UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM 10-Q
x
QUARTERLY REPORT PURSUANT TO SECTION 13
OR 15(d)
OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY
PERIOD ENDED SEPTEMBER 30, 2008
OR
o
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d)
OF
THE SECURITIES EXCHANGE ACT OF 1934
Commission
file number 1-7933
Aon Corporation
(Exact Name of Registrant as
Specified in Its Charter)
DELAWARE
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36-3051915
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(State or Other Jurisdiction of
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(I.R.S. Employer
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Incorporation or Organization)
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Identification No.)
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200 E. RANDOLPH STREET, CHICAGO, ILLINOIS
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60601
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(Address of Principal Executive Offices)
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(Zip Code)
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(312)
381-1000
(Registrants
Telephone Number,
Including Area Code)
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. YES
x
NO
o
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, a non-accelerated filer or a smaller reporting
company. See definition of large
accelerated filer, accelerated filer, and smaller reporting company in Rule 12b-2
of the Exchange Act.
Large
accelerated filer
x
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Accelerated
filer
o
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Non-accelerated
filer
o
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Smaller
reporting company
o
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(Do
not check if a smaller reporting company)
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Indicate by check mark whether the registrant
is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES
o
NO
x
Number of shares of common stock, $1.00 par value, outstanding as of September 30,
2008: 269,782,261
Part I.
Financial Information
ITEM 1.
FINANCIAL STATEMENTS
Aon Corporation
Condensed
Consolidated Statements of Financial Position
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As of
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(millions)
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Sept. 30, 2008
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Dec. 31, 2007
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(Unaudited)
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ASSETS
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CURRENT ASSETS
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Cash
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$
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478
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$
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584
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Short-term investments
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1,946
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1,209
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Receivables
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1,877
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1,996
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Fiduciary assets
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9,109
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9,498
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Other current assets
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245
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219
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Assets held for sale
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31
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4,418
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Total Current Assets
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13,686
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17,924
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Goodwill
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4,882
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4,915
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Other intangible assets
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222
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204
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Fixed assets, net
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449
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497
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Long-term investments
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370
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417
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Other non-current assets
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1,109
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920
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TOTAL ASSETS
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$
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20,718
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$
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24,877
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LIABILITIES AND STOCKHOLDERS EQUITY
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CURRENT LIABILITIES
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Fiduciary liabilities
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$
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9,109
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$
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9,498
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Short-term debt
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252
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Accounts payable and accrued liabilities
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1,180
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1,416
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Other current liabilities
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346
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288
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Liabilities held for sale
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3
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3,028
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Total Current Liabilities
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10,638
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14,482
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Long-term debt
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1,964
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1,893
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Pension, post employment and post
retirement liabilities
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1,136
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1,251
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Other non-current liabilities
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1,033
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1,030
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TOTAL LIABILITIES
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14,771
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18,656
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STOCKHOLDERS EQUITY
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Common stock-$1 par value
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361
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361
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Additional paid-in capital
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3,153
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3,064
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Retained earnings
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6,868
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5,607
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Accumulated other comprehensive loss
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(738
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)
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(726
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)
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Treasury stock at cost
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(3,697
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)
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(2,085
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)
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TOTAL STOCKHOLDERS EQUITY
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5,947
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6,221
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TOTAL LIABILITIES AND STOCKHOLDERS EQUITY
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$
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20,718
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$
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24,877
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See the accompanying notes to the condensed consolidated financial
statements.
2
Ao
n
Corporation
Condensed Consolidated Statements of Income
(Unaudited)
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Three Months Ended
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Nine Months Ended
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(millions, except per share data)
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Sept. 30,
2008
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Sept. 30,
2007
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Sept. 30,
2008
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Sept. 30,
2007
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Revenue
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Commissions, fees and other
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$
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1,756
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$
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1,672
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$
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5,493
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$
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5,125
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Investment income
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91
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77
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218
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236
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Total revenue
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1,847
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1,749
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5,711
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5,361
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Expenses
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Compensation and benefits
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1,132
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1,048
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3,432
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3,188
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Other general expenses
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425
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397
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1,350
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1,228
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Depreciation and amortization
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49
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48
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157
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141
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Total operating expenses
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1,606
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1,493
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4,939
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4,557
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241
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256
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772
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804
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Interest expense
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32
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33
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96
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102
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Other income
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(3
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)
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(9
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)
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(29
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)
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Income from continuing operations before
provision for income tax
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212
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223
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685
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731
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Provision for income tax
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59
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93
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191
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262
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Income from continuing operations
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153
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130
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494
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469
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Income (loss) from discontinued operations
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(55
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)
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88
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1,445
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261
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Provision for (benefit from) income tax
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(19
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)
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14
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471
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73
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Income (loss) from discontinued operations,
net of tax
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(36
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)
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74
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974
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188
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Net income
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$
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117
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$
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204
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$
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1,468
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$
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657
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Basic net income (loss) per share
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Continuing operations
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$
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0.56
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$
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0.44
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$
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1.70
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$
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1.59
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Discontinued operations
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(0.13
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)
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0.25
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3.37
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0.63
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Net income
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$
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0.43
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$
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0.69
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$
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5.07
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$
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2.22
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Diluted net income (loss) per share
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Continuing operations
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$
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0.52
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$
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0.41
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$
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1.62
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$
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1.47
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Discontinued operations
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(0.12
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)
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0.23
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3.19
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0.58
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Net income
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$
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0.40
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$
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0.64
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$
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4.81
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$
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2.05
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Cash dividends per share paid on common
stock
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$
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0.15
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$
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0.15
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$
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0.45
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$
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0.45
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Weighted average common shares outstanding
- diluted
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290.3
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321.5
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305.2
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322.6
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See the accompanying notes to the condensed consolidated financial
statements.
3
Aon Corporation
Condensed Consolidated Statements of Cash
Flows
(Unaudited)
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Nine Months Ended
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Sept. 30,
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Sept. 30,
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(millions)
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2008
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2007
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Cash Flows - Operating Activities:
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Net income
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$
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1,468
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$
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657
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Gain from disposal of operations
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(1,403
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)
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Adjustments to reconcile net income to cash
provided by operating activities
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Depreciation and amortization of property,
equipment and software
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117
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118
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Stock compensation expense
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194
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152
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Amortization of intangible assets
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40
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31
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Valuation changes on investments, income on
disposals and net bond amortization
|
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9
|
|
(12
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)
|
Income taxes
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318
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155
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|
Contribution to major defined benefit
pension plans in excess of expense
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(86
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)
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(83
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)
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Cash paid (in excess of) less than expense
for restructuring plans
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47
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(30
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)
|
Provision for New York and other state
settlements
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|
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|
(37
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)
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Change in funds held on behalf of brokerage
and consulting clients
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50
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150
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Change in insurance underwriting assets and
liabilities
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|
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Net reinsurance and net due &
deferred premium
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6
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|
49
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Prepaid premiums
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7
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|
42
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|
Deferred policy acquisition costs
|
|
(3
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)
|
(14
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)
|
Policy liabilities
|
|
(37
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)
|
(10
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)
|
Net due reinsurance
|
|
|
|
(4
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)
|
Change in other assets and liabilities
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|
|
|
|
|
Accounts payable and accrued liabilities
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(357
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)
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(418
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)
|
Other assets and liabilities - net
|
|
43
|
|
180
|
|
Cash Provided by Operating Activities
|
|
413
|
|
926
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|
|
|
|
|
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Cash Flows - Investing Activities:
|
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Sale of investments
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|
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Fixed maturities
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Maturities
|
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54
|
|
102
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|
Calls and prepayments
|
|
29
|
|
61
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|
Sales
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186
|
|
538
|
|
Equity securities and other investments
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|
1
|
|
73
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|
Purchase of investments
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|
|
|
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Fixed maturities
|
|
(273
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)
|
(789
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)
|
Other investments
|
|
(8
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)
|
(21
|
)
|
Short-term investments - net
|
|
(761
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)
|
363
|
|
Acquisition of subsidiaries
|
|
(85
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)
|
(228
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)
|
Net proceeds from sale of discontinued operations
|
|
2,427
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|
39
|
|
Property and equipment and other - net
|
|
(80
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)
|
(103
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)
|
Cash Provided by Investing Activities
|
|
1,490
|
|
35
|
|
|
|
|
|
|
|
Cash Flows - Financing Activities:
|
|
|
|
|
|
Issuance of common stock
|
|
42
|
|
15
|
|
Treasury stock transactions - net
|
|
(1,773
|
)
|
(563
|
)
|
Repayments of short-term borrowings - net
|
|
(232
|
)
|
(29
|
)
|
Issuance of long-term debt
|
|
364
|
|
677
|
|
Repayments of long-term debt
|
|
(297
|
)
|
(924
|
)
|
Cash dividends to stockholders
|
|
(130
|
)
|
(132
|
)
|
Cash Used by Financing Activities
|
|
(2,026
|
)
|
(956
|
)
|
|
|
|
|
|
|
Effect of Exchange Rate Changes on Cash
|
|
17
|
|
35
|
|
Increase (Decrease) in Cash
|
|
(106
|
)
|
40
|
|
Cash at Beginning of Period
|
|
584
|
|
281
|
|
Cash at End of Period
|
|
$
|
478
|
|
$
|
321
|
|
See the accompanying notes to the condensed consolidated financial
statements.
4
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, 2008 are not necessarily indicative of
results that may be expected for the year ending December 31, 2008.
Refer to the consolidated financial statements and notes in the Annual
Report on Form 10-K for the year ended December 31, 2007 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 12.
The Companys operations include collecting premiums and claims amounts
from clients and insurers. Beginning in 2008, the Company began reporting
unremitted amounts as fiduciary assets. Previously, these amounts were reported
in short-term investments and receivables.
2007 amounts have been reclassified to conform to this presentation. At September 30, 2008, short-term investments
of $3.1 billion and receivables of $6.0 billion are included in the Companys
fiduciary assets. At December 31, 2007, short-term investments of $3.1
billion and receivables of $6.4 billion are included in the Companys fiduciary
assets.
2.
New
Accounting Pronouncement
In December 2007, the Financial Accounting
Standards Board (FASB) issued Statement No. 141 (revised 2007),
Business Combinations
(Statement No. 141(R))
and Statement No. 160,
Noncontrolling
Interests in Consolidated Financial Statements, an amendment of ARB No. 51.
Statement No. 141(R) replaces
Statement No. 141 and applies to all transactions or other events in which
an entity obtains control over one or more businesses. This Statement requires an acquirer to
recognize the assets acquired, the liabilities assumed, and any noncontrolling
interest in the acquiree at the acquisition date, measured at their fair values
as of that date. Business combinations
achieved in stages require recognition of the identifiable assets and liabilities,
as well as the noncontrolling interest in the acquiree, at the full amounts of
their fair values. Statement No. 141(R) also
changes the requirements for recognizing assets acquired and liabilities
assumed arising from contingencies, and requires direct acquisition costs to be
expensed.
Statement No. 160 amends ARB No. 51 to establish accounting
and reporting standards for the noncontrolling interests in a subsidiary and
for the deconsolidation of a subsidiary.
It clarifies that a noncontrolling interest in a subsidiary is an
ownership interest in the consolidated entity that should be reported as equity
in the consolidated financial statements.
This Statement also requires consolidated net income to be reported at
amounts that include the amounts attributable to both the parent and the
noncontrolling interest. Statement No. 160 requires retrospective
adjustments, for all periods presented, of stockholders equity and net income
for noncontrolling interests.
Both Statements are effective for Aon as of January 1, 2009. Early adoption is prohibited. Aon is currently evaluating these Statements
to determine what impact, if any, they will have on its consolidated financial
statements.
In March 2008, the FASB issued Statement No. 161,
Disclosures about Derivative Instruments and Hedging
Activities, an amendment of FASB Statement No. 133.
This
5
Statement changes disclosure requirements for derivative instruments
and hedging activities. Companies are
required to provide enhanced disclosures about (i) how and why a company
uses derivative instruments, (ii) how derivative instruments and related
hedged items are accounted for under Statement No. 133 and its related
interpretations, and (iii) how derivative instruments and related hedged
items affect a Companys financial position, financial performance and cash
flows. This Statement is effective for
financial statements issued for fiscal years beginning after November 15,
2008. Aon is currently evaluating this
Statement to determine the extent of disclosures that will be necessary.
In June 2008, the FASB issued Staff Position No. EITF 03-6-1
(FSP EITF 03-6-1),
Determining Whether
Instruments Granted in Share-Based Payment Transactions are Participating
Securities.
The staff
position holds that unvested share-based payment awards that contain
non-forfeitable rights to dividends or dividend equivalents are participating
securities as defined in EITF 03-6,
Participating
Securities and the Two-Class Method under FASB Statement No. 128,
and
therefore should be included in computing earnings per share using the two
class method. Certain of Aons
restricted stock awards allow the holder to receive a nonforfeitable dividend
equivalent. FSP EITF 03-6-1 is effective
for Aon as of January 1, 2009. All
prior periods earnings per share data that are disclosed must be adjusted to
conform to the current presentation.
Early application is not permitted.
Aon is currently evaluating the FSP to determine what impact it will
have on its consolidated financial statements.
In September 2008, the FASB issued Staff Position No. FAS
133-1 and FIN 45-4 (FSP FAS 133-1 and FIN 45-4),
Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133
and FASB Interpretation No. 45; and Clarification of the Effective Date of
FASB Statement No. 161.
This
FSP (1) requires disclosures by sellers of credit derivatives, including
credit derivatives embedded in a hybrid instrument (2) requires an
additional disclosure about the current status of the payment/performance risk
of a guarantee and (3) clarifies the FASBs intent about the effective
date of Statement No. 161. The
provisions of the FSP that amends Statement No. 133 and Interpretation No. 45
are effective for reporting periods ending after November 15, 2008. The clarification of the effective date of
Statement No. 161 is effective upon issuance of the FSP. The portion of the FSP amending Statement No. 133
is not currently applicable to the Company.
Aon is currently evaluating the portion of the FSP amending
Interpretation No. 45 to determine what impact, if any, it will have on
its disclosures.
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 2008 and 2007, 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 stock-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 stock-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 stock-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
6
for estimated forfeitures.
Forfeitures are 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 stock-based payments recognized in continuing operations in the
condensed consolidated statements of income in compensation and benefits (in
millions):
|
|
Three months ended
|
|
Nine months ended
|
|
|
|
September 30,
|
|
September 30,
|
|
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
RSUs
|
|
$
|
27
|
|
$
|
24
|
|
$
|
102
|
|
$
|
82
|
|
Performance plans
|
|
16
|
|
12
|
|
47
|
|
42
|
|
Stock options
|
|
7
|
|
5
|
|
20
|
|
16
|
|
Employee stock purchase plan
|
|
1
|
|
1
|
|
3
|
|
3
|
|
Total
|
|
$
|
51
|
|
$
|
42
|
|
$
|
172
|
|
$
|
143
|
|
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 performance-based RSUs and service-based RSUs. Service-based awards generally vest between
five and ten years from the date of grant.
For most employees, individuals whose incentive compensation is over
$50,000 are partially paid in RSUs, which vest ratably over three years. Stock awards are issued as they vest. 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 amortized over the service period using the straight-line
method. Dividend equivalents are paid on
certain service-based RSUs, based on the initial grant amount.
Performance-based RSUs are granted to certain executives and key
employees. Vesting of performance-based
RSUs is contingent upon meeting various individual, divisional or company-wide
performance conditions, including revenue generation or growth in revenue,
pretax income or earnings per share over a three- to five-year period. 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 earned at the end of the programs. The issuance 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 performance-based RSUs.
Information regarding Aons performance-based plans follows (shares in
thousands, dollars in millions):
|
|
Nine months ended
September 30,
|
|
|
|
2008
|
|
2007
|
|
Potential RSUs to be issued based on
current performance levels
|
|
5,723
|
|
4,910
|
|
Shares forfeited during the period
|
|
370
|
|
66
|
|
RSUs awarded during the period
|
|
20
|
|
9
|
|
Unamortized expense, based on current
performance levels
|
|
$
|
85
|
|
$
|
110
|
|
|
|
|
|
|
|
|
|
7
A summary of Aons non-vested stock awards is as follows (shares in
thousands):
|
|
2008
|
|
2007
|
|
Nine months ended September 30,
|
|
Shares
|
|
Fair
Value
|
|
Shares
|
|
Fair
Value
|
|
Non-vested at beginning of period
|
|
14,150
|
|
$
|
31
|
|
12,870
|
|
$
|
28
|
|
Granted
|
|
3,196
|
|
42
|
|
4,087
|
|
39
|
|
Vested
|
|
(3,586
|
)
|
28
|
|
(1,920
|
)
|
30
|
|
Forfeited
|
|
(429
|
)
|
33
|
|
(430
|
)
|
33
|
|
Non-vested at end of period
|
|
13,331
|
|
34
|
|
14,607
|
|
32
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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, although a number of options were
granted that require five continuous years of service before all options would
vest. The maximum contractual term on
stock options is generally ten years from the date of grant.
Aon uses a lattice-binomial option-pricing
model to value stock options.
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
|
|
2008
|
|
2007
|
|
Weighted average volatility
|
|
30.1
|
%
|
26.9
|
%
|
Expected dividend yield
|
|
1.3
|
%
|
1.4
|
%
|
Risk-free rate
|
|
3.4
|
%
|
4.9
|
%
|
|
|
|
|
|
|
Weighted average expected life, in years
|
|
5.7
|
|
5.8
|
|
Weighted average estimated fair value per
share
|
|
$
|
13.98
|
|
$
|
12.59
|
|
|
|
|
|
|
|
|
|
|
|
Nine months ended September 30,
|
|
|
|
2008
|
|
2007
|
|
|
|
Executives
|
|
Key Employees
|
|
Executives
|
|
Key
Employees
|
|
Weighted average volatility
|
|
29.4
|
%
|
29.9
|
%
|
26.2
|
%
|
26.8
|
%
|
Expected dividend yield
|
|
1.3
|
%
|
1.4
|
%
|
1.7
|
%
|
1.6
|
%
|
Risk-free rate
|
|
3.2
|
%
|
3.0
|
%
|
4.7
|
%
|
4.6
|
%
|
|
|
|
|
|
|
|
|
|
|
Weighted average expected life, in years
|
|
5.1
|
|
5.7
|
|
4.6
|
|
5.8
|
|
Weighted average estimated fair value per
share
|
|
$
|
11.87
|
|
$
|
12.95
|
|
$
|
9.58
|
|
$
|
11.67
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8
A summary of Aons stock options is as follows (shares in thousands):
|
|
Nine months ended September 30,
|
|
|
|
2008
|
|
2007
|
|
|
|
Shares
|
|
Weighted
Average
Exercise Price
|
|
Shares
|
|
Weighted
Average
Exercise
Price
|
|
Beginning outstanding
|
|
26,479
|
|
$
|
31
|
|
32,889
|
|
$
|
30
|
|
Granted
|
|
1,537
|
|
44
|
|
1,901
|
|
40
|
|
Excercised
|
|
(4,886
|
)
|
29
|
|
(5,885
|
)
|
28
|
|
Forfeited and expired
|
|
(1,517
|
)
|
41
|
|
(619
|
)
|
32
|
|
Outstanding at end of period
|
|
21,613
|
|
31
|
|
28,286
|
|
31
|
|
Excercisable at end of period
|
|
12,214
|
|
30
|
|
16,473
|
|
31
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The weighted average remaining contractual life, in years, of
outstanding options was 4.5 years and 5.2 years at September 30, 2008 and
2007, 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 $44.96 as of September 30, 2008, which would have been
received by the option holders had those option holders exercised their options
as of that date. At September 30,
2008, the aggregate intrinsic value of options outstanding was $296 million, of
which $180 million was exercisable. The
aggregate intrinsic value of options exercised during the third quarter and
nine months ended September 30, 2008 were $17 million and $80 million,
respectively, and for the third quarter and nine months ended September 30,
2007 were $16 million and $75 million, respectively.
Unamortized deferred compensation expense, which includes both options
and awards, amounted to $311 million as of September 30, 2008, with a
remaining weighted-average amortization period of approximately 2.1 years.
Cash received from the exercise of stock options was $146 million and
$165 million during the nine months ended September 30, 2008 and 2007,
respectively. The tax benefit realized
from stock options exercised in the first nine months of 2008 and 2007 was $21
million and $25 million, respectively.
During the first nine months ended September 30, 2008, a majority
of option exercises and award vestings were satisfied through the reissuance of
treasury shares.
9
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)
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
Income from continuing operations
|
|
$
|
153
|
|
$
|
130
|
|
$
|
494
|
|
$
|
469
|
|
Income (loss) from discontinued operations,
net of tax
|
|
(36
|
)
|
74
|
|
974
|
|
188
|
|
Net income for basic per share calculation
|
|
117
|
|
204
|
|
1,468
|
|
657
|
|
Interest expense on convertible debt
securities, net of tax
|
|
|
|
2
|
|
|
|
5
|
|
Net income for diluted per share
calculation
|
|
$
|
117
|
|
$
|
206
|
|
$
|
1,468
|
|
$
|
662
|
|
Basic shares outstanding
|
|
274
|
|
295
|
|
289
|
|
296
|
|
Effect of convertible debt securities
|
|
|
|
11
|
|
|
|
13
|
|
Common stock equivalents
|
|
16
|
|
15
|
|
16
|
|
14
|
|
Diluted potential common shares
|
|
290
|
|
321
|
|
305
|
|
323
|
|
Basic net income (loss) per share:
|
|
|
|
|
|
|
|
|
|
Continuing operations
|
|
$
|
0.56
|
|
$
|
0.44
|
|
$
|
1.70
|
|
$
|
1.59
|
|
Discontinued operations
|
|
(0.13
|
)
|
0.25
|
|
3.37
|
|
0.63
|
|
Net income
|
|
$
|
0.43
|
|
$
|
0.69
|
|
$
|
5.07
|
|
$
|
2.22
|
|
Diluted net income (loss) per share:
|
|
|
|
|
|
|
|
|
|
Continuing operations
|
|
$
|
0.52
|
|
$
|
0.41
|
|
$
|
1.62
|
|
$
|
1.47
|
|
Discontinued operations
|
|
(0.12
|
)
|
0.23
|
|
3.19
|
|
0.58
|
|
Net income
|
|
$
|
0.40
|
|
$
|
0.64
|
|
$
|
4.81
|
|
$
|
2.05
|
|
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 2 million and 7 million at September 30,
2008 and 2007, respectively. For nine
months ended September 30, 2008 and 2007, the number of options excluded
was 3 million and 7 million, respectively.
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)
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
Net income
|
|
$
|
117
|
|
$
|
204
|
|
$
|
1,468
|
|
$
|
657
|
|
Net derivative (losses) gains
|
|
(12
|
)
|
10
|
|
(31
|
)
|
8
|
|
Net unrealized investment (losses) gains
|
|
(24
|
)
|
18
|
|
(4
|
)
|
(10
|
)
|
Net foreign exchange translation
|
|
(221
|
)
|
97
|
|
25
|
|
159
|
|
Change in postretirement plans
|
|
9
|
|
12
|
|
(2
|
)
|
62
|
|
|
|
$
|
(131
|
)
|
$
|
341
|
|
$
|
1,456
|
|
$
|
876
|
|
10
The components of accumulated other comprehensive loss, net of tax, are
as follows:
(millions)
|
|
September 30, 2008
|
|
December 31, 2007
|
|
Net derivative gains (losses)
|
|
$
|
(7
|
)
|
$
|
24
|
|
Net unrealized investment gains
|
|
72
|
|
76
|
|
Net foreign exchange translation
|
|
309
|
|
284
|
|
Postretirement plans
|
|
(1,112
|
)
|
(1,110
|
)
|
Accumulated other comprehensive loss
|
|
$
|
(738
|
)
|
$
|
(726
|
)
|
6.
Business
Segments
Aon classifies its businesses into two
operating segments: Risk and Insurance Brokerage Services and Consulting. 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, investment banking
products and services, and premium financing.
The Consulting segment provides a broad range of consulting
services. These services are delivered
predominantly to corporate clientele utilizing two subsegments (Consulting
Services and Outsourcing) that operate in the following practice areas:
Consulting Services - employee benefits, compensation, management consulting,
communications, strategic human resource consulting and financial advisory and
litigation consulting, and Outsourcing - human resource outsourcing. Results relating to Aons accident, health
and life operations, which were previously reported in a separate Insurance
Underwriting segment, have been reclassified to discontinued operations for all
periods presented. The remaining
operations that were previously reported in the Insurance Underwriting segment,
which relate to property and casualty insurance that is in runoff, are now included
in unallocated income and expense for all periods presented. Unallocated income consists of investment
income from equity, fixed-maturity and short-term investments. These assets include non-income producing
equities. 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.
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, 2007,
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
purposes 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 operating expenses.
11
Commissions, fees and other revenue by operating segment is as follows:
|
|
Three months ended
|
|
Nine months ended
|
|
|
|
September 30,
|
|
September 30,
|
|
(millions)
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
Risk management and insurance brokerage:
|
|
|
|
|
|
|
|
|
|
Americas
|
|
$
|
557
|
|
$
|
546
|
|
$
|
1,638
|
|
$
|
1,609
|
|
United Kingdom
|
|
182
|
|
193
|
|
546
|
|
545
|
|
Europe, Middle East & Africa
|
|
314
|
|
268
|
|
1,188
|
|
988
|
|
Asia Pacific
|
|
120
|
|
116
|
|
373
|
|
343
|
|
Reinsurance brokerage and related services
|
|
252
|
|
232
|
|
756
|
|
691
|
|
Total Risk and Insurance Brokerage Services
|
|
1,425
|
|
1,355
|
|
4,501
|
|
4,176
|
|
|
|
|
|
|
|
|
|
|
|
Consulting services
|
|
284
|
|
269
|
|
850
|
|
794
|
|
Outsourcing
|
|
51
|
|
55
|
|
162
|
|
177
|
|
Total Consulting
|
|
335
|
|
324
|
|
1,012
|
|
971
|
|
|
|
|
|
|
|
|
|
|
|
Total commissions, fees and other revenue
|
|
$
|
1,760
|
|
$
|
1,679
|
|
$
|
5,513
|
|
$
|
5,147
|
|
Investment income by operating segment is as
follows:
|
|
Three months ended
|
|
Nine months ended
|
|
|
|
September 30,
|
|
September 30,
|
|
(millions)
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
Risk and Insurance Brokerage Services
|
|
$
|
48
|
|
$
|
56
|
|
$
|
148
|
|
$
|
154
|
|
Consulting
|
|
2
|
|
1
|
|
4
|
|
8
|
|
Total operating segment investment income
|
|
$
|
50
|
|
$
|
57
|
|
$
|
152
|
|
$
|
162
|
|
Aons total revenue is as follows:
|
|
Three months ended
|
|
Nine months ended
|
|
|
|
September 30,
|
|
September 30,
|
|
(millions)
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
Risk and Insurance Brokerage Services
|
|
$
|
1,473
|
|
$
|
1,411
|
|
$
|
4,649
|
|
$
|
4,330
|
|
Consulting
|
|
337
|
|
325
|
|
1,016
|
|
979
|
|
Unallocated
|
|
41
|
|
21
|
|
66
|
|
76
|
|
Intersegment
|
|
(4
|
)
|
(8
|
)
|
(20
|
)
|
(24
|
)
|
Total revenue
|
|
$
|
1,847
|
|
$
|
1,749
|
|
$
|
5,711
|
|
$
|
5,361
|
|
12
Aons operating segments geographic revenue
and income before income tax is as follows:
Three months ended September 30:
|
|
Risk and Insurance
Brokerage Services
|
|
Consulting
|
|
(millions)
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
Revenue
|
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
503
|
|
$
|
504
|
|
$
|
158
|
|
$
|
156
|
|
Americas, other than U.S.
|
|
184
|
|
162
|
|
30
|
|
27
|
|
United Kingdom
|
|
251
|
|
266
|
|
65
|
|
69
|
|
Europe, Middle East & Africa
|
|
389
|
|
341
|
|
63
|
|
56
|
|
Asia Pacific
|
|
146
|
|
138
|
|
21
|
|
17
|
|
Total revenue
|
|
$
|
1,473
|
|
$
|
1,411
|
|
$
|
337
|
|
$
|
325
|
|
|
|
|
|
|
|
|
|
|
|
Income before income tax
|
|
$
|
188
|
|
$
|
228
|
|
$
|
52
|
|
$
|
38
|
|
Nine months ended September 30:
|
|
Risk and Insurance
Brokerage Services
|
|
Consulting
|
|
(millions)
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
Revenue
|
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
1,465
|
|
$
|
1,485
|
|
$
|
459
|
|
$
|
484
|
|
Americas, other than U.S.
|
|
548
|
|
468
|
|
100
|
|
88
|
|
United Kingdom
|
|
743
|
|
749
|
|
199
|
|
197
|
|
Europe, Middle East & Africa
|
|
1,449
|
|
1,226
|
|
201
|
|
168
|
|
Asia Pacific
|
|
444
|
|
402
|
|
57
|
|
42
|
|
Total revenue
|
|
$
|
4,649
|
|
$
|
4,330
|
|
$
|
1,016
|
|
$
|
979
|
|
|
|
|
|
|
|
|
|
|
|
Income before income tax
|
|
$
|
657
|
|
$
|
734
|
|
$
|
158
|
|
$
|
129
|
|
A reconciliation of segment income before income tax to income from
continuing operations before provision for income tax is as follows:
|
|
Three months ended
|
|
Nine months ended
|
|
|
|
September 30,
|
|
September 30,
|
|
(millions)
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
Risk and Insurance Brokerage Services
|
|
$
|
188
|
|
$
|
228
|
|
$
|
657
|
|
$
|
734
|
|
Consulting
|
|
52
|
|
38
|
|
158
|
|
129
|
|
Segment income before income tax
|
|
240
|
|
266
|
|
815
|
|
863
|
|
Unallocated investment income
|
|
40
|
|
19
|
|
62
|
|
70
|
|
Unallocated expenses
|
|
(34
|
)
|
(24
|
)
|
(91
|
)
|
(91
|
)
|
Property & Casualty - revenues
|
|
1
|
|
2
|
|
4
|
|
6
|
|
Property & Casualty - expenses
|
|
(3
|
)
|
(7
|
)
|
(9
|
)
|
(15
|
)
|
Interest expense
|
|
(32
|
)
|
(33
|
)
|
(96
|
)
|
(102
|
)
|
Income from continuing operations before provision
for income tax
|
|
$
|
212
|
|
$
|
223
|
|
$
|
685
|
|
$
|
731
|
|
13
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 was included.
The changes in the net carrying amount of goodwill by operating segment
for the nine months ended September 30, 2008 are as follows:
(millions)
|
|
Risk and
Insurance
Brokerage
Services
|
|
Consulting
|
|
Total
|
|
Balance as of December 31, 2007
|
|
$
|
4,527
|
|
$
|
388
|
|
$
|
4,915
|
|
Goodwill acquired
|
|
16
|
|
1
|
|
17
|
|
Foreign currency revaluation
|
|
(47
|
)
|
(3
|
)
|
(50
|
)
|
Balance as of September 30, 2008
|
|
$
|
4,496
|
|
$
|
386
|
|
$
|
4,882
|
|
Other intangible assets are classified into
two categories:
·
Customer
Related and Contract Based include client lists as well as non-compete
covenants, and
·
Marketing,
Technology and Other are all other purchased intangibles.
Other intangible assets by asset class are as follows:
(millions)
|
|
Customer
Related and
Contract
Based
|
|
Marketing,
Technology
and Other
|
|
Total
|
|
As of September 30, 2008
|
|
|
|
|
|
|
|
Gross carrying amount
|
|
$
|
242
|
|
$
|
347
|
|
$
|
589
|
|
Accumulated amortization
|
|
177
|
|
190
|
|
367
|
|
Net carrying amount
|
|
$
|
65
|
|
$
|
157
|
|
$
|
222
|
|
(millions)
|
|
Customer
Related and
Contract
Based
|
|
Marketing,
Technology
and Other
|
|
Total
|
|
As of December 31, 2007
|
|
|
|
|
|
|
|
Gross carrying amount
|
|
$
|
206
|
|
$
|
332
|
|
$
|
538
|
|
Accumulated amortization
|
|
168
|
|
166
|
|
334
|
|
Net carrying amount
|
|
$
|
38
|
|
$
|
166
|
|
$
|
204
|
|
Amortization expense for intangible assets for the years ended December 31,
2008, 2009, 2010, 2011 and 2012 is estimated to be $50 million, $44 million,
$41 million, $35 million and $27 million, respectively.
14
8.
Restructuring
Charges
2007 Restructuring
Plan
In 2007, the Company announced a global
restructuring plan intended to create a more streamlined organization and
reduce future expense growth to better serve clients (2007 Plan). The Company estimates that the 2007 Plan will
result in cumulative pretax charges totaling approximately $450 million. Expenses will include workforce reduction and
lease consolidation costs, asset impairments, as well as other expenses
necessary to implement the restructuring initiative. Costs related to the restructuring are
included in compensation and benefits, other general expenses, and depreciation
and amortization in the accompanying condensed consolidated statements of
income. The Company expects the
restructuring and related expenses to affect continuing operations through the
end of 2009.
Below is a summary of the 2007 Plan
restructuring and related expenses by type incurred and estimated to be
incurred through the end of the restructuring initiative.
|
|
Actual
|
|
Estimated
|
|
|
|
|
|
2008
|
|
Total
|
|
Total for
|
|
(millions)
|
|
2007
|
|
Six
Months
|
|
Third
Quarter
|
|
Nine
Months
|
|
Incurred
to Date
|
|
Restructuring
Period (1)
|
|
Workforce reduction
|
|
$
|
17
|
|
$
|
76
|
|
$
|
42
|
|
$
|
118
|
|
$
|
135
|
|
$
|
284
|
|
Lease consolidation
|
|
22
|
|
18
|
|
7
|
|
25
|
|
47
|
|
88
|
|
Asset impairments
|
|
4
|
|
14
|
|
(1
|
)
|
13
|
|
17
|
|
44
|
|
Other costs associated with restructuring
|
|
3
|
|
5
|
|
4
|
|
9
|
|
12
|
|
34
|
|
Total restructuring and related expenses
|
|
$
|
46
|
|
$
|
113
|
|
$
|
52
|
|
$
|
165
|
|
$
|
211
|
|
$
|
450
|
|
(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.
The following is a summary of actual
restructuring and related expenses incurred and estimated to be incurred
through the end of the restructuring initiative, by segment.
|
|
Actual
|
|
Estimated
|
|
|
|
|
|
2008
|
|
Total
|
|
Total for
|
|
(millions)
|
|
2007
|
|
Six
Months
|
|
Third
Quarter
|
|
Nine
Months
|
|
Incurred
to Date
|
|
Restructuring
Period
|
|
Risk and Insurance Brokerage Services
|
|
$
|
41
|
|
$
|
106
|
|
$
|
51
|
|
$
|
157
|
|
$
|
198
|
|
$
|
403
|
|
Consulting
|
|
5
|
|
7
|
|
1
|
|
8
|
|
13
|
|
47
|
|
Total restructuring and related expenses
|
|
$
|
46
|
|
$
|
113
|
|
$
|
52
|
|
$
|
165
|
|
$
|
211
|
|
$
|
450
|
|
15
As of September 30, 2008, the Companys
liabilities for the 2007 plan are as follows:
(millions)
|
|
|
|
Balance at January 1, 2007
|
|
$
|
|
|
Expensed in 2007
|
|
42
|
|
Cash payments in 2007
|
|
(17
|
)
|
Balance at December 31, 2007
|
|
25
|
|
Expensed in 2008
|
|
152
|
|
Cash payments in 2008
|
|
(85
|
)
|
Foreign exchange translation
|
|
(4
|
)
|
Balance at September 30, 2008
|
|
$
|
88
|
|
2005 Restructuring
Plan
In 2005, the Company commenced a
restructuring plan that resulted in cumulative pretax charges totaling $368
million, including $2 million in third quarter 2008. There were no charges in third quarter 2007;
however, $34 million and $2 million was recorded in continuing and discontinued
operations, respectively, for the nine months ended September 30,
2007. Restructuring costs included $18
million in workforce reductions, $11 million in lease consolidation costs, $3
million of asset impairments and $4 million of other expenses for the nine
months ended September 30, 2007.
These costs are included in compensation and benefits, other general
expenses and depreciation and amortization in the accompanying condensed
consolidated statements of income.
Restructuring and related expenses incurred by segment were as follows
for the nine months ended September 30, 2007: Risk and Insurance Brokerage Services - $28
million and Consulting - $6 million.
The following table sets forth the activity related to the 2005
restructuring plan liabilities:
(millions)
|
|
|
|
Balance at January 1, 2007
|
|
$
|
134
|
|
Expensed in 2007
|
|
38
|
|
Cash payments in 2007
|
|
(110
|
)
|
Foreign currency revaluation
|
|
1
|
|
Balance at December 31, 2007
|
|
63
|
|
Expensed in 2008
|
|
2
|
|
Cash payments in 2008
|
|
(27
|
)
|
Foreign exchange translation
|
|
(1
|
)
|
Balance at September 30, 2008
|
|
$
|
37
|
|
Aons unpaid restructuring liabilities are
included in accounts payable and accrued liabilities as well as other
non-current liabilities in the condensed consolidated statements of financial
position.
9.
Capital
Stock
During the first nine months of 2008, Aon
issued 47,000 new shares of common stock for employee benefit plans. In addition, Aon reissued approximately 7.5
million shares of treasury stock for employee benefit programs and 255,000
shares in connection with the employee stock purchase plans.
16
In 2007, Aon announced that its Board of Directors had increased the
authorized repurchase program to $4.6 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
employee stock plans and for other corporate purposes. The Company repurchased approximately 9.3
million shares at a cost of $426 million in third quarter 2008. For the first nine months of 2008, the
Company repurchased approximately 42.6 million shares at a cost of $1.9
billion.
There are also 22.4 million shares of common stock held in treasury at September 30,
2008 which are restricted as to their reissuance.
10.
Disposal
of Operations
In October 2008, Aon reached a
definitive agreement to sell AIS Management Corporation (AIS), which was
previously included in the Risk and Insurance Brokerage Services segment, to
Mercury General Corporation, for approximately $120 million in cash, plus a
potential earn-out of up to $35 million, payable over the two years following
the completion of the agreement. The
disposition is subject to various closing conditions and is expected to be completed
in first quarter 2009. Operating results
have been reclassified to discontinued operations for the quarter and nine
months ended September 30, 2008 and 2007.
In accordance with FASB Statement No. 144,
Accounting for the Impairment or Disposal of
Long-Lived Assets,
Aon has reclassified the assets and liabilities
of this operation to assets held-for-sale and liabilities held-for-sale,
respectively, in the September 30, 2008 and December 31, 2007
condensed consolidated statements of financial position. Goodwill has been allocated to AIS based on
an estimate of its fair value compared to the fair value of the reporting unit
in which it was previously included. The
Company does not expect a pretax loss from the sale of AIS.
In fourth quarter 2007, the Company announced
that it had signed separate definitive agreements to sell its Combined
Insurance Company of America (CICA) and Sterling Life Insurance Company (Sterling)
subsidiaries. These two subsidiaries
were previously included in the Insurance Underwriting segment. On April 1, 2008, the CICA business was
sold to ACE Limited and Sterling was sold to Munich Re Group. After final adjustments, Aon received $2.525
billion in cash for CICA and $341 million in cash for Sterling. Additionally, CICA paid a $325 million
dividend to Aon before the sale transaction was completed. A pretax gain of $1.4 billion was recognized
on the sale of these businesses.
Aons insurance subsidiaries have been involved in both the cession and
assumption of reinsurance with other companies.
Aons reinsurance consists primarily of 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 Aon Warranty Group (AWG) in 2006, Aon sold
Virginia Surety Company (VSC). VSC
remains 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 totals $663 million at September 30,
2008. Trust balances and letters of
credit offsetting these reinsurance recoverables total approximately $149
million. The estimated fair value of the
guarantee was $9 million at September 30, 2008.
A&A Discontinued Operations
Prior to its acquisition by Aon, Alexander &
Alexander Services, Inc. (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
17
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, 2008, the
liabilities associated with the foregoing indemnities were included in other
non-current liabilities in the condensed consolidated statements of financial
position. Such liabilities amounted to
$53 million. Reinsurance recoverables
and other assets related to these liabilities are $70 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.
The operating results of the businesses that
are classified as discontinued operations are as follows:
|
|
Three months ended
|
|
Nine months ended
|
|
|
|
September 30,
|
|
September 30,
|
|
(millions)
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
CICA and Sterling
|
|
$
|
|
|
$
|
632
|
|
$
|
677
|
|
$
|
1,837
|
|
AIS
|
|
23
|
|
26
|
|
71
|
|
78
|
|
Total
|
|
$
|
23
|
|
$
|
658
|
|
$
|
748
|
|
$
|
1,915
|
|
|
|
|
|
|
|
|
|
|
|
Pretax income (loss):
|
|
|
|
|
|
|
|
|
|
Operations:
|
|
|
|
|
|
|
|
|
|
CICA and Sterling
|
|
$
|
|
|
$
|
82
|
|
$
|
66
|
|
$
|
237
|
|
AIS
|
|
(22
|
)
|
7
|
|
(13
|
)
|
20
|
|
Other
|
|
|
|
2
|
|
(1
|
)
|
3
|
|
|
|
(22
|
)
|
91
|
|
52
|
|
260
|
|
Gain (loss) on sale
|
|
(33
|
)
|
(3
|
)
|
1,393
|
|
1
|
|
Total
|
|
$
|
(55
|
)
|
$
|
88
|
|
$
|
1,445
|
|
$
|
261
|
|
|
|
|
|
|
|
|
|
|
|
After-tax income (loss):
|
|
|
|
|
|
|
|
|
|
Operations
|
|
$
|
(14
|
)
|
$
|
61
|
|
$
|
27
|
|
$
|
172
|
|
Sale
|
|
(22
|
)
|
13
|
|
947
|
|
16
|
|
Total
|
|
$
|
(36
|
)
|
$
|
74
|
|
$
|
974
|
|
$
|
188
|
|
18
11.
Net
Periodic Benefit Cost
The following table provides the components
of the net periodic benefit cost for Aons U.S. pension plans, along with the
material international plans, which are located in the U.K., The Netherlands,
and Canada.
|
|
U.S.
|
|
International
|
|
(millions) Three months ended September 30,
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
Service cost
|
|
$
|
7
|
|
$
|
10
|
|
$
|
4
|
|
$
|
6
|
|
Interest cost
|
|
28
|
|
25
|
|
71
|
|
69
|
|
Expected return on plan assets
|
|
(32
|
)
|
(30
|
)
|
(76
|
)
|
(79
|
)
|
Amortization of prior service costs
|
|
(3
|
)
|
(4
|
)
|
1
|
|
|
|
Amortization of net loss
|
|
7
|
|
11
|
|
10
|
|
10
|
|
Net periodic benefit cost
|
|
$
|
7
|
|
$
|
12
|
|
$
|
10
|
|
$
|
6
|
|
|
|
U.S.
|
|
International
|
|
(millions) Nine months ended September 30,
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
Service cost
|
|
$
|
29
|
|
$
|
38
|
|
$
|
18
|
|
$
|
28
|
|
Interest cost
|
|
81
|
|
74
|
|
219
|
|
203
|
|
Expected return on plan assets
|
|
(96
|
)
|
(90
|
)
|
(234
|
)
|
(233
|
)
|
Amortization of prior service cost
|
|
(10
|
)
|
(11
|
)
|
1
|
|
|
|
Amortization of net loss
|
|
18
|
|
33
|
|
30
|
|
40
|
|
Net periodic benefit costs
|
|
$
|
22
|
|
$
|
44
|
|
$
|
34
|
|
$
|
38
|
|
In connection with the sale of CICA,
curtailment gains of $12 million and $1 million were recognized in discontinued
operations in second and third quarter 2008, respectively.
Aon previously disclosed in its 2007
financial statements that it expected to contribute $8 million and $187 million
in 2008 to its U.S. and material international defined benefit pension plans,
respectively. Based on current rules and
assumptions, Aon now plans to contribute $174 million to its material
international defined benefit pension plans.
As of September 30, 2008, contributions of $6 million have been
made to the U.S. pension plans and $136 million to its material international
pension plans.
12.
Fair
Value
Aon adopted the provisions of FASB Statement No. 157,
Fair Value Measurements
and Statement No. 159,
The Fair Value Option for Financial Assets
and Financial Liabilities
as of January 1, 2008. Both standards address aspects of fair-value
accounting. Statement No. 157
defines fair value, establishes a consistent framework for measuring fair value
and expands disclosure requirements about fair-value measurements. Under
Statement No. 159, the Company has the ability to elect to report most
financial instruments and certain other items at fair value on an
instrument-by-instrument basis with changes in fair value reported in
earnings. After the initial adoption,
the election is made at the acquisition of an eligible financial asset,
financial liability, or firm commitment or when certain specified
reconsideration events occur. The fair
value election may not be revoked once an election is made. The implementation
of Statement No. 157 did not have a material impact on the condensed
consolidated financial statements. When
adopting Statement No. 159, the Company did not elect to report any
additional financial instruments at fair value.
Statement No. 157 establishes a hierarchy of fair value
measurements based on whether the inputs to those measurements are observable
or unobservable. Observable inputs
reflect market data obtained from independent sources, while unobservable
inputs reflect the Companys market assumptions.
19
The fair-value hierarchy consists of three levels:
·
Level 1 Quoted
prices for identical instruments in active markets.
·
Level 2 Quoted
prices for similar instruments in active markets; quoted prices for identical
or similar instruments in markets that are not active; and model-derived
valuations in which all significant inputs are observable in active markets.
·
Level 3
Valuations derived from valuation techniques in which one or more significant
inputs are unobservable.
This hierarchy requires the use of observable market data when
available.
Aon measures fair value using the procedures set forth below for all
assets and liabilities measured at fair value, irrespective of whether they are
carried at fair value.
When available, the Company generally uses quoted market prices to
determine fair value, and classifies such items in Level 1. In some cases where a market price is
available, the Company will make use of acceptable practical expedients (such
as matrix pricing) to estimate fair value, in which case the items are
classified in Level 2.
If quoted market prices are not available, fair value is based upon
internally developed valuation techniques that use, where possible, current
market-based or independently sourced market parameters, such as interest
rates, currency rates, option volatilities, etc. Items valued using such internally generated
valuation techniques are classified according to the lowest level input that is
significant to the valuation. Thus, an
item may be classified in Level 3 even though there may be some significant
inputs that are observable.
The following table presents, for each of the fair-value hierarchy
levels, the Companys assets and liabilities that are measured at fair value on
a recurring basis at September 30, 2008.
|
|
|
|
Fair Value Measurements at
|
|
|
|
|
|
September 30, 2008 Using
|
|
|
|
|
|
Quoted Prices in
|
|
Significant
|
|
Significant
|
|
|
|
|
|
Active Markets
|
|
Other
|
|
Unobservable
|
|
|
|
Balance at
|
|
for Identical
|
|
Observable
|
|
Inputs
|
|
(millions)
|
|
September 30, 2008
|
|
Assets (Level I)
|
|
Inputs (Level 2)
|
|
(Level 3)
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
Short-term investments including money market
funds and highly liquid debt securities
|
|
$
|
2,928
|
|
$
|
|
|
$
|
2,928
|
|
$
|
|
|
Other investments
|
|
258
|
|
|
|
132
|
|
126
|
|
Derivatives
|
|
131
|
|
|
|
131
|
|
|
|
Retained interests
|
|
79
|
|
|
|
|
|
79
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
Derivatives
|
|
24
|
|
|
|
24
|
|
|
|
Guarantees
|
|
9
|
|
|
|
|
|
9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
20
The following table presents the changes in the Level 3 fair-value
category for the three months ended September 30, 2008.
|
|
Fair Value Measurements Using
|
|
|
|
Level 3 Inputs
|
|
|
|
Other
|
|
|
|
Retained
|
|
|
|
(millions)
|
|
Investments
|
|
Derivatives
|
|
Interests
|
|
Guarantees
|
|
Balance at June 30, 2008
|
|
$
|
162
|
|
$
|
4
|
|
$
|
106
|
|
$
|
(10
|
)
|
Total gains (losses):
|
|
|
|
|
|
|
|
|
|
Included in earnings
|
|
|
|
6
|
|
9
|
|
1
|
|
Included in other comprehensive income
|
|
(36
|
)
|
|
|
|
|
|
|
Purchases, issuances and settlements
|
|
|
|
(8
|
)
|
(36
|
)
|
|
|
Transfers
|
|
|
|
(2
|
)
|
|
|
|
|
Balance at September 30, 2008
|
|
$
|
126
|
|
$
|
|
|
$
|
79
|
|
$
|
(9
|
)
|
|
|
|
|
|
|
|
|
|
|
The amount of total gains (losses) for the
period included in earnings attributable to the change in unrealized losses
relating to assets or liabilities held at September 30, 2008
|
|
$
|
|
|
$
|
6
|
|
$
|
9
|
|
$
|
1
|
|
Gains (losses), both realized and unrealized,
included in earnings for the three months ended September 30, 2008 are as
follows:
|
|
|
|
|
|
Income from
|
|
|
|
Other general
|
|
Commissions,
|
|
Discontinued
|
|
(millions)
|
|
expenses
|
|
fees and other
|
|
Operations
|
|
Total gains (losses) included in earnings
|
|
$
|
6
|
|
$
|
9
|
|
$
|
1
|
|
Change in unrealized gains (losses)
relating to assets or liabilities held at September 30, 2008
|
|
$
|
6
|
|
$
|
9
|
|
$
|
1
|
|
The following table presents the changes in the Level 3 fair-value
category for the nine months ended September 30, 2008.
|
|
Fair Value Measurements Using
|
|
|
|
Level 3 Inputs
|
|
|
|
Other
|
|
|
|
Retained
|
|
|
|
(millions)
|
|
Investments
|
|
Derivatives
|
|
Interests
|
|
Guarantees
|
|
Balance at December 31, 2007
|
|
$
|
168
|
|
$
|
1
|
|
$
|
103
|
|
$
|
(12
|
)
|
Total gains (losses):
|
|
|
|
|
|
|
|
|
|
Included in earnings
|
|
|
|
3
|
|
42
|
|
3
|
|
Included in other comprehensive income
|
|
(42
|
)
|
|
|
2
|
|
|
|
Purchases, issuances and settlements
|
|
|
|
(2
|
)
|
(68
|
)
|
|
|
Transfers
|
|
|
|
(2
|
)
|
|
|
|
|
Balance at September 30, 2008
|
|
$
|
126
|
|
$
|
|
|
$
|
79
|
|
$
|
(9
|
)
|
|
|
|
|
|
|
|
|
|
|
The amount of total gains (losses) for the
period included in earnings attributable to the change in unrealized losses
relating to assets or liabilities held at September 30, 2008
|
|
$
|
|
|
$
|
3
|
|
$
|
42
|
|
$
|
3
|
|
21
Gains (losses), both realized and unrealized,
included in earnings for the nine months ended September 30, 2008 are as
follows:
|
|
|
|
|
|
Income from
|
|
|
|
Other general
|
|
Commissions,
|
|
Discontinued
|
|
(millions)
|
|
expenses
|
|
fees and other
|
|
Operations
|
|
Total gains (losses) included in earnings
|
|
$
|
3
|
|
$
|
42
|
|
$
|
3
|
|
Change in unrealized gains (losses)
relating to assets or liabilities held at September 30, 2008
|
|
$
|
4
|
|
$
|
42
|
|
$
|
3
|
|
13.
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. Amounts related to settlement provisions
are recorded in other general expenses in the condensed consolidated statements
of income.
At the time of the 2004-05 investigation of the insurance industry by
the Attorney General of New York (NYAG) and other regulators, purported
classes of clients filed civil litigation against Aon and other companies 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 August and October 2007, respectively. Plaintiffs
have appealed these dismissals. 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.
Also at the time of the NYAG investigation, putative classes filed
actions against Aon in the U.S. District Court for the Northern District of
Illinois under the federal securities laws and ERISA. Plaintiffs in the federal
securities class action have recently submitted purported expert reports
estimating a range of alleged damages of $353 million to $498 million, and
plaintiffs in the ERISA class actions have recently submitted purported expert
reports estimating a range of alleged damages of $59 million to $349 million.
Aon will soon submit its own expert reports, which will vigorously challenge
these damage estimates, as well as plaintiffs underlying theories of
liability. 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.
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. Certain
governmental agencies, including the U.K. Financial Services Authority, the
City of London police, the U.S. Securities and Exchange Commission, and the
U.S. Department of Justice, are also investigating these matters. Aon is fully
cooperating with these investigations, and has agreed with the U.S. agencies to
toll any applicable statute of limitations pending completion of the investigations.
Based on current information, the Company is unable to predict at this time
when these matters will be concluded, or what regulatory or other outcomes may
result.
22
A financial institution in the U.K. called Standard Life Assurance Ltd.
brought an action in London Commercial Court against Aon seeking more than £50
million ($92 million at September 30, 2008 exchange rates) for alleged
errors or omissions in the placement of a professional indemnity policy with
certain underwriters. In a preliminary decision issued on February 13,
2008, the court construed the relevant policy language to excuse underwriters
from paying Standard Life and concluded that Aon was negligent in not seeking
changes to the language. Aon filed an interlocutory appeal of this preliminary
decision. In July 2008, Aon reached a settlement with underwriters under
which underwriters agreed to pay a portion of the ultimate recovery by Standard
Life in exchange for Aon dropping its appeal of the preliminary decision. In
subsequent proceedings in the Commercial Court, Aon will vigorously contest
Standard Lifes claims based on a variety of legal and factual arguments. Aon
has a potential negligence claim against a different third party which provided
advice with respect of the relevant policy language, and Aon further believes
that, as a result of an indemnity given to Aon by a third party, Aon is
entitled to indemnification in whole or part for its losses in this matter.
A putative class action,
Buckner v.
Resource Life
, is pending in state court in Columbus, Georgia
against a former subsidiary of Aon, Resource Life Insurance Company. The
complaint alleges that Resource Life, which wrote policies insuring repayment
of auto loans, was obligated to identify and return unearned premium to
policyholders whose loans terminated before the end of their scheduled terms. In
connection with the sale of Resource Life in 2006, Aon agreed to indemnify
Resource Lifes buyer in certain respects relating to this action. Aon believes
that Resource Life has meritorious defenses and is vigorously defending this
action. The outcome of the action, and the amount of any losses or other
payments that may result, cannot be predicted at this time.
VSC, a former property and casualty underwriting subsidiary of Aon, is
engaged in arbitration and litigation proceedings with Applied Underwriters, Inc.
(Applied), a managing general agent (MGA). In these proceedings, Applied
seeks approximately $190 million for,
inter
alia
, an alleged diminution in Applieds value following VSCs
termination of an MGA contract between the parties. In connection with the sale
of AWG (which includes VSC) in 2006, Aon agreed to retain certain obligations
related to VSCs property and casualty underwriting business, now in runoff,
including this matter. Aon believes that VSC has meritorious defenses and is
vigorously defending the arbitration and litigation. The outcome of the action,
and the amount of any losses or other payments that may result, cannot be
predicted at this time.
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.
14.
Premium
Financing Operations
Some of Aons 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 FASB Statement No. 140,
Accounting for Transfers and Servicing of Financial
Assets and Extinguishment of Liabilities.
In the U.S. and U.K.,
premium finance agreements are sold to special purpose entities (SPEs), which
are considered qualified special purpose entities (QSPEs), as defined by
Statement No. 140. The QSPEs fund their purchases of premium finance
agreements by selling
23
undivided beneficial interests in the
agreements to multi-seller commercial paper conduit SPEs sponsored by
unaffiliated banks (Bank SPEs). In Canada and Australia, undivided interests
in the premium finance agreements are sold directly to Bank SPEs. The Bank SPEs
are variable interest entities as defined by FIN 46R.
The QSPEs used in the U.S. and U.K are not
consolidated in Aons financial statements because the criteria for sale
accounting have been met under Statement No. 140.
For the Canadian and Australian sales, the
Company has analyzed qualitative and quantitative factors related to the
transactions with the Bank SPEs and have determined that non-consolidation of
the Bank SPEs is appropriate in accordance with FIN 46R because Aon is not
their primary beneficiary. Specific factors considered include the fact that
Aon is not the sponsor of any of the Bank SPEs, various other unaffiliated
companies sell receivables to the Bank SPEs, and unaffiliated third parties
have either made substantial equity investments in the Bank SPEs, hold voting
control of the Bank SPEs, or generally have the risks and rewards of ownership
of the assets of the Bank SPEs through liquidity support agreements or other
arrangements involving significant variable interests.
Aons variable interest in the Bank SPEs in
these jurisdictions is limited to the retained interests in premium finance
agreements sold to the Bank SPEs. The Company reviews all material off-balance
sheet transactions annually or whenever a reconsideration event occurs for the
continued propriety of its accounting.
Pursuant to the sale agreements, the total
amount advanced by the Bank SPEs on premium finance agreements sold to them at
any one time is limited by the sale agreements to $1.8 billion. The Bank SPEs
had advanced $1.2 billion and $1.4 billion at September 30, 2008 and December 31,
2007, respectively, on portfolios sold to the Bank SPEs of $1.3 billion and
$1.5 billion at September 30, 2008 and December 31, 2007,
respectively.
Aon records gains on the sale of premium
finance agreements. When Aon calculates the gain, all costs expected to be
incurred for the relevant Bank SPEs are included. The gains, which are included
in commissions, fees and other revenue in the condensed consolidated statements
of income, were $9 million and $15 million for the three months ended September 30,
2008 and 2007, respectively, and $41 million and $46 million for the nine
months ended September 30, 2008 and 2007, respectively.
Aon records its retained interest in the sold
premium finance agreements at fair value, and reports it in receivables in the
condensed consolidated statements of financial position. Aon estimates fair
value by discounting estimated future cash flows using discount rates that are
commensurate with the underlying risk, expected future prepayment rates, and
credit loss estimates.
Aon also retains servicing rights for sold
agreements, and earns servicing fee income over the servicing period. Because
the servicing fees represent adequate compensation for the servicing of the receivables,
the Company has not recorded any servicing assets or liabilities.
The third-party bank sponsors or other
participants in the Bank SPEs provide the liquidity support and bear the credit
risks on the receivables, subject to limited recourse, in the form of
over-collateralization provided by Aon (and other sellers) as required by the
sales agreements. The over-collateralization of the sold receivables represents
Aons maximum exposure to credit-related losses, and was approximately $115
million at September 30, 2008. Aon also remains contingently liable should
the funding costs of the U.S. Bank SPEs exceed the interest and late fees
accrued or collected on the sold U.S. portfolio. The Company continually
reviews the retained interest in the sold portfolio, taking into
24
consideration credit loss trends in the sold
portfolio, conditions in the credit markets and other factors, and adjusts its
carrying value accordingly.
With the exception of the Australian sales
agreements, all the other sales agreements require Aon to meet the following
covenants:
·
consolidated net worth, as defined,
of at least $2.5 billion,
·
consolidated
EBITDA to consolidated net interest of at least 4 to 1, and
·
consolidated
indebtedness to consolidated EBITDA of no more than 3 to 1.
Aon intends to renew these sales agreements
as they expire. The Company renewed the U.S. sales agreement on October 3,
2008 and intends to renew its European agreement in the fourth quarter of 2008.
The current environment in the credit market influenced the renewal process and
the renewed U.S. terms are more restrictive: the over-collateralization
requirements increased significantly ($40 million on the renewal date), and,
based upon the Companys estimated needs for the coming year, Aon reduced the
level of committed availability by $436 million and scheduled additional
decreases of $220 million by March 31, 2009. In addition, the
securitization program costs added on the pass-through funding costs from the
U.S. Bank SPEs. Similar restricted terms are expected for the European
agreement. Moreover, as Aons ability to originate and fund new premium finance
agreements is dependent on the pass-through funding costs of the Bank SPEs,
disruptions in the markets through which the Bank SPEs obtain funds could
further have a significant impact on Aons premium finance results of
operations and cash flows. The Company also faces the risk that the Bank SPEs
will be unable to provide the liquidity or will become an unreliable source of
the liquidity necessary to fund new premium finance agreements. Such an occurrence
would require the Company to consider alternate sources of funding, including
other forms of off-balance sheet as well as on-balance sheet financing, or
discontinue the origination of premium finance agreements. Additionally, if
there were adverse bank, regulatory, tax, or accounting rule changes, Aons
access to the conduit facilities and special purpose vehicles could be
affected.
15.
Acquisition
On August 22, 2008, the Company announced that it had entered into
an agreement to acquire Benfield Group Limited (Benfield), a leading
independent reinsurance intermediary. Under the terms of the definitive
agreement, the Company will acquire all of the outstanding shares of common
stock of Benfield for £844 million or 350 pence per share ($1,557 million at September 30,
2008 exchange rates) in cash and assume £91 million ($168 million at September 30,
2008 exchange rates) of Benfield debt.
The transaction is expected to close in the fourth quarter of 2008,
subject to customary closing conditions, including regulatory approvals. On October 14,
2008, Benfield shareholders voted to approve the sale of Benfield.
25
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 2008. We then review our consolidated results and
segments with comparisons for the third quarter 2008 to the corresponding
period in 2007. 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
Acquisitions
and Divestitures
Restructuring
Initiatives
Share
Repurchase Program
Change in
Chairman of Aons Board of Directors
CRITICAL ACCOUNTING POLICIES
REVIEW OF CONSOLIDATED RESULTS
General
Consolidated
Results
REVIEW BY SEGMENT
General
Risk and
Insurance Brokerage Services
Consulting
Unallocated
Income and Expense
FINANCIAL CONDITION AND LIQUIDITY
Cash Flows
Financial
Condition
Borrowings
Stockholders
Equity
Off Balance
Sheet Arrangements
INFORMATION CONCERNING FORWARD-LOOKING
STATEMENTS
26
KEY RECENT EVENTS
Acquisitions and Divestitures
In October 2008, we reached a definitive agreement to sell AIS,
which was previously included in our Risk and Insurance Brokerage Services
segment, to Mercury General Corporation, for approximately $120 million in
cash, plus a potential earn-out of up to $35 million, payable over the two
years following the completion of the agreement. The sale is subject to various closing
conditions and is expected to be completed in first quarter 2009. Operating results have been reclassified to
discontinued operations for the quarter and nine months ended September 30,
2008 and 2007.
On August 22, 2008, we announced that we had entered into an
agreement to acquire Benfield, a leading independent reinsurance intermediary. Under the terms of the definitive agreement,
we will acquire all of the outstanding shares of common stock of Benfield for
£844 million or 350 pence per share ($1,557 million at September 30, 2008
exchange rates) in cash and assume £91 million ($168 million) of Benfield
debt. We intend to fund the transaction
through cash on hand.
The transaction is expected to close in the fourth quarter of 2008,
subject to customary closing conditions, including regulatory approval. On October 14, 2008, Benfield shareholders
voted to approve the sale of Benfield.
Following the close of the transaction, we intend to integrate the
Benfield business with our existing reinsurance operations (Aon Re Global) and
operate the division globally under the newly created Aon Benfield Re brand.
In first quarter 2008, we agreed to buy substantially all of A. J.
Gallaghers U.S. and U.K. reinsurance brokerage business for $30 million in
cash, plus the revenue produced by the acquired businesses in the first year
after the deal closes. This transaction
gives us a larger presence as a reinsurance broker for accident, health and
life insurance in the U.S., and for accident and specialty casualty and
financial institutions insurance in the U.K.
In December 2007, we announced that we signed definitive
agreements to sell our CICA and Sterling subsidiaries. These two subsidiaries were previously
included in an Insurance Underwriting segment.
Both of these transactions were completed on April 1, 2008. In more detail:
·
CICA was sold to
ACE Limited for cash consideration of $2.525 billion, after final
adjustments. We also received a one-time
dividend of $325 million from CICA prior to the close of the transaction.
·
Sterling was sold to Munich Re Group
for cash consideration of $341 million, after final adjustments.
We have included CICA and Sterlings operating results through the date
of sale in discontinued operations. We
recorded a pretax gain on these sales of approximately $1.4 billion.
Restructuring Initiatives
In 2007, we announced a global restructuring plan intended to create a
more streamlined organization and reduce expense growth to better serve
clients. This three-year plan has
evolved as new opportunities have been identified and existing initiatives have
been finalized. We estimate this
restructuring plan will result in cumulative pretax charges totaling
approximately $450 million, which is an increase of $90 million from our
estimates in previous quarters. Expenses
will include workforce reduction and lease consolidation costs, asset
impairments, and other expenses necessary to implement the restructuring
initiative. We recorded approximately
$211 million of restructuring and related expenses through September 30,
2008, including $52 million and $165 million in the third
27
quarter and nine months of 2008, respectively. We expect the remaining restructuring and
related expenses to affect continuing operations through the end of 2009. We anticipate that these initiatives will
lead to annualized cost-savings of approximately $75-$80 million in 2008,
$220-$245 million in 2009, and $300 million by 2010. However, there can be no assurances that we
will achieve the targeted savings.
Based on our current projections, the 2007 restructuring plan
eliminates an estimated 2,700 jobs, 300 more jobs than previously disclosed,
beginning in the third quarter of 2007 and continuing into 2009. To date, approximately 1,000 jobs have been
eliminated. 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.
The following table summarizes 2007 restructuring and related expenses
by type incurred and estimated to be incurred through the end of the
restructuring initiative.
|
|
Actual
|
|
Estimated
|
|
|
|
|
|
2008
|
|
Total
|
|
Total for
|
|
(millions)
|
|
2007
|
|
Six
Months
|
|
Third
Quarter
|
|
Nine
Months
|
|
Incurred
to Date
|
|
Restructuring
Period (1)
|
|
Workforce reduction
|
|
$
|
17
|
|
$
|
76
|
|
$
|
42
|
|
$
|
118
|
|
$
|
135
|
|
$
|
284
|
|
Lease consolidation
|
|
22
|
|
18
|
|
7
|
|
25
|
|
47
|
|
88
|
|
Asset impairments
|
|
4
|
|
14
|
|
(1
|
)
|
13
|
|
17
|
|
44
|
|
Other costs associated with restructuring
|
|
3
|
|
5
|
|
4
|
|
9
|
|
12
|
|
34
|
|
Total restructuring and related expenses
|
|
$
|
46
|
|
$
|
113
|
|
$
|
52
|
|
$
|
165
|
|
$
|
211
|
|
$
|
450
|
|
(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 table summarizes actual restructuring and related costs
incurred and estimated to be incurred through the end of the restructuring
initiative, by segment.
|
|
Actual
|
|
Estimated
|
|
|
|
|
|
2008
|
|
Total
|
|
Total for
|
|
(millions)
|
|
2007
|
|
Six
Months
|
|
Third
Quarter
|
|
Nine
Months
|
|
Incurred
to Date
|
|
Restructuring
Period
|
|
Risk and Insurance Brokerage Services
|
|
$
|
41
|
|
$
|
106
|
|
$
|
51
|
|
$
|
157
|
|
$
|
198
|
|
$
|
403
|
|
Consulting
|
|
5
|
|
7
|
|
1
|
|
8
|
|
13
|
|
47
|
|
Total restructuring and related expenses
|
|
$
|
46
|
|
$
|
113
|
|
$
|
52
|
|
$
|
165
|
|
$
|
211
|
|
$
|
450
|
|
Share Repurchase Program
We are currently authorized to repurchase $4.6 billion of Aons common
stock. Pursuant to this program, during
the first nine months of 2008, we repurchased approximately 42.6 million shares
at a cost of $1.9 billion. The volume of
share repurchases increased during the second quarter, as we began to use the
proceeds received from the sales of CICA and Sterling to repurchase shares.
Since the program began, through September 30, 2008, we have now
repurchased 90.8 million shares at a cost of $3.7 billion. Share repurchases were suspended
28
in August 2008 in light of the anticipated acquisition of
Benfield. We do not expect to make any
further share repurchases in 2008, but expect to complete the share repurchase
program by the end of 2009.
Any repurchased shares are available for issuance through employee stock
plans and for other corporate purposes.
Of the shares repurchased since the programs inception, we have
reissued approximately 21.6 million shares for stock options, stock awards and
other benefit plans.
Change in Chairman of Aons Board of
Directors
Patrick Ryan, the Executive Chairman of Aons Board of Directors,
retired from Aon on August 1, 2008.
Mr. Ryan founded Aon, which had its origin in a small insurance
agency he started in 1964.
Mr. Ryan is succeeded by Lester B. Knight, an independent director
since 1999. Mr. Knight was elected
Non-Executive Chairman of Aons Board of Directors on July 18, 2008.
CRITICAL ACCOUNTING POLICIES
There have been no changes in our critical accounting policies, which
include restructuring, pensions, contingencies, policy liabilities, valuation
of investments, intangible assets, share-based payments and income taxes, as
discussed in our 2007 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.
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.
Because we conduct business in over 120 countries, foreign exchange
rate 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 commissions, fees and other 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, transfers of business units,
reimbursable expenses, and unusual items, which represent the most significant
reconciling items.
29
Consolidated Results
The following table and commentary provide selected consolidated
financial information.
|
|
Third Quarter Ended
|
|
Nine Months Ended
|
|
|
|
Sept. 30,
|
|
Sept. 30,
|
|
(millions)
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
Revenue:
|
|
|
|
|
|
|
|
|
|
Commissions, fees and other
|
|
$
|
1,756
|
|
$
|
1,672
|
|
$
|
5,493
|
|
$
|
5,125
|
|
Investment income
|
|
91
|
|
77
|
|
218
|
|
236
|
|
Total revenue
|
|
1,847
|
|
1,749
|
|
5,711
|
|
5,361
|
|
|
|
|
|
|
|
|
|
|
|
Expenses:
|
|
|
|
|
|
|
|
|
|
Compensation and benefits
|
|
1,132
|
|
1,048
|
|
3,432
|
|
3,188
|
|
Other general expenses
|
|
425
|
|
397
|
|
1,350
|
|
1,228
|
|
Depreciation and amortization
|
|
49
|
|
48
|
|
157
|
|
141
|
|
Total operating expenses
|
|
1,606
|
|
1,493
|
|
4,939
|
|
4,557
|
|
Operating income
|
|
241
|
|
256
|
|
772
|
|
804
|
|
Interest expense
|
|
32
|
|
33
|
|
96
|
|
102
|
|
Other income
|
|
(3
|
)
|
|
|
(9
|
)
|
(29
|
)
|
Income from continuing operations before provision
for income tax
|
|
$
|
212
|
|
$
|
223
|
|
$
|
685
|
|
$
|
731
|
|
Pretax margin - continuing operations
|
|
11.5
|
%
|
12.8
|
%
|
12.0
|
%
|
13.6
|
%
|
Revenue
Commissions, fees and other
increased by $84 million or 5% on a quarterly basis and $368 million or 7% on a
year-to-date basis. The impact of foreign currency translation and organic
growth in the Risk and Insurance Brokerage Services and Consulting segments
primarily drove the increases in both periods.
Investment income
increased $14 million or 18% on a quarterly basis but decreased $18 million or
8% on a year-to-date basis. Interest income from investing the sale proceeds of
CICA and Sterling positively impacted investment income on both a quarterly and
year-to-date basis while distributions from our Private Equity Partnership
Structures I, LLC (PEPS I) investment increased $13 million for the quarter
but decreased $25 million on year-to-date basis from 2007.
Expenses
Compensation and benefits
increased $84 million or 8% on a quarterly basis and $244 million or 8% on a
year-to-date basis. The impact of foreign currency translation and higher
restructuring charges primarily drove the increase in both periods. Partially offsetting
these increases are benefits from our 2007 and 2005 restructuring programs, and
on a year-to-date basis, lower pension expense from the 2007 changes to our
U.K. defined benefit pension plans.
Other general expenses
increased $28 million or 7% on a quarterly basis and $122 million or 10% on a
year-to-date basis. The increases were driven by the impact of foreign currency
translation, higher litigation and restructuring expenses, and costs related to
anti-bribery investigations and related compliance initiatives. On a
year-to-date basis, last years expenses included $21 million for the
settlement of litigation in early 2007 for acquired employees in our U.K.
reinsurance business. Partially offsetting these increases are benefits from
our restructuring programs.
30
Depreciation and amortization expense
increased $1 million or 2% on a quarterly basis and $16 million or 11% on a
year-to-date basis. The nine month increase was due to restructuring-related
impairments and foreign exchange translations, partially offset by lower
software amortization.
Interest expense
decreased $1 million on a quarterly basis and $6 million on a year-to-date
basis, due primarily to the redemption of our 3.5% Senior Convertible
Debentures during 2007.
Other income
increased $3 million on a quarterly basis resulting from a restructuring of
ownership interests of one of our subsidiaries in third quarter 2008, which
more than offset expenses related to the pending Benfield acquisition. On a
year-to-date basis, other income decreased $20 million primarily due to gains
on the sales of businesses in 2007.
Income from
Continuing Operations Before Provision for Income Tax
Income from continuing operations before provision for income tax
decreased $11 million or 5% to $212 million on a quarterly basis and $46
million or 6% for the nine months ended September 30, 2008. The decrease
is mainly attributable to higher restructuring costs and gains on the sale of
businesses in 2007, which more than offset the favorable impacts of foreign
currency translation and organic revenue growth in 2008.
Income Taxes
The
effective tax rate for
continuing operations was 27.8% for third quarter 2008 compared to 41.7% for
third quarter 2007. The effective tax rate for continuing operations was 27.9%
and 35.8% for the nine month periods ended September 30, 2008 and 2007,
respectively. The rates for all reported periods were favorably impacted by the
resolution of prior year tax items. In the third quarter 2007, legislation was
finalized in the United Kingdom which reduced the corporate tax rate from 30%
to 28%. This required us to revalue our deferred tax assets related to the U.K.
operations, and which resulted in a one-time non-cash charge of approximately
$22 million, which was included in the third quarter 2007 tax provision. Our
2008 third quarter and nine month tax rates also reflect the benefit of
statutory rate reductions in key operating jurisdictions, particularly the
U.K., and the projected geographic distribution of earnings. The underlying tax
rate for continuing operations was 29% in 2008 and 33.5% in 2007.
Income from
Continuing Operations
Income from continuing operations for third quarter 2008 and 2007 was
$153 million and $130 million, respectively. Basic and diluted income per share
in the third quarter 2008 was $0.56 and $0.52, respectively, versus $0.44 and
$0.41 in 2007, respectively. Income from continuing operations for nine months
2008 and 2007 was $494 million and $469 million, respectively. Basic and
diluted income per share for nine months 2008 was $1.70 and $1.62,
respectively, versus $1.59 and $1.47 in 2007, respectively. Income from
continuing operations in 2008 included $0.04 and $0.17 per share for foreign
currency translation gains for the third quarter and nine months, respectively.
Our basic and diluted per share calculation for the quarter and nine months
2008 was favorably impacted by lower shares outstanding as a result of our
share repurchase program.
Discontinued Operations
The third quarter loss from discontinued operations was $36 million
(($0.13) and ($0.12) per basic and diluted share, respectively) for 2008 versus
income of $74 million for 2007 ($0.25 and $0.23 per basic and diluted share,
respectively). Nine months income from discontinued operations was $974 million
($3.37 and $3.19 per basic and diluted share, respectively) for 2008 versus
$188 million for 2007 ($0.63 and $0.58 per basic and diluted share,
respectively). In third quarter 2008, a definitive agreement to sell AIS was
reached and as such, the business was reclassified to discontinued operations
for all periods presented.
31
Included in the third quarter 2008 results of AIS was a $25 million
provision for a lawsuit settlement. Also included in third quarter 2008 results
was a $26 million pretax expense related to final settlements with ACE Limited
and Munich Re Group in connection with the sale of CICA and Sterling. Results
for 2007 primarily reflect operating results from our AIS, CICA and Sterling
businesses, while year-to-date results for 2008 primarily reflect first quarter
operating results from our CICA and Sterling businesses and a $1.0 billion
after-tax gain from the sales of these operations, which were sold on April 1,
2008.
REVIEW BY SEGMENT
General
We classify our businesses into two operating segments: Risk and
Insurance Brokerage Services and Consulting. 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
. Our Risk and Insurance
Brokerage Services and Consulting businesses invest funds held on behalf of
clients and operating funds in short-term obligations.
The following table and commentary provide selected financial
information on the operating segments.
|
|
Third Quarter Ended
|
|
Nine Months Ended
|
|
|
|
Sept. 30,
|
|
Sept. 30,
|
|
(millions)
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
Operating segment revenue:
(1) (2)
|
|
|
|
|
|
|
|
|
|
Risk and Insurance Brokerage Services
|
|
$
|
1,473
|
|
$
|
1,411
|
|
$
|
4,649
|
|
$
|
4,330
|
|
Consulting
|
|
337
|
|
325
|
|
1,016
|
|
979
|
|
|
|
|
|
|
|
|
|
|
|
Income before income tax:
|
|
|
|
|
|
|
|
|
|
Risk and Insurance Brokerage Services
|
|
$
|
188
|
|
$
|
228
|
|
$
|
657
|
|
$
|
734
|
|
Consulting
|
|
52
|
|
38
|
|
158
|
|
129
|
|
|
|
|
|
|
|
|
|
|
|
Pretax Margins:
|
|
|
|
|
|
|
|
|
|
Risk and Insurance Brokerage Services
|
|
12.8
|
%
|
16.2
|
%
|
14.1
|
%
|
17.0
|
%
|
Consulting
|
|
15.4
|
%
|
11.7
|
%
|
15.6
|
%
|
13.2
|
%
|
(1)
Intersegment
revenues of $4 million and $8 million were included in third quarter 2008 and
2007, respectively.
(2)
Intersegment revenues of $20 million and $24 million were included in nine
months 2008 and 2007, respectively.
32
The following table reflects investment income earned by the operating
segments, which is included in the foregoing results.
|
|
Third Quarter Ended
|
|
Nine Months Ended
|
|
|
|
Sept. 30,
|
|
Sept. 30,
|
|
(millions)
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
Risk and Insurance Brokerage Services
|
|
$
|
48
|
|
$
|
56
|
|
$
|
148
|
|
$
|
154
|
|
Consulting
|
|
2
|
|
1
|
|
4
|
|
8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Risk and Insurance Brokerage Services investment income decreased $8
million from third quarter 2007 and $6 million on a year-to-date basis
reflecting the impact of lower interest rates, partially offset by overall
weakness in the dollar and higher invested balances. The $4 million
year-to-date decrease in Consulting investment income is attributable to a 2007
gain from the sale of an investment.
Risk and Insurance Brokerage Services
Aon is a leader in many sectors of the insurance industry. Aon was
ranked in 2008 by
Business Insurance
as the worlds largest insurance broker, by A.M.
Best
as the number one global insurance brokerage in 2008
and 2007 based on brokerage revenues, and voted the best insurance intermediary
and best reinsurance intermediary in 2008 and 2007 by the readers of
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 are cyclical,
and may vary widely based on market conditions. Premium rates usually increase
when the industry has heavier than expected losses or capital shortages; this
situation is referred to as a hard market. A hard market tends to increase
commission revenues. Conversely, a soft market, characterized by flat or
reduced premium rates, results from increased competition for market share
among insurance carriers or increased underwriting capacity. A soft market
tends to reduce commission revenues. Hard and soft markets may be broad-based
or more narrowly focused across certain product lines or geographic areas. We
experienced a soft market in many business lines/segments and in many
geographic areas in 2007. Prices fell throughout the year, with the greatest
declines seen in large and middle-market accounts. Prices have continued to
decline in the first nine months of 2008, and we expect the soft market to
continue through the remainder of 2008.
The recent disruption in the global credit markets, the repricing of
credit risk and the deterioration of the financial markets have created
increasing difficult conditions for financial institutions, including those in
the insurance industry. Continued volatility and further deterioration in the
credit markets may reduce our customers demand for our brokerage and
reinsurance services and products and could negatively impact our results of
operations and financial condition. In addition, the potential for a
significant insurer to fail or withdraw from writing certain insurance
coverages that we offer our clients could negatively impact overall capacity in
the industry. This could then reduce placement of certain lines and types of
insurance and reduce our revenues and profitability.
Risk and Insurance Brokerage Services generated approximately 81% of
Aons total operating segment revenues for third quarter 2008 and 82% for nine
months 2008. Revenues are generated primarily through:
·
fees paid by
clients,
·
commissions and
fees paid by insurance and reinsurance companies, and
·
interest income
on funds held on behalf of clients.
33
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, and
·
the income we
earn on investments, which is heavily influenced by short-term interest rates.
Our 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
investment banking products and services, including mergers and acquisitions
and other financial advisory services, capital raising, contingent capital
financing, insurance-linked securitizations and derivative applications;
·
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; and
·
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.
·
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 along with investment banking products and services.
34
Revenue
This table shows Risk and Insurance Brokerage Services commissions,
fees and other revenue by sub-segment.
|
|
Third Quarter Ended September 30,
|
|
|
|
|
|
|
|
|
|
|
|
Less:
|
|
|
|
|
|
|
|
|
|
|
|
Less:
|
|
Acquisitions,
|
|
Organic
|
|
|
|
|
|
|
|
Percent
|
|
Currency
|
|
Divestitures,
|
|
Revenue
|
|
(millions)
|
|
2008
|
|
2007
|
|
Change
|
|
Impact
|
|
& Other
|
|
Growth
|
|
Americas
|
|
$
|
557
|
|
$
|
546
|
|
2
|
%
|
1
|
%
|
|
%
|
1
|
%
|
United Kingdom
|
|
182
|
|
193
|
|
(6
|
)
|
(2
|
)
|
(3
|
)
|
(1
|
)
|
Europe, Middle East & Africa
|
|
314
|
|
268
|
|
17
|
|
10
|
|
2
|
|
5
|
|
Asia Pacific
|
|
120
|
|
116
|
|
3
|
|
3
|
|
(1
|
)
|
1
|
|
Reinsurance
|
|
252
|
|
232
|
|
9
|
|
4
|
|
4
|
|
1
|
|
Total
|
|
$
|
1,425
|
|
$
|
1,355
|
|
5
|
%
|
3
|
%
|
|
%
|
2
|
%
|
|
|
Nine Months Ended September 30,
|
|
|
|
|
|
|
|
|
|
|
|
Less:
|
|
|
|
|
|
|
|
|
|
|
|
Less:
|
|
Acquisitions,
|
|
Organic
|
|
|
|
|
|
|
|
Percent
|
|
Currency
|
|
Divestitures,
|
|
Revenue
|
|
(millions)
|
|
2008
|
|
2007
|
|
Change
|
|
Impact
|
|
& Other
|
|
Growth
|
|
Americas
|
|
$
|
1,638
|
|
$
|
1,609
|
|
2
|
%
|
2
|
%
|
|
%
|
|
%
|
United Kingdom
|
|
546
|
|
545
|
|
|
|
1
|
|
(1
|
)
|
|
|
Europe, Middle East & Africa
|
|
1,188
|
|
988
|
|
20
|
|
13
|
|
2
|
|
5
|
|
Asia Pacific
|
|
373
|
|
343
|
|
9
|
|
8
|
|
(1
|
)
|
2
|
|
Reinsurance
|
|
756
|
|
691
|
|
9
|
|
5
|
|
3
|
|
1
|
|
Total
|
|
$
|
4,501
|
|
$
|
4,176
|
|
8
|
%
|
5
|
%
|
1
|
%
|
2
|
%
|
·
Americas revenue
grew 2% on a quarterly and year-to-date basis. The quarterly increase is driven
by the positive impact of the weak U.S. dollar and strong growth in our Latin
American, Canadian and affinity operations, partially offset by soft market conditions
in the U.S. and a decline in our Cananwill premium financing business.
·
U.K. revenue
declined 6% in the quarter but was essentially unchanged on a year-to-date
basis. The quarterly decrease was driven by unfavorable foreign exchange.
Organic revenue decreased 1% for the quarter and was unchanged on a
year-to-date basis, impacted by soft market conditions in our U.K. retail
business, partially offset by growth in our affinity and captive operations.
·
Europe, Middle
East & Africa revenue increased 17% and 20% on a quarterly and
year-to-date basis, respectively, reflecting favorable foreign currency
translation and organic revenue growth. Organic growth of 5% for both the
quarter and year-to-date was primarily due to solid growth in Continental Europe
and strong growth in the emerging markets in Africa and the Middle East.
·
Asia Pacifics
3% and 9% revenue growth on a quarterly and year-to-date basis, respectively,
was driven by positive foreign currency translation and strong organic growth
in New Zealand and most markets in Asia, partially offset by the impact of
certain regulatory changes in Japan. Organic growth was 1% and 2% for the
35
third quarter and nine months, respectively.
·
Reinsurance
revenue grew 9% on both a quarterly and year-to-date basis driven by the favorable
impact of foreign currency translation, the acquisition of Gallagher Re and
organic revenue growth. Growth in global facultative and treaty placements and,
on a year-to-date basis, capital markets transactions more than offset overall
soft market conditions. Organic growth was 1% for both the third quarter and
nine months.
This table shows Risk and Insurance Brokerage
Services revenue by geographic area.
|
|
Third Quarter
|
|
Nine Months
|
|
(millions)
|
|
Sept. 30,
2008
|
|
Sept. 30,
2007
|
|
Percent
Change
|
|
Sept. 30,
2008
|
|
Sept. 30,
2007
|
|
Percent
Change
|
|
United States
|
|
$
|
503
|
|
$
|
504
|
|
|
%
|
$
|
1,465
|
|
$
|
1,485
|
|
(1
|
)%
|
Americas, other than U.S.
|
|
184
|
|
162
|
|
14
|
|
548
|
|
468
|
|
17
|
|
United Kingdom
|
|
251
|
|
266
|
|
(6
|
)
|
743
|
|
749
|
|
(1
|
)
|
Europe, Middle East & Africa
|
|
389
|
|
341
|
|
14
|
|
1,449
|
|
1,226
|
|
18
|
|
Asia Pacific
|
|
146
|
|
138
|
|
6
|
|
444
|
|
402
|
|
10
|
|
Total revenue
|
|
$
|
1,473
|
|
$
|
1,411
|
|
4
|
%
|
$
|
4,649
|
|
$
|
4,330
|
|
7
|
%
|
·
U.S. revenues
were essentially unchanged for the quarter and declined 1% on a year-to-date
basis, due to soft market conditions in our retail and reinsurance businesses. We
experienced a decline in our Cananwill business, which impacted our retail
business.
·
Americas other
than U.S. revenue rose 14% and 17% for the quarter and nine months,
respectively, reflecting strong organic growth in Latin America and the
favorable impact of foreign currency translation.
·
U.K. revenue
decreased 6% for the quarter and 1% for nine months, driven by unfavorable
foreign currency translation during the quarter and soft market conditions in
our retail and reinsurance businesses.
·
Europe, Middle
East & Africa increased 14% and 18% on a quarterly and year-to-date
basis, respectively, driven by favorable foreign currency translation as well
as solid organic growth in Europe and strong results in our emerging markets.
·
Asia Pacific
revenue rose 6% and 10% for the quarter and nine months, respectively, due to
favorable foreign currency translation and organic growth.
Income Before Income
Tax
Third quarter 2008 pretax income declined $40 million to $188 million,
and nine months 2008 pretax income fell $77 million to $657 million. Pretax
margins in 2008 were 12.8% and 14.1% on a quarterly and year-to-date basis,
respectively, compared to 16.2% and 17.0% on a quarterly and year-to-date
basis, respectively, in 2007. Higher restructuring charges, litigation expense,
costs related to our anti-bribery investigations and related compliance
initiatives and gains on the sale of businesses in 2007 more than offset the
positive impact of foreign currency translation, savings realized from the 2007
and 2005 restructuring plans, organic revenue growth, a restructuring of
ownership interests of one of our subsidiaries, and on a year-to-date basis,
the inclusion in 2007 of $21 million of expense related to the settlement of
litigation.
Consulting
Aon Consulting is one of the worlds largest integrated human capital
consulting organizations. Our Consulting segment:
·
provides a broad
range of consulting services, and
36
·
generated 19% and 18% of Aons total
operating segment revenue for third quarter and nine months 2008, respectively.
The recent disruption in the global credit markets and the
deterioration of the financial markets has created significant uncertainty in
the marketplace. A severe and/or
prolonged economic downturn could adversely affect our clients financial
condition and the levels of business activities in the industries and
geographies where we operate. This may
reduce demand for our services or depress pricing of those services and have an
adverse effect on our new business and results of operations.
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
helps 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. During the third quarter
2008, we began to wind down certain parts of this practice, and the remaining
operation will be transferred to our U.S. retail brokerage unit.
·
Outsourcing
, which offers employment
processing, performance improvement, benefits administration and other
employment-related services.
37
Revenue
This table shows Consulting commissions, fees and other revenue by
sub-segment.
|
|
Third Quarter Ended September 30,
|
|
|
|
|
|
|
|
|
|
|
|
Less:
|
|
|
|
|
|
|
|
|
|
|
|
Less:
|
|
Acquisitions,
|
|
Organic
|
|
|
|
|
|
|
|
Percent
|
|
Currency
|
|
Divestitures,
|
|
Revenue
|
|
(millions)
|
|
2008
|
|
2007
|
|
Change
|
|
Impact
|
|
& Other
|
|
Growth
|
|
Consulting Services
|
|
$
|
284
|
|
$
|
269
|
|
6
|
%
|
1
|
%
|
(3
|
)%
|
8
|
%
|
Outsourcing
|
|
51
|
|
55
|
|
(7
|
)
|
(2
|
)
|
(1
|
)
|
(4
|
)
|
Total
|
|
$
|
335
|
|
$
|
324
|
|
3
|
%
|
1
|
%
|
(4
|
)%
|
6
|
%
|
|
|
Nine Months Ended September 30,
|
|
|
|
|
|
|
|
|
|
|
|
Less:
|
|
|
|
|
|
|
|
|
|
|
|
Less:
|
|
Acquisitions,
|
|
Organic
|
|
|
|
|
|
|
|
Percent
|
|
Currency
|
|
Divestitures,
|
|
Revenue
|
|
(millions)
|
|
2008
|
|
2007
|
|
Change
|
|
Impact
|
|
& Other
|
|
Growth
|
|
Consulting Services
|
|
$
|
850
|
|
$
|
794
|
|
7
|
%
|
3
|
%
|
(1
|
)%
|
5
|
%
|
Outsourcing
|
|
162
|
|
177
|
|
(8
|
)
|
1
|
|
(1
|
)
|
(8
|
)
|
Total
|
|
$
|
1,012
|
|
$
|
971
|
|
4
|
%
|
3
|
%
|
(2
|
)%
|
3
|
%
|
·
Consulting
Services commissions, fees and other revenue increased $15 million or 6% and
$56 million or 7% on a quarterly and year-to-date basis, respectively. Organic revenue growth was 8% and 5% for
third quarter and nine months 2008, respectively, reflecting the impact of
favorable foreign currency translation and growth in our retirement and health
and benefit consulting practices for both periods.
·
Outsourcing
revenue decreased $4 million for the quarter and $15 million for nine
months. Organic revenue declined 4% for
the quarter and 8% on a year-to-date basis driven by the termination of our
contract with AT&T in 2007.
This table shows Consulting revenue by geographic area.
|
|
Third Quarter
|
|
Nine Months
|
|
(millions)
|
|
Sept. 30,
2008
|
|
Sept. 30,
2007
|
|
Percent
Change
|
|
Sept. 30,
2008
|
|
Sept. 30,
2007
|
|
Percent
Change
|
|
United States
|
|
$
|
158
|
|
$
|
156
|
|
1
|
%
|
$
|
459
|
|
$
|
484
|
|
(5
|
)%
|
Americas, other than U.S.
|
|
30
|
|
27
|
|
11
|
|
100
|
|
88
|
|
14
|
|
United Kingdom
|
|
65
|
|
69
|
|
(6
|
)
|
199
|
|
197
|
|
1
|
|
Europe, Middle East & Africa
|
|
63
|
|
56
|
|
13
|
|
201
|
|
168
|
|
20
|
|
Asia Pacific
|
|
21
|
|
17
|
|
24
|
|
57
|
|
42
|
|
36
|
|
Total revenue
|
|
$
|
337
|
|
$
|
325
|
|
4
|
%
|
$
|
1,016
|
|
$
|
979
|
|
4
|
%
|
·
U.S. revenue
increased 1% for the quarter but declined 5% on a year-to-date basis. The quarterly growth was driven by our
compensation and health and benefits practices, partially offset by lower
outsourcing
38
revenue.
The year-to-date decline was driven primarily by lower investment income
and the loss of outsourcing revenue related to the AT&T contract
termination.
·
Americas other
than the U.S. revenue grew 11% and 14% for the quarter and nine months,
respectively, driven by favorable foreign currency translation and organic
growth.
·
United Kingdom
revenue declined 6% for the quarter as a result of unfavorable foreign exchange
translation, which more than offset organic growth. The nine month improvement was due to organic
revenue growth and favorable foreign exchange translation.
·
Europe, Middle
East & Africa revenue increased 13% and 20% on a quarterly and
year-to-date basis, respectively, driven by favorable foreign currency
translation, acquisitions and organic revenue growth.
·
Asia Pacific
revenues grew 24% and 36% for the third quarter and nine months, respectively,
reflecting the impact of favorable foreign currency translation and organic
revenue growth.
Income Before Income
Tax
Third quarter 2008 pretax income increased 37% to $52 million, compared
to $38 million in 2007. On a
year-to-date basis, 2008 pretax income increased $29 million or 22% to $158
million. Pretax margins for the quarter
were 15.4% and 11.7% for 2008 and 2007, respectively, and for nine months were
15.6% and 13.2% for 2008 and 2007, respectively. The quarterly and year-to-date
pretax income and margin improvement was primarily driven by organic growth,
benefits related to the 2007 and 2005 restructuring plans, other operational
improvements and favorable foreign currency translation, partially offset by
the gain on sale of an investment in 2007.
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.
Private equities are principally carried at cost; however, where we
have significant influence, they are reported under the equity method of
accounting. These investments usually do
not pay dividends. Limited partnerships
(LP) are accounted for using the equity method and changes in the value of
the underlying LP investments flow through unallocated investment income.
Unallocated income also includes the operations of our Property and
Casualty runoff business. We previously
included results related to this business in our former Insurance Underwriting
segment.
Unallocated investment income
was $40 million and $19 million for the third quarter 2008 and 2007,
respectively, and $62 million and $70 million for nine months 2008 and 2007,
respectively. Higher interest income
from increased balances, reflecting the investment of proceeds from the sales
of CICA and Sterling, positively impacted the quarter and nine months while
higher income from our PEPS I investment positively impacted our quarterly
results but is lower on a year-to-date basis.
Unallocated expenses
include corporate governance costs not allocated to the operating segments. Third quarter 2008 and 2007 expenses were $34
million and $24 million, respectively, and for both nine months 2008 and 2007
were $91 million. The quarterly increase
reflects $6 million in costs associated with the acquisition of Benfield, as
well as higher absorbed costs previously allocated to the underwriting
businesses. Year-to-date expenses were
unchanged as the Benfield costs offset the 2007 non-recurring accounting and
legal expenses related to the review of historical equity compensation practices.
39
Property and Casualty
revenues
were $1 million and $2 million for the third quarter 2008 and 2007,
respectively, and were $4 million and $6 million for nine months 2008 and 2007,
respectively. Associated expenses were
$3 million and $7 million for third quarter 2008 and 2007, respectively, and
were $9 million and $15 million for nine months 2008 and 2007, respectively.
Interest expense
,
which represents the cost of our worldwide debt obligations, totaled $32
million and $33 million for third quarter 2008 and 2007, respectively, and were
$96 million and $102 million for nine months 2008 and 2007, respectively. The decreases for both periods primarily
reflect the impact of the redemption of our 3.5% Senior Convertible Debentures
in 2007.
FINANCIAL CONDITION AND LIQUIDITY
Cash Flows
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,
2008 and 2007 are as follows:
(millions) Nine months ended September 30,
|
|
2008
|
|
2007
|
|
Insurance Underwriting operating cash flows
|
|
$
|
(14
|
)
|
$
|
225
|
|
All other operating cash flows
|
|
377
|
|
551
|
|
|
|
363
|
|
776
|
|
Change in funds held on behalf of brokerage
and consulting clients
|
|
50
|
|
150
|
|
Cash provided by operating activities
|
|
$
|
413
|
|
$
|
926
|
|
Insurance
Underwriting operating cash flows
Our insurance underwriting operations include accident &
health and life and certain property & casualty businesses in
run-off. These insurance products have
distinct differences in the timing of premiums earned and payment of future
liabilities. As noted earlier, we sold our CICA and Sterling businesses on April 1,
2008.
Our operating cash flows from our insurance subsidiaries were $(14)
million for 2008, a decrease of $239 million compared to 2007. Due to the sale of CICA and Sterling, cash
flows for 2008 include only activity through the date of sale. For 2008, operating cash flows, analyzed by
major income statement component, indicated that premium and other fees
collected, net of reinsurance, were $624 million compared to $1,681 million in
2007. Investment and other miscellaneous
income received were $50 million and $135 million in 2008 and 2007,
respectively.
The insurance underwriting subsidiaries 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 $368
million in 2008 versus $979 million in 2007.
Commissions and general expenses paid were $257 million for 2008,
compared to $578 million in 2007. Tax
payments for 2008 were $63 million compared to $34 million last year.
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.
40
·
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.
All other operating
cash flows
Our operating cash flows from our Risk and Insurance Brokerage Services
and Consulting segments, as well as related corporate items, were $377 million
in 2008 compared to $551 million in 2007.
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 CICA prior to its sale 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 generated cash of $1.5 billion. We received $2.4 billion in cash, net of
taxes, from the sale of our CICA and Sterling subsidiaries. Cash flows used by investing activities
included purchases, net of sales of investments, of $772 million, principally
reflecting the investment of the proceeds of the CICA and Sterling sale. In addition, $80 million of cash was used for
capital expenditures, net of disposals and we spent $85 million for various
acquisitions of subsidiaries, the largest being our acquisition of the U.S. and
U.K. reinsurance operations of A.J. Gallagher for $30 million.
Our financing needs were $2.0 billion.
Financing uses primarily included share repurchase activity, net of
reissuance for our employee benefit plans of $1.7 billion, cash dividends paid
to shareholders of $130 million, and debt repayments, net of issuance, of $165
million.
Financial Condition
In our capacity as an insurance broker or agent, we collect premiums
from insureds and, after deducting our commission, remit the premiums to the
respective insurance underwriter. We
also collect claims or refunds from underwriters on behalf of insureds. Unremitted insurance premiums and claims are
held by us in a fiduciary capacity as short-term investments.
In our condensed consolidated statements of financial position, we
report fiduciary assets equal to our fiduciary liabilities. Our fiduciary assets include short-term
investments of $3,092 million and $3,122 million at September 30, 2008 and
December 31, 2007, respectively.
Since year-end 2007, total assets decreased $4.2 billion to $20.7
billion.
·
Working capital, excluding assets and
liabilities held-for-sale, increased $968 million to $3.0 billion. The increase is primarily attributed to an
increase in short-term investments from the sales of CICA and Sterling.
·
Short-term debt decreased by $252
million as a result of paying down all of our short-term Euro facility
borrowings.
41
·
Accounts payable and accrued
liabilities decreased $236 million due primarily to the payment of incentive
compensation in March.
·
Goodwill decreased $33 million due to
the impact of foreign currency translation, partially offset by acquisition
activity during the year.
·
Long-term debt increased by $71
million, reflecting higher long-term Euro facility borrowings and the impact of
foreign currency translation.
Borrowings
Total debt at September 30, 2008 was $1,964 million, a decrease of
$181 million from December 31, 2007, which is the net result of our Euro
facility repayments and borrowings.
At September 30, 2008, 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, 2008, we have issued
$20 million in letters of credit.
We also have foreign credit facilities available. At September 30, 2008, we had available
to us:
·
a five-year 650
million ($950 million at September 30, 2008 exchange rates) multi-currency
facility of which $636 million was outstanding at September 30, 2008. See Note 7 to the consolidated financial
statements in our 2007 Form 10-K for further discussion of both the U.S.
and Euro facilities, and
·
a 364-day 25
million ($37 million) facility.
We also have a 20 million ($29 million) uncommitted facility.
The major rating agencies ratings of our debt at November 3, 2008
appear in the table below.
|
|
Ratings
|
|
|
|
|
|
Senior
Long-term Debt
|
|
Commercial
Paper
|
|
Outlook
|
|
Standard & Poors
|
|
BBB+
|
|
A-2
|
|
Negative
|
|
Moodys Investor Services
|
|
Baa2
|
|
P-2
|
|
Stable
|
|
Fitch, Inc.
|
|
BBB+
|
|
F-2
|
|
Stable
|
|
During the third quarter 2008, Moodys Investor Service changed our
rating outlook to stable from positive, reflecting the integration risk
associated with the pending Benfield acquisition and the expected decline in
our cash position. Also in the third
quarter, Standard & Poors placed our counterparty credit rating on
Credit Watch with negative implications, reflecting the uncertainty regarding
Benfields impact on our cash flows, capital structure and coverage ratios.
A downgrade in the credit ratings of our senior debt and commercial
paper would:
·
increase our borrowing costs and
reduce our financial flexibility, and
·
increase
our commercial paper interest rates or possibly 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.
42
Stockholders Equity
Stockholders equity decreased $274 million from December 31, 2007
to $5,947 million, driven primarily by an increase in net income of $1,468
million, which was more than offset by share repurchase activity, net of reissuances
for our employee benefit plans of $1,731 million.
Accumulated other comprehensive loss increased $12 million since December 31,
2007. Compared to year end 2007:
·
net foreign currency translation
increased by $25 million because of the weakening of the U.S. dollar against
foreign currencies.
·
net
unrealized investment losses rose $4 million, and
·
net
derivative losses increased $31 million.
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
that a loss is probable and estimable.
Following the guidance of Statement No. 140 and other relevant
accounting guidance, we use SPEs and QSPEs, also known as special purpose
vehicles, in some of our operations.
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.
These reinsurance recoverables amount to $663 million at September 30,
2008. Trust balances and letters of
credit offsetting these reinsurance recoverables total approximately $149
million. At December 31, 2007, we
had recorded a $12 million liability, reflecting the fair value of this
indemnification. The value decreased to
approximately $9 million as of September 30, 2008. The indemnification represents the present
value of the indemnification based on the credit risk of the reinsurers.
Premium Financing
Operations
Some 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.
·
In
the U.S. and U.K., premium finance agreements are sold to SPEs, which are
considered QSPEs as defined by Statement No. 140. The QSPEs fund their
purchases of premium finance agreements by selling undivided beneficial
interests in the agreements to Bank SPEs.
·
In
Canada and Australia, undivided interests in the premium finance agreements are
sold directly to Bank SPEs. The Bank
SPEs are variable interest entities as defined by FIN 46R.
The QSPEs used in the U.S. and U.K. are not
consolidated in our financial statements because the criteria for sale
accounting have been met under Statement No. 140.
43
For the Canadian and Australian sales, we
have analyzed qualitative and quantitative factors related to our transactions
with the Bank SPEs and have determined that non-consolidation of the Bank SPEs
is appropriate in accordance with FIN 46R because we are not their primary
beneficiary. Specific factors we
considered include:
·
the
fact that we are not the sponsor of any of the Bank SPEs,
·
various
other unaffiliated companies sell receivables to the Bank SPEs, and
·
unaffiliated
third parties have either made substantial equity investments in the Bank SPEs,
hold voting control of the Bank SPEs, or generally have the risks and rewards
of ownership of the assets of the Bank SPEs through liquidity support
agreements or other arrangements involving significant variable interests.
Our variable interest in the Bank SPEs in
these jurisdictions is limited to our retained interests in premium finance
agreements sold to the Bank SPEs. We
review all material off-balance sheet transactions annually or whenever a
reconsideration event occurs for the continued propriety of our accounting.
Pursuant to the sale agreements, the total
amount advanced by the Bank SPEs on premium finance agreements sold to them at
any one time is limited by the sale agreements to $1.8 billion. The Bank SPEs had advanced to us $1.2 billion
and $1.4 billion at September 30, 2008 and December 31, 2007,
respectively, on portfolios sold to the Bank SPEs of $1.3 billion and $1.5
billion at September 30, 2008 and December 31, 2007, respectively.
We record gains on the sale of premium
finance agreements. When we calculate
the gain, we include all costs we expect to incur for the relevant Bank
SPEs. The gains, which are included in
commissions, fees and other revenue in the condensed consolidated statements of
income, were $9 million and $15 million for the three months ended September 30,
2008 and 2007, respectively, and $41 million and $46 million for the nine
months ended September 30, 2008 and 2007, respectively.
·
We record our
retained interest in the sold premium finance agreements at fair value, and
report it in receivables in the condensed consolidated statements of financial
position. We estimate fair value by
discounting estimated future cash flows using discount rates that are
commensurate with the underlying risk, expected future prepayment rates, and
credit loss estimates.
·
We also retain
servicing rights for sold agreements, and earn servicing fee income over the
servicing period. Because the servicing
fees represent adequate compensation for the servicing of the receivables, we
have not recorded any servicing assets or liabilities.
The third-party bank sponsors or other participants in the Bank SPEs
provide the liquidity support and bear the credit risks on the receivables,
subject to limited recourse, in the form of over-collateralization provided by
us (and other sellers) as required by the sales agreements. The over-collateralization of our sold
receivables represents our maximum exposure to credit-related losses, and was
approximately $115 million at September 30, 2008. We also remain contingently liable should the
funding costs of the U.S. Bank SPEs exceed the interest and late fees accrued
or collected on the sold U.S. portfolio.
We continually review our retained interest in the sold portfolio,
taking into consideration credit loss trends in the sold portfolio, conditions
in the credit markets and other factors, and adjust its carrying value
accordingly.
With the exception of our Australian sales agreements, all our other
sales agreements require us to meet the following covenants:
·
consolidated net
worth, as defined, of at least $2.5 billion,
·
consolidated
EBITDA (earnings before interest, taxes, depreciation and amortization) to
consolidated net interest of at least 4 to 1, and
·
consolidated indebtedness to
consolidated EBITDA of no more than 3 to 1.
44
We intend to renew these conduit facilities as they expire. We renewed the U.S. sales agreement on October 3,
2008 and intend to renew our European agreement in the fourth quarter of
2008. The current environment in the
credit markets influenced the renewal process and the renewed U.S. terms are
more restrictive: the over-collateralization requirements have increased
significantly ($40 million on the renewal date), and, based upon our estimated
needs for the coming year, we reduced the level of committed availability by
$436 million and scheduled additional decreases of $220 million by March 31,
2009. In addition, the securitization
program costs added on the pass-through funding costs from the U.S. Bank
SPEs. We expect similarly restrictive
terms in Europe. Moreover, as our
ability to originate and fund new premium finance agreements is dependent on
the pass-through funding costs of the Bank SPEs, disruptions in the markets
through which the Bank SPEs obtain funds could further impact on our premium
finance results of operations and cash flows.
We also face the risk the Bank SPEs will be unable to provide the
liquidity or will become an unreliable source of the liquidity necessary to
fund new premium finance agreements.
Such an occurrence would require us to consider alternate sources of
funding, including other forms of off-balance sheet as well as on-balance sheet
financing, or discontinue the origination of premium finance agreements. Additionally, if there were adverse bank,
regulatory, tax, or accounting rule changes, our access to the conduit
facilities and special purpose vehicles could be affected.
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 held by a limited liability company, owned by us
(49%) and by a charitable trust, which we do not control (51%). We do not include the assets and liabilities
and operations of PEPS I in our consolidated financial statements.
In 2001, PEPS I sold approximately $171 million of investment grade
fixed-maturity securities to unaffiliated third parties. PEPS I 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.
As part of this transaction, Aon is 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 $1 million were funded by us in 2008. As of September 30, 2008, unfunded
commitments amounted to $43 million.
These commitments have specific expiration dates and the general
partners may decide not to draw on these commitments.
Our 2008 income distributions from our preferred investment in PEPS I
increased $13 million for the quarter but decreased $25 million on a
year-to-date basis. These distributions
are included 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, began to pay preferred income distributions. Whether we receive additional preferred
returns will depend on the performance of the LP interests underlying PEPS I,
which we expect to vary from period to period.
We do not control the timing of the distributions.
Aon derives the estimated fair value of its preferred investments in
PEPS I primarily from valuations received from the general partners of the LP
interests held by PEPS I.
45
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, changes in
commercial property and casualty markets and commercial premium rates that
could impact revenues, the outcome of inquiries from regulators and
investigations related to compliance with U.S. Foreign Corrupt Practices Act
and non-U.S. anti-corruption laws, the impact of class actions and individual
lawsuits including client class actions, securities class actions, derivative
actions and ERISA class actions, the cost of resolution of other contingent
liabilities and loss contingencies, our ability to complete our pending
acquisition of Benfield Group Limited and, if completed, to integrate Benfield
successfully and to realize the anticipated benefits of the Benfield
acquisition.
We undertake no obligation to publicly update forward-looking
statements, whether as a result of new information, future events or otherwise.
46
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 and Euros but most of its expenses are incurred in
pounds sterling. Our policy is to
convert into pounds sterling sufficient U.S. dollar and Euro revenue to fund
the subsidiarys pound sterling expenses using OTC options and forward exchange
contracts. At September 30, 2008,
we have hedged approximately 24% and 77% of our U.K. subsidiaries expected
U.S. dollar and Euro transaction exposures for the next twelve months,
respectively. We do not generally hedge
these exposures beyond three years.
The translated value of revenue and expense from our international
brokerage operations are subject to fluctuations in foreign exchange
rates. Third quarter 2008 diluted
earnings per share were positively impacted by $0.04 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.
47
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 2008 that have materially affected, or are
reasonably likely to materially affect, Aons internal control over financial
reporting.
48
PART II
OTHER INFORMATION
ITEM 1.
LEGAL PROCEEDINGS
See Note 13 (Contingencies) to the condensed consolidated financial
statements contained in Part I, Item 1, which is incorporated by reference
herein.
ITEM 1A.
RISK FACTORS
The risk factors set forth in Part I, Item 1A. Risk Factors to the
2007 Form 10-K of Aon Corporation (Aon, we, us or our) have been
updated as set forth below to reflect our divestiture earlier this year of our
Combined Insurance Company of America and Sterling Life Insurance Company
subsidiaries that reduced our risk from underwriting businesses and the new
acquisition and integration risks arising from our intention to acquire
Benfield Group Limited. These updated risk factors set forth below supersede those
contained in our 2007 Form 10-K and readers should consider them in
addition to the other information contained in this report as our business,
financial condition or results of operations could be adversely affected if any
of these risks actually occur.
The following are certain risks related to our business specifically
and the insurance industry generally that could adversely affect our business,
financial condition and results of operations. The risk factors are:
Our results
may fluctuate due to many factors, including cyclical or permanent changes in
the insurance and reinsurance industries.
Our results historically have
been subject to significant fluctuations arising from uncertainties and changes
in the insurance industry. Changes in premium rates generally affect the
commissions and fees payable to our brokerage businesses.
Our results
may be adversely affected by changes in the mode of compensation in the
insurance industry.
Since the Attorney General of
New York brought charges against one of our competitors in October 2004,
there has been a great deal of uncertainty concerning then longstanding methods
of compensating insurance brokers. Soon after the Attorney General brought
those charges, Aon and certain other large insurance brokers announced that
they would terminate contingent commission arrangements with underwriters. Most
insurance brokers, however, currently continue to enter into such arrangements,
and regulators have not taken action to end such arrangements throughout the
industry.
Our results may be adversely affected by the impact disruptions in the
credit and financial markets have on our customers and the insurance industry.
The recent disruption in the global credit markets, the repricing of
credit risk and the deterioration of the financial markets have created
increasing difficult conditions for financial institutions, including those in
the insurance industry. Continued volatility and further deterioration in the
credit markets may reduce our customers demand for our brokerage and
reinsurance services and products and could negatively impact our results of
operations and financial condition. In addition, the potential for a
significant insurer to fail or withdraw from writing certain insurance
coverages that we offer our clients could negatively impact overall capacity in
the industry. This could then reduce placement of certain lines and types of
insurance and reduce our revenues and profitability.
We face
significant competitive pressures in each of our businesses.
We believe that competition in
our lines of business is based on service, product features, price, commission
structure, financial strength and name recognition. In particular, we compete
with a large number of national, regional and local insurance companies and
other financial services providers and brokers.
We encounter strong competition
for both clients and professional talent in our insurance brokerage and risk
management services operations from other insurance brokerage firms which also
operate on a nationwide or worldwide basis, from a large number of regional and
local firms throughout the world, from insurance and reinsurance companies that
market and service their insurance products without the assistance of brokers
or agents and from other businesses, including commercial and investment banks,
accounting firms and consultants that provide risk related services and
products. Our consulting operations compete with independent
49
consulting firms and consulting
organizations affiliated with accounting, information systems, technology and
financial services firms around the world.
In addition, the increase in
competition due to new legislative or industry developments could adversely
affect us. These developments include:
·
the selling of insurance by
insurance companies directly to insureds;
·
changes in our business compensation
model as a result of regulatory investigations;
·
the establishment of programs in
which state sponsored entities provide property insurance in catastrophe prone
areas or other alternative types of coverage;
·
additional regulations promulgated
by the Financial Services Authority (FSA) in the United Kingdom, or other
regulatory bodies in jurisdictions in which we operate.
New competition as a result of
these developments could cause the supply of, and demand for, our products and
services to change, which could adversely affect our results of operations and
financial condition.
We may not
realize all of the expected benefits from our restructuring plans.
In third quarter 2007, we
announced a global restructuring plan intended to create a more streamlined
organization and to reduce future expense growth to better serve clients (the 2007
Plan). As a result, we have adopted restructuring initiatives that are
expected to result in the elimination of an estimated 2,700 employee positions,
the closing or consolidation of several offices, asset impairments and other
expenses necessary to implement these initiatives. We currently expect that the
2007 Plan will result in cumulative pretax charges of $450 million. We anticipate that our annualized savings
from the 2007 Plan will be approximately $300 million by 2010. We cannot assure that we will achieve the
targeted savings. In 2005, we began a restructuring initiative to reduce our
fixed cost base and increase efficiency (the 2005 Plan). The 2005 Plan is
substantially complete, and resulted in cumulative pretax charges totalling
$368 million. Restructuring costs included the elimination of approximately
3,600 employee positions, the closing of various offices, asset impairments and
other expenses necessary to implement these initiatives. We anticipate that our
annualized savings from the 2005 Plan will be approximately $270 million by
2008. Estimated savings from the 2007 and 2005 Plans do not include any
benefits related to businesses placed in discontinued operations. We cannot
assure that we will achieve the targeted savings.
Changes in
interest rates and investment prices could reduce the value of our investment
portfolio and adversely affect our financial condition or results
.
We carry an investment portfolio
of fixed-maturity and other long-term investments. As of September 30,
2008, our continuing operations had fixed-maturity investments (100 percent
investment grade) that had a carrying value of $132 million and our other long
term investments had a carrying value of $276 million. Funds held on behalf of
clients, which were $3.1 billion at September 30, 2008, are held in
short-term investments. Changes in interest rates and investment prices could
reduce the value of our investment portfolio and adversely affect our financial
condition or results.
For example, changes in domestic
and international interest rates directly affect our income from, and the
market value of, fixed maturity investments. Similarly, general economic
conditions, stock market conditions and other factors beyond our control affect
the value of our equity investments. We monitor our portfolio for other than
temporary impairments in carrying value. For securities judged to have an other
than temporary impairment, we recognize a realized loss through the statement
of income to write down the value of those securities.
50
We are also subject to potential
declines in credit quality, either related to issues specific to certain
industries or to a weakening in the economy in general. The concentration of
our investment portfolio in any particular industry, group of related
industries or geographic sector could have an adverse effect on our investment
portfolio and, consequently, on our results of operations and financial
condition. A decline in the quality of our investment portfolio as a result of
adverse economic conditions or otherwise could cause realized losses on
securities, including realized losses relating to derivative strategies. The
financial and liquidity needs of our business could also cause us to sell
assets from our investment portfolio at unfavorable prices.
Our net
pension liabilities may grow, and the fair value of our pension plan assets may
decrease, which could adversely affect our stockholders equity, net income,
cash flow and liquidity and require us to make additional cash contributions to
our pension plans.
To the extent that the present
value of the benefits incurred to date for pension obligations in the major
countries in which we operate continues to exceed the value of the assets
supporting these obligations, our financial position and results of operations
may be adversely affected. In certain previous years, there have been declines
in interest rates. As a result of lower interest rates, the present value of
plan liabilities increased faster than the value of plan assets, resulting in
significantly higher unfunded positions in several of our major pension plans.
We currently plan on
contributing approximately $182 million to our major pension plans, although we
may elect to contribute more. Total cash
contributions to these pension plans in 2007 were $211 million, which was an
increase of $7 million from 2006. In 2006, we also contributed $166 million of
non cash financial instruments to certain of our United Kingdom plans. In
total, our 2007 contributions to these pension plans were $159 million less
than in 2006. Future estimates are based on certain assumptions, including
discount rates, interest rates, mortality, fair value of assets and expected
return on plan assets.
Periodic revision of pension
assumptions can materially change the present value of future benefits, and
therefore the funded status of the plans and the resulting periodic pension
expense. Changes in our pension benefit obligations and the related net
periodic costs or credits may occur in the future due to any variance of actual
results from our assumptions and changes in the number of participating
employees. As a result, there can be no assurance that we will not experience
future decreases in stockholders equity, net income, cash flow and liquidity
or that we will not be required to make additional cash contributions in the
future beyond those which have been estimated.
We are subject to a number of
contingencies and legal proceedings which, if determined unfavorably to us,
would adversely affect our financial results.
We 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. We have
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.
Amounts related to settlement provisions are recorded in other general
expenses in the condensed consolidated statements of income.
At the time of the 2004-05 investigation of the insurance industry by
the Attorney General of New York (NYAG) and other regulators, purported
classes of clients filed civil litigation against us and other companies 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.
51
In the New Jersey actions, the Court dismissed plaintiffs federal
antitrust and RICO claims in separate orders in August and October 2007,
respectively. Plaintiffs have appealed
these dismissals. We believe we have
meritorious defenses in all of these cases and intend to vigorously defend
ourselves 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.
Also at the time of the NYAG investigation, putative classes filed
actions against us in the U.S. District Court for the Northern District of
Illinois under the federal securities laws and ERISA. Plaintiffs in the federal securities class
action have recently submitted purported expert reports estimating a range of
alleged damages of $353 million to $498 million, and plaintiffs in the ERISA
class actions have recently submitted purported expert reports estimating a
range of alleged damages of $59 million to $349 million. We will soon submit
our own expert reports, which will vigorously challenge these damage estimates,
as well as plaintiffs underlying theories of liability. We believe we have
meritorious defenses in all of these cases and intend to vigorously defend
ourselves 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.
Following inquiries from regulators, we commenced an internal review of
our 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. Certain
governmental agencies, including the U.K. Financial Services Authority, the
City of London police, the U.S. Securities and Exchange Commission, and the
U.S. Department of Justice, are also investigating these matters. We are fully cooperating with these
investigations, and have agreed with the U.S. agencies to toll any applicable
statute of limitations pending completion of the investigations. Based on current information, we are unable
to predict at this time when these matters will be concluded, or what
regulatory or other outcomes may result.
A financial institution in the U.K. called Standard Life Assurance Ltd.
brought an action in London Commercial Court against us seeking more than £50
million ($92 million at September 30, 2008 exchange rates) for alleged
errors or omissions in the placement of a professional indemnity policy with
certain underwriters. In a preliminary
decision issued on February 13, 2008, the court construed the relevant
policy language to excuse underwriters from paying Standard Life and concluded
that we were negligent in not seeking changes to the language. We filed an interlocutory appeal of this
preliminary decision. In July 2008,
we reached a settlement with underwriters under which underwriters agreed to
pay a portion of the ultimate recovery by Standard Life in exchange for us
dropping our appeal of the preliminary decision. In subsequent proceedings in the Commercial
Court, we will vigorously contest Standard Lifes claims based on a variety of
legal and factual arguments. We have a
potential negligence claim against a different third party which provided
advice with respect of the relevant policy language, and we further believe
that, as a result of an indemnity given to us by a third party, we are entitled
to indemnification in whole or part for our losses in this matter.
A putative class action,
Buckner v.
Resource Life
, is pending in state court in Columbus, Georgia
against a former subsidiary of Aon, Resource Life Insurance Company. The complaint alleges that Resource Life,
which wrote policies insuring repayment of auto loans, was obligated to
identify and return unearned premium to policyholders whose loans terminated
before the end of their scheduled terms.
In connection with the sale of Resource Life in 2006, we agreed to
indemnify Resource Lifes buyer in certain respects relating to this
action. We believe that Resource Life
has meritorious defenses and are vigorously defending this action. The outcome of the action, and the amount of
any losses or other payments that may result, cannot be predicted at this time.
Virginia Surety Company, Inc. (VSC), a former property and
casualty underwriting subsidiary of Aon, is engaged in arbitration and
litigation proceedings with Applied Underwriters, Inc. (Applied), a
managing general agent (MGA). In these
proceedings, Applied seeks approximately $190 million for,
inter alia
, an alleged diminution in
Applieds value following VSCs termination of an MGA contract between the
parties. In connection with the sale of
Aon Warranty Group (AWG) (which includes VSC) in 2006, we agreed to retain
certain obligations related to VSCs property and casualty underwriting
business, now in runoff, including this matter.
We believe that VSC has meritorious defenses and are vigorously
defending the arbitration and litigation.
52
The outcome of the action, and the amount of any losses or other
payments that may result, cannot be predicted at this time.
Although the ultimate outcome of all matters referred to above cannot
be ascertained, and liabilities in indeterminate amounts may be imposed on us
or our subsidiaries, on the basis of present information, amounts already
provided, availability of insurance coverages and legal advice received, it is
the opinion of our management that the disposition or ultimate determination of
such claims will not have a material adverse effect on our consolidated
financial position. However, it is
possible that our 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.
We are subject to E&O
claims against us.
In our insurance brokerage and consulting
businesses, we often assist our clients with matters which include the
placement of insurance coverage or employee benefit plans and the handling of
related claims. E&O claims against us may allege our potential liability
for all or part of the amounts in question. E&O claims could include, for
example, the failure of our employees or sub agents, whether negligently or
intentionally, to place coverage correctly or notify carriers of claims on behalf
of clients or to provide insurance carriers with complete and accurate
information relating to the risks being insured. It is not always possible to
prevent and detect errors and omissions, and the precautions we take may not be
effective in all cases. In addition, E&O claims may harm our reputation or
divert management resources away from operating our business.
Our success depends, in part,
on our ability to attract and retain experienced and qualified personnel.
Our future success depends on our ability to
attract and retain experienced personnel, including underwriters, brokers and
other professional personnel. Competition for such experienced professional
personnel is intense. If we cannot hire and retain talented personnel, our
business, operating results and financial condition could be adversely
affected.
Our businesses are subject to
extensive governmental regulation which could reduce our profitability or limit
our growth.
Our businesses are subject to extensive
federal, state and foreign governmental regulation and supervision, which could
reduce our profitability or limit our growth by increasing the costs of
regulatory compliance, limiting or restricting the products or services we sell
or the methods by which we sell our products and services or subjecting our
businesses to the possibility of regulatory actions or proceedings. With
respect to our insurance brokerage businesses, this supervision generally
includes the licensing of insurance brokers and agents and third party
administrators and the regulation of the handling and investment of client
funds held in a fiduciary capacity. Our continuing ability to provide insurance
brokering and third party administration in the jurisdictions in which we
currently operate depends on our compliance with the rules and regulations
promulgated from time to time by the regulatory authorities in each of these
jurisdictions. Also, we can be affected indirectly by the governmental
regulation and supervision of other insurance companies. For instance, if we are providing managing
general underwriting services for an insurer, we may have to contend with
regulations affecting our client.
Further, regulation affecting the insurance companies with whom our
brokers place business can affect how we conduct those operations.
Although the federal government does not
directly regulate the insurance business, federal legislation and
administrative policies in several areas, including employee benefit plan
regulation, Medicare, age, race, disability and sex discrimination, investment
company regulation, financial services regulation, securities laws and federal
taxation, do affect the insurance industry generally. For instance, several
laws and regulations adopted by the federal government, including the Gramm
Leach Bliley Act and the Health Insurance Portability and Accountability Act of
1996, have created additional administrative and compliance requirements for
us.
With respect to our international operations,
we are subject to various regulations relating to, among other things,
licensing, currency, policy language and terms, reserves and the amount of
local investment. These various regulations also add to our cost of doing
business through increased compliance expenses, the financial impact of use of
capital restrictions and increased training and employee expenses. Furthermore,
the loss of a license in a particular jurisdiction could restrict or eliminate
our ability to conduct business in that jurisdiction.
53
In all jurisdictions the applicable laws and
regulations are subject to amendment or interpretation by regulatory
authorities. Generally, such authorities are vested with relatively broad
discretion to grant, renew and revoke licenses and approvals and to implement
regulations. Accordingly, we may be precluded or temporarily suspended from
carrying on some or all of our activities or otherwise fined or penalized in a
given jurisdiction. No assurances can be given that our businesses can continue
to be conducted in any given jurisdiction as we it has been conducted in the
past.
Our significant global
operations expose us to various international risks that could adversely affect
our business.
A significant portion of our operations are
conducted outside the U.S. Accordingly, we are subject to legal, economic and
market risks associated with operating in foreign countries, including:
·
the
general economic and political conditions existing in those countries;
·
devaluations
and fluctuations in currency exchange rates;
·
imposition
of limitations on conversion of foreign currencies or remittance of dividends
and other payments by foreign subsidiaries;
·
imposition
or increase of withholding and other taxes on remittances and other payments by
subsidiaries;
·
difficulties
in staffing and managing our foreign offices, and the increased travel,
infrastructure and legal and compliance costs associated with multiple
international locations;
·
hyperinflation
in certain foreign countries;
·
imposition
or increase of investment and other restrictions by foreign governments;
·
longer
payment cycles;
·
greater
difficulties in accounts receivables collection; and
·
the
requirement of complying with a wide variety of foreign laws.
Some of our foreign brokerage subsidiaries
receive revenues in currencies that differ from their functional
currencies. We must also translate the
financial results of our foreign subsidiaries into U.S. dollars. Although we
use various derivative financial instruments to help protect against adverse
transaction and translation effects due to exchange rate fluctuations, we
cannot eliminate such risks and significant changes in exchange rates may
adversely affect our results.
Our financial results could
be adversely affected if assumptions used in establishing our underwriting
reserves differ from actual experience.
We maintain claims reserves as an estimate of
our liability under insurance policies issued by our insurance underwriting
operations, which are in runoff. These reserves could cause variability in our
financial results.
Claim reserves reflect our estimated liability
for unpaid claims and claims adjustment expenses, including legal and other
fees and general expenses for administering the claims adjustment process, and
for reported and unreported losses incurred as of the end of each accounting
period. If the reserves, as currently estimated for future claims, prove
inadequate, we would be required to increase our liabilities, which could have
an adverse effect on our business, results of operations and financial
condition.
The obligation for future claims does not
represent an exact calculation of liability. Rather, reserves represent our
managements best estimate of what we expect the ultimate settlement and
administration of claims will cost. These estimates represent informed
judgments based on our assessment of currently available data, as well as
estimates of future trends in claims severity, frequency, judicial theories of
liability and other factors. Many of these factors are not quantifiable in
advance and both internal and external events, such as changes in claims
handling procedures, inflation,
54
judicial and legal developments and legislative
changes, can cause our estimates to vary. The inherent uncertainty of
estimating reserves is greater for certain types of liabilities, where the
variables affecting these types of claims are subject to change and long
periods of time may elapse before a definitive determination of liability is
made. Reserve estimates are periodically refined as experience develops and
further losses are reported and settled. Adjustments to reserves are reflected
in the results of the periods in which such estimates are changed. Because
setting the level of claims reserves is inherently uncertain, we cannot assure
investors that our current reserves will prove adequate in light of subsequent
events.
Each of our business lines
may be adversely affected by an overall decline in economic activity
.
The demand for property and casualty insurance
generally rises as the overall level of economic activity increases and
generally falls as such activity decreases, affecting both the commissions and
fees generated by our brokerage and consulting businesses. In particular, a
growing number of insolvencies associated with an economic downturn, especially
insolvencies in the insurance industry, could adversely affect our brokerage
business through the loss of clients or by hampering our ability to place
insurance and reinsurance business. Moreover, the results of our consulting
business are generally affected by the level of business activity of our
clients, which in turn is affected by the level of economic activity in the
industries and markets these clients serve. As our clients become adversely
affected by declining business conditions, they may choose to delay or forgo
consulting engagements with Aon.
We have debt outstanding that
could adversely affect our financial flexibility.
As of September 30, 2008, we had total
consolidated debt outstanding of approximately $2.0 billion. The level of debt
outstanding could adversely affect our financial flexibility.
A decline in the credit
ratings of our senior debt and commercial paper may adversely affect our
borrowing costs and financial flexibility
.
A downgrade in the credit ratings of our senior
debt and commercial paper could increase our borrowing costs and reduce our
financial flexibility. In addition, certain downgrades may trigger our
obligations to fund certain amounts with respect to our premium finance
securitizations. Similarly, a downgrade would increase our commercial paper
interest rates or may result in our inability to access the commercial paper
market altogether. We cannot assume that our financial position would not be
adversely affected if we are unable to access the commercial paper market.
Changes in our accounting
estimates and assumptions could negatively affect our financial position and
results.
We prepare our financial statements in
accordance with U.S. GAAP. These accounting principles require us to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, and the disclosure of contingent assets and liabilities at the
date of our financial statements. We are
also required to make certain judgments that affect the reported amounts of
revenues and expenses during each reporting period. We periodically evaluate our estimates and
assumptions including those relating to reserves to pay policy liabilities,
deferred policy acquisition costs, the valuation of investments, income taxes,
stock based compensation and contingencies and litigation. We base our estimates on historical
experience and various assumptions that we believe to be reasonable based on
specific circumstances. Actual results could differ from these estimates, and
changes in accounting standards could increase costs to our organization and
could have an adverse impact on our future financial position and results of
operations.
We are a holding company and,
therefore, may not be able to receive dividends in needed amounts from our
subsidiaries.
Our principal assets are the shares of capital
stock of our subsidiaries. We have to rely on dividends from these subsidiaries
to meet our obligations for paying principal and interest on outstanding debt
obligations and for paying dividends to stockholders and corporate expenses.
We cannot guarantee that our
reinsurers of our property and casualty business will pay in a timely fashion,
if at all.
To better manage our portfolio of underwriting
risk, we purchased reinsurance by transferring part of the risk (known as
ceding) to a reinsurance company in exchange for part of the premium that we
had received in connection with the risk.
55
Although reinsurance makes the reinsurer liable
to us to the extent the risk is transferred (or ceded) to the reinsurer, it
does not relieve us of our liability to our policyholders. Accordingly, we bear
credit risk with respect to our reinsurers. Recently, due to industry and
general economic conditions, there is an increasing risk of insolvency among
reinsurance companies, resulting in a greater incidence of litigation and
affecting the recoverability of claims. We cannot assure that our reinsurers
will pay the reinsurance recoverables owed to us or that they will pay these
recoverables on a timely basis.
In connection with the sale of AWG on November 30,
2006, we sold the capital stock of VSC. Because VSC issued property and
casualty policies, VSC continues to remain liable to property and casualty
policyholders. However, pursuant to contractual arrangements entered into as
part of the sale of AWG, Aon has agreed to indemnify the buyer of VSC for all
obligations arising out of the property and casualty business, including any
failure by reinsurers to meet their obligations with respect to the property
and casualty business. We have also agreed to guarantee amounts owed by
reinsurers in respect of the Construction Program Group (CPG) business issued
prior to the closing of that transaction. If reinsurers fail to pay the
reinsurance recoverables owed to VSC with respect to the property and casualty
business (including with respect to CPG business) or do not pay on a timely
basis, we will be responsible for these amounts.
The occurrence of natural or
man made disasters could adversely affect our financial condition and results
of operations
.
We are exposed to various risks arising out of
natural disasters, including earthquakes, hurricanes, fires, floods and
tornadoes, and pandemic health events such as avian influenza, as well as
man-made disasters, including acts of terrorism and military actions. For
example, a natural or man-made disaster could lead to unexpected changes in
persistency rates as policyholders and contract holders who are affected by the
disaster may be unable to meet their contractual obligations, such as payment
of premiums on their insurance policies. The continued threat of terrorism and
ongoing military actions may cause significant volatility in global financial
markets, and a natural or man-made disaster could trigger an economic downturn
in the areas directly or indirectly affected by the disaster. These
consequences could, among other things, result in a decline in business and
increased claims from those areas. Disasters also could disrupt public and
private infrastructure, including communications and financial services, which
could disrupt our normal business operations.
A natural or man-made disaster also could
disrupt the operations of our counterparties or result in increased prices for
the products and services they provide to us. In addition, a disaster could
adversely affect the value of the assets in our investment portfolio if it
affects companies ability to pay principal or interest on their securities.
Finally, a natural or man-made disaster could increase the incidence or
severity of E&O claims against us.
In connection with the
implementation of our corporate strategy, we face certain risks associated with
the acquisition or disposition of businesses.
In pursuing our corporate strategy, we may
acquire other businesses or dispose of or exit businesses we currently own. The
success of this strategy is dependent upon our ability to identify appropriate
acquisition and disposition targets, negotiate transactions on favorable terms
and ultimately complete such transactions. If acquisitions are made, there can
be no assurance that we will realize the anticipated benefits of such
acquisitions, including revenue growth, operational efficiencies or expected
synergies. In addition, we may not be able to integrate acquisitions
successfully into our existing business, and we could incur or assume unknown
or unanticipated liabilities or contingencies, which may impact our results of
operations. If we dispose of or otherwise exit certain businesses, there can be
no assurance that we will not incur certain disposition related charges, or
that we will be able to reduce overhead related to the divested assets.
Factors Relating to the Acquisition of Benfield
On August 22, 2008, we and Benfield Group
Limited, a Bermuda company and an independent insurance intermediary (Benfield),
issued an announcement (the Announcement) under Section 2.5 of the U.K.
City Code on Takeovers and Mergers (the Code) disclosing that they have
reached an agreement pursuant to which we will acquire all of the share capital
of Benfield (the Acquisition). The
Acquisition will be effected by a newly-formed, wholly-owned Bermuda subsidiary
of ours through an amalgamation under the Bermuda Companies Act for an
aggregate cash purchase price of £844 million or £3.50 per Benfield share
($1,557 million at September 30, 2008 exchange rates). Also on August 22, 2008, we and Benfield
contemporaneously entered into an Implementation Agreement (the Implementation
Agreement) which sets forth certain key terms relative to the Acquisition.
56
The closing
of the Acquisition is subject to a number of conditions; if these conditions
are not satisfied or waived, we will not be able to close the Acquisition.
The Acquisition contains a number of conditions
which must be satisfied or waived prior to the closing of the Acquisition. These conditions include, among others, the
parties obtaining certain antitrust and regulatory approvals including those
required in the United States, United Kingdom and Bermuda, the accuracy of
certain representations and warranties (subject to agreed-upon materiality
standards) and the compliance by us and Benfield with covenants contained in
the Implementation Agreement and the Announcement. We cannot assure you that the Acquisition
will be closed on the terms described herein or at all.
If the Acquisition is not closed, there may be
various adverse consequences including:
·
certain of
the transaction costs, including accounting, legal and other financial advisory
fees, must still be paid, without any offsetting benefits from the Acquisition;
·
Aons
businesses may have been adversely impacted by the failure to pursue other
beneficial opportunities due to the focus of management on the Acquisition,
without realizing any of the anticipated benefits of completing the Acquisition;
and
·
the market
price of Aon common stock might decline to the extent that the current market
price reflects a market assumption that the merger will be completed.
The
anticipated benefits from the Acquisition may not be realized
.
The success of the Acquisition will depend, in
part, on our ability to realize the anticipated benefits from combining the
businesses of Aon and Benfield including, among other things, synergies, cost
savings and operating efficiencies.
Although we expect to achieve the anticipated benefits of the
Acquisition, no assurance can be given that we will successfully combine the
businesses of Aon and Benfield and that these anticipated Acquisition benefits
will actually be achieved as achieving such benefits is subject to a number of
uncertainties. Additionally, the
elimination of duplicative costs may not be possible or may take longer than
anticipated, the benefits from the Acquisition may be offset by costs incurred
or delays in integrating Benfield into Aon, and regulatory authorities may
impose adverse conditions on our business in connection with granting approval
of the Acquisition. If we are not able
to achieve these objectives, the anticipated benefits and cost savings of the
Acquisition may not be realized fully or at all or may take longer to realize
than expected. If we fail to realize all
or some of the benefits we anticipate from the Acquisition or if we fail to
realize those benefits in the anticipated time period, our results of
operations may be adversely affected.
The
integration of Benfield may not be successful.
We may be unable to effectively integrate
Benfield into our operations, which would result in fewer benefits from the
Acquisition than are currently anticipated, as well as increased costs. The Acquisition involves numerous integration
and other risks, including:
·
potential
difficulties in the assimilation of operations, services, products and
personnel;
·
potential
loss of customers, vendors and other business partners;
·
the
diversion of managements attention from other business concerns;
·
the
potential loss of key employees;
·
the
consolidation of functional areas, such as sales and marketing operations;
·
possible
inconsistencies in standards, controls, procedures and policies, business
cultures and compensation structures between us and Benfield;
57
·
the
integration of information, purchasing, accounting, finance, sales, billing,
payroll and regulatory compliance systems;
·
the
coordination of organizations headquartered in different geographic regions;
and
·
potentially
significant transaction, integration and restructuring costs.
If the integration is not successful, we may
not be able to achieve expected results and our business, financial condition
and results of operations may be adversely affected. We cannot give any assurance that Benfield
will be successfully or cost-effectively integrated into us.
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 2008:
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)
|
|
7/1/08 7/31/08
|
|
6,638,000
|
|
$
|
45.64
|
|
6,638,000
|
|
$
|
977,166,188
|
|
8/1/08 8/31/08
|
|
2,638,000
|
|
$
|
46.53
|
|
2,638,000
|
|
$
|
854,412,149
|
|
9/1/08 9/30/08
|
|
|
|
$
|
|
|
|
|
$
|
854,412,169
|
|
Total
|
|
9,276,000
|
|
$
|
45.90
|
|
9,276,000
|
|
|
|
(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 2006, the Company announced that its Board
of Directors had increased the authorized share repurchase program to $2
billion. In fourth quarter 2007, the
Company announced that its Board of Directors had increased the authorized
share repurchase program to $4.6 billion.
Shares may be repurchased through the open market or in privately
negotiated transactions. Through September 30,
2008, the Company has repurchased 90.8
million shares of common stock at an average price (excluding commissions) of
$41.26 per share for an aggregate purchase price of $3,746 million since
inception of the stock repurchase program, and the remaining authorized amount
for stock repurchases under this program is $854 million, with no termination
date.
ITEM 6.
|
EXHIBITS
|
|
|
|
Exhibits The exhibits filed with this
report are listed on the attached Exhibit Index.
|
58
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 7, 2008
|
By: /s/ Christa Davies
|
|
CHRISTA DAVIES
|
|
EXECUTIVE VICE PRESIDENT AND
|
|
CHIEF FINANCIAL OFFICER
|
|
(Principal Financial and Accounting
Officer and
duly authorized officer of Registrant)
|
59
Aon CORPORATION
Exhibit Index
Exhibit
Number
|
|
Description of Exhibit
|
2.1
|
|
Announcement dated August 22, 2008 of Aon Corporation and
Benfield Group Limited incorporated by reference to Exhibit 2.1 to Aon
Corporations Current Report on Form 8-K filed with the Securities and
Exchange Commission on August 22, 2008.
|
|
|
|
2.2
|
|
Implementation Agreement dated August 22, 2008 between Aon
Corporation and Benfield Group Limited incorporated by reference to
Exhibit 2.2 to Aon Corporations Current Report on Form 8-K filed
with the Securities and Exchange Commission on August 22, 2008.
|
|
|
|
10.1#
|
|
Form of Severance Agreement, as amended on September 19, 2008.
|
|
|
|
10.2
|
|
Letter Amendment dated January 30, 2008 to $600 million
Three-Year Credit Agreement dated as of February 3, 2005 among Aon
Corporation, Citibank, N.A., as Administrative Agent, and the lenders and
other parties listed therein, as amended by Amendment No. 1 dated as of
September 30, 2005.
|
|
|
|
10.3
|
|
Letter Amendment dated February 25, 2008, 2008 to
650 million Facility Agreement dated February 7, 2005 among Aon
Corporation, Citibank International plc, as Agent, and the lenders and
other parties listed therein, as amended by the Transfer and Amendment
Agreement dated October 24, 2005.
|
|
|
|
12.1
|
|
Statement regarding Computation of Ratio of Earnings to Fixed Charges
|
|
|
|
12.2
|
|
Statement regarding Computation of Ratio of Earnings to 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
|
#
|
|
Indicates a management contract or compensatory plan or arrangement.
|
60
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