EXECUTIVE SUMMARY OF 2012 FINANCIAL RESULTS
On April 2, 2012, we completed the Redomestication, moving our corporate
headquarters to London. In the Redomestication, each issued and outstanding
share of Aon Corporation common stock held by stockholders of Aon Corporation
was converted into the right to receive one Class A Ordinary Share, nominal
value $0.01 per share, of Aon plc. In connection with the Redomestication, we
have incurred costs related to the headquarters relocation of $26 million in
2012. We anticipate that we will incur an additional $4 million of costs through
2013 related to the headquarters relocation. We believe the Redomestication will
strengthen our long term strategy by:
º •
º Enabling Risk Solutions to deliver superior value to our clients by
improving execution on the Aon Broking strategy;
º •
º Expanding the HR Solutions portfolio penetration, especially within
consulting, which already has a significant presence in the U.K. and
EMEA;
º •
º Enhancing our Risk Solutions' relationship with, and integration into,
London markets;
º •
º Increasing our connection to emerging markets, accelerating our
ability to grow there, and further aligning our strategy with
underwriters and carriers who are also targeting these high growth
markets;
º •
º Strengthening our international brand awareness and positioning as a
global firm;
º •
º Advancing our talent strategy through better development, retention
and acquisition of professional talent, with a special focus on
London's insurance talent; and
º •
º Optimizing our fiscal planning and capital allocation and reducing our
global tax rate in a manner that provides us with the increased
flexibility to properly invest in our growth.
During 2012, we continued to face certain headwinds impacting our business.
In our Risk Solutions segment, these included economic weakness in continental
Europe and a significant decline in investment income due to lower short-term
interest rates globally. In our HR Solutions segment, these headwinds included
price compression in our benefits administration business and competitive
pressures across continental Europe.
The following is a summary of our 2012 financial results:
º •
º Revenue increased $227 million, or 2%, to $11.5 billion in 2012 due
primarily to solid organic revenue growth of 4% in both the Risk
Solutions and HR Solutions segments, partially offset by a 2%
unfavorable impact from foreign currency. The increase in revenue was
driven primarily by strong management of the renewal book portfolio
across all regions and solid new business growth in Asia and other
emerging markets, as well as solid growth across our Reinsurance
business and new client wins in our HR Solutions segment.
º •
º Operating expenses increased $227 million, or 2%, from the prior year
to $9.9 billion in 2012, primarily as a result of organic revenue
growth of 4%, higher intangible asset amortization expenses of
$61 million, and an increase in headquarters relocation costs of
$21 million, partially offset by benefits achieved from the
restructuring plans, a decrease in Hewitt related integration costs of
$47 million, $18 million related to the write-off of legacy
receivables in 2011, and a decrease in restructuring charges of
$12 million.
º •
º Our consolidated operating margin from continuing operations for the
year on a U.S. generally accepted accounting principles ("GAAP") basis
was 13.9% in 2012, a decrease of 20 basis points from our operating
margin of 14.1% in 2011.
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º •
º Net income from continuing operations attributable to Aon shareholders
was $994 million, an increase of $19 million, or 2%, from $975 million
in 2011.
º •
º Cash flows from operating activities was a record $1.4 billion in
2012, an increase of $401 million, or 28%, from $1.0 billion in 2011.
We historically have focused on three key metrics that we communicate to
shareholders: grow organically, expand margins, and increase earnings per share.
Beginning in the fourth quarter of 2012, and going forward, we will add free
cash flow to our key metrics given its fundamental importance to both the value
of the firm and how we think about value creation for shareholders. The
following is our measure of performance against these four metrics for 2012:
º •
º Organic revenue growth, a non-GAAP measure as defined under the
caption "Review of Consolidated Results - General" below, was 4% in
2012, demonstrating continued improvement compared to the prior year's
2% organic revenue growth. Organic revenue growth was driven by solid
growth across our businesses in both Risk and HR Solutions. In Risk
Solutions, strong management of the renewal book portfolio across all
regions, solid new business growth in Asia and other emerging markets,
and growth across our treaty business in Reinsurance drove organic
revenue growth. In HR Solutions, organic growth was driven by new
client wins in outsourcing and increased demand across consulting.
º •
º Adjusted operating margin, a non-GAAP measure as defined under the
caption "Review of Consolidated Results - General" below, was 18.6%
for Aon overall, 21.7% for the Risk Solutions segment, and 16.6% for
the HR Solutions segment in 2012. In 2011, adjusted operating margin
was 19.0% for Aon overall, 21.6% for the Risk Solutions segment, and
17.6% for the HR Solutions segment. The increase in adjusted operating
margin for the Risk Solutions segment reflects strong organic revenue
growth and restructuring savings, partially offset by investments in
Asia, Latin America and GRIP solutions, as well as lower investment
income. The decrease in adjusted operating margin for both the HR
Solutions segment and Aon overall reflects significant investment in
new growth opportunities in health care exchanges and HR BPO and
anticipated pricing compression in our benefits administration
business, partially offset by new client wins.
º •
º Adjusted diluted earnings per share from continuing operations
attributable to Aon shareholders, a non-GAAP measure as defined under
the caption "Review of Consolidated Results - General" below, was
$4.21 per share in 2012, an increase of $0.15 per share, or 4%, from
$4.06 per share in 2011. The increase demonstrates solid operational
performance and effective capital management despite a difficult
business environment, as well as the impact of $1.1 billion of share
repurchases during 2012.
º •
º Free cash flow, a non-GAAP measure as defined under the caption
"Review of Consolidated Results - General" below, was $1.2 billion in
2012, an increase of $373 million, or 48%, from $777 million in 2011.
The increase in free cash flow from the prior year was driven by
record cash flow from operations of $1.4 billion in 2012.
REVIEW OF CONSOLIDATED RESULTS
General
In our discussion of operating results, we sometimes refer to supplemental
information derived from consolidated financial information specifically related
to organic revenue growth, adjusted operating margin, adjusted diluted earnings
per share, free cash flow, and the impact of foreign exchange rate fluctuations
on operating results.
