|
3
|
|
Total
|
|
$
|
45
|
|
$
|
35
|
|
$
|
152
|
|
$
|
113
|
|
Stock Awards
Stock awards, in the form of RSUs, are granted to certain executives
and key employees of Aon. Prior to 2006, RSUs granted to employees were
service-based. Beginning with awards granted in 2006, awards to employees may
consist of both performance-based RSUs and service-based RSUs. For
service-based awards, employees are generally required to complete three
continuous years of service before stock awards begin to vest in increments
until the completion of a 10-year period of continuous employment. Beginning in
2002, a large number of awards have been granted that vest in various patterns
over five years from the date of grant. For most employees, individual
incentive compensation over $50,000 is paid partially in RSUs, which vest over
three years. In general, most stock awards are issued as they become vested. In
years prior to 2006, in certain circumstances, an employee was able to elect to
defer the receipt of vested shares to a later date. With certain limited
exceptions, any break in continuous employment will cause forfeiture of all
unvested awards. The compensation cost associated with each stock award is
deferred and amortized over the period of continuous employment using the
straight-line method. Dividend equivalents are generally paid on certain
service-based RSUs.
In 2007 and 2006, performance-based RSUs were granted to certain executives
and key employees, whose vesting is contingent upon meeting various individual,
divisional or company-wide performance goals, including revenue generation or
growth in revenue, pretax income or earnings per share over a one- to five-year
period. Aon accounts for these awards as performance condition RSUs. The
performance condition is not considered in the determination of grant date fair
value of these awards. Compensation cost is recognized over the performance
period, and in certain cases an additional vesting period, based on managements
estimate of the number of units expected to vest. Compensation cost will be
adjusted to reflect the actual number of shares paid out at the end of the
programs. The payout of shares under these performance-based plans may range
from 0-200% of the number of units granted, based on the plan. Dividend
equivalents are generally not paid on the performance-based RSUs.
Information regarding Aons performance-based plans follows (shares in
thousands, dollars in millions):
|
|
Nine months ended
September 30,
|
|
|
|
2007
|
|
2006
|
|
Potential RSUs to be issued based on
current performance levels
|
|
4,910
|
|
2,551
|
|
Shares forfeited during the period
|
|
66
|
|
9
|
|
RSUs awarded during the period
|
|
9
|
|
30
|
|
Unamortized expense, based on current
performance levels
|
|
$
|
110
|
|
$
|
77
|
|
|
|
|
|
|
|
|
|
6
A summary of the status of Aons non-vested stock awards is as follows
(shares in thousands):
|
|
2007
|
|
2006
|
|
|
|
|
|
Fair
|
|
|
|
Fair
|
|
Nine months ended September 30,
|
|
Shares
|
|
Value
|
|
Shares
|
|
Value
|
|
Non-vested at beginning of period
|
|
12,870
|
|
$
|
28
|
|
11,641
|
|
$
|
25
|
|
Granted
|
|
4,087
|
|
39
|
|
3,334
|
|
38
|
|
Vested
|
|
(1,920
|
)
|
30
|
|
(1,661
|
)
|
25
|
|
Forfeited
|
|
(430
|
)
|
33
|
|
(438
|
)
|
28
|
|
Non-vested at end of period
|
|
14,607
|
|
$
|
32
|
|
12,876
|
|
$
|
28
|
|
Stock Options
Options to purchase common stock are granted to certain executives and
key employees of Aon and its subsidiaries, generally at 100% of market value on
the date of grant. Generally, employees are required to complete two continuous
years of service before the options begin to vest in increments until the
completion of a 4-year period of continuous employment. However, beginning in
2004 a significant number of options were granted that required five continuous
years of service before all options would vest. For all grants made prior to an
amendment to the former stock option plan in 2000, employees were required to
complete three continuous years of service before the options began to vest in
increments until the completion of a 6-year period of continuous employment. The
maximum contractual term on stock options is generally ten years from the date
of grant.
Upon the adoption of FASB Statement No. 123(R) on January 1, 2006, Aon
changed its method of valuation for stock options granted beginning in 2006 to
a lattice-binomial option-pricing model from the Black-Scholes option-pricing
model, which was previously used for Aons pro forma information required under
FASB Statement No. 123. Lattice-based option valuation models utilize a range
of assumptions over the expected term of the options. Expected volatilities are
based on the average of the historical volatility of Aons stock price and the
implied volatility of traded options and Aons stock. Aon uses historical data
to estimate option exercise and employee terminations within the valuation
model, stratifying between executives and key employees. The expected dividend
yield assumption is based on the companys historical and expected future
dividend rate. The risk-free rate for periods within the contractual life of
the option is based on the U.S. Treasury yield curve in effect at the time of
grant. The weighted average assumptions, the weighted average expected life and
estimated fair value of employee stock options are summarized as follows:
|
|
Three months ended September 30,
|
|
Key employees
|
|
2007
|
|
2006
|
|
Weighted average volatility
|
|
26.9
|
%
|
30.1
|
%
|
Expected dividend yield
|
|
1.4
|
%
|
2.3
|
%
|
Risk-free rate
|
|
4.9
|
%
|
5.1
|
%
|
|
|
|
|
|
|
Weighted average expected life, in years
|
|
5.8
|
|
6.0
|
|
Weighted average estimated fair value per
share
|
|
$
|
12.59
|
|
$
|
10.14
|
|
|
|
|
|
|
|
|
|
7
|
|
Nine months ended September 30,
|
|
|
|
2007
|
|
2006
|
|
|
|
Executives
|
|
Key
Employees
|
|
Executives
|
|
Key
Employees
|
|
Weighted average volatility
|
|
26.2
|
%
|
26.8
|
%
|
30.5
|
%
|
29.5
|
%
|
Expected dividend yield
|
|
1.7
|
%
|
1.6
|
%
|
2.3
|
%
|
2.3
|
%
|
Risk-free rate
|
|
4.7
|
%
|
4.6
|
%
|
4.4
|
%
|
4.6
|
%
|
|
|
|
|
|
|
|
|
|
|
Weighted average expected life, in years
|
|
4.6
|
|
5.8
|
|
5.0
|
|
6.0
|
|
Weighted average estimated fair value per
share
|
|
$
|
9.58
|
|
$
|
11.67
|
|
$
|
11.08
|
|
$
|
10.75
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
A summary of the status of Aons stock options and related information
is as follows (shares in thousands):
|
|
Nine months ended September 30,
|
|
|
|
2007
|
|
2006
|
|
|
|
|
|
Weighted
|
|
|
|
Weighted
|
|
|
|
|
|
Average
|
|
|
|
Average
|
|
|
|
|
|
Exercise
|
|
|
|
Exercise
|
|
|
|
Shares
|
|
Price
|
|
Shares
|
|
Price
|
|
Beginning outstanding
|
|
32,889
|
|
$
|
30
|
|
34,851
|
|
$
|
29
|
|
Granted
|
|
1,901
|
|
40
|
|
2,883
|
|
39
|
|
Exercised
|
|
(5,885
|
)
|
28
|
|
(3,494
|
)
|
28
|
|
Forfeited and expired
|
|
(619
|
)
|
32
|
|
(523
|
)
|
29
|
|
Outstanding at end of period
|
|
28,286
|
|
$
|
31
|
|
33,717
|
|
$
|
30
|
|
Exercisable at end of period
|
|
16,473
|
|
$
|
31
|
|
18,987
|
|
$
|
32
|
|
The weighted average remaining contractual life, in years, of
outstanding options was 5.2 years and 5.5 years at September 30, 2007 and 2006,
respectively.
The aggregate intrinsic value represents the total pretax intrinsic
value, based on options with an exercise price less than the Companys closing
stock price of $44.81 as of September 30, 2007, which would have been received
by the option holders had those option holders exercised their options as of
that date. At September 30, 2007, the aggregate intrinsic value of options
outstanding was $397 million, of which $223 million was exercisable.
The aggregate intrinsic value of options exercised during the third
quarter and nine months ended September 30, 2007 were $16 million and $75
million, respectively, and for the third quarter and nine months ended
September 30, 2006 were $4 million and $45 million, respectively.
Unamortized deferred compensation expense, which includes both options
and awards, amounted to $350 million as of September 30, 2007, with a remaining
weighted-average amortization period of approximately 2.2 years.
Cash received from the exercise of stock options was $165 million and $103
million during the nine months ended September 30, 2007 and 2006, respectively.
The tax benefit realized from stock options exercised in the first nine months
of 2007 and 2006 was $25 million and $20 million, respectively.
During the first nine months ended September 30, 2007, a majority of
option exercises and award vestings were satisfied through the reissuance of
treasury shares.
8
4.
Income Per Share
Income per share is calculated as follows:
|
|
Three months ended
September 30,
|
|
Nine months ended
September 30,
|
|
(millions, except per share data)
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
Income from continuing operations
|
|
$
|
188
|
|
$
|
90
|
|
$
|
638
|
|
$
|
438
|
|
Income from discontinued operations, net of
tax
|
|
16
|
|
16
|
|
19
|
|
58
|
|
Cumulative effect of a change in accounting
principle, net of tax
|
|
|
|
|
|
|
|
1
|
|
Net income for basic per share calculation
|
|
204
|
|
106
|
|
657
|
|
497
|
|
Interest expense on convertible debt
securities, net of tax
|
|
2
|
|
2
|
|
5
|
|
5
|
|
Net income for diluted per share
calculation
|
|
$
|
206
|
|
$
|
108
|
|
$
|
662
|
|
$
|
502
|
|
|
|
|
|
|
|
|
|
|
|
Basic shares outstanding
|
|
295
|
|
316
|
|
296
|
|
320
|
|
Effect of convertible debt securities
|
|
11
|
|
14
|
|
13
|
|
14
|
|
Common stock equivalents
|
|
15
|
|
10
|
|
14
|
|
11
|
|
Diluted potential common shares
|
|
321
|
|
340
|
|
323
|
|
345
|
|
Basic net income per share:
|
|
|
|
|
|
|
|
|
|
Continuing operations
|
|
$
|
0.64
|
|
$
|
0.29
|
|
$
|
2.16
|
|
$
|
1.37
|
|
Discontinued operations
|
|
0.05
|
|
0.05
|
|
0.06
|
|
0.18
|
|
Cumulative effect of a change in accounting
principle, net of tax
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
0.69
|
|
$
|
0.34
|
|
$
|
2.22
|
|
$
|
1.55
|
|
Diluted net income per share:
|
|
|
|
|
|
|
|
|
|
Continuing operations
|
|
$
|
0.59
|
|
$
|
0.27
|
|
$
|
1.99
|
|
$
|
1.29
|
|
Discontinued operations
|
|
0.05
|
|
0.05
|
|
0.06
|
|
0.17
|
|
Cumulative effect of a change in accounting
principle, net of tax
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
0.64
|
|
$
|
0.32
|
|
$
|
2.05
|
|
$
|
1.46
|
|
Certain common stock equivalents related to options were not included
in the computation of diluted net income per share because those options
exercise price was greater than the average market price of the common shares. The
number of options excluded from the quarterly calculation was 7 million and 12
million at September 30, 2007 and 2006, respectively. For the nine months ended
September 30, 2007 and 2006, the number of options excluded was 7 million and 7
million, respectively.
During the second quarter 2007, holders of $57 million of Aons $300
million 3.5% convertible debt securities due November 2012 converted their
holdings into Aon common stock, resulting in the issuance of approximately 2.7
million shares.
9
5.
Comprehensive
Income
The components of comprehensive income, net of tax, are as follows:
|
|
Three months ended
September 30,
|
|
Nine months ended
September 30,
|
|
(millions)
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
Net income
|
|
$
|
204
|
|
$
|
106
|
|
$
|
657
|
|
$
|
497
|
|
Net derivative gains
|
|
10
|
|
3
|
|
8
|
|
11
|
|
Net unrealized investment gains (losses)
|
|
18
|
|
51
|
|
(10
|
)
|
8
|
|
Net foreign exchange gains
|
|
97
|
|
3
|
|
159
|
|
134
|
|
Change in postretirement plans
|
|
12
|
|
|
|
62
|
|
|
|
Comprehensive income
|
|
$
|
341
|
|
$
|
163
|
|
$
|
876
|
|
$
|
650
|
|
The components of accumulated other
comprehensive loss, net of tax, are as follows:
(millions)
|
|
September 30, 2007
|
|
December 31, 2006
|
|
Net derivative gains
|
|
$
|
23
|
|
$
|
15
|
|
Net unrealized investment gains
|
|
63
|
|
73
|
|
Net foreign exchange translation
|
|
277
|
|
118
|
|
Postretirement plans
|
|
(1,154
|
)
|
(1,216
|
)
|
Accumulated other comprehensive loss
|
|
$
|
(791
|
)
|
$
|
(1,010
|
)
|
6.
Business
Segments
Aon classifies its businesses into three operating segments: Risk and
Insurance Brokerage Services, Consulting, and Insurance Underwriting. Unallocated
income and expense, when combined with the operating segments and after the
elimination of intersegment revenues, totals to the amounts in the accompanying
condensed consolidated financial statements.
The Risk and Insurance Brokerage Services segment consists primarily of
Aons retail and reinsurance brokerage operations, as well as related insurance
services, including underwriting management, captive insurance company
management services, and premium financing. The Consulting segment provides a
full range of consulting services delivered predominantly to corporate
clientele utilizing seven major practices: employee benefits, compensation,
management consulting, communications, strategic human resource consulting,
financial advisory and litigation consulting, and human resource outsourcing. The
Insurance Underwriting segment provides specialty insurance products including
accident, health and life insurance coverages as well as select property and
casualty insurance products. Aon has ceased writing property and casualty
business and has placed the remaining lines of business into runoff. Unallocated
income consists of investment income from equity, fixed-maturity and short-term
investments that are assets primarily of the insurance underwriting
subsidiaries that exceed policyholders liabilities. These assets include
non-income producing equities, and income and losses on disposals of
essentially all securities, including those pertaining to assets maintained by
the operating segments. Unallocated expenses include administrative costs not
attributable to the operating segments, such as corporate governance costs. Interest
expense represents the cost of worldwide debt obligations.
10
The accounting policies of the operating segments are the same as those
described in this Form 10-Q and Aons Annual Report on Form 10-K for the year
ended December 31, 2006, except that the disaggregated financial results have
been prepared using a management approach, which is consistent with the basis
and manner in which Aon senior management internally disaggregates financial
information for the purpose of assisting in making internal operating decisions.
Aon evaluates performance based on stand-alone operating segment income before
income taxes and generally accounts for intersegment revenue as if the revenue
were from third parties, that is, considered by management to be at current
market prices.
Revenues are generally attributed to geographic areas based on the
location of the resources producing the revenues. Intercompany revenues and
expenses are eliminated in computing consolidated revenues and income before
tax.
Revenue by subsegment is as follows:
|
|
Three months ended
September 30,
|
|
Nine months ended
September 30,
|
|
(millions)
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
Risk management and insurance brokerage:
|
|
|
|
|
|
|
|
|
|
Americas
|
|
$
|
582
|
|
$
|
567
|
|
$
|
1,719
|
|
$
|
1,665
|
|
United Kingdom
|
|
207
|
|
180
|
|
581
|
|
526
|
|
Europe, Middle East & Africa
|
|
275
|
|
242
|
|
1,016
|
|
886
|
|
Asia Pacific
|
|
123
|
|
114
|
|
361
|
|
331
|
|
Reinsurance brokerage and related services
|
|
250
|
|
238
|
|
731
|
|
698
|
|
Total Risk and Insurance Brokerage Services
|
|
1,437
|
|
1,341
|
|
4,408
|
|
4,106
|
|
|
|
|
|
|
|
|
|
|
|
Consulting services
|
|
270
|
|
234
|
|
803
|
|
709
|
|
Outsourcing
|
|
55
|
|
67
|
|
176
|
|
209
|
|
Total Consulting
|
|
325
|
|
301
|
|
979
|
|
918
|
|
|
|
|
|
|
|
|
|
|
|
Accident & Health and Life
|
|
625
|
|
511
|
|
1,809
|
|
1,491
|
|
Property & Casualty
|
|
2
|
|
8
|
|
2
|
|
28
|
|
Total Insurance Underwriting
|
|
627
|
|
519
|
|
1,811
|
|
1,519
|
|
|
|
|
|
|
|
|
|
|
|
Intersegment revenues
|
|
(8
|
)
|
(12
|
)
|
(24
|
)
|
(36
|
)
|
Total operating segments
|
|
2,381
|
|
2,149
|
|
7,174
|
|
6,507
|
|
Unallocated income
|
|
26
|
|
19
|
|
102
|
|
34
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
$
|
2,407
|
|
$
|
2,168
|
|
$
|
7,276
|
|
$
|
6,541
|
|
11
Aons operating segments
geographic revenue and income before income tax is as follows:
Three months ended Sept. 30:
|
|
Risk and Insurance
Brokerage Services
|
|
Consulting
|
|
Insurance
Underwriting
|
|
(millions)
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
Revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
530
|
|
$
|
528
|
|
$
|
156
|
|
$
|
165
|
|
$
|
441
|
|
$
|
354
|
|
Americas, other than U.S.
|
|
162
|
|
143
|
|
27
|
|
25
|
|
60
|
|
53
|
|
United Kingdom
|
|
266
|
|
243
|
|
69
|
|
58
|
|
55
|
|
51
|
|
Europe, Middle East & Africa
|
|
341
|
|
303
|
|
56
|
|
43
|
|
43
|
|
38
|
|
Asia Pacific
|
|
138
|
|
124
|
|
17
|
|
10
|
|
28
|
|
23
|
|
Total revenue
|
|
$
|
1,437
|
|
$
|
1,341
|
|
$
|
325
|
|
$
|
301
|
|
$
|
627
|
|
$
|
519
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income tax
|
|
$
|
236
|
|
$
|
190
|
|
$
|
38
|
|
$
|
18
|
|
$
|
63
|
|
$
|
(27
|
)
|
Nine months ended Sept. 30,
|
|
Risk and Insurance
Brokerage Services
|
|
Consulting
|
|
Insurance
Underwriting
|
|
(millions)
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
Revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
1,563
|
|
$
|
1,538
|
|
$
|
484
|
|
$
|
505
|
|
$
|
1,277
|
|
$
|
1,036
|
|
Americas, other than U.S.
|
|
468
|
|
422
|
|
88
|
|
84
|
|
168
|
|
156
|
|
United Kingdom
|
|
749
|
|
707
|
|
197
|
|
169
|
|
161
|
|
151
|
|
Europe, Middle East & Africa
|
|
1,226
|
|
1,075
|
|
168
|
|
136
|
|
125
|
|
108
|
|
Asia Pacific
|
|
402
|
|
364
|
|
42
|
|
24
|
|
80
|
|
68
|
|
Total revenue
|
|
$
|
4,408
|
|
$
|
4,106
|
|
$
|
979
|
|
$
|
918
|
|
$
|
1,811
|
|
$
|
1,519
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income tax
|
|
$
|
756
|
|
$
|
645
|
|
$
|
129
|
|
$
|
71
|
|
$
|
189
|
|
$
|
101
|
|
A reconciliation of segment income before income tax to income from
continuing operations before provision for income tax is as follows:
|
|
Three months ended
September 30,
|
|
Nine months ended
September 30,
|
|
(millions)
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
Risk and Insurance Brokerage Services
|
|
$
|
236
|
|
$
|
190
|
|
$
|
756
|
|
$
|
645
|
|
Consulting
|
|
38
|
|
18
|
|
129
|
|
71
|
|
Insurance Underwriting
|
|
63
|
|
(27
|
)
|
189
|
|
101
|
|
Segment income before income tax
|
|
337
|
|
181
|
|
1,074
|
|
817
|
|
Unallocated income
|
|
26
|
|
19
|
|
102
|
|
34
|
|
Unallocated expenses
|
|
(18
|
)
|
(27
|
)
|
(86
|
)
|
(80
|
)
|
Interest expense
|
|
(33
|
)
|
(34
|
)
|
(102
|
)
|
(99
|
)
|
Income from continuing operations before provision
for income tax
|
|
$
|
312
|
|
$
|
139
|
|
$
|
988
|
|
$
|
672
|
|
12
7.
Goodwill and
Other Intangible Assets
Goodwill represents the excess of cost over the fair market value of
net assets acquired. Goodwill is allocated to Aons various reporting units,
which are either its operating segments or one reporting level below the
operating segments. Goodwill is not amortized but is instead subject to
impairment testing at least annually. When a business entity is sold, goodwill
is allocated to the disposed entity based on the fair value of that entity
compared to the fair value of the reporting unit in which it is included.
The changes in the net carrying amount of
goodwill by operating segment for the nine months ended September 30, 2007 are
as follows:
|
|
Risk and
|
|
|
|
|
|
|
|
|
|
Insurance
|
|
|
|
|
|
|
|
|
|
Brokerage
|
|
|
|
Insurance
|
|
|
|
(millions)
|
|
Services
|
|
Consulting
|
|
Underwriting
|
|
Total
|
|
Balance as of December 31, 2006
|
|
$
|
4,142
|
|
$
|
379
|
|
$
|
11
|
|
$
|
4,532
|
|
Goodwill acquired
|
|
157
|
|
1
|
|
|
|
158
|
|
Goodwill related to disposals
|
|
(14
|
)
|
|
|
|
|
(14
|
)
|
Goodwill related to a previous business combination
(Note 8)
|
|
(7
|
)
|
|
|
|
|
(7
|
)
|
Foreign currency revaluation
|
|
207
|
|
7
|
|
|
|
214
|
|
Balance as of September 30, 2007
|
|
$
|
4,485
|
|
$
|
387
|
|
$
|
11
|
|
$
|
4,883
|
|
Other intangible assets are classified into
three categories:
Customer
Related and Contract Based include client lists as well as non-compete covenants;
Present Value
of Future Profits represent the future profits of purchased books of business
of the insurance underwriting subsidiaries; and
Marketing,
Technology and Other are all other purchased intangibles not included in the
preceding categories.
Other intangible assets by asset class are as
follows:
|
|
Customer
|
|
Present Value
|
|
Marketing,
|
|
|
|
|
|
Related and
|
|
of Future
|
|
Technology
|
|
|
|
(millions)
|
|
Contract Based
|
|
Profits
|
|
and Other
|
|
Total
|
|
As of September 30, 2007
|
|
|
|
|
|
|
|
|
|
Gross carrying amount
|
|
$
|
214
|
|
$
|
23
|
|
$
|
317
|
|
$
|
554
|
|
Accumulated amortization
|
|
173
|
|
23
|
|
155
|
|
351
|
|
Net carrying amount
|
|
$
|
41
|
|
$
|
|
|
$
|
162
|
|
$
|
203
|
|
|
|
Customer
|
|
Present Value
|
|
Marketing,
|
|
|
|
|
|
Related and
|
|
of Future
|
|
Technology
|
|
|
|
(millions)
|
|
Contract Based
|
|
Profits
|
|
and Other
|
|
Total
|
|
As of December 31, 2006
|
|
|
|
|
|
|
|
|
|
Gross carrying amount
|
|
$
|
232
|
|
$
|
23
|
|
$
|
245
|
|
$
|
500
|
|
Accumulated amortization
|
|
203
|
|
21
|
|
129
|
|
353
|
|
Net carrying amount
|
|
$
|
29
|
|
$
|
2
|
|
$
|
116
|
|
$
|
147
|
|
13
Amortization expense for intangible assets for the years ended December
31, 2007, 2008, 2009, 2010 and 2011 is estimated to be $42 million, $36
million, $34 million, $29 million and $24 million, respectively.
8.
Restructuring Charges
2007 Restructuring Plan
In October 2007, the Company announced a global restructuring plan
intended to create a more streamlined organization and reduce future expense
growth to better serve clients. The 2007 Restructuring Plan includes an
estimated 2,700 job eliminations beginning in the third quarter of 2007 and
continuing into 2009. The Company also expects to close or consolidate several
offices resulting in sublease losses or lease buy-outs. The Company estimates
that this Plan will result in cumulative pretax charges totaling approximately
$360 million. Expenses will include workforce reduction and lease consolidation
costs, asset impairments, as well as other expenses necessary to implement the
restructuring initiative. Approximately $17 million of restructuring and related
expenses were recorded through September 30, 2007, of which $4 million was paid.
The Company expects the remaining restructuring-related expenses to affect
continuing operations from fourth quarter 2007 through the end of 2009.
Below is a summary of 2007 restructuring and related expenses by type
incurred and estimated to be incurred through the end of the restructuring
initiative.
|
|
Actual
|
|
Estimated
|
|
|
|
Third
|
|
Total for
|
|
|
|
Quarter
|
|
Restructuring
|
|
(millions)
|
|
2007
|
|
Period
(1)
|
|
|
|
|
|
|
|
Workforce reduction
|
|
$
|
10
|
|
$
|
228
|
|
Lease consolidation
|
|
4
|
|
80
|
|
Asset impairments
|
|
2
|
|
36
|
|
Other costs associated with restructuring
|
|
1
|
|
16
|
|
Total restructuring and related expenses
|
|
$
|
17
|
|
$
|
360
|
|
(1)
|
|
Actual costs, when
incurred, will vary due to changes in the assumptions built into this plan.
Significant assumptions likely to change when plans are finalized and
approved include, but are not limited to, changes in severance calculations,
changes in the assumptions underlying sublease loss calculations due to
changing market conditions, and changes in the overall analysis that might
cause the Company to add or cancel component initiatives.
|
14
Below is a summary by geographic region of actual restructuring and
related costs incurred and estimated to be incurred through the end of the
restructuring initiative:
|
|
United
|
|
|
|
Europe,
|
|
|
|
|
|
|
|
States &
|
|
United
|
|
Middle East
|
|
Asia
|
|
|
|
(millions)
|
|
Americas
|
|
Kingdom
|
|
& Africa
|
|
Pacific
|
|
Total
|
|
Actual third quarter 2007
|
|
$
|
1
|
|
$
|
14
|
|
$
|
|
|
$
|
2
|
|
$
|
17
|
|
Estimated total restructuring and related
expenses
|
|
$
|
116
|
|
$
|
82
|
|
$
|
152
|
|
$
|
10
|
|
$
|
360
|
|
The following is a summary by segment of actual restructuring and
related expenses incurred and estimated to be incurred through the end of the
restructuring initiative.
|
|
Actual
Third Quarter
|
|
Estimated Total
for Restructuring
Period
|
|
(millions)
|
|
2007
|
|
|
Risk & Insurance Brokerage Services
|
|
$
|
16
|
|
$
|
335
|
|
Consulting
|
|
1
|
|
25
|
|
Total restructuring and related expenses
|
|
$
|
17
|
|
$
|
360
|
|
2005 Restructuring Plan
In 2005, the Company began executing a broad
restructuring initiative to reduce its fixed cost base and increase efficiency.
This three-year plan is substantially complete, with minimal costs being
incurred this quarter. The Company expects additional expenses of $4 million
during 2007. Restructuring costs include workforce reductions, lease
consolidation costs, asset impairments and other expenses. These costs are
included in compensation and benefits, other general expenses and depreciation
and amortization in the accompanying condensed consolidated statements of
income.
The following is a summary of the
restructuring and related expenses incurred and estimated to be incurred by
type through the end of the restructuring initiative:
|
|
Actual
|
|
|
|
|
|
Full
|
|
Full
|
|
First Six
|
|
Third
|
|
|
|
|
|
|
|
Year
|
|
Year
|
|
Months
|
|
Quarter
|
|
Total
|
|
Estimated
|
|
(millions)
|
|
2005
|
|
2006
|
|
2007
|
|
2007
|
|
Incurred
|
|
Total
|
|
Workforce reduction
|
|
$
|
116
|
|
$
|
116
|
|
$
|
18
|
|
$
|
|
|
$
|
250
|
|
$
|
250
|
|
Lease consolidation
|
|
20
|
|
27
|
|
11
|
|
|
|
58
|
|
62
|
|
Asset impairments
|
|
17
|
|
12
|
|
3
|
|
|
|
32
|
|
32
|
|
Other related expenses
|
|
5
|
|
12
|
|
4
|
|
|
|
21
|
|
21
|
|
Total restructuring and related expenses
|
|
$
|
158
|
|
$
|
167
|
|
$
|
36
|
|
$
|
|
|
$
|
361
|
|
$
|
365
|
|
15
The following table details the restructuring
and related expenses incurred and estimated to be incurred by segment through
the end of the restructuring initiative:
|
|
Actual
|
|
|
|
|
|
Full
|
|
Full
|
|
First Six
|
|
Third
|
|
|
|
|
|
|
|
Year
|
|
Year
|
|
Months
|
|
Quarter
|
|
Inception
|
|
Estimated
|
|
(millions)
|
|
2005
|
|
2006
|
|
2007
|
|
2007
|
|
to Date
|
|
Total
|
|
Risk and Insurance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Brokerage Services
|
|
$
|
143
|
|
$
|
136
|
|
$
|
28
|
|
$
|
|
|
$
|
307
|
|
$
|
311
|
|
Consulting
|
|
8
|
|
20
|
|
6
|
|
|
|
34
|
|
34
|
|
Insurance Underwriting
|
|
3
|
|
8
|
|
2
|
|
|
|
13
|
|
13
|
|
Unallocated
|
|
4
|
|
3
|
|
|
|
|
|
7
|
|
7
|
|
Total restructuring and related expenses
|
|
$
|
158
|
|
$
|
167
|
|
$
|
36
|
|
$
|
|
|
$
|
361
|
|
$
|
365
|
|
The following table sets forth the activity
related to the 2005 restructuring plan liabilities:
(millions)
|
|
|
|
Balance at
December 31, 2005
|
|
$
|
116
|
|
Expensed in 2006
|
|
155
|
|
Cash payments in
2006
|
|
(141
|
)
|
Foreign currency
revaluation
|
|
4
|
|
Balance at
December 31, 2006
|
|
134
|
|
Expensed in 2007
|
|
33
|
|
Cash payments in
2007
|
|
(74
|
)
|
Balance at
September 30, 2007
|
|
$
|
93
|
|
Restructuring Charges Prior
Years
In 1996 and 1997, Aon recorded restructuring liabilities as a result of
the acquisition of Alexander and Alexander Services, Inc. (A&A) and Bain
Hogg. During third quarter and nine months 2007, Aon made payments of $2
million and $5 million, respectively, for these liabilities. In the second
quarter 2007, the Company determined that certain of these reserves were no
longer required. Accordingly, the Company recorded a $7 million adjustment to
decrease the restructuring reserve and the corresponding goodwill that was
established when the transaction occurred in 1997. The remaining liability of
$10 million is primarily for lease abandonments and is being paid out over
several years, as planned.
Aons unpaid restructuring liabilities are
included in general expense liabilities in the condensed consolidated statements
of financial position.
16
9.
Capital
Stock
During the first nine months of 2007, Aon
issued 310,000 new shares of common stock for employee benefit plans and 97,000
shares in connection with the employee stock purchase plans. In addition, Aon
reissued 7.4 million shares of treasury stock for employee benefit programs and
223,000 shares in connection with the employee stock purchase plans.
During the second quarter 2007, certain holders of Aons $300 million
3.5% convertible debt securities due November 2012 converted their holdings
into Aon common stock. $57 million was converted, resulting in the issuance of
approximately 2.7 million shares.
In November 2006, Aon announced that its Board of Directors had
increased the authorized repurchase program to $2 billion. Shares may be
repurchased through the open market or in privately negotiated transactions
from time to time, based on prevailing market conditions and will be funded
from available capital. Any repurchased shares will be available for use in
connection with employee stock plans and for other corporate purposes. The
Company repurchased approximately 2.3 million shares at a total cost of $100
million in third quarter 2007. For the first nine months of 2007, the Company
repurchased approximately 18.5 million shares at a cost of $725 million.
There are also 22.4 million shares of common stock held in treasury at
September 30, 2007 which are restricted as to their reissuance.
10.
Disposal
of Operations
In July 2007, the Company announced that it
is considering strategic options for Combined Insurance Company of America (CICA)
and its subsidiaries. Preparations are being made for a spin-off of CICA to Aons
shareholders. However, the Company has also received inquiries from potential
buyers and is responding accordingly.
Continuing Operations
In second quarter 2007, Aon sold Media
Professionals, Inc., a managing general underwriter, which was included in the
Risk and Insurance Brokerage Services segment. A pretax gain of $26 million was
recognized on this sale, which was included in other general expenses in the
condensed consolidated statement of income. Aon has a continuing revenue-sharing
agreement with the disposed business, and therefore this business does not
qualify as a discontinued operation. Also in second quarter 2007, Aon sold 25%
of its Botswana subsidiary, which is included in the Risk and Insurance
Brokerage Services segment. A pretax gain of $4 million was recognized on the
sale, which also was included in other general expenses.
Discontinued Operations
In 2006, Aon sold the following businesses:
|
|
Aon Warranty Group (AWG) and its
worldwide warranty and credit operations, which was previously included in
the Insurance Underwriting segment. Included in discontinued operations was
pretax income of $25 million and $72 million for the three and nine months
ended September 30, 2006. A pretax gain of $16 million was recognized on the
sale in fourth quarter 2006.
|
17
|
|
Construction Program Group (CPG), a
managing general underwriter whose policies were underwritten by Aons property
and casualty operation. Results of CPG were previously included in both the
Risk and Insurance Brokerage Services and Insurance Underwriting segments.
Included in discontinued operations was a pretax loss of $14 million and
pretax income of $7 million for the three and nine months ended September 30,
2006, respectively. A pretax gain of $27 million was recognized on the sale
in fourth quarter 2006.
|
|
|
|
|
|
A non-core Australian brokerage unit, which
was previously included in the Risk and Insurance Brokerage Services segment.
A pretax gain of $1 million was recognized on the sale in first quarter 2006.
|
Aons insurance subsidiaries are involved in both the cession and
assumption of reinsurance with other companies. Aons reinsurance consists
primarily of certain newer accident and health initiatives, as well as certain
property and casualty lines that are in runoff. Aons insurance subsidiaries
remain liable to the extent that the reinsurers are unable to meet their
obligations. In connection with the sale of AWG, Aon sold Virginia Surety
Company (VSC). VSC will continue to remain liable to policyholders to the
extent reinsurers of the property and casualty business do not meet their
obligations.
Aon has provided a corporate guarantee with respect to these
reinsurance recoverables, which amounts to $887 million at September 30, 2007.
A&A Discontinued Operations
Prior to its acquisition by Aon, A&A
discontinued its property and casualty insurance underwriting operations in
1985, some of which were then placed into run-off, with the remainder sold in
1987. In connection with those sales, A&A provided indemnities to the
purchaser for various estimated and potential liabilities, including provisions
to cover future losses attributable to insurance pooling arrangements, a
stop-loss reinsurance agreement, and actions or omissions by various
underwriting agencies previously managed by an A&A subsidiary.
As of September 30, 2007, the liabilities
associated with the foregoing indemnities were included in other liabilities in
the condensed consolidated statements of financial position. Such liabilities
amounted to $71 million. Reinsurance recoverables and other assets related to
these liabilities are $91 million. The remaining insurance liabilities
represent estimates of known and future claims expected to be settled over the
next 20 to 30 years, principally with regard to asbestos, pollution and other
health exposures. Although these insurance liabilities represent a best
estimate of the probable liabilities, adverse developments may occur given the
nature of the information available and the variables inherent in the
estimation processes.
18
The operating results of all these businesses
are classified as discontinued operations as follows:
|
|
Three months ended
September 30,
|
|
Nine months ended
September 30,
|
|
(millions)
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
AWG
|
|
$
|
|
|
$
|
320
|
|
$
|
|
|
$
|
923
|
|
CPG
|
|
|
|
61
|
|
|
|
183
|
|
Other
|
|
|
|
1
|
|
|
|
1
|
|
Total
|
|
$
|
|
|
$
|
382
|
|
$
|
|
|
$
|
1,107
|
|
|
|
|
|
|
|
|
|
|
|
Pretax income:
|
|
|
|
|
|
|
|
|
|
Operations:
|
|
|
|
|
|
|
|
|
|
AWG
|
|
$
|
|
|
$
|
25
|
|
$
|
|
|
$
|
72
|
|
CPG
|
|
|
|
(14
|
)
|
|
|
7
|
|
Other
|
|
2
|
|
13
|
|
3
|
|
12
|
|
|
|
2
|
|
24
|
|
3
|
|
91
|
|
Gain on sale
|
|
(3
|
)
|
|
|
1
|
|
1
|
|
Total
|
|
$
|
(1
|
)
|
$
|
24
|
|
$
|
4
|
|
$
|
92
|
|
|
|
|
|
|
|
|
|
|
|
After-tax income (loss):
|
|
|
|
|
|
|
|
|
|
Operations
|
|
$
|
3
|
|
$
|
16
|
|
$
|
3
|
|
$
|
59
|
|
Sale
|
|
13
|
|
|
|
16
|
|
(1
|
)
|
Total
|
|
$
|
16
|
|
$
|
16
|
|
$
|
19
|
|
$
|
58
|
|
19
11.
Net
Periodic Benefit Cost
The following table provides the components of the net periodic benefit
cost for Aons U.S. plans:
|
|
Pension Benefits
|
|
Other Benefits
|
|
(millions) Three months ended September 30,
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
Service cost
|
|
$
|
10
|
|
$
|
12
|
|
$
|
1
|
|
$
|
1
|
|
Interest cost
|
|
25
|
|
26
|
|
1
|
|
1
|
|
Expected return on plan assets
|
|
(30
|
)
|
(29
|
)
|
|
|
|
|
Amortization of prior service cost
|
|
(4
|
)
|
1
|
|
(1
|
)
|
(1
|
)
|
Amortization of net loss
|
|
11
|
|
15
|
|
|
|
|
|
Net periodic benefit cost
|
|
$
|
12
|
|
$
|
25
|
|
$
|
1
|
|
$
|
1
|
|
|
|
Pension Benefits
|
|
Other Benefits
|
|
(millions) Nine months ended September 30,
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
Service cost
|
|
$
|
38
|
|
$
|
45
|
|
$
|
2
|
|
$
|
2
|
|
Interest cost
|
|
74
|
|
76
|
|
3
|
|
3
|
|
Expected return on plan assets
|
|
(90
|
)
|
(86
|
)
|
|
|
|
|
Amortization of prior service cost
|
|
(11
|
)
|
1
|
|
(1
|
)
|
(1
|
)
|
Amortization of net loss
|
|
33
|
|
38
|
|
|
|
|
|
Net periodic benefit cost
|
|
$
|
44
|
|
$
|
74
|
|
$
|
4
|
|
$
|
4
|
|
The following table provides the components of net periodic benefit
costs for Aons material international pension plans, which are located
primarily in the U.K. and The Netherlands:
|
|
Pension Benefits
|
|
|
|
Three months ended Sept. 30,
|
|
Nine months ended Sept. 30,
|
|
(millions)
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
Service cost
|
|
$
|
3
|
|
$
|
16
|
|
$
|
20
|
|
$
|
48
|
|
Interest cost
|
|
64
|
|
56
|
|
189
|
|
163
|
|
Expected return on plan assets
|
|
(75
|
)
|
(58
|
)
|
(221
|
)
|
(168
|
)
|
Amortization of prior service costs
|
|
|
|
1
|
|
|
|
1
|
|
Amortization of net loss
|
|
9
|
|
23
|
|
36
|
|
67
|
|
Net periodic benefit cost
|
|
$
|
1
|
|
$
|
38
|
|
$
|
24
|
|
$
|
111
|
|
Aon previously disclosed in its 2006
financial statements that it expected to contribute $36 million in 2007 to its
U.S. defined benefit pension plans to satisfy minimum funding requirements and
$5 million to fund other postretirement benefit plans. Based on current rules
and assumptions, Aon now plans to contribute $22 million to its defined benefit
pension plans. As of September 30, 2007, contributions of $20 million have been
made to the U.S. pension plans and $4 million to other postretirement benefit
plans.
Aon previously disclosed in its 2006
financial statements that it expected to contribute $197 million in 2007 to its
major international defined benefit pension plans. Based on current rules and
assumptions, Aon now plans to contribute approximately $164 million to its
major international defined pension plans during 2007. As of September 30,
2007, $132 million has been contributed.
20
In March 2007, the trustees of Aons U.K.
pension plans approved the Companys proposal to cease crediting future pension
plan benefits relating to salary and service, effective April 1, 2007. Future
pension provisions will be provided under the defined contribution section of
the Aon U.K. Pension Scheme. As a result of the adoption of these changes, the
Company remeasured its U.K. defined benefit pension plans, which resulted in an
improvement in the funded status of these plans, and decreased other
comprehensive loss by an after tax amount of $20 million. In accordance with
FASB Statement No. 87,
Employers Accounting for
Pensions
, unrecognized gains and losses in the U.K. pension plans
are now amortized over the average remaining life expectancy of participants
instead of the average remaining service period of employees, which was
previously used.
21
12.
Other-Than-Temporary
Impairments
The following table analyzes our investment positions with unrealized
losses segmented by quality and period of continuous unrealized loss as of
September 30, 2007.
|
|
Investment Grade
|
|
|
|
|
|
6 -12
|
|
|
|
|
|
($ in millions)
|
|
0-6 Months
|
|
Months
|
|
> 12 Months
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
FIXED MATURITIES
|
|
|
|
|
|
|
|
|
|
U.S. government and agencies
|
|
|
|
|
|
|
|
|
|
# of positions
|
|
1
|
|
1
|
|
17
|
|
19
|
|
Fair Value
|
|
$
|
11
|
|
$
|
8
|
|
$
|
129
|
|
$
|
148
|
|
Amortized Cost
|
|
11
|
|
8
|
|
131
|
|
150
|
|
Unrealized Loss
|
|
|
|
|
|
(2
|
)
|
(2
|
)
|
Foreign governments
|
|
|
|
|
|
|
|
|
|
# of positions
|
|
18
|
|
34
|
|
77
|
|
129
|
|
Fair Value
|
|
$
|
136
|
|
$
|
565
|
|
$
|
444
|
|
$
|
1,145
|
|
Amortized Cost
|
|
138
|
|
575
|
|
455
|
|
1,168
|
|
Unrealized Loss
|
|
(2
|
)
|
(10
|
)
|
(11
|
)
|
(23
|
)
|
Corporate securities
|
|
|
|
|
|
|
|
|
|
# of positions
|
|
82
|
|
87
|
|
259
|
|
428
|
|
Fair Value
|
|
$
|
183
|
|
$
|
173
|
|
$
|
507
|
|
$
|
863
|
|
Amortized Cost
|
|
186
|
|
181
|
|
529
|
|
896
|
|
Unrealized Loss
|
|
(3
|
)
|
(8
|
)
|
(22
|
)
|
(33
|
)
|
Mortgage- and asset-backed securities
|
|
|
|
|
|
|
|
|
|
# of positions
|
|
65
|
|
72
|
|
297
|
|
434
|
|
Fair Value
|
|
$
|
109
|
|
$
|
64
|
|
$
|
179
|
|
$
|
352
|
|
Amortized Cost
|
|
110
|
|
65
|
|
184
|
|
359
|
|
Unrealized Loss
|
|
(1
|
)
|
(1
|
)
|
(5
|
)
|
(7
|
)
|
|
|
|
|
|
|
|
|
|
|
TOTAL FIXED MATURITIES
|
|
|
|
|
|
|
|
|
|
# of positions
|
|
166
|
|
194
|
|
650
|
|
1,010
|
|
Fair Value
|
|
$
|
439
|
|
$
|
810
|
|
$
|
1,259
|
|
$
|
2,508
|
|
Amortized Cost
|
|
445
|
|
829
|
|
1,299
|
|
2,573
|
|
Unrealized Loss
|
|
(6
|
)
|
(19
|
)
|
(40
|
)
|
(65
|
)
|
|
|
|
|
|
|
|
|
|
|
% of Total Unrealized Loss
|
|
9
|
%
|
28
|
%
|
60
|
%
|
97
|
%
|
|
|
Non-Investment Grade
|
|
|
|
|
|
6 -12
|
|
|
|
|
|
|
|
0-6 Months
|
|
Months
|
|
> 12 Months
|
|
Total
|
|
EQUITY SECURITIES
|
|
|
|
|
|
|
|
|
|
# of positions
|
|
1
|
|
1
|
|
|
|
2
|
|
Fair Value
|
|
$
|
11
|
|
$
|
9
|
|
$
|
|
|
$
|
20
|
|
Amortized Cost
|
|
12
|
|
10
|
|
|
|
22
|
|
Unrealized Loss
|
|
(1
|
)
|
(1
|
)
|
|
|
(2
|
)
|
|
|
|
|
|
|
|
|
|
|
% of Total Unrealized Loss
|
|
2
|
%
|
1
|
%
|
|
|
3
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
22
For categorization purposes, Aon considers any rating of Baa or higher
by Moodys Investor Services or equivalent rating agency to be investment grade.
Aon has no fixed maturities below investment grade with an unrealized loss.
Aons fixed-maturity portfolio in total had a
$65 million gross unrealized loss at September 30, 2007, and is subject to
interest rate, market, and credit risks. No single position had an unrealized
loss greater than $3 million. With a carrying value of $2,970 million at
September 30, 2007, Aons total fixed-maturity portfolio is approximately 100%
investment grade based on market value. Fixed-maturity securities with an
unrealized loss are 100% investment grade and have a weighted average rating of
Aa based on amortized cost. Aons non-publicly-traded fixed maturity
portfolio had a carrying value of $216 million. Valuations of these securities
primarily reflect the fundamental analysis of the issuer and current market
price of comparable securities.
Aons equity portfolio is comprised of
non-redeemable preferred stocks, publicly traded common stocks and other common
and preferred stocks not publicly traded. This portfolio had $2 million of
gross unrealized losses at September 30, 2007, and is subject to interest rate,
market, credit, illiquidity, concentration and operational performance risks.
Aon reviews invested assets with material unrealized losses each
quarter. Please see Managements Discussion and Analysis of Financial Condition
and Results of Operations Critical Accounting Policies and Estimates in Aons
2006 Annual Report on Form 10-K for further information.
13.
Uncertain
Tax Positions
Aon adopted the provisions of FASB Interpretation No. 48 (FIN 48),
Accounting for Uncertainty in Income Taxes, an interpretation of FASB
Statement No. 109
, on January 1, 2007. As a result of the
implementation of FIN 48, Aon did not recognize any material adjustments in the
liability for unrecognized tax benefits. As of March 31, 2007, Aon had $61
million of gross unrecognized tax benefits, $49 million of which would affect
the effective tax rate if recognized. There were no material changes to these
amounts in either the second or third quarter 2007.
Aon recognizes interest and penalties related to unrecognized income
tax benefits in its provision for income taxes. As of March 31, 2007, Aon had
accrued $8 million for the payment of interest and penalties, which is included
as a component of the $61 million of total unrecognized tax benefits noted
above. There were no material changes to these amounts in either the second or
third quarter 2007.
Aon has substantially concluded all U.S. federal income tax matters for
years through 2004. Substantially, all material state and local income tax
jurisdiction examinations have been concluded for years through 2001. Aons
primary international jurisdictions have concluded income tax examinations
through 2000.
23
14.
Endurance
Warrants and Common Stock Investment
In 2001, Aon invested $227 million in the
common stock of Endurance Specialty Holdings, Ltd. (Endurance), a
Bermuda-based insurance and reinsurance company. Aon sold virtually all of its
common stock investment in Endurance in 2004. In conjunction with the initial
common stock investment, Aon also received 4.1 million stock purchase warrants,
which allowed Aon to purchase additional Endurance common stock through
December 2011. These warrants met the definition of a derivative, which required
them to be recorded in the financial statements at fair value, with changes in
fair value recognized in earnings on a current basis. On March 31, 2006, Aon
contributed all of the Endurance warrants to its U.K. pension plans. The
warrants had a fair value of approximately $73 million at March 31, 2006. The
change in the fair value of the warrants from December 31, 2005 was a decrease
of $17 million, and was included in investment income for the nine months ended
September 30, 2006.
15.
Contingencies
Aon and its subsidiaries are subject to
numerous claims, tax assessments, lawsuits and proceedings that arise in the
ordinary course of business. The damages claimed in these matters are or may be
substantial, including, in many instances, claims for punitive, treble or
extraordinary damages. Aon has purchased errors and omissions (E&O)
insurance and other appropriate insurance to provide protection against losses
that arise in such matters. Accruals for these items, and related insurance
receivables, when applicable, have been provided to the extent that losses are
deemed probable and are reasonably estimable. These accruals and receivables
are adjusted from time to time as developments warrant.
In 2004, Aon, other insurance brokers, insurers and numerous other
industry participants received subpoenas and other requests for information
from the office of the Attorney General of the State of New York and from other
states relating to certain practices in the insurance industry.
On March 4, 2005, Aon entered into an agreement (the Settlement
Agreement) with the Attorney General of the State of New York, the
Superintendent of Insurance of the State of New York, the Attorney General of
the State of Connecticut, the Illinois Attorney General and the Director of the
Division of Insurance, Illinois Department of Financial and Professional
Regulation (collectively, the State Agencies) to resolve all the issues
related to investigations conducted by the State Agencies. The 2005 Settlement
Agreement, under which Aon distributed funds to certain clients and implemented
business reforms, has been described in detail in Aons previous financial
filings.
Purported clients have also filed civil litigation against Aon and
other companies under a variety of laws and legal theories relating to broker
compensation practices and other issues under investigation by New York and
other states. As previously reported, a putative class action styled
Daniel v. Aon (Affinity)
has been pending in the Circuit
Court of Cook County, Illinois since August 1999. In March 2005, the Court gave
preliminary approval to a nationwide class action settlement under which Aon
agreed to pay a total of $38 million to its policyholders. The Court granted
final approval to the settlement in March 2006. Parties that objected to the
settlement have appealed.
24
Beginning in
June 2004, a number of other putative class actions were filed against Aon and
other companies by purported classes of clients under a variety of legal
theories, including state tort, contract, fiduciary duty, antitrust and
statutory theories and federal antitrust and Racketeer Influenced and Corrupt
Organizations Act (RICO) theories. The federal actions were consolidated in
the U.S. District Court for the District of New Jersey, and a state court
collective action was filed in California. In the New Jersey actions, the Court
dismissed plaintiffs federal antitrust and RICO claims in separate orders in,
respectively, August and October 2007. Plaintiffs are expected to appeal. Aon
believes it has meritorious defenses in all of these cases and intends to
vigorously defend itself against these claims. The outcome of these lawsuits,
and any losses or other payments that may occur as a result, cannot be
predicted at this time.
Beginning in late October 2004, several putative securities class
actions were filed against Aon in the U.S. District Court for the Northern
District of Illinois. Also beginning in late October 2004, several putative ERISA
class actions were filed against Aon in the U.S. District Court for the
Northern District of Illinois. Aon believes it has meritorious defenses in all
of these cases and intends to vigorously defend itself against these claims. The
outcome of these lawsuits, and any losses or other payments that may occur as a
result, cannot be predicted at this time. With respect to the various
securities and ERISA class actions, we are unable to estimate a range of
possible losses, as these actions have not yet progressed to the stages where
damages can be estimated.
Following inquiries from regulators, the Company commenced an internal
review of its compliance with certain U.S. and non-U.S. anti-bribery laws,
including the U.S. Foreign Corrupt Practices Act (FCPA). An outside law firm
with significant experience in the area is overseeing the review. Aon has
advised the U.K. Financial Services Authority, the U.S. Securities and Exchange
Commission, the U.S. Department of Justice, and certain other non-U.S.
regulators of the review and has agreed with the U.S. regulators to toll any
applicable statute of limitations pending completion of the review. Based on
current information, the Company is unable at this time to predict when the
review will be completed or what regulatory or other outcomes may result.
Although the ultimate outcome of all matters referred to above cannot
be ascertained, and liabilities in indeterminate amounts may be imposed on Aon
or its subsidiaries- on the basis of present information, amounts already
provided, availability of insurance coverages and legal advice received, it is
the opinion of management that the disposition or ultimate determination of
such claims will not have a material adverse effect on the consolidated
financial position of Aon. However, it is possible that future results of
operations or cash flows for any particular quarterly or annual period could be
materially affected by an unfavorable resolution of these matters.
25
16.
Subsequent
Event
On October 4, 2007, the Company announced
that it will redeem on November 19, 2007 all of its outstanding 3 ½ % Senior
Convertible Debentures due 2012 (Debentures). On September 30, 2007, the
aggregate principal amount of the Debentures outstanding was approximately $243
million. The redemption price for the Debentures will be 101% of the principal
amount of the Debentures, together with accrued and unpaid interest. On or
before the close of business on November 16, 2007, the holders of the
Debentures may elect to convert their Debentures into Aon common stock at a
conversion rate of 46.5658 shares of common stock for each $1,000 principal
amount of Debentures, subject to the terms and conditions set forth in the
Indenture dated as of November 7, 2002 by and between Aon and the Bank of New
York, as Trustee (Indenture) and the Debentures. Debentures not converted on
or before the close of business on November 16, 2007 will no longer be
convertible and holders will only be entitled to the right to receive the
redemption price of the Debentures and accrued and unpaid interest to, but
excluding November 19, 2007.
If all outstanding debentures as of September
30, 2007 are converted into Aon common stock, approximately 11.3 million shares
will be issued.
26
ITEM 2.
|
|
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
|
Overview
This Managements Discussion and Analysis is divided into six sections.
First, key recent events are described that have affected or will affect our
financial results during 2007. We then review our consolidated results and
segments with comparisons for the third quarter and nine-months 2007 to the
corresponding periods in 2006. We then discuss our financial condition and
liquidity as well as information on our off balance sheet arrangements. The
final section addresses certain factors that can influence future results.
The outline for our Managements Discussion and Analysis is as follows:
KEY RECENT EVENTS
Strategic Alternatives for Combined Insurance Company of America
Redemption of Senior Convertible Debentures
Restructuring Initiatives
Recent Regulatory and Legislative Activity
Acquisitions and Dispositions of Various Businesses
Distributions from PEPS I
Stock Repurchase Program
CRITICAL ACCOUNTING POLICIES
REVIEW OF CONSOLIDATED RESULTS
General
Consolidated Results
REVIEW BY SEGMENT
General
Risk and Insurance Brokerage Services
Consulting
Insurance Underwriting
Unallocated Income and Expense
FINANCIAL CONDITION AND LIQUIDITY
Cash Flows
Financial Condition
Short-term Borrowings and Notes Payable
Stockholders Equity
Off Balance Sheet Arrangements
INFORMATION CONCERNING FORWARD-LOOKING
STATEMENTS
27
KEY RECENT EVENTS
Strategic Alternatives for Combined Insurance Company of America
In July 2007, we announced that we are considering strategic options
for Combined Insurance Company of America (CICA) and its subsidiaries. Preparations
are being made for a spin-off of CICA to our shareholders, but we have received
inquiries from potential buyers and are responding accordingly.
CICA and its subsidiaries, including Sterling Life Insurance Company (Sterling),
provide accident, health and life insurance coverage in the U.S., Canada,
Europe and Asia Pacific primarily through more than 7,000 career insurance
agents.
Redemption
of Senior Convertible Debentures
On October 4, 2007, we announced that the Company will redeem on
November 19, 2007 all of our outstanding 3 ½ % Senior Convertible Debentures
due 2012 (Debentures). On September 30, 2007, the aggregate principal amount
of the Debentures outstanding was approximately $243 million. The redemption
price for the Debentures will be 101% of the principal amount of the
Debentures, together with accrued and unpaid interest. On or before the close
of business on November 16, 2007, the holders of the Debentures may elect to
convert their Debentures into Aon common stock at a conversion rate of 46.5658
shares of common stock for each $1,000 principal amount of Debentures, subject
to the terms and conditions set forth in the Indenture and the Debentures. Debentures
not converted on or before the close of business on November 16, 2007 will no
longer be convertible and holders will only be entitled to the right to receive
the redemption price of the Debentures and accrued and unpaid interest to, but
excluding November 19, 2007.
If all outstanding debentures as of September 30, 2007 are converted into
Aon common stock, approximately 11.3 million shares will be issued.
Restructuring
Initiatives
In October
2007, we announced a global restructuring plan intended to create a more
streamlined organization and reduce future expense growth to better serve
clients. We estimate that this Plan will result in cumulative pretax charges
totaling approximately $360 million. Expenses will include workforce reduction
and lease consolidation costs, asset impairments, as well as other expenses
necessary to implement the restructuring initiative. Approximately $17 million
of restructuring and related expenses were recorded through September 30, 2007,
of which $4 million was paid. We expect the remaining restructuring-related
expenses to affect continuing operations from fourth quarter 2007 through the
end of 2009. We anticipate that these initiatives will lead to annualized
cost-savings of approximately $50-$70 million in 2008, $175-$200 million in
2009, and $240 million of annualized savings by 2010. There can be no assurances
that Aon will achieve the targeted savings.
The 2007
Restructuring Plan includes an estimated 2,700 job eliminations beginning in
the third quarter of 2007 and continuing into 2009. We also expect to close or
consolidate several offices resulting in sublease losses or lease buy-outs. These
efforts will also trigger asset impairments in the form of accelerated
amortization of the remaining leasehold improvements.
28
The
following is a summary of 2007 restructuring and related expenses by type
incurred and estimated to be incurred through the end of the restructuring
initiative.
(millions)
|
|
Actual
Third Quarter
2007
|
|
Estimated Total for
Restructuring Period (1)
|
|
Workforce reduction
|
|
$
|
10
|
|
$
|
228
|
|
Lease consolidation
|
|
4
|
|
80
|
|
Asset impairments
|
|
2
|
|
36
|
|
Other costs associated with restructuring
|
|
1
|
|
16
|
|
Total restructuring and related expenses
|
|
$
|
17
|
|
$
|
360
|
|
(1)
Actual costs, when incurred, will vary due to changes
in the assumptions built into this plan. Significant assumptions likely to
change when plans are finalized and approved include, but are not limited to,
changes in severance calculations, changes in the assumptions underlying our
sublease loss calculations due to changing market conditions, and changes in
our overall analysis that might cause us to add or cancel component
initiatives.
Workforce
reductions reflect a cash expense, though we may recognize the expense prior to
paying for the expenditure. Asset impairments are non-cash expenses. Lease
consolidation accruals reflect the present value of future cash flows. Other
costs are cash expenses, which are expensed in the period in which they are
incurred.
The
following is a summary by segment of actual restructuring and related costs
incurred and estimated to be incurred through the end of the restructuring
initiative.
(millions)
|
|
Actual
Third
Quarter 2007
|
|
Estimated Total for
for Restructuring Period
|
|
Risk & Insurance Brokerage Services
|
|
$
|
16
|
|
$
|
335
|
|
Consulting
|
|
1
|
|
25
|
|
Total restructuring and related expenses
|
|
$
|
17
|
|
$
|
360
|
|
2005
Restructuring Plan
In 2005, we began executing a broad
restructuring initiative to reduce our fixed cost base and increase efficiency.
This three-year plan is substantially complete, with minimal costs being
incurred this quarter. We expect the remaining portion to cost $4 million
during 2007, which is in addition to the $361 million expensed through
September 30, 2007. Restructuring costs include workforce reductions, lease
consolidation costs, asset impairments and other expenses. For the third
quarter 2007, the estimated restructuring benefits were approximately $63
million. These initiatives are expected to lead to annualized cost savings of
approximately $280 million by 2008.
We estimate 3,600 positions will have been
eliminated as a result of this initiative. As of September 30, 2007,
approximately 3,300 of these eliminations had already occurred. The remaining
terminations have been largely accrued for in accordance with FASB Statement
No. 112.
The following table details the restructuring
and related expenses by type we incurred through third quarter 2007 and our
estimate to be incurred through the end of the restructuring initiative:
29
|
|
Actual
|
|
|
|
(millions)
|
|
2005
|
|
2006
|
|
First
Six Months
2007
|
|
Third
Quarter
2007
|
|
Total
Incurred
|
|
Estimated
Total
|
|
Workforce reduction
|
|
$
|
116
|
|
$
|
116
|
|
$
|
18
|
|
$
|
|
|
$
|
250
|
|
$
|
250
|
|
Lease consolidation
|
|
20
|
|
27
|
|
11
|
|
|
|
58
|
|
62
|
|
Asset impairments
|
|
17
|
|
12
|
|
3
|
|
|
|
32
|
|
32
|
|
Other related expenses
|
|
5
|
|
12
|
|
4
|
|
|
|
21
|
|
21
|
|
Total restructuring and related expenses
|
|
$
|
158
|
|
$
|
167
|
|
$
|
36
|
|
$
|
|
|
$
|
361
|
|
$
|
365
|
|
Recent Regulatory and Legislative Activity
A substantial portion of CICAs revenue growth over the past two years
has been generated by its Sterling unit and the bulk of that growth was
generated from its Medicare Advantage (MA) products which are Private-Fee-For
Service plans (PFFS plans).
Prior to July 2006, Sterling was authorized to market and enroll
beneficiaries in MA products year-round, but that authorization was due to
expire and change to an open enrollment period of November 15
th
through December 31
st
of each year, with a switch enrollment period
of January through March of each year. Federal legislation that passed in late
2006 extended year-round enrollment (through 2008) for certain health plans
like those marketed by Sterling. In July of 2007, that legislation was repealed.
Accordingly, beginning on August 1, 2007, Sterling and all other MA plans no
longer have the ability to enroll beneficiaries in their plans throughout the
year.
In 2008 and beyond, Sterling and all other MA plans will be permitted
to enroll Medicare beneficiaries until March 31st of a calendar year, unless a
special enrollment period applies. Additionally, Sterling will be able to
enroll year-round those individuals just becoming eligible for Medicare.
On June 15, 2007, Sterling voluntarily agreed, upon the Centers for
Medicare & Medicaid Services (CMS) request of Sterling and other private
fee-for-service providers, to temporarily suspend marketing activities of
non-group, individual PFFS plans effective June 22, 2007.
In September 2007, Sterling received approval from CMS to resume
marketing its non-group plans. This announcement followed the statement by CMS
that the agency has completed its review and determined that Sterling has
demonstrated accelerated compliance with 2008 CMS marketing requirements. Sterling
immediately resumed marketing to beneficiaries eligible to enroll, and is
prepared to begin 2008 marketing on schedule.
Acquisitions and Dispositions of Various Businesses
We continually review our portfolio of businesses, making acquisitions
where we think it will help us deliver distinctive client value, as well as
exploring strategic alternatives of businesses we currently have. In 2006, we
spent $138 million for acquisitions. In the first nine months of 2007, we spent
$228 million for several 2007 acquisitions. We increased our position in the
U.K. affinity market by purchasing Footman James, and our technology platform
was strengthened through the acquisition of Valley Oak Systems in the U.S.
In second quarter 2007, Aon sold the assets and operations of Media
Professional Insurance, Inc. (Media Pro), a managing general underwriter
specializing in professional liability lines of business, which is included in
our Risk and Insurance Brokerage Services segment. This disposition resulted in
a $26 million gain, which is
30
included in other general expenses in the condensed consolidated
statement of income. We have a continuing revenue sharing arrangement, and
therefore this business does not qualify as a discontinued operation.
We sold a 25% stake in our Botswana brokerage subsidiary in second
quarter 2007. This disposition resulted in a $4 million gain, which is included
in other general expenses within our Risk and Insurance Brokerage Services
segment.
During first quarter 2006, we completed the sale of a non-core
brokerage business in Australia. In fourth quarter 2006, we completed the sale
of our AWG and CPG businesses. The results of those businesses through the date
of sale are shown as discontinued operations in our condensed consolidated
statements of income.
Distributions from PEPS I
We received income distributions from our preferred investment in
Private Equity Partnership Structures I, LLC (PEPS I) of $16 million during
the third quarter and $55 million for the first nine months of 2007, which were
recorded in investment income. Prior to 2007, income distributions received
from PEPS I were limited to interest payments on various PEPS I debt
instruments. Beginning in 2007, PEPS I had redeemed or collateralized all of
its debt, and as a result, paid preferred income distributions. Receipt of
additional preferred returns is dependent on the performance of the limited
partnership (LP) interests underlying PEPS I and is expected to vary from period
to period. We do not control the timing of the distribution.
Share Repurchase Program
We are currently authorized to repurchase $2 billion of Aons common
stock. Pursuant to this program, during the first nine months of 2007, we
repurchased approximately 18.5 million shares at a cost of $725 million. Since
the program began, we have now repurchased 47.6 million shares at a cost of
$1,797 million. Of the shares repurchased since the programs inception, we
have reissued approximately 11.8 million shares for stock options, stock awards
and other benefit plans.
CRITICAL ACCOUNTING POLICIES
There have been no changes in our critical accounting policies, which
include pensions, contingencies, policy liabilities, valuation of investments,
intangible assets, share-based payments and income taxes, as discussed in our
2006 Annual Report on Form 10-K.
REVIEW OF CONSOLIDATED RESULTS
General
In our discussion of operating results, we sometimes refer to
supplemental information derived from our consolidated financial information.
We use supplemental information related to organic revenue growth to
help us and our investors evaluate business growth from existing operations. Organic
revenue growth excludes the impact of foreign exchange rate changes, acquisitions,
divestitures, transfers between business units, investment income, reimbursable
expenses, and unusual items. Organic revenue growth for the insurance
underwriting segment is based on written premiums.
Supplemental organic revenue growth information should be viewed in
addition to, not instead of, our condensed consolidated statements of income. Industry
peers provide similar supplemental information about their revenue performance,
although they may not make identical adjustments.
31
Because we conduct business in over 120 countries, foreign exchange
rates fluctuations have an impact on our business. In comparison to the U.S.
dollar, foreign exchange rate movements may be significant and may distort true
period-to-period comparisons of changes in revenue or pretax income. Therefore,
we have isolated the impact of the change in currencies between periods by
providing percentage changes on a comparable currency basis for revenue, and
have disclosed the effect on earnings per share. We have also provided this
form of reporting to give financial statement users more meaningful information
about our operations.
Some tables in the segment discussions
reconcile organic revenue growth percentages to the reported revenue growth
percentages for the segments and sub-segments. We separately disclose the
impact of foreign currency as well as the impact from acquisitions,
divestitures, and transfers of business units, which represent the most
significant reconciling items. In an all other category, we total other
reconciling items that are not generally significant individually or in the
aggregate. If there is a significant individual reconciling item within the all
other category, we provide additional disclosure in a footnote.
32
Consolidated Results
The following table and commentary provide
selected consolidated financial information.
|
|
Third Quarter Ended
|
|
Nine Months Ended
|
|
|
|
Sept. 30,
|
|
Sept. 30,
|
|
Percent
|
|
Sept. 30,
|
|
Sept. 30,
|
|
Percent
|
|
(millions)
|
|
2007
|
|
2006
|
|
Change
|
|
2007
|
|
2006
|
|
Change
|
|
Revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commissions and fees
|
|
$
|
1,702
|
|
$
|
1,589
|
|
7
|
%
|
$
|
5,218
|
|
$
|
4,852
|
|
8
|
%
|
Premiums and other
|
|
589
|
|
487
|
|
21
|
|
1,701
|
|
1,423
|
|
20
|
|
Investment income
|
|
116
|
|
92
|
|
26
|
|
357
|
|
266
|
|
34
|
|
Total revenue
|
|
2,407
|
|
2,168
|
|
11
|
|
7,276
|
|
6,541
|
|
11
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Compensation and benefits
|
|
1,156
|
|
1,116
|
|
4
|
|
3,515
|
|
3,344
|
|
5
|
|
Other general expenses
|
|
490
|
|
474
|
|
3
|
|
1,477
|
|
1,394
|
|
6
|
|
Benefits to policyholders
|
|
366
|
|
349
|
|
5
|
|
1,044
|
|
864
|
|
21
|
|
Depreciation and amortization
|
|
50
|
|
56
|
|
(11
|
)
|
149
|
|
166
|
|
(10
|
)
|
Interest expense
|
|
33
|
|
34
|
|
(3
|
)
|
102
|
|
99
|
|
3
|
|
Provision for New York and other state
settlements
|
|
|
|
|
|
|
|
1
|
|
2
|
|
(50
|
)
|
Total expenses
|
|
2,095
|
|
2,029
|
|
3
|
|
6,288
|
|
5,869
|
|
7
|
|
Income from continuing operations before
provision for income tax
|
|
$
|
312
|
|
$
|
139
|
|
124
|
%
|
$
|
988
|
|
$
|
672
|
|
47
|
%
|
Pretax margin - continuing operations
|
|
13.0
|
%
|
6.4
|
%
|
|
|
13.6
|
%
|
10.3
|
%
|
|
|
Revenue
Commissions and fees
increased by $113 million or 7% on a quarterly basis and $366 million or
8% on a year-to-date basis. Organic growth in the Risk and Insurance Brokerage
Services and Consulting segments and the impact of foreign currency translation
primarily drove the increase.
Premiums and other
increased $102 million or
21% on a quarterly basis and $278 million or 20% on a year-to-date basis,
driven by strong growth in our Sterling subsidiarys MA health product in our
Accident & Health and Life sub-segment.
Investment income
increased $24 million or 26%
on a quarterly basis and $91 million or 34% on a year-to-date basis. The
increase was primarily driven by:
Non-liquidating
distributions from our PEPS I investment, which contributed an additional $15
million and $52 million of income on a quarterly and year-to-date basis,
respectively,
realized gains
from the sale of investments,
$17 million of
realized losses on our Endurance warrants in first quarter 2006, and
higher interest
rates on our investment portfolio,
33
partially offset
by a $35 million gain on the contribution of our Scandent preferred stock in
first quarter 2006.
Expenses
Compensation and benefits
increased $40 million or 4% on a quarterly basis and $171 million or 5% on a
year-to-date basis. Driving the increase in both periods was the impact of
foreign currency translation and higher salary and incentive costs, partially
offset by lower pension expenses and the benefits of the 2005 restructuring
program. Lower pension expense results primarily from the previously announced
changes to both our U.S. and U.K. defined benefit pension plans.
Other general expenses
increased $16 million or 3% on a quarterly basis and $83 million or 6% on a
year-to-date basis. The quarterly increase was driven by a $30 million gain on
the sale of a building in Spain in 2006, and the impact of foreign currency
translation, partially offset by lower restructuring costs. On a year-to-date
basis, foreign currency translation, the gain on the sale of the Spain
building, and the settlement of litigation in early 2007 for acquired employees
in our U.K. reinsurance business more than offset 2007 gains from the sale or
partial sale of businesses and lower restructuring costs.
Benefits to policyholders
increased $17 million or 5% on a quarterly basis and $180 million or 21% on a
year-to-date basis. The increase for both periods was driven by the growth in
Sterlings MA product, partially offset by $81 million in Property and Casualty
reserve adjustments in 2006.
Depreciation and amortization expense
decreased $6 million or 11% on a quarterly basis and $17 million or 10% on a
year-to-date basis. The decline for both periods was caused by asset disposals
and write-offs in 2006, primarily driven by restructuring activity.
Interest expense
decreased $1 million on a quarterly basis, but increased $3 million or 3%
on a year-to-date basis. Higher year-to-date interest costs resulted from
higher international debt levels and interest rates.
Income from Continuing Operations Before
Provision for Income Tax and Cumulative Effect of a Change in Accounting
Principle
Income from continuing operations before provision for income tax
increased $173 million to $312 million on a quarterly basis and increased $316
million or 47% for the nine months ended September 30, 2007. The improvements
are attributable to organic revenue growth in all segments, the favorable
impact of foreign currency translation, increased investment income and lower
restructuring costs, which more than offset higher compensation and benefit
costs and benefits to policyholders.
Income Taxes
The effective tax rate for continuing operations was 39.7% and 35.3%
for the third quarters ended September 30, 2007 and 2006, respectively. The
effective tax rate for continuing operations was 35.4% and 34.8% for the nine
month period ended September 30, 2007 and 2006, respectively. During the third
quarter 2007, legislation was finalized in the United Kingdom which reduces the
corporate tax rate from 30% to 28%. While the lower U.K. tax rate will be a
benefit to Aons recurring effective tax rate in future periods, it also
requires a reevaluation of the deferred tax assets related to our U.K. operations,
which resulted in a one-time non-cash charge of approximately $22 million that
was included in the third quarter tax provision. The year-to-date rate was
impacted by the geographic distribution of earnings and the favorable
resolution of certain tax matters as well as the third quarter U.K. tax
adjustment.
34
Income from Continuing Operations
Income from continuing operations before accounting change for third
quarter 2007 and 2006 was $188 million and $90 million, respectively. Basic and
diluted income per share in the third quarter 2007 was $0.64 and $0.59,
respectively, versus $0.29 and $0.27 for basic and diluted income per share in
2006, respectively. Income from continuing operations before accounting change
for nine months 2007 and 2006 was $638 million and $438 million, respectively. Basic
and diluted income per share for the nine months ended September 30, 2007 was
$2.16 and $1.99, respectively, versus $1.37 and $1.29 for basic and diluted income
per share for the comparable period of 2006, respectively. Income from
continuing operations in 2007 included $0.01 and $0.03 per share for currency
translation gains for the third quarter and nine months, respectively.
Discontinued Operations
Third quarter income from discontinued operations was $16 million
($0.05 per basic and diluted share) for both 2007 and 2006. Nine months income
from discontinued operations was $19 million in 2007 ($0.06 per basic and
diluted share) versus $58 million for 2006 ($0.18 and $0.17 per basic and
diluted share, respectively). Pretax income for our discontinued operations for
2007 included some residual settlement activity relating to our AWG and CPG
disposals. Income from discontinued operations for 2007 was positively impacted
by $18 million for both the quarter and year-to-date periods due to our ability
to recognize a favorable tax credit relating to the sale of AWG. Results in
2006 principally reflect the quarterly and nine months operating results from
our AWG and CPG businesses, which were sold in fourth quarter 2006.
REVIEW BY SEGMENT
General
We classify our businesses into three
operating segments: Risk and Insurance Brokerage Services, Consulting and
Insurance Underwriting (see Note 6). Our operating segments are identified as
those that:
report
separate financial information, and
are
evaluated regularly when we are deciding how to allocate resources and assess
performance.
Segment revenue includes investment income
generated by invested assets of that segment, as well as the impact of related
derivatives
.
Investment characteristics mirror liability characteristics of the
respective segments:
Our
Risk and Insurance Brokerage Services and Consulting businesses invest funds
held on behalf of clients and operating funds in short-term obligations.
In
Insurance Underwriting, policyholder claims and other types of non-interest
sensitive insurance liabilities are primarily supported by intermediate to
long-term fixed-maturity instruments. For this business segment, operating
invested assets are approximately equal to average net policy liabilities.
Our
insurance subsidiaries also have invested assets that exceed net policy
liabilities, which allow us to maintain solid claims paying ratings. Income
from these investments is reflected in unallocated revenue.
35
The following table and commentary provide selected financial
information on the operating segments.
|
|
Third Quarter Ended
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
September 30,
|
|
(millions)
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
Operating segment revenue:
(1) (2)
|
|
|
|
|
|
|
|
|
|
Risk and Insurance Brokerage Services
|
|
$
|
1,437
|
|
$
|
1,341
|
|
$
|
4,408
|
|
$
|
4,106
|
|
Consulting
|
|
325
|
|
301
|
|
979
|
|
918
|
|
Insurance Underwriting
|
|
627
|
|
519
|
|
1,811
|
|
1,519
|
|
Income (loss) before income tax:
|
|
|
|
|
|
|
|
|
|
Risk and Insurance Brokerage Services
|
|
$
|
236
|
|
$
|
190
|
|
$
|
756
|
|
$
|
645
|
|
Consulting
|
|
38
|
|
18
|
|
129
|
|
71
|
|
Insurance Underwriting
|
|
63
|
|
(27
|
)
|
189
|
|
101
|
|
Pretax Margins:
|
|
|
|
|
|
|
|
|
|
Risk and Insurance Brokerage Services
|
|
16.4
|
%
|
14.2
|
%
|
17.2
|
%
|
15.7
|
%
|
Consulting
|
|
11.7
|
%
|
6.0
|
%
|
13.2
|
%
|
7.7
|
%
|
Insurance Underwriting
|
|
10.0
|
%
|
-5.2
|
%
|
10.4
|
%
|
6.6
|
%
|
(1) Intersegment revenues of
$8 million and $12 million were included in third quarter 2007 and 2006,
respectively.
(2)
Intersegment revenues of $24 million and $36 million were included in nine
months 2007 and 2006, respectively.
The
following table reflects investment income earned by the operating segments,
which is included in the foregoing results.
|
|
Third Quarter Ended
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
September 30,
|
|
(millions)
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
|
|
|
|
|
|
|
|
|
|
Risk and Insurance Brokerage Services
|
|
$
|
56
|
|
$
|
47
|
|
$
|
154
|
|
$
|
152
|
|
Consulting
|
|
1
|
|
1
|
|
8
|
|
4
|
|
Insurance Underwriting
|
|
33
|
|
25
|
|
93
|
|
76
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Risk and
Insurance Brokerage Services investment income increased $9 million and $2
million on a quarterly and year-to-date basis, respectively. The quarterly
increase was primarily driven by higher interest rates, while the year-to-date
increase was driven by higher interest rates and the gain on the sale of
certain investments, mostly offset by the contribution of our Scandent
preferred stock investment to a U.K. pension plan in 2006, which resulted in a
gain of $35 million.
The $4 million
improvement at Consulting for nine months is a result of a gain on the sale of
an investment.
Insurance
Underwriting investment income increased $8 million and $17 million on a
quarterly and year-to-date basis, respectively, primarily because of higher
invested balances and increases in interest rates.
36
Risk and Insurance Brokerage Services
Aon is a leader in many sectors of the
insurance industry. Globally, we are the largest insurance broker, the largest
reinsurance broker, and the leading manager of captive insurance companies
worldwide. These rankings are based on the most recent surveys compiled and
reports printed by
Business Insurance.
Changes in premiums have a direct and potentially material impact on
the insurance brokerage industry, as commission revenues are generally based on
a percentage of the premiums paid by insureds. Insurance premiums may vary
widely based on market conditions. Heavier than anticipated loss experience or
capital shortages can result in increasing premium rates, which is referred to
as a hard market. A hard market tends
to favorably impact commission revenues. Conversely, increased competition for
market share among insurance carriers or increased underwriting capacity can
result in flat or reduced premium rates, or a soft market. A soft market tends to put downward pressure
on commission revenues. Hard and soft markets may be broad-based or more
narrowly focused across certain product lines or geographic areas.
Risk and Insurance Brokerage Services generated approximately 60% and
61% of Aons total operating segment revenues for third quarter and nine months
2007, respectively. Revenues are generated primarily through:
fees paid by
clients
commissions and
fees paid by insurance and reinsurance companies
interest income
on funds held on behalf of clients.
Our revenues vary from quarter to quarter throughout the year as a
result of:
the timing of
our clients policy renewals
the net effect
of new and lost business
the timing of
services provided to our clients
the income we
earn on investments, which is heavily influenced by short-term interest rates.
Our risk brokerage companies operate in a
highly competitive industry and compete with many retail insurance brokerage
and agency firms, as well as individual brokers, agents, and direct writers of
insurance coverage. Specifically, this segment:
addresses
the highly specialized product development and risk management needs of commercial
enterprises, professional groups, insurance companies, governments, healthcare
providers, and non-profit groups, among others
provides
affinity products for professional liability, life, disability income and
personal lines for individuals, associations and businesses
provides
reinsurance services to insurance and reinsurance companies and other risk
assumption entities by acting as brokers or intermediaries on all classes of
reinsurance
provides
managing underwriting and premium finance services to independent agents and
brokers as well as corporate clients
provides
actuarial, loss prevention and administrative services to businesses and
consumers
manages
captive insurance companies.
We review our revenue results using the following sub-segments:
Risk Management and Insurance Brokerage
encompasses our
retail brokerage services, affinity products, managing general underwriting,
placement and captive management services, and premium finance services in the
following geographic areas: Americas;
United Kingdom; Europe, Middle East & Africa; and Asia Pacific.
37
Reinsurance Brokerage and Related Services (Reinsurance)
offers sophisticated advisory services in program design
and claim recoveries that enhance the risk/return characteristics of insurance
policy portfolios, improve capital utilization and evaluate and mitigate
catastrophic loss exposures worldwide.
Revenue
These tables
show Risk and Insurance Brokerage Services revenue by sub-segment.
|
|
Third Quarter Ended September 30,
|
|
|
|
|
|
|
|
|
|
|
|
Less:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less:
|
|
Acquisitions,
|
|
Less:
|
|
Organic
|
|
|
|
|
|
|
|
Percent
|
|
Currency
|
|
Divestitures,
|
|
All
|
|
Revenue
|
|
(millions)
|
|
2007
|
|
2006
|
|
Change
|
|
Impact
|
|
& Transfers
|
|
Other
|
|
Growth
|
|
Americas
|
|
$
|
582
|
|
$
|
567
|
|
3
|
%
|
1
|
%
|
|
%
|
(1
|
)%
|
3
|
%
|
United Kingdom
|
|
207
|
|
180
|
|
15
|
|
4
|
|
1
|
|
5
|
|
5
|
|
Europe, Middle East & Africa
|
|
275
|
|
242
|
|
14
|
|
7
|
|
(2
|
)
|
6
|
|
3
|
|
Asia Pacific
|
|
123
|
|
114
|
|
8
|
|
9
|
|
(3
|
)
|
(1
|
)
|
3
|
|
Reinsurance
|
|
250
|
|
238
|
|
5
|
|
3
|
|
2
|
|
|
|
|
|
Total revenue
|
|
$
|
1,437
|
|
$
|
1,341
|
|
7
|
%
|
4
|
%
|
|
%
|
|
%
|
3
|
%
|
|
|
Nine Months Ended September 30,
|
|
|
|
|
|
|
|
|
|
|
|
Less:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less:
|
|
Acquisitions,
|
|
Less:
|
|
Organic
|
|
|
|
|
|
|
|
Percent
|
|
Currency
|
|
Divestitures,
|
|
All
|
|
Revenue
|
|
(millions)
|
|
2007
|
|
2006
|
|
Change
|
|
Impact
|
|
& Transfers
|
|
Other
|
|
Growth
|
|
Americas
|
|
$
|
1,719
|
|
$
|
1,665
|
|
3
|
%
|
1
|
%
|
|
%
|
(3
|
)%
|
5
|
%
|
United Kingdom
|
|
581
|
|
526
|
|
10
|
|
5
|
|
3
|
|
2
|
|
|
|
Europe, Middle East & Africa
|
|
1,016
|
|
886
|
|
15
|
|
7
|
|
|
|
5
|
|
3
|
|
Asia Pacific
|
|
361
|
|
331
|
|
9
|
|
8
|
|
(3
|
)
|
(1
|
)
|
5
|
|
Reinsurance
|
|
731
|
|
698
|
|
5
|
|
3
|
|
1
|
|
|
|
1
|
|
Total revenue
|
|
$
|
4,408
|
|
$
|
4,106
|
|
7
|
%
|
4
|
%
|
1
|
%
|
(2
|
)%
|
4
|
%
|
Americas
revenue was up 3% on a quarterly and year-to-date basis driven by strong new
business growth in the U.S. and Latin America and effective management of our
renewal book portfolio. Nine months 2006 results were impacted by a $35 million
gain on the contribution of our Scandent preferred stock.
U.K.
revenue rose 15% and 10% on a quarterly and year-to-date basis, respectively,
due to favorable foreign currency translation and acquisitions. Organic revenue
growth was 5% in the third quarter, driven by new business and an improved
retention rate.
Europe,
Middle East & Africa revenue rose 14% and 15% on a quarterly and
year-to-date basis, respectively, reflecting favorable foreign currency
translation, improved investment income and 3% organic revenue growth on both a
quarterly and year-to-date basis. Organic growth was primarily due to a higher
retention rate in most of Europe and strong growth in emerging markets.
Asia
Pacifics 8% and 9% revenue growth on a quarterly and year-to-date basis,
respectively, was driven by positive foreign currency translation and organic
growth in most markets in Asia, partially offset by continued weakness in
Australia.
38
Reinsurance
revenue grew 5% on a quarterly and year-to-date basis. The growth was driven by
the favorable impact of foreign currency translation, acquisitions, and organic
revenue growth in international markets, driven by growth of facultative
placements, which more than offset a quarterly decline in the U.S. due to soft
market conditions.
This table
shows Risk and Insurance Brokerage Services revenue by geographic area.
|
|
Third Quarter Ended
|
|
Nine Months Ended
|
|
|
|
Sept. 30,
|
|
Sept. 30,
|
|
Percent
|
|
Sept. 30,
|
|
Sept. 30,
|
|
Percent
|
|
(millions)
|
|
2007
|
|
2006
|
|
Change
|
|
2007
|
|
2006
|
|
Change
|
|
United States
|
|
$
|
530
|
|
$
|
528
|
|
|
%
|
$
|
1,563
|
|
$
|
1,538
|
|
2
|
%
|
Americas, other than U.S.
|
|
162
|
|
143
|
|
13
|
|
468
|
|
422
|
|
11
|
|
United Kingdom
|
|
266
|
|
243
|
|
9
|
|
749
|
|
707
|
|
6
|
|
Europe, Middle East & Africa
|
|
341
|
|
303
|
|
13
|
|
1,226
|
|
1,075
|
|
14
|
|
Asia Pacific
|
|
138
|
|
124
|
|
11
|
|
402
|
|
364
|
|
10
|
|
Total revenue
|
|
$
|
1,437
|
|
$
|
1,341
|
|
7
|
%
|
$
|
4,408
|
|
$
|
4,106
|
|
7
|
%
|
U.S.
revenues are unchanged on a quarterly basis as growth in our U.S. retail
business was offset by soft market conditions in our reinsurance business.
Revenue rose 2% on a year-to-date basis as strong new business, effective
renewal book management in U.S. retail, and investment income gains were
partially offset by last years gain on the contribution of our Scandent
preferred stock.
Americas
other than U.S. revenue rose 13% on a quarterly and 11% on a year-to-date
basis, respectively, due to strong organic growth in Latin America and the favorable
impact of foreign currency translation.
UK
revenue increased 9% and 6% on a quarterly and year-to-date basis,
respectively, primarily driven by favorable foreign currency translation as
well as organic growth on a quarterly basis.
Europe,
Middle East & Africa grew 13% and 14% on a quarterly and year-to-date
basis, respectively, driven by favorable foreign currency translation, higher
investment income, and organic growth.
Asia
Pacific revenue rose 11% and 10%, respectively, due to favorable foreign
currency translation and organic revenue growth.
Income Before Income Tax
Pretax
income rose $46 million to $236 million for the quarter and increased $111
million to $756 million for nine months. Pretax margins were 16.4% and 17.2% on
a quarterly and year-to-date basis, respectively, compared to 14.2% and 15.7%
on a quarterly and year-to-date basis, respectively, in 2006. Organic revenue
growth of 3% and 4% on a quarterly and year-to-date basis, respectively,
savings from the restructuring program, primarily for workforce reduction, and
lower pension expenses were partially offset by higher salary costs and
investment in talent and the impact of the gain on the sale of a building in
Spain in 2006 of $30 million.
Consulting
Aon
Consulting is one of the worlds largest integrated human capital consulting
organizations. Our Consulting segment:
provides
a broad range of consulting services
generated
14% of Aons total operating segment revenue for both the third quarter and
nine months 2007.
39
We review
our revenue results using the following sub-segments:
Consulting services
, which provide consulting services in
six major practice areas:
1.
Employee Benefits
advises clients about how to structure, fund and administer employee benefit
programs that attract, retain and motivate employees. Benefits consulting
includes health and welfare, retirement, executive benefits, absence
management, compliance, employer commitment, investment advisory and elective
benefit services.
2.
Compensation
focuses on designing salary, bonus, commission,
stock option and other pay structures, with special expertise in the financial
services and technology industries.
3.
Management Consulting
assists clients in process improvement and design, leadership, organization and
human capital development, and change management.
4.
Communications
advises clients on how to communicate initiatives that support their corporate
vision.
5.
Strategic Human Resource
Consulting
advises complex global organizations on talent, change
and organization effectiveness issues including assessment, selection
performance management, succession planning, organization design and related
people-management programs.
6.
Financial Advisory and
Litigation Consulting
provides consulting services including
white-collar and financial statement investigation, securities litigation,
financial due diligence, financial valuation services and other related
specialties.
Outsourcing
, which offers employment processing, performance
improvement, benefits administration and other employment-related services.
Revenues in the Consulting segment are
affected by changes in clients industries, including government regulation, as
well as new products and services, the state of the economic cycle, broad
trends in employee demographics and the management of large organizations.
40
Revenue
These tables show Consulting revenue by product sub-segment.
|
|
Third Quarter Ended September 30,
|
|
|
|
|
|
|
|
|
|
|
|
Less:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less:
|
|
Acquisitions,
|
|
Less:
|
|
Organic
|
|
|
|
|
|
|
|
Percent
|
|
Currency
|
|
Divestitures,
|
|
All
|
|
Revenue
|
|
(millions)
|
|
2007
|
|
2006
|
|
Change
|
|
Impact
|
|
& Transfers
|
|
Other
|
|
Growth
|
|
Consulting services
|
|
$
|
270
|
|
$
|
234
|
|
15
|
%
|
4
|
%
|
3
|
%
|
|
%
|
8
|
%
|
Outsourcing
|
|
55
|
|
67
|
|
(18
|
)
|
3
|
|
(1
|
)
|
|
|
(20
|
)
|
Total revenue
|
|
$
|
325
|
|
$
|
301
|
|
8
|
%
|
4
|
%
|
2
|
%
|
|
%
|
2
|
%
|
|
|
Nine Months Ended September 30,
|
|
|
|
|
|
|
|
|
|
|
|
Less:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less:
|
|
Acquisitions,
|
|
Less:
|
|
Organic
|
|
|
|
|
|
|
|
Percent
|
|
Currency
|
|
Divestitures,
|
|
All
|
|
Revenue
|
|
(millions)
|
|
2007
|
|
2006
|
|
Change
|
|
Impact
|
|
& Transfers
|
|
Other
|
|
Growth
|
|
Consulting services
|
|
$
|
803
|
|
$
|
709
|
|
13
|
%
|
4
|
%
|
2
|
%
|
1
|
%
|
6
|
%
|
Outsourcing
|
|
176
|
|
209
|
|
(16
|
)
|
3
|
|
|
|
(1
|
)
|
(18
|
)
|
Total revenue
|
|
$
|
979
|
|
$
|
918
|
|
7
|
%
|
3
|
%
|
2
|
%
|
1
|
%
|
1
|
%
|
Consulting
Services revenue increased $36 million and $94 million on a quarterly and
year-to-date basis, respectively. Organic revenue growth was 8% for the quarter
and 6% for nine months 2007, reflecting growth in most major practice groups
and geographies. Revenue also increased due to favorable foreign currency
translation and the transfer in of certain small units from the Risk and
Insurance Brokerage Service segment.
Outsourcing
revenue declined $12 million and $33 million on a quarterly and year-to-date
basis, respectively. Organic revenue declined 20% and 18% on a quarterly and
year-to-date basis, respectively, driven by lower revenue from AT&T. AT&T,
which is our largest outsourcing client, terminated many services in a contract
with us at the end of 2006, and recently informed us that they intend to
terminate our remaining outsourcing services effective at the end of 2007.
This table shows Consulting revenue by geographic area.
|
|
Third Quarter Ended
|
|
Nine Months Ended
|
|
|
Sept. 30,
|
|
Sept. 30,
|
|
Percent
|
|
Sept. 30,
|
|
Sept. 30,
|
|
Percent
|
|
(millions)
|
|
2007
|
|
2006
|
|
Change
|
|
2007
|
|
2006
|
|
Change
|
|
United States
|
|
$
|
156
|
|
$
|
165
|
|
(5
|
)%
|
$
|
484
|
|
$
|
505
|
|
(4
|
)%
|
Americas, other than U.S.
|
|
27
|
|
25
|
|
8
|
|
88
|
|
84
|
|
5
|
|
United Kingdom
|
|
69
|
|
58
|
|
19
|
|
197
|
|
169
|
|
17
|
|
Europe, Middle East & Africa
|
|
56
|
|
43
|
|
30
|
|
168
|
|
136
|
|
24
|
|
Asia Pacific
|
|
17
|
|
10
|
|
70
|
|
42
|
|
24
|
|
75
|
|
Total revenue
|
|
$
|
325
|
|
$
|
301
|
|
8
|
%
|
$
|
979
|
|
$
|
918
|
|
7
|
%
|
41
The
U.S. revenue decline in both periods was primarily caused by reduced
outsourcing business triggered by the loss of revenue from AT&T as
discussed above, partially offset by organic revenue growth in Consulting
Services, and on a year-to-date basis, a $5 million gain on the sale of an investment.
Americas
other than the U.S. grew 8% and 5% on a quarterly and year-to-date basis driven
by favorable foreign currency translation.
United
Kingdom revenue rose 19% and 17% on a quarterly and year-to-date basis driven
by both organic growth and favorable foreign currency translation.
Europe,
Middle East & Africa increased 30% and 24% on a quarterly and year-to-date
basis, respectively, driven by favorable foreign currency translation, the
transfer in of certain small units from our brokerage segment and organic
revenue growth.
Asia
Pacific grew 70% and 75% on a quarterly and year-to-date basis, respectively,
due to favorable foreign currency translation, the transfer in of certain small
units from our brokerage segment and organic revenue growth.
Income Before Income Tax
Third
quarter 2007 pretax income was up 111% to $38 million, compared to $18 million
in 2006. Year-to-date pretax income was up 82% to $129 million, compared to $71
million in 2006. Pretax margins for the quarter were 11.7% and 6.0% for 2007
and 2006, respectively. Pretax margins for the first nine months were 13.2% and
7.7% for 2007 and 2006, respectively. The pretax income and margin improvement
was principally driven by higher revenues, benefits related to the restructuring
program and disciplined expense management in the U.S., and on a year-to-date
basis, the gain on the sale of an investment.
Insurance Underwriting
The Insurance Underwriting segment:
provides
accident, health and life insurance coverage mostly through direct distribution
networks, primarily through more than 7,000 career insurance agents working for
our subsidiaries. Our revenues are affected by our success in attracting and
retaining these career agents.
previously
offered select commercial property and casualty business on a limited basis
through managing general underwriters. We have ceased writing property and
casualty business and have placed all programs in runoff.
has
operations in the United States, Canada, Europe and Asia Pacific.
generated
26% and 25% of Aons total operating segment revenue for the third quarter and
nine months 2007, respectively.
Refer
to the Key Recent Events section for a discussion on Aons examination of
strategic options for the remaining operations of this segment.
Revenue
Written premium and fees are the basis for
organic revenue growth in this segment; however, reported revenues reflect
earned premiums and fees.
42
We review our revenue results using the following sub-segments:
Accident & Health and Life
, through which we provide an
array of accident, health (including Medicare Advantage), short-term disability
and other insurance products. Most of these products are primarily
fixed-indemnity obligations and are not subject to escalating medical cost
inflation;
Property and Casualty.
We have ceased writing property and
casualty business. This subsegment is entirely composed of runoff liabilities
pertaining to various personal and commercial risks we formerly underwrote,
such as:
professional
liability errors and omissions
excess liability
workers
compensation
commercial
property and casualty risk.
These tables show Insurance Underwriting
revenue by product sub-segment:
|
|
Third Quarter Ended September 30,
|
|
|
|
|
|
|
|
|
|
Less:
|
|
Less:
|
|
Organic
|
|
|
|
|
|
|
|
Percent
|
|
Currency
|
|
All
|
|
Revenue
|
|
(millions)
|
|
2007
|
|
2006
|
|
Change
|
|
Impact
|
|
Other
|
|
Growth (1)
|
|
Accident & health and life
|
|
$
|
625
|
|
$
|
511
|
|
22
|
%
|
3
|
%
|
(2
|
)%
|
21
|
%
|
Property & casualty
|
|
2
|
|
8
|
|
(75
|
)
|
N/A
|
|
N/A
|
|
N/A
|
|
Total revenue
|
|
$
|
627
|
|
$
|
519
|
|
21
|
%
|
3
|
%
|
(1
|
)%
|
19
|
%
|
(1) Organic revenue growth
for Property & casualty is no longer meaningful as the remaining business
in in run-off.
|
|
Nine Months Ended September 30,
|
|
|
|
|
|
|
|
|
|
Less:
|
|
Less:
|
|
Organic
|
|
|
|
|
|
|
|
Percent
|
|
Currency
|
|
All
|
|
Revenue
|
|
(millions)
|
|
2007
|
|
2006
|
|
Change
|
|
Impact
|
|
Other
|
|
Growth (1)
|
|
Accident & health and life
|
|
$
|
1,809
|
|
$
|
1,491
|
|
21
|
%
|
2
|
%
|
1
|
%
|
18
|
%
|
Property & casualty
|
|
2
|
|
28
|
|
(93
|
)
|
N/A
|
|
N/A
|
|
N/A
|
|
Total revenue
|
|
$
|
1,811
|
|
$
|
1,519
|
|
19
|
%
|
2
|
%
|
|
%
|
17
|
%
|
(1)
Organic revenue growth for Property & casualty is no longer meaningful as
the remaining business in in run-off.
In the
Accident & health and life business, revenue increased $114 million or 22%
for the quarter and $318 million or 21% on a year-to-date basis, driven by
strong growth in Sterlings MA product, favorable foreign currency translation
and higher investment income.
43
This table shows Insurance Underwriting
revenue by geographic area.
|
|
Third Quarter Ended
|
|
Nine Months Ended
|
|
|
|
Sept. 30,
|
|
Sept. 30,
|
|
Percent
|
|
Sept. 30,
|
|
Sept. 30,
|
|
Percent
|
|
(millions)
|
|
2007
|
|
2006
|
|
Change
|
|
2007
|
|
2006
|
|
Change
|
|
United States
|
|
$
|
441
|
|
$
|
354
|
|
25
|
%
|
$
|
1,277
|
|
$
|
1,036
|
|
23
|
%
|
Americas, other than U.S.
|
|
60
|
|
53
|
|
13
|
|
168
|
|
156
|
|
8
|
|
United Kingdom
|
|
55
|
|
51
|
|
8
|
|
161
|
|
151
|
|
7
|
|
Europe, Middle East & Africa
|
|
43
|
|
38
|
|
13
|
|
125
|
|
108
|
|
16
|
|
Asia Pacific
|
|
28
|
|
23
|
|
22
|
|
80
|
|
68
|
|
18
|
|
Total revenue
|
|
$
|
627
|
|
$
|
519
|
|
21
|
%
|
$
|
1,811
|
|
$
|
1,519
|
|
19
|
%
|
U.S.
revenue increased $87 million or 25% for the quarter and $241 million or 23%
for the first nine months driven by growth in Sterlings MA product.
Americas,
other than U.S. revenues increased $7 million and $12 million over the third
quarter and first nine months of 2006 principally due to the positive impact of
foreign currency translation.
United
Kingdom revenue growth of 8% and 7% on a quarterly and year-to-date basis,
respectively, was driven by favorable foreign currency translation.
Europe,
Middle East & Africa increased 13% and 16% on a quarterly and year-to-date
basis, respectively, due to organic growth and foreign currency translation.
Asia
Pacific revenue increased 22% and 18% on a quarterly and year-to-date basis,
respectively, driven by organic growth and foreign currency translation.
Income Before Income Tax
Third
quarter pretax income was $63 million and the pretax margin was 10.0%, compared
to a $27 million pretax loss with a -5.2% margin in the third quarter 2006. Year-to-date
pretax income was $189 million and the pretax margin was 10.4%, compared to
pretax income of $101 million with a margin of 6.6% in 2006. The significant
increase in pretax income as well as comparable margins for both periods is
driven by the $81 million reserve increase recorded in 2006 in our property and
casualty sub-segment, which reflected adverse development, refined assumptions
and additional claim information relating to programs placed in run-off. Also
positively impacting both pretax income and margins was higher investment
income and growth in our U.S. operations, which was somewhat offset by higher
loss ratios at Sterling, as well as losses incurred in our property and
casualty run-off businesses.
Unallocated Income and Expense
Unallocated income consists primarily of
investment income (including income or loss on investment disposals and
other-than-temporary impairment losses), which is not otherwise reflected in
the operating segments. We include:
invested
assets and related investment income not directly required to support the risk
and insurance brokerage services and consulting businesses, and
44
the
assets in excess of net policyholder liabilities of the insurance underwriting
subsidiaries and related income.
Unallocated revenue included changes in the valuation of Endurance
warrants. Through March 31, 2006 we carried our investment in Endurance
warrants at fair value and recorded changes in the fair value through
unallocated investment income. On March 31, 2006, the investment in Endurance
warrants was contributed to our U.K. pension plans.
Private equities are principally carried at
cost; however, where we have significant influence, they are carried under the
equity method. These investments usually do not pay dividends. Limited
partnerships are accounted for using the equity method and changes in the value
of the underlying LP investments flow through unallocated investment income.
Unallocated
revenue was $26 million and $102 million for the three and nine month periods
ended September 30, 2007, respectively, compared to $19 million and $34 million
for the comparable periods of 2006. The increase was driven by:
an increase in income from our PEPS I investment of
$15 million on a quarterly basis and $52 million on a year-to-date basis (refer
to Distributions from PEPS I within the Key Recent Events section).
negative mark-to-market adjustments of $17 million
recorded in first quarter 2006 on our investment in Endurance warrants. The
warrants were contributed to the U.K. pension plans on March 31, 2006.
Unallocated expenses, excluding interest expense, were $18 million and
$86 million for the three and nine month periods ended September 30, 2007,
respectively; compared to $27 million and $80 million for comparable periods of
2006. The quarterly decline reflects a foreign exchange gain in 2007 on an
investment. The increase on a year-to-date basis was primarily driven by higher
expenses associated with a review of historical equity compensation practices.
Interest expense totaled $33 million and $102 million for the three and
nine month periods ended September 30, 2007, respectively, and $34 million and
$99 million during comparable periods of 2006. $57 million of debt was
converted to our common stock during the second quarter of 2007, which slightly
reduced interest expense. That benefit was more than offset by higher
international borrowings and increased interest rates.
CASH FLOW
Cash flows from operations represent the net
income we earned in the reported periods adjusted for non-cash charges and
changes in operating assets and liabilities.
Cash flows provided by operating activities
for the nine months ended September 30, 2007 and 2006 are as follows:
(millions) Nine months ended September 30,
|
|
2007
|
|
2006
|
|
Insurance underwriting operating cash flows
(including AWG for 2006)
|
|
$
|
225
|
|
$
|
520
|
|
All other operating cash flows
|
|
551
|
|
254
|
|
|
|
776
|
|
774
|
|
Change in funds held on behalf of brokerage
and consulting clients
|
|
150
|
|
50
|
|
Cash provided by operating activities
|
|
$
|
926
|
|
$
|
824
|
|
45
Insurance Underwriting operating cash flows
Our 2007
insurance underwriting operations include accident & health and life and
certain property & casualty businesses that are in run-off. These insurance
products have distinct differences in the timing of premiums earned and payment
of future liabilities. The 2006 cash flows include the operations of AWG and
CPG, sold on November 30, 2006.
The operating
cash flow from our insurance subsidiaries, which also includes related
corporate items, was $225 million for 2007, a decrease of $295 million compared
to 2006. This decrease was primarily related to the sale of AWG and CPG. For
2007, operating cash flows, analyzed by major income statement component,
indicated that premiums and fees collected, net of reinsurance, were $1,681
million compared to $2,643 million in 2006. Investment and other miscellaneous
income received was $135 million and $195 million in 2007 and 2006,
respectively.
We used
revenues generated from premiums, investments and other miscellaneous income to
pay claims and other cash benefits, commissions, general expenses and taxes. Claims
and other cash benefits paid were $979 million in 2007 versus $1,204 million in
2006. Commissions and general expenses paid were $578 million for 2007,
compared to $947 million in 2006. Tax payments for 2007 were $34 million
compared to $167 million last year.
We will invest
and use operating cash flows to satisfy future benefits to policyholders and
when appropriate, make them available to pay dividends to the Aon parent
company.
Generally, we
invest in highly liquid and marketable investment grade securities to support
policy liabilities. These invested assets are subject to insurance regulations
set forth by the various governmental jurisdictions in which we operate, both
domestically and internationally. The insurance regulations may restrict both
the quantity and quality of various types of assets within the portfolios.
Our insurance
subsidiaries policy liabilities are segmented among multiple accident and
health and property casualty portfolios. Those portfolios have widely varying
estimated durations and interest rate characteristics. Generally, our policy
liabilities are not subject to interest rate volatility risk. Therefore, in
many of the portfolios, asset and policy liability duration are not closely
matched. Interest rate sensitive policy liabilities are generally supported by
floating rate assets.
Funds held on behalf of clients
In our Risk
and Insurance Brokerage Services and Consulting segments, we typically hold
funds on behalf of clients as a result of:
premiums received
from clients that are in transit to insurers. These premiums held on behalf of,
or due from, clients are reported as assets with a corresponding liability due
to the insurer.
claims due to
clients that are in transit from insurers. Claims held by, or due to us and
which are due to clients, are also shown as both assets and liabilities.
These funds
held on behalf of clients are generally invested in interest bearing trust
accounts and can fluctuate significantly depending on when we collect cash from
our clients and when premiums are remitted to the insurance carriers.
46
All other operating cash flows
The operating
cash flow from our Risk and Insurance Brokerage Services and Consulting
segments, as well as related corporate items, was $551 million in 2007 compared
to $254 million in 2006. These amounts exclude the change in funds held on
behalf of clients as described above. The operating cash flows depend on the
timing of receipts and payments related to revenues, incentive compensation,
other operating expenses and income taxes.
Aon uses the
excess cash generated by our brokerage and consulting businesses as well as
dividends received from our insurance company subsidiaries to meet its
liquidity needs, which consist of servicing its debt, paying dividends to its
stockholders and repurchasing outstanding shares.
Investing and Financing Activities
Investing activities during 2007
provided cash of $35 million. The cash flows provided by investing activities
included sales of investments, net of purchases, of $327 million. Cash used by
investing activities included capital expenditures, net of disposals, of $103
million and acquisition of subsidiaries, net of divestitures of $189 million.
For the first nine months of
2007, we used $956 million of cash for financing needs. Financing uses
primarily included cash dividends paid to stockholders of $132 million, net
share repurchase activity of $548 million, and debt repayments, net of
issuance, of $276 million.
Financial Condition
Since year-end
2006, total assets decreased $495 million to $23.8 billion.
Total
investments at September 30, 2007 and December 31, 2006 were $7.5 billion and
$7.6 billion, respectively. Approximately 94% of our investment portfolio at
quarter end was in short-term investments and fixed maturities, with
approximately 100% of our fixed maturities rated investment grade.
Total
receivables decreased $736 million in the first nine months of 2007, primarily
the result of the timing of cash receipts and the impact of foreign currency
translation. Insurance premiums payable decreased $247 million over the same
period. The primary difference between the change in receivables and premiums
payable is reflected in a change in funds held on behalf of clients, which is a
component of short-term investments.
47
|
|
Amount Shown
|
|
|
|
|
|
in Statement
|
|
Percentage
|
|
|
|
of Financial
|
|
of Total
|
|
(millions)
|
|
Position
|
|
Investments
|
|
|
|
|
|
|
|
Fixed maturities - available for sale:
|
|
|
|
|
|
US government and agencies
|
|
$
|
212
|
|
3
|
%
|
States and political subdivisions
|
|
6
|
|
|
|
Debt securities of foreign governments not
classified as loans
|
|
1,353
|
|
18
|
|
Corporate securities
|
|
866
|
|
12
|
|
Public utilities
|
|
81
|
|
1
|
|
Mortgage-backed and asset-backed securities
|
|
452
|
|
6
|
|
Total Fixed Maturities
|
|
2,970
|
|
40
|
|
|
|
|
|
|
|
Equity securities - available for sale:
|
|
|
|
|
|
Common stocks
|
|
38
|
|
|
|
Non-redeemable preferred stocks
|
|
1
|
|
|
|
Total Equity Securities
|
|
39
|
|
|
|
|
|
|
|
|
|
Policy loans
|
|
56
|
|
1
|
|
Other long-term investments
|
|
|
|
|
|
PEPS I Preferred Stock
|
|
181
|
|
2
|
|
Other
|
|
143
|
|
2
|
|
Total Other Long Term Investments
|
|
324
|
|
4
|
|
Total Other Investments
|
|
380
|
|
5
|
|
|
|
|
|
|
|
Short-term investments
|
|
4,096
|
|
55
|
|
|
|
|
|
|
|
TOTAL INVESTMENTS
|
|
$
|
7,485
|
|
100
|
%
|
Goodwill and
intangible assets increased $407 million from year-end 2006 due to recent
acquisition activity and the impact of foreign currency translation.
Other assets
decreased $167 million from December 31, 2006. Other assets are comprised
principally of prepaid premiums related to reinsurance, prepaid pension assets,
and current and deferred income taxes. The decrease is principally related to a
lower current tax receivable and a decrease in prepaid premiums, somewhat
offset by higher prepaid pension assets.
General
expense liabilities fell $396 million from December 31, 2006, due to paying
annual incentives during the first quarter, lower restructuring reserves and
the timing of accounts payable payments.
Short-term Borrowings and Notes Payable
Borrowings
Total debt at September 30, 2007 was $2,008 million, a decrease of $277
million from December 31, 2006. In January, we paid down $250 million of U.S.
debt which had become due. Also during the first quarter we repaid most of our
short-term debt. Our Euro facility borrowings increased $9 million since
December 31, 2006.
In May 2007, holders of $57 million of our 3.5% convertible debt
securities due November 2012 converted their holdings into approximately 2.7
million shares of Aon stock.
On October 4, 2007, we announced that the Company will redeem on
November 19, 2007 all of our outstanding 3 ½ % Senior Convertible Debentures
due 2012 (Debentures). On September 30, 2007, the aggregate principal amount
of the Debentures outstanding was approximately $243 million. The redemption
price for the Debentures will be 101% of the principal amount of the
Debentures, together with accrued and unpaid interest.
48
On or before the close of business on November 16, 2007, the holders of
the Debentures may elect to convert their Debentures into Aon common stock at a
conversion rate of 46.5658 shares of common stock for each $1,000 principal
amount of Debentures, subject to the terms and conditions set forth in the
Indenture and the Debentures. Debentures not converted on or before the close
of business on November 16, 2007 will no longer be convertible and holders will
only be entitled to the right to receive the redemption price of the Debentures
and accrued and unpaid interest to, but excluding November 19, 2007.
If all outstanding debentures as of September 30, 2007 are converted
into Aon common stock, approximately 11.3 million shares will be issued.
At September 30, 2007, we had a $600 million U.S. bank credit facility,
which expires in February 2010, to support commercial paper and other
short-term borrowings. The facility allows us to issue up to $150 million in
letters of credit. At September 30, 2007, we have issued $20 million in letters
of credit.
We also have
several foreign credit facilities available. At September 30, 2007, we had
available to us:
a
five-year 650 million ($918 million) multi-currency facility of which $412
million was outstanding at September 30, 2007. See Note 8 to the consolidated
financial statements in our 2006 Form 10-K for further discussion of both the
U.S. and Euro facilities;
a £37.5 million ($76 million) facility, a 364-day 10
million Canadian dollar ($10 million) facility and a 364-day 25 million
($35 million) facility.
a 20 million ($28 million) open-ended facility.
The major rating agencies ratings of our debt at November 2, 2007
appear in the table below.
|
|
Senior long-term debt
|
|
Commercial paper
|
|
|
|
Rating
|
|
Outlook
|
|
Rating
|
|
Outlook
|
|
Standard & Poors
|
|
BBB+
|
|
Stable
|
|
A-2
|
|
Stable
|
|
Moodys Investor Services
|
|
Baa2
|
|
Positive
|
|
P-2
|
|
Positive
|
|
Fitch, Inc.
|
|
BBB+
|
|
Stable
|
|
F-2
|
|
Stable
|
|
A downgrade in the credit ratings of our senior debt and commercial
paper would:
increase
our borrowing costs and reduce our financial flexibility
increase
our commercial paper interest rates or may restrict our access to the commercial
paper market altogether. Although we have committed backup lines, we cannot
ensure that our financial position will not be hurt if we can no longer access
the commercial paper market.
In addition,
intercompany notes between Aon Parent and certain of our accident & health
and life insurance companies will become payable within 30 days if Aons credit
rating on its senior long-term debt falls below investment grade.
Stockholders
Equity
Stockholders
equity increased $397 million from the fourth quarter 2006 to $5,615 million. The
change was driven primarily by $657 million of net income and an increase in
foreign exchange translation gains, principally offset by $443 million of net
treasury stock repurchases as a result of our stock repurchase program.
49
Accumulated
other comprehensive loss decreased $219 million since December 31, 2006. Net
foreign exchange translation increased by $159 million because of the weakening
of the U.S. dollar against certain foreign currencies as compared to the prior
year-end. Changes in our postretirement plans decreased our accumulated other
comprehensive loss by $62 million.
Our total
debt as a percentage of total capital was 26.3% at September 30, 2007. This is
compared to our total debt as a percentage of total capital of 30.5% at
year-end 2006.
Off Balance Sheet Arrangements
We record various contractual obligations as liabilities in our
consolidated financial statements. Other items, such as certain purchase commitments
and other executory contracts, are not recognized as liabilities in our
consolidated financial statements, but we are required to disclose them.
Aon and its subsidiaries have issued letters
of credit to cover contingent payments for taxes and other business obligations
to third parties. We accrue amounts in our consolidated financial statements
for these letters of credit to the extent they are probable and estimable.
Following the guidance of FASB Statement No. 140,
Accounting
for Transfers and Servicing of Financial Assets and Extinguishment of
Liabilities
and other relevant accounting guidance, we use special
purpose entities (SPEs) and qualifying special purpose entities (QSPEs),
also known as special purpose vehicles, in some of our operations.
Premium Financing
Certain of our
U.S., U.K., Canadian and Australian subsidiaries originate short-term loans
(generally with terms of 12 months or less) to businesses to finance their
insurance premium obligations, and then sell these premium finance agreements
in securitization transactions that meet the criteria for sale accounting under
Statement No. 140. These sales involve:
special
purpose entities which are considered QSPEs by Statement No. 140, and per
Statement No. 140 should not be consolidated in the financial statements of a
transferor or its affiliates (Aons subsidiaries).
multi-seller,
non-qualified bank commercial paper conduit SPEs (Bank SPEs) that are
variable interest entities according to FIN 46.
We have
analyzed qualitative and quantitative factors related to our subsidiaries
interests in the Bank SPEs and have determined that these subsidiaries are not
the sponsors of the Bank SPEs. Additionally, independent third parties:
have
made substantial equity investments in the Bank SPEs
have
voting control of the Bank SPEs
generally
have the risks and rewards of ownership of the assets of the Bank SPEs.
Thus, we have
concluded that non-consolidation of the Bank SPEs is appropriate in accordance
with FIN 46 given that our subsidiaries do not have significant variable
interests.
Through the
securitization agreements we, or one of our QSPEs, sell undivided interests in
specified premium finance agreements to the Bank SPEs. The total amount
advanced on premium finance agreements sold to the Bank SPEs at any one time is
limited by the securitization agreements to $1.8 billion. The Bank SPEs had
advanced $1.6 billion and $1.7 billion at September 30, 2007 and December 31,
2006, respectively. We can receive additional advances as:
50
we
sell more eligible premium finance agreements to the Bank SPEs
collections,
which we administer, on previously sold agreements reduce available advances.
We record at
fair value our retained interest in the sold premium finance agreements, and
report it in insurance brokerage and consulting services receivables in the
condensed consolidated statements of financial position. We also:
retain
servicing rights for sold agreements
earn
servicing fee income over the servicing period and include these servicing fees
in the gain/loss calculation.
At September 30, 2007 and December 31, 2006, since the fair value of
the servicing rights approximates the estimated costs to service the
receivables, we have not recorded any servicing assets or liabilities.
We estimate
fair value by discounting estimated future cash flows from the servicing rights
and servicing costs using:
discount
rates that approximate current market rates
expected
future prepayment rates.
The Bank SPEs
bear the credit risks on the receivables, subject to limited recourse in the
form of credit loss reserves, which are covered by collateral enhancements.
All but the
Australian facility require Aon to maintain consolidated net worth, as defined,
of at least $2.5 billion, and:
consolidated
EBITDA (earnings before interest, taxes, depreciation and amortization) to
consolidated net interest of at least 4 to 1
consolidated
indebtedness to consolidated EBITDA of no more than 3 to 1.
We intend to renew the conduit facilities when they expire. In October
2007, we renewed our U.S. facility for an additional year, with no significant
changes to the terms of the agreement. The Australian facility was also renewed.
The new agreement reduced their facility limit from Australian dollar (AUD)
150 million to AUD 100 million. If there were adverse bank, regulatory, tax or
accounting rule changes, our access to the conduit facilities and special
purpose vehicles would be restricted. These special purpose vehicles are not
included in our consolidated financial statements, following the appropriate
accounting standards.
PEPS I
In 2001, we sold the vast majority of our LP
portfolio, valued at $450 million, to PEPS I, a QSPE. The common stock interest
in PEPS I is currently held by a limited liability company, owned by Aon
Corporation (49%) and by a charitable trust, which we do not control,
established for victims of the September 11th attacks (51%).
PEPS I sold approximately $171 million of
investment grade fixed-maturity securities to unaffiliated third parties. It
then paid our insurance underwriting subsidiaries the $171 million in cash and
issued them an additional $279 million in fixed-maturity and preferred stock
securities.
51
Standard & Poors Ratings Services rated
the fixed-maturity securities our subsidiaries received from PEPS I as
investment grade. As part of this transaction, the insurance companies had been
required to purchase additional fixed-maturity securities from PEPS I in an
amount equal to the unfunded LP commitments as they are requested. These
fixed-maturity securities are rated below investment grade. Commitments of $2
million were funded by us in 2007. As of September 30, 2007, unfunded
commitments amounted to $44 million. These commitments have specific expiration
dates and the general partners may decide not to draw on these commitments. We
have not included the assets, liabilities and operations of PEPS I in our condensed
consolidated financial statements.
In previous years Aon has recognized other
than temporary impairment write-downs of $59 million, equal to the original
cost of one tranche. The preferred stock interest represents a beneficial
interest in securitized LP investments. The fair value of the private preferred
stock interests depends on the value of the LP investments held by PEPS I. These
preferred stock interests have an unrealized investment gain as of September
30, 2007. We assess other-than-temporary declines in the fair value below cost
using a financial model that considers the:
value
of the underlying LP investments of PEPS I
nature
and timing of the cash flows from the underlying LP investments of PEPS I.
Reinsurance Guarantee
In connection
with the AWG disposal, we issued an indemnification that protects the purchaser
from credit exposure relating to the property and casualty reserves that have
been reinsured. Aon has provided a corporate guarantee with respect to these
reinsurance recoverables, which amount to approximately $887 million at
September 30, 2007. At December 31, 2006, we had recorded a $13 million
liability, reflecting the fair value of this indemnification. The value
declined to approximately $12 million as of September 30, 2007. The
indemnification represents the present value of the indemnification on the
credit risk of the reinsurers. Aon no longer reports reinsurance recoverables
related to its property and casualty business, which was not part of the sale
of AWG.
52
INFORMATION CONCERNING FORWARD-LOOKING STATEMENTS
This report contains certain statements related to future results, or
states our intentions, beliefs and expectations or predictions for the future
which are forward-looking statements as that term is defined in the Private
Securities Litigation Reform Act of 1995. These forward-looking statements are
subject to certain risks and uncertainties that could cause actual results to
differ materially from either historical or anticipated results depending on a
variety of factors. Potential factors that could impact results include:
general economic conditions in different countries in which we do business
around the world, changes in global equity and fixed income markets that could
affect the return on invested assets, fluctuations in exchange and interest
rates that could influence revenue and expense, rating agency actions that
could affect our ability to borrow funds, funding of our various pension plans,
changes in the competitive environment, our ability to implement restructuring
initiatives and other initiatives intended to yield cost savings, our ability
to successfully execute strategic options for our Combined Insurance
subsidiary, the impact of current, pending and future regulatory and
legislative actions that affect our ability to market or sell, and be
reimbursed at current levels for, our Sterling subsidiarys Medicare Advantage
health plans, changes in commercial property and casualty markets and commercial
premium rates that could impact revenues, changes in revenues and earnings due
to the elimination of contingent commissions, other uncertainties surrounding a
new compensation model, the impact of investigations brought by state attorneys
general, state insurance regulators, federal prosecutors and federal
regulators, the impact of class actions and individual lawsuits including
client class actions, securities class actions, derivative actions and ERISA
class actions, the impact of the analyses of practices relating to stock
options, the cost of resolution of other contingent liabilities and loss
contingencies, and the difference in ultimate paid claims in our underwriting
companies from actuarial estimates.
We undertake no obligation to publicly update forward-looking
statements, whether as a result of new information, future events or otherwise.
53
ITEM
3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed
to potential fluctuations in earnings, cash flows and the fair value of certain
of our assets and liabilities due to changes in interest rates, foreign
exchange rates and equity prices. To manage the risk from these exposures, we
enter into a variety of derivative instruments. We do not enter into
derivatives or financial instruments for trading purposes.
We are subject
to foreign exchange rate risk from translating the financial statements of our
foreign subsidiaries into U.S. dollars. Our primary exposures are to the British
pound, the Euro, the Canadian dollar, and the Australian dollar. We use
over-the-counter (OTC) options and forward contracts to reduce the impact of
foreign currency fluctuations on the translation of our foreign operations
financial statements.
Additionally,
some of our foreign brokerage subsidiaries receive revenues in currencies that
differ from their functional currencies. Our U.K. subsidiary earns a portion of
its revenue in U.S. dollars but most of its expenses are incurred in pounds
sterling. Our policy is to convert into pounds sterling sufficient U.S. dollar
revenue to fund the subsidiarys pound sterling expenses using OTC options and
forward exchange contracts. At September 30, 2007, we have hedged approximately
65% of our U.K. subsidiaries
expected U.S. dollar transaction exposure for the next twelve months. We do not
generally hedge these exposures beyond three years.
The translated
value of revenue and expense from our international brokerage and underwriting
operations are subject to fluctuations in foreign exchange rates. Third quarter
2007 diluted earnings per share were positively
impacted by $0.01 related
to translation gains.
We also use
forward contracts to offset foreign exchange risk associated with foreign
denominated inter-company notes.
Our businesses
income is affected by changes in international and domestic short-term interest
rates. We monitor our net exposure to short-term interest rates and, as
appropriate, hedge our exposure with various derivative financial instruments. A
decrease in global short-term interest rates adversely affects our income. This
activity primarily relates to brokerage funds held on behalf of clients in the
U.S. and on the Continent of Europe.
Our
underwriting companies fixed income investment portfolios are subject to
credit risk. The reduction of a fixed income securitys credit rating will
adversely affect the price of the security. The credit quality of Aons fixed
income portfolio is high. The portfolio maintains an Aa average credit rating.
The fixed maturity portfolio credit profile is monitored daily and evaluated
regularly.
The valuation
of our marketable equity security portfolio is subject to equity price risk. We
sell futures contracts and purchase options to reduce the price volatility of
our equity securities portfolio and equity securities we own indirectly through
limited partnership investments.
54
ITEM 4. CONTROLS
AND PROCEDURES
Evaluation
of disclosure controls and procedures.
Based on Aon
managements evaluation (with the participation of the chief executive officer
and chief financial officer), as of the end of the period covered by this
report, Aons chief executive officer and chief financial officer have
concluded that the disclosure controls and procedures (as defined in Rules
13a-15(e) and 15(d) 15(e) under the Securities Exchange Act of 1934, as
amended, (the Exchange Act)) are effective to ensure that information
required to be disclosed by Aon in reports that it files or submits under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in SEC rules and forms.
Changes in
internal control over financial reporting.
There were
no changes in Aons internal control over financial reporting (as defined in
Rules 13a-15(f) and 15(d)15(f) under the Exchange Act) during third quarter
2007 that have materially affected, or are reasonably likely to materially
affect, Aons internal control over financial reporting.
55
PART II
OTHER INFORMATION
ITEM 1.
|
|
LEGAL
PROCEEDINGS
|
|
|
|
|
|
See Note 15
(Contingencies) to the condensed consolidated financial statements contained
in Part I, Item 1, which is incorporated by reference herein.
|
ITEM 2.
|
|
UNREGISTERED
SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
|
|
|
|
|
|
(a) None.
|
|
|
(b) None.
|
|
|
(c) Issuer Purchases of Equity Securities.
|
The following information relates to the
repurchase of equity securities by Aon or any affiliated purchaser during each
month within the third quarter of 2007:
Period
|
|
Total Number of
Shares Purchased
|
|
Average Price
Paid per Share (1)
|
|
Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs
|
|
Maximum Dollar
Value of Shares
that May Yet Be
Purchased Under
the Plans or
Programs (1) (2)
|
|
7/1/07 7/31/07
|
|
|
|
$
|
|
|
|
|
$
|
303,022,875
|
|
8/1/07 8/31/07
|
|
1,413,680
|
|
$
|
42.65
|
|
1,413,680
|
|
$
|
242,729,153
|
|
9/1/07 9/30/07
|
|
914,400
|
|
$
|
43.61
|
|
914,400
|
|
$
|
202,847,776
|
|
Total
|
|
2,328,080
|
|
$
|
43.03
|
|
2,328,080
|
|
|
|
(1)
Does not include
commissions paid to repurchase shares.
(2)
In 2005, the Company
announced that its Board of Directors had authorized the repurchase of up to $1
billion of Aons common stock. In fourth quarter 2006, the Company announced
that its Board of Directors had increased the authorized share repurchase
program to $2 billion. Shares may be repurchased through the open market or in
privately negotiated transactions. Through September 30, 2007, the Company has
repurchased 47.6 million shares of common stock at an average price (excluding
commissions) of $37.76 per share for an aggregate purchase price of $1,797
million since inception of the stock repurchase program, and the remaining
authorized amount for stock repurchases under this program is $203 million,
with no termination date.
ITEM 6.
|
EXHIBITS
|
|
|
|
Exhibits
The exhibits filed with this report are listed on the attached Exhibit Index.
|
56
SIGNATURE
Pursuant to the
requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly
authorized.
|
Aon
Corporation
|
|
(Registrant)
|
|
|
November 8,
2007
|
/s/ David P.
Bolger
|
|
|
DAVID P.
BOLGER
|
|
EXECUTIVE
VICE PRESIDENT AND
|
|
CHIEF
FINANCIAL OFFICER
|
|
(Principal
Financial and Accounting Officer and
duly
authorized officer of Registrant)
|
57
Aon
CORPORATION
Exhibit Number
In Regulation
S-K
Item 601
Exhibit Table
12
|
Statements
regarding Computation of Ratios
|
|
|
|
|
(a)
|
Statement
regarding Computation of Ratio of Earnings to Fixed Charges.
|
|
|
|
|
(b)
|
Statement
regarding Computation of Ratio of Earnings to Combined Fixed Charges and
Preferred Stock Dividends.
|
|
|
|
31.1
|
Certification
of CEO
|
|
|
|
31.2
|
Certification
of CFO
|
|
|
|
32.1
|
Certification
of CEO Pursuant to section 1350 of Title 18 of the United States Code
|
|
|
|
32.2
|
Certification
of CFO Pursuant to section 1350 of Title 18 of the United States Code
|
|
|
|
|
58
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