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Organic Revenue
We use supplemental information related to organic revenue to help us and
our investors evaluate business growth from existing operations. Organic revenue
excludes the impact of foreign exchange rate changes, acquisitions,
divestitures, transfers between business units, fiduciary investment income,
reimbursable expenses, and certain unusual items. Supplemental information
related to organic growth represents a measure not in accordance with U.S. GAAP,
and should be viewed in addition to, not instead of, our Consolidated Financial
Statements and Notes thereto. Industry peers provide similar supplemental
information about their revenue performance, although they may not make
identical adjustments. Reconciliation of this non-GAAP measure, organic revenue
growth percentages to the reported Commissions, fees and other revenue growth
percentages, has been provided in the "Review by Segment" caption, below.
Adjusted Operating Margins
We use adjusted operating margin as a measure of core operating performance
of our Risk Solutions and HR Solutions segments. Adjusted operating margin
excludes the impact of certain items, including restructuring charges,
intangible asset amortization and headquarters relocation costs. This
supplemental information related to adjusted operating margin represents a
measure not in accordance with U.S. GAAP, and should be viewed in addition to,
not instead of, our Consolidated Financial Statements and Notes thereto.
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Reconciliations of this non-GAAP measure to the reported operating margin is
as follows (in millions):
Total Risk HR
Year Ended December 31, 2012 Aon (1) Solutions Solutions
Revenue - U.S. GAAP $ 11,514 $ 7,632 $ 3,925
Operating income - U.S. GAAP $ 1,596 $ 1,493 $ 289
Restructuring charges 101 35 66
Intangible asset amortization 423 126 297
Headquarters relocation costs 24 - -
Operating income - as adjusted $ 2,144 $ 1,654 $ 652
Operating margins - U.S. GAAP 13.9 % 19.6 % 7.4 %
Operating margins - as adjusted 18.6 % 21.7 % 16.6 %
Total Risk HR
Year Ended December 31, 2011 Aon (1) Solutions Solutions
Revenue - U.S. GAAP $ 11,287 $ 7,537 $ 3,781
Operating income - U.S. GAAP $ 1,596 $ 1,413 $ 336
Restructuring charges 113 65 48
Legacy receivables write-off 18 18 -
Intangible asset amortization 362 129 233
Transaction related costs - UK reincorporation 3 - -
Hewitt related costs 47 - 47
Operating income - as adjusted $ 2,139 $ 1,625 $ 664
Operating margins - U.S. GAAP 14.1 % 18.7 % 8.9 %
Operating margins - as adjusted 19.0 % 21.6 % 17.6 %
Total Risk HR
Year Ended December 31, 2010 Aon (1) Solutions Solutions
Revenue - U.S. GAAP $ 8,512 $ 6,989 $ 1,545
Operating income - U.S. GAAP $ 1,244 $ 1,328 $ 121
Restructuring charges 172 115 57
Intangible asset amortization 154 114 40
Pension adjustment 49 - -
Hewitt related costs 40 - 19
Anti bribery and compliance initiatives 9 9 -
Operating income - as adjusted $ 1,668 $ 1,566 $ 237
Operating margins - U.S. GAAP 14.6 % 19.0 % 7.8 %
Operating margins - as adjusted 19.6 % 22.4 % 15.3 %
º (1)
º Includes unallocated expenses and the elimination of intersegment revenue.
Adjusted Diluted Earnings per Share from Continuing Operations
We also use adjusted diluted earnings per share from continuing operations
as a measure of our core operating performance. Adjusted diluted earnings per
share excludes the impact of restructuring charges, intangible asset
amortization and headquarters relocation costs, along with related income taxes.
This supplemental information related to adjusted diluted earnings per share
represents a measure not in accordance with U.S. GAAP and should be viewed in
addition to, not instead of, our Consolidated Financial Statements and Notes
thereto.
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Reconciliations of this non-GAAP measure to the reported diluted earnings
per share are as follows (in millions except per share data):
As
Year Ended December 31, 2012 U.S. GAAP Adjustments Adjusted
Operating income $ 1,596 $ 548 $ 2,144
Interest income 10 - 10
Interest expense (228 ) - (228 )
Other income 3 2 5
Income from continuing operations before
income taxes 1,381 550 1,931
Income taxes 360 144 504
Income from continuing operations 1,021 406 1,427
Less: Net income attributable to
noncontrolling interests 27 - 27
Income from continuing operations
attributable to Aon shareholders $ 994 $ 406 $ 1,400
Diluted earnings per share from continuing
operations $ 2.99 $ 1.22 $ 4.21
Weighted average common shares outstanding -
diluted 332.6 332.6 332.6
Year Ended December 31, 2011 U.S. GAAP Adjustments As Adjusted
Operating income $ 1,596 $ 543 $ 2,139
Interest income 18 - 18
Interest expense (245 ) - (245 )
Other income (expense) 15 19 34
Income from continuing operations before
income taxes 1,384 562 1,946
Income taxes 378 153 531
Income from continuing operations 1,006 409 1,415
Less: Net income attributable to
noncontrolling interests 31 - 31
Income from continuing operations
attributable to Aon shareholders $ 975 $ 409 $ 1,384
Diluted earnings per share from continuing
operations $ 2.86 $ 1.2 $ 4.06
Weighted average common shares
outstanding - diluted 340.9 340.9 340.9
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Year Ended December 31, 2010 U.S. GAAP Adjustments As Adjusted
Operating income $ 1,244 $ 424 $ 1,668
Interest income 15 - 15
Interest expense (182 ) 14 (168 )
Other income (expense) (18 ) - (18 )
Income from continuing operations before
income taxes 1,059 438 1,497
Income taxes 300 133 433
Income from continuing operations 759 305 1,064
Less: Net income attributable to
noncontrolling interests 26 - 26
Income from continuing operations
attributable to Aon shareholders $ 733 $ 305 $ 1,038
Diluted earnings per share from continuing
operations $ 2.46 $ 1.02 $ 3.48
Weighted average common shares
outstanding - diluted 298.1 298.1 298.1
Free Cash Flow
We use free cash flow, defined as cash flow provided by operations minus
capital expenditures, as a measure of our core operating performance. This
supplemental information related to free cash flow represents a measure not in
accordance with U.S. GAAP and should be viewed in addition to, not instead of,
our Consolidated Financial Statements and Notes thereto. The use of this
non-GAAP measure does not imply or represent the residual cash flow for
discretionary expenditures.
Years Ended December 31, 2012 2011 2010
Cash flow provided by operations-U.S. GAAP $ 1,419 $ 1,018 $ 783
Less: Capital expenditures 269 241 180
Free cash flow $ 1,150 $ 777 $ 603
Impact of Foreign Exchange Rate Fluctuations
Because we conduct business in more than 120 countries, foreign exchange
rate fluctuations can have a significant 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, to give financial statement users meaningful information
about our operations, we have provided a discussion of the impact of foreign
currency exchange rates on our financial results. For comparative purposes, the
methodology used to calculate this impact is intended to isolate the impact of
the change in currencies between periods by translating last year's revenue,
expenses and net income at this year's foreign exchange rates. Currency
fluctuations had an unfavorable impact of $0.06 during the year ended
December 31, 2012, on adjusted net income from continuing operations per diluted
share when the Company translates prior year results at current year end foreign
exchange rates for comparative purposes.
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Summary of Results
The consolidated results of continuing operations are as follows (in
millions):
Years ended December 31 2012 2011 2010
Revenue:
Commissions, fees and other $ 11,476 $ 11,235 $ 8,457
Fiduciary investment income 38 52 55
Total revenue 11,514 11,287 8,512
Expenses:
Compensation and benefits 6,709 6,567 5,097
Other general expenses 3,209 3,124 2,171
Total operating expenses 9,918 9,691 7,268
Operating income 1,596 1,596 1,244
Interest income 10 18 15
Interest expense (228 ) (245 ) (182 )
Other income (expense) 3 15 (18 )
Income from continuing operations before income taxes 1,381 1,384 1,059
Income taxes
360 378 300
Income from continuing operations 1,021 1,006 759
(Loss) income from discontinued operations, after-tax (1 ) 4 (27 )
Net income 1,020 1,010 732
Less: Net income attributable to noncontrolling
interests 27 31 26
Net income attributable to Aon shareholders $ 993 $ 979 $ 706
Consolidated Results for 2012 Compared to 2011
Revenue
Revenue increased by $227 million, or 2%, to $11.5 billion in 2012, as
compared to $11.3 billion in 2011. The increase was driven by organic revenue
growth of 4% for both the Risk Solutions and HR Solutions segments. Organic
growth in the Risk Solutions segment was driven by solid growth across all
regions, including strong new business growth for U.S. retail and continued
management of the renewal book portfolio in the Americas. International organic
revenue growth was driven by strong growth in Asia and in emerging markets, as
well as modest growth in continental Europe. Reinsurance organic growth was
driven by strong growth across global treaty, driven by favorable pricing in the
near-term and new business growth, partially offset by a significant decline in
capital market transactions and advisory business. Organic growth in the HR
Solutions segment was driven by growth in investment consulting, pension
administration services, talent and rewards, and communications consulting, as
well as new client wins in HR BPO, partially offset by a modest decline in
benefits administration.
Compensation and Benefits
Compensation and benefits increased $142 million, or 2%, when compared to
2011. The increase was driven by 4% organic revenue growth, partially offset by
the impact of realization of benefits from restructuring initiatives.
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Other General Expenses
Other general expenses increased by $85 million, or 3%, in 2012 compared to
2011. The increase was due largely to an increase in intangible amortization of
$61 million and increased costs related to the headquarters relocation of
$21 million. These increased costs were partially offset by lower restructuring
charges of $12 million and restructuring savings.
Interest Income
Interest income represents income earned on operating cash balances and
other income-producing investments. It does not include interest earned on funds
held on behalf of clients. Interest income decreased $8 million, or 44%, from
2011, due to lower average interest rates globally.
Interest Expense
Interest expense, which represents the cost of our worldwide debt
obligations, decreased $17 million, or 7%, from 2011. The decrease was due
primarily to a lower average debt outstanding during the year, as well as the
use of commercial paper to meet short-term working capital needs.
Other Income (Expense)
Other income (expense) in 2012 of $3 million decreased $12 million from
2011. The decrease in income is the result of foreign exchange gains (losses)
that were $26 million additional loss in 2012 and an $11 million decrease in
gains related to long-term investments, partially offset by $6 million of
additional income from equity method investments and $19 million loss on
extinguishment of debt in 2011.
Income from Continuing Operations before Income Taxes
Income from continuing operations before income taxes was $1.4 billion, flat
as compared to $1.4 billion in 2011.
Income Taxes
The effective tax rate on income from continuing operations was 26.1% in
2012 and 27.3% in 2011. The 2012 rate reflects the release of a valuation
allowance relating to foreign tax credits and net operating losses, partially
offset by the impact of a U.K. tax rate change. The 2011 rate reflects the
release of a valuation allowance relating to foreign tax credits offset
partially by net unfavorable deferred tax adjustments in non-U.S. jurisdictions
including the impact of a U.K. tax rate change. The underlying tax rate for
continuing operations is estimated to be approximately 26.0% for 2013.
Income from Continuing Operations
Income from continuing operations remained at $1.0 billion ($2.99 diluted
net income per share) in 2012 as compared to $1.0 billion ($2.86 diluted net
income per share) in 2011.
Consolidated Results for 2011 Compared to 2010
Revenue
Revenue increased by $2.8 billion, or 33%, in 2011 compared to 2010. This
increase principally reflects a $2.4 billion, or 113%, increase in the HR
Solutions segment, and a $394 million, or 6%, increase in the Risk Solutions
segment. The 113% increase in the HR Solutions segment was principally driven by
acquisitions, primarily Hewitt in October 2010, net of dispositions, and a 2%
positive impact from foreign currency exchange rates with flat organic revenue
growth. The 6%
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increase in the Risk Solutions segment was primarily driven by a 3% favorable
impact from foreign currency exchange rates, a 2% increase in organic revenue
growth reflecting the growth in both the Americas and International regions and
a 1% increase from acquisitions, primarily Glenrand MIB Limited ("Glenrand") in
April 2011, net of dispositions.
Compensation and Benefits
Compensation and benefits increased $1.5 billion, or 29%, when compared to
2010. The increase reflects a $1.3 billion, or 101%, increase in the HR
Solutions segment and a $161 million, or 4%, increase in the Risk Solutions
segment. In total, the increase for the year was driven by the impact of the
Hewitt and Glenrand acquisitions and an unfavorable impact of foreign currency
exchange rates, partially offset by the realization of benefits from
restructuring initiatives. In addition, 2010 included a $49 million non-cash
U.S. defined benefit pension plan expense resulting from an adjustment to the
market-related value of plan assets.
Other General Expenses
Other general expenses increased by $925 million, or 42%, in 2011 compared
to 2010. This increase reflects a $852 million, or 152%, increase in the HR
Solutions segment and a $113 million, or 7%, increase in the Risk Solutions
segment partially offset by a $46 million decrease in unallocated expenses. The
overall increase was due largely to the impact of the Hewitt and Glenrand
acquisitions, reflecting the inclusion of operating expenses and intangible
amortization, as well as the unfavorable impact of foreign currency exchange
rates. These increased costs were partially offset by lower restructuring
charges and restructuring savings and operational expense management.
Interest Income
Interest income represents income earned on operating cash balances and
other income-producing investments. It does not include interest earned on funds
held on behalf of clients. Interest income increased $3 million, or 20%, from
2010, due to higher levels of interest bearing assets.
Interest Expense
Interest expense, which represents the cost of our worldwide debt
obligations, increased $63 million, or 35%, from 2010 due to an increase in the
amount of debt outstanding for the full year primarily related to the Hewitt
acquisition. Additionally, 2010 included charges of $14 million attributable to
a $1.5 billion Bridge Loan Facility that was put in place to finance the Hewitt
acquisition, but was cancelled following the issuance of the notes.
Other Income (Expense)
Other income (expense) of $15 million in 2011 includes death benefits on
certain Company owned life insurance plans, partially offset by losses and
write-offs related to our ownership in certain insurance investment funds and
other long-term investments and a $19 million loss on the extinguishment of
debt. Additionally, 2010 included a loss of $8 million on extinguishment of debt
and losses related to certain long-term investments, partially offset by gains
related to our ownership in certain insurance investment funds.
Income from Continuing Operations before Income Taxes
Income from continuing operations before income taxes was $1.4 billion, a
31% increase from $1.1 billion in 2010. The increase in income was driven by the
2% increase in organic growth, the inclusion of Hewitt's and Glenrand's
operating results, lower costs and increased benefits from restructuring
initiatives and operational improvement, and favorable foreign currency exchange
rates.
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Income Taxes
The effective tax rate on income from continuing operations was 27.3% in
2011 and 28.4% in 2010. The 2011 rate reflects the release of a valuation
allowance relating to foreign tax credits offset partially by net unfavorable
deferred tax adjustments in non-U.S. jurisdictions including the impact of a
U.K. tax rate change. The 2010 rate reflects the impact of the Hewitt
acquisition in the fourth quarter, the favorable effect of a U.S. pension
expense adjustment, which had a tax rate of 40%, and deferred tax adjustments.
Income from Continuing Operations
Income from continuing operations increased to $1.0 billion ($2.86 diluted
net income per share) in 2011 from $759 million ($2.46 diluted net income per
share) in 2010. Currency fluctuations positively impacted income from continuing
operations in 2011 by $0.04 per diluted share, when the 2010 Consolidated
Statement of Income is translated using 2011 foreign exchange rates.
Discontinued Operations
In 2011, after-tax income from discontinued operations of $4 million ($0.01
diluted net income per share) was recorded compared to after-tax loss from
discontinued operations of $27 million ($0.09 diluted net loss per share) in
2010. The loss in 2010 was driven by the settlement of legacy litigation related
to the Buckner vs. Resource Life case.
Restructuring Initiatives
Aon Hewitt Restructuring Plan
On October 14, 2010, we announced a global restructuring plan (the "Aon
Hewitt Plan") in connection with our acquisition of Hewitt. The Aon Hewitt Plan,
which will continue into 2013, is intended to streamline operations across the
combined Aon Hewitt organization. The restructuring plan is expected to result
in cumulative costs of approximately $325 million through the end of the plan,
consisting of approximately $192 million in employee termination costs and
approximately $133 million in real estate lease rationalization costs. An
estimated 2,000 positions globally, predominantly non-client facing, are
expected to be eliminated as part of the plan.
As of December 31, 2012, in excess of 1,900 jobs have been eliminated under
the Aon Hewitt Plan and total expenses of $255 million have been incurred.
Charges related to the restructuring are included in Compensation and benefits
and Other general expenses in the accompanying Consolidated Statements of
Income.
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The following summarizes the restructuring and related costs, by type, that
have been incurred and are estimated to be incurred through the end of the
restructuring initiative related to the Aon Hewitt Plan (in millions):
Estimated
Total Cost for
Total Restructuring
2010 2011 2012 to Date Plan (1)
Workforce reduction $ 49 $ 64 $ 74 $ 187 $ 192
Lease consolidation 3 32 18 53 95
Asset impairments - 7 4 11 33
Other costs associated with
restructuring (2) - 2 2 4 5
Total restructuring and related
expenses $ 52 $ 105 $ 98 $ 255 $ 325
º (1)
º Actual costs, when incurred, may vary due to changes in the assumptions
built into this plan. Significant assumptions that may change when plans
are finalized and implemented 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.
º (2)
º Other costs associated with restructuring initiatives, including moving
costs and consulting and legal fees, are recognized when incurred.
The following summarizes the restructuring and related expenses by segment
that have been incurred and are estimated to be incurred through the end of the
restructuring initiative related to the Aon Hewitt Plan (in millions):
Estimated
Total Cost for
Total Restructuring
2010 2011 2012 to Date Plan (1)
HR Solutions $ 52 $ 49 $ 66 $ 167 $ 226
Risk Solutions - 56 32 88 99
Total restructuring and related
expenses $ 52 $ 105 $ 98 $ 255 $ 325
º (1)
º Costs included in the Risk Solutions segment are associated with the
transfer of the health and benefits consulting business from HR Solutions
to Risk Solutions effective January 1, 2012. Costs incurred in 2011 in the
HR Solutions segment of $41 million related to the health and benefits
consulting business have been reclassified and presented in the Risk
Solutions segment.
The restructuring plan, before any potential reinvestment of savings, is
expected to deliver approximately $280 million of annual savings in 2013, of
which, approximately $52 million will be achieved in the Risk Solution segment.
We expect to achieve approximately $355 million in annual cost savings across
the Company in 2013, including approximately $280 million of annual savings
related to the restructuring plan, and additional savings in areas such as
information technology, procurement and public company costs. All of the
components of the restructuring and integration plan are not finalized and
actual total savings, costs and timing may vary from those estimated due to
changes in the scope or assumptions underlying the plan. We estimate that we
realized approximately $236 million and $137 million of cost savings before any
reinvestment in 2012 and 2011, respectively. Approximately $196 million and
$40 million of the cost savings before reinvestment in 2012 was realized in the
HR Solutions segment and Risk Solutions segment, respectively.
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Aon Benfield Restructuring Plan
We announced a global restructuring plan ("Aon Benfield Plan") in
conjunction with our 2008 acquisition of Benfield. The restructuring plan was
intended to integrate and streamline operations across the combined Aon Benfield
organization. The Aon Benfield Plan included 810 job eliminations. Additionally,
duplicate space and assets were abandoned. The plan was closed in January 2012
and $6 million of costs were incurred in 2012.
The following is a summary of the restructuring and related expenses by type
that were incurred related to the Aon Benfield Plan (in millions):
Purchase Total Cost for
Price Restructuring
Allocation 2009 2010 2011 2012 Period
Workforce reduction $ 32 $ 38 $ 15 $ 33 $ 6 $ 124
Lease consolidation 20 14 7 (15 ) - 26
Asset impairments - 2 2 - - 4
Other costs associated with
restructuring 1 1 2 1 - 5
Total restructuring and
related expenses $ 53 $ 55 $ 26 $ 19 $ 6 $ 159
All costs associated with the Aon Benfield Plan are included in the Risk
Solutions segment. Charges related to the restructuring are included in
Compensation and benefits and Other general expenses in the Consolidated
Statements of Income. These restructuring activities and related expenses were
concluded in January 2012.
LIQUIDITY AND FINANCIAL CONDITION
Liquidity
Executive Summary
We believe that our balance sheet and strong cash flow provide us with
financial flexibility to create long-term value for our shareholders. Our
primary sources of liquidity are cash flow from operations, available cash
reserves and debt capacity available under various credit facilities. Our
primary uses of liquidity are operating expenses, capital expenditures,
acquisitions, share repurchases, restructuring initiatives, funding pension
obligations and shareholder dividends.
Cash on our balance sheet includes funds available for general corporate
purposes. Funds held on behalf of clients in a fiduciary capacity are segregated
and shown together with uncollected insurance premiums in Fiduciary assets in
the Consolidated Statement of Financial Position, with a corresponding amount in
Fiduciary liabilities. Fiduciary funds cannot be used for general corporate
purposes, and should not be considered a source of liquidity for us.
Cash and cash equivalents and Short-term investments decreased $420 million
to $637 million in 2012. During 2012, cash flow from operating activities
increased $401 million to a record $1.4 billion. Additional sources of funds in
2012 included $178 million in sales of long-term investments and $440 million in
net sales of short-term investments that were non-fiduciary. The primary uses of
funds in 2012 included share repurchases of $1.1 billion, cash contributions to
our major defined benefit plans in excess of pension expense of $585 million,
capital expenditures of $269 million, repayment of debt net of debt issuances of
$344 million, and dividends paid to shareholders of $204 million.
Our investment grade rating is important to us for a number of reasons, the
most important of which is preserving our financial flexibility. If our credit
ratings were downgraded to below investment grade, the interest expense on any
outstanding balances on our credit facilities would increase and we
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could incur additional requests for pension contributions. To manage unforeseen
situations, we have committed credit lines of approximately $1.3 billion and we
manage our business to ensure we maintain our current investment grade ratings.
At December 31, 2012, we had no borrowings on these credit lines.
Cash Flows Provided by Operating Activities
Net cash provided by operating activities in 2012 increased $401 million to
$1.4 billion as compared to $1.0 billion in 2011. Primary contributors to cash
flow from operations included net income of $1.0 billion and adjustments for
non-cash items of $772 million, primarily related to depreciation, amortization,
and stock compensation expense. These items were partially offset by
$585 million of cash contributions to our major defined benefit plans in excess
of pension expense. Pension contributions during 2012 were $638 million as
compared to $477 million in 2011. In 2013, we expect to contribute $548 million
to our major defined benefit plans, with a modest decrease in pension expense.
In 2013, we also expect to have cash payments related to restructuring plans of
$94 million
We continue to progress with elevated levels of invoicing and cash
collections related to a delay in invoicing HR Solutions' customers in
connection with the upgrade of our financial systems that occurred in 2011. We
expect the increase in unbilled receivables and accounts receivable of
approximately $350 million to reverse and return to normalized levels in 2013.
Cash Flows Provided by (Used For) Investing Activities
Cash provided by investing activities in 2012 was $177 million. Sales of
long term investments provided $178 million and net sales of short term
investments provided $440 million, partially offset by acquisitions which used
$160 million, and capital expenditures used $269 million.
Cash used for investing activities in 2011 was $186 million. Acquisitions
used $97 million, primarily related to the acquisition of Glenrand. Net
purchases of non-fiduciary short-term investments used $8 million, and capital
expenditures used $241 million. The sale of businesses provided $9 million,
consisting of proceeds from several small dispositions, and sales, net of
purchases, of long-term investments provided $160 million.
Cash used for investing activities in 2010 was $2.5 billion. Acquisitions
used $2.1 billion, primarily related to the acquisition of Hewitt. Net purchases
of non-fiduciary short-term investments used $337 million, and capital
expenditures used $180 million. Sales, net of purchases, of long-term
investments provided $56 million.
Cash Flows Used For Financing Activities
Cash used for financing activities during 2012 was $1.6 billion. Share
repurchases were $1.1 billion and dividends to shareholders were $204 million.
Net repayment of debt in 2012 used $344 million. Proceeds from the exercise of
stock options and issuance of shares purchased through employee stock purchase
plans were $118 million.
Cash used for financing activities during 2011 was $896 million. Share
repurchases were $828 million and dividends to shareholders were $200 million.
Dividends paid to, and purchase of shares from non-controlling interests were
$54 million. Proceeds from the exercise of stock options and issuance of shares
purchased through employee stock purchase plans were $201 million.
Cash provided by financing activities during 2010 was $1.8 billion. During
2010 we received $2.9 billion from the issuance of debt, primarily a
$600 million 3.5% note due in 2015, a $600 million 5% note due in 2020, a
$300 million 6.25% note due 2040, and a $1 billion three-year term note due in
2013, all associated with the acquisition of Hewitt. Additionally, we borrowed
$308 million from our Euro credit facility and $100 million of commercial paper
during the year, which were repaid as of year
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end. We also repaid $299 million of debt assumed in the Hewitt acquisition.
Other uses of cash include $250 million for share repurchases and $175 million
for dividends to shareholders. Proceeds from the exercise of stock options and
issuance of shares purchased through the employee stock purchase plan were
$194 million.
Cash and Investments
At December 31, 2012, our Cash and cash equivalents and Short-term
investments were $637 million, a decrease of $420 million as compared to the
balance of $1.1 billion as of December 31, 2011. In both 2012 and 2011, the
Company was required to hold £77 million of operating funds in the U.K. as
required by the Financial Services Authority, which were included in Short-term
investments. These operating funds, when translated to U.S. dollars, were
$124 million and $120 million at December 31, 2012 and 2011, respectively. Cash
and cash equivalents included restricted balances of $76 million and $71 million
at December 31, 2012 and 2011, respectively. The restricted balances primarily
relate to cash required to be held as collateral.
At December 31, 2012, $138 million of cash and cash equivalents and
short-term investments were held in the U.S. and $499 million were held in other
countries. Due to differences in tax rates, the repatriation of funds from
certain countries into the U.S., if repatriated, could have an unfavorable tax
impact.
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, which are then remitted to the insureds.
Unremitted insurance premiums and claims are held by us in a fiduciary capacity.
In addition, some of our outsourcing agreements require us to hold funds on
behalf of clients to pay obligations on their behalf. The levels of fiduciary
assets and liabilities can fluctuate significantly, primarily depending on when
we collect the premiums, claims and refunds, make payments to underwriters and
insureds, collect funds from clients and make payments on their behalf.
Fiduciary assets, because of their nature, are required to be invested in very
liquid securities with highly-rated, credit-worthy financial institutions. In
our Consolidated Statements of Financial Position, the amount we report for
fiduciary assets and fiduciary liabilities are equal. Our fiduciary assets
included cash and investments of $4.0 billion and fiduciary receivables of
$8.2 billion at December 31, 2012. While we earn investment income on the
fiduciary assets held in cash and investments, the cash and investments are not
owned by us, and cannot be used for general corporate purposes.
The majority of our short-term investments carried at fair value are money
market funds. As disclosed in Note 15 "Fair Value Measurements and Financial
Instruments" of the Notes to Consolidated Financial Statements, money market
funds are carried at cost as an approximation of fair value. Based on market
convention, we consider cost a practical and expedient measure of fair value.
These money market funds are held throughout the world with various financial
institutions. We do not believe that there are any significant market liquidity
issues affecting the fair value of these investments.
As of December 31, 2012, our investments in money market funds and highly
liquid debt instruments had a fair value of $2.1 billion and are included in
Cash and cash equivalents, Short-term investments and Fiduciary assets in the
Consolidated Statements of Financial Position depending on their nature and
initial maturity.
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The following table summarizes our Fiduciary assets and non-fiduciary Cash
and cash equivalents and Short-term investments as of December 31, 2012 (in
millions):
Statement of Financial Position
Classification
Cash and Cash Short-term Fiduciary
Asset Type Equivalents Investments Assets Total
Certificates of deposit,
bank deposits or time
deposits $ 291 - $ 2,241 $ 2,532
Money market funds - 345 1,763 2,108
Highly liquid debt
instruments - - 25 25
Other investments due
within one year - 1 - 1
Cash and investments 291 346 4,029 4,666
Fiduciary receivables - - 8,185 8,185
Total $ 291 $ 346 $ 12,214 $ 12,851
Share Repurchase Program
In January 2010, our Board of Directors authorized a share repurchase
program under which up to $2 billion of common stock was authorized to be
repurchased ("2010 Stock Repurchase Program"). Shares of common stock were
authorized to be repurchased through the open market or in privately negotiated
transactions, including structured repurchase programs, from time to time, based
on prevailing market conditions, and were funded from available capital. Any
repurchased shares of common stock were available for employee stock plans and
for other corporate purposes.
The 2010 Stock Repurchase Program, which related to common stock of Aon
Corporation and preceded the Redomestication, did not extend to the shares of
Aon plc. In April 2012, our Board of Directors therefore authorized a share
repurchase program under which up to $5 billion of Class A Ordinary Shares may
be repurchased ("2012 Share Repurchase Program"). Under this program, 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.
During 2012, the Company repurchased 21.6 million shares at an average price
per share of $52.16 for a total cost of $1.1 billion. The remaining authorized
amount for share repurchase under the 2012 Share Repurchase Program is
approximately $4.0 billion.
For information regarding share repurchases made during the fourth quarter
of 2012, see Item 5 - "Market for Registrant's Common Equity, Related
Stockholder Matters and Issuer Purchases of Equity Securities" as previously
described.
Dividends
During 2012, 2011, and 2010, we paid dividends on our ordinary shares of
$204 million, $200 million, and $175 million, respectively. Dividends paid per
ordinary share were $0.62 for the year ended December 31, 2012 and $0.60 for
each of the years ended December 31, 2011 and 2010.
Redomestication
As a U.K. incorporated company, we must have "distributable reserves" to
make share repurchases or pay dividends to shareholders. Distributable reserves
may be created through the earnings of the U.K. parent company and, amongst
other methods, through a reduction in share capital approved by the English
Companies Court. Distributable reserves are not linked to a U.S. GAAP reported
amount. On April 4, 2012, we received approval from the English Companies Court
to reduce our share
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premium and in connection with that approval, recognized distributable reserves
in the amount of $8.0 billion. As of December 31, 2012, we had distributable
reserves of $7.0 billion.
Debt Securities
We use proceeds from the commercial paper market from time to time in order
to meet short-term working capital needs. We had $50 million of commercial paper
outstanding at December 31, 2012 and 2011, respectively. The weighted average
commercial paper outstanding for 2012 and 2011 was $67 million and $35 million,
respectively. The weighted average interest rate of the commercial paper
outstanding during 2012 and 2011 was 0.41% and 0.35%, respectively.
On August 31, 2012, we filed a shelf registration statement with the SEC,
registering the offer and sale from time to time of an indeterminate amount of,
among other securities, debt, securities, preference shares, Class A Ordinary
Shares and convertible securities. The availability of any potential liquidity
for these types of securities is dependent on investor demand, market conditions
and other factors.
On December 12, 2012, we issued $166 million aggregate principal amount of
4.250% Notes Due 2042 in connection with an exchange offer of Aon Corporation's
outstanding 8.205% junior subordinated deferrable interest debentures due
January 2027. In connection with this exchange, the Company paid a premium of
$59 million which will be amortized into Interest expense over the life of the
new notes. Concurrently with the issuance, the Company entered into a
registration rights agreement that gives the holders of the new notes certain
exchange and registration rights.
Credit Facilities
At December 31, 2012, we have a five-year $400 million unsecured revolving
credit facility in the U.S. ("U.S. Facility") that expires in 2017. The U.S.
facility is for general corporate purposes, including commercial paper support.
Additionally, we have a five-year €650 million ($860 million at December 31,
2012 exchange rates) multi-currency European credit facility ("Euro Facility")
available, which expires in October 2015. At December 31, 2012, we had no
borrowings under either of the credit facilities.
For both our U.S. and Euro Facilities, the two most significant covenants
require us to maintain a ratio of consolidated EBITDA (earnings before interest,
taxes, depreciation and amortization), adjusted for Hewitt related transaction
costs and up to $50 million in non-recurring cash charges ("Adjusted EBITDA") to
consolidated interest expense and a ratio of consolidated debt to Adjusted
EBITDA. For both facilities, the ratio of Adjusted EBITDA to consolidated
interest expense must be at least 4 to 1. For the Euro Facility, the ratio of
consolidated debt to Adjusted EBITDA must not exceed 3 to 1. For the U.S.
Facility, the ratio of consolidated debt to Adjusted EBITDA must not exceed the
lower of (a) 3.25 to 1.00 or (b) the greater of (i) 3.00 to 1.00 or (ii) the
lowest ratio of consolidated debt to Adjusted EBITDA then set forth in the Euro
Facility or Aon's $450,000,000 Term Loan Facility. We were in compliance with
these and all other covenants during 2012.
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Rating Agency Ratings
The major rating agencies' ratings of our debt at February 22, 2013 appear
in the table below.
Ratings
Senior Commercial
Long-term Debt Paper Outlook
Standard & Poor's BBB+ A-2 Stable
Moody's Investor Services Baa2 P-2 Stable
Fitch, Inc. BBB+ F-2 Stable
A downgrade in the credit ratings of our senior debt and commercial paper
would increase our borrowing costs, reduce or eliminate our access to capital,
reduce our financial flexibility, and increase our commercial paper interest
rates or possibly restrict our access to the commercial paper market altogether.
Letters of Credit
We have total letters of credit ("LOCs") outstanding for approximately
$74 million and $75 million at December 31, 2012 and 2011, respectively. These
letters of credit cover the beneficiaries related to certain of our U.S. and
Canadian non-qualified pension plan schemes and secure deductible retentions on
our own workers compensation program. We have also issued LOCs to cover
contingent payments for taxes and other business obligations to third parties,
and other guarantees for miscellaneous purposes at its international
subsidiaries.
Adequacy of Liquidity Sources
We believe that cash flows from operations and available credit facilities
will be sufficient to meet our liquidity needs, including capital expenditures,
pension contributions, cash restructuring costs, and anticipated working capital
requirements, for the foreseeable future. Our cash flows from operations,
borrowing capacity and overall liquidity are subject to risks and uncertainties.
See Item 1, "Information Concerning Forward-Looking Statements" and Item 1A,
"Risk Factors."
Contractual Obligations
Summarized in the table below are our contractual obligations and
commitments as of December 31, 2012 (in millions):
Payments due in
2014 - 2016 - 2018 and
2013 2015 2017 beyond Total
Short- and long-term borrowings $ 452$ 1,294$ 514$ 1,905$ 4,165
Interest expense on debt
207 377 255 1,243 2,082
Operating leases 432 761 625 1,072 2,890
Pension and other postretirement
benefit plan (1) (2) 548 884 670 943 3,039
Purchase obligations (3) (4) (5) 189 170 89 129 577
Insurance premiums payable 12,214 - - - 12,214
$ 14,042 $ 3,486 $ 2,153 $ 5,292 $ 24,967
º (1)
º Pension and other postretirement benefit plan obligations include estimates
of our minimum funding requirements, pursuant to ERISA and other
regulations and minimum funding requirements agreed with the trustees of
our U.K. pension plans. Additional amounts may be
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agreed to with, or required by, the U.K. pension plan trustees.
Nonqualified pension and other postretirement benefit obligations are based
on estimated future benefit payments. We may make additional discretionary
contributions.
º (2)
º In 2007, our principal U.K subsidiary agreed with the trustees of one of
the U.K. plans to contribute £9.4 million ($15 million) per year to that
pension plan for the next six years, with the amount payable increasing by
approximately 5% on each April 1. The trustees of the plan have certain
rights to request that our U.K. subsidiary advance an amount equal to an
actuarially determined winding-up deficit. As of December 31, 2012, the
estimated winding-up deficit was £260 million ($420 million). The trustees
of the plan have accepted in practice the agreed-upon schedule of
contributions detailed above and have not requested the winding-up deficit
be paid.
º (3)
º Purchase obligations are defined as agreements to purchase goods and
services that are enforceable and legally binding on us, and that specifies
all significant terms, including what is to be purchased, at what price and
the approximate timing of the transaction. Most of our purchase obligations
are related to purchases of information technology services or for claims
outsourcing in the U.K.
º (4)
º Excludes $74 million of unfunded commitments related to an investment in a
limited partnership due to our inability to reasonably estimate the
period(s) when the limited partnership will request funding.
º (5)
º Excludes $156 million of liabilities for uncertain tax positions due to our
inability to reasonably estimate the period(s) when cash settlements will
be made.
Financial Condition
At December 31, 2012, our net assets of $7.8 billion, representing total
assets minus total liabilities, were $315 million lower than the balance at
December 31, 2011. The decrease is primarily related to share repurchases of
$1.1 billion and dividends of $204 million, partially offset by net income of
$1.0 billion. Working capital decreased $713 million to $1.0 billion, primarily
due to a decrease in cash and short-term investments to fund share repurchases.
Borrowings
Total debt at December 31, 2012 was $4.2 billion, a decrease of $327 million
from December 31, 2011. The decrease was primarily related to debt repayments
during the year (see Note 8 "Debt").
On March 20, 2012, we entered into the U.S. Facility. Borrowings under the
U.S. Facility will bear interest, at the Company's option, at a rate equal to
either (a) the rate for eurodollar deposits as reflected on the applicable
Reuters LIBOR01 page for the interest period relevant to such borrowing
("Eurodollar Rate"), plus the applicable margin or (b) the highest of (i) the
rate of interest publicly announced by Citibank as its prime rate, (ii) the
federal funds effective rate from time to time plus 0.5% and (iii) the one month
Eurodollar rate plus 1.0%, in each case plus the applicable margin. The
applicable margin for borrowings under the U.S. Facility may change depending on
achievement of certain public debt ratings. The U.S. Facility has a maturity
date of March 20, 2017. In conjunction with the Company entering into the U.S.
Facility the prior revolving U.S. credit agreement dated December 4, 2009 was
terminated.
Our total debt as a percentage of total capital attributable to Aon
shareholders was 35.0% and 35.8% at December 31, 2012 and December 31, 2011,
respectively.
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Equity
Equity at December 31, 2012 was $7.8 billion, a decrease of $315 million
from December 31, 2011. The decrease resulted primarily from an increase in
share repurchases to $1.1 billion in 2012, $204 million of dividends to
shareholders, and an increase in Accumulated other comprehensive loss of
$240 million, offset by net income of $1.0 billion and stock compensation
expense of $212 million.
Accumulated other comprehensive loss increased $240 million since
December 31, 2011, primarily reflecting the following:
º •
º an increase in net foreign currency translation adjustments of
$109 million, which was attributable to the weakening of the U.S.
dollar against foreign currencies;
º •
º an increase of $358 million in the net underfunded position of our
post-retirement benefit obligations due primarily to a decrease in the
discount rate used to determine the future benefit obligation; and
º •
º net unrealized derivative gains of $9 million.
REVIEW BY SEGMENT
General
We serve clients through the following segments:
º •
º Risk Solutions acts as an advisor and insurance and reinsurance
broker, helping clients manage their risks, via consultation, as well
as negotiation and placement of insurance risk with insurance carriers
through our global distribution network.
º •
º HR Solutions partners with organizations to solve their most complex
benefits, talent and related financial challenges, and improve
business performance by designing, implementing, communicating and
administering a wide range of human capital, retirement, investment
consulting, health care, compensation and talent management
strategies.
Risk Solutions
Years ended December 31 2012 2011 2010
Revenue $ 7,632 $ 7,537 $ 6,989
Operating income 1,493 1,413 1,328
Operating margin 19.6% 18.7% 19.0%
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 business. The economic activity that impacts property and casualty
insurance is described as exposure units, and is closely correlated with
employment levels, corporate revenue and asset values. During 2012 we began to
see improvement in pricing on average globally; however, we would still consider
this to be a "soft market," which began in 2007. In a soft market, premium rates
flatten or decrease, along with commission revenues, due to increased
competition for market share among insurance carriers or increased underwriting
capacity. 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. In 2012, pricing showed signs of
stabilization and improvement in both our retail and reinsurance brokerage
product lines and we expect this trend to slowly continue into 2013.
Additionally, beginning in late 2008 and continuing through 2012, we faced
difficult conditions as a result of unprecedented disruptions in the global
economy, the repricing of credit risk and the
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deterioration of the financial markets. Weak global economic conditions have
reduced our customers' demand for our retail brokerage products, which have had
a negative impact on our operational results.
Risk Solutions generated approximately 66% of our consolidated total
revenues in 2012. Revenues are generated primarily through fees paid by clients,
commissions and fees paid by insurance and reinsurance companies, and investment
income on funds held on behalf of clients. Our revenues vary from quarter to
quarter throughout the year as a result of the timing of our clients' policy
renewals, the net effect of new and lost business, the timing of services
provided to our clients, and the income we earn on investments, which is heavily
influenced by short-term interest rates.
We operate in a highly competitive industry and compete with many retail
insurance brokerage and agency firms, as well as with individual brokers,
agents, and direct writers of insurance coverage. Specifically, we address the
highly specialized product development and risk management needs of commercial
enterprises, professional groups, insurance companies, governments, health care
providers, and non-profit groups, among others; provide affinity products for
professional liability, life, disability income, and personal lines for
individuals, associations, and businesses; provide products and services via
GRIP Solutions; provide reinsurance services to insurance and reinsurance
companies and other risk assumption entities by acting as brokers or
intermediaries on all classes of reinsurance; provide capital management
transaction and advisory products and services, including mergers and
acquisitions and other financial advisory services, capital raising, contingent
capital financing, insurance-linked securitizations and derivative applications;
provide managing underwriting to independent agents and brokers as well as
corporate clients; provide risk consulting, actuarial, loss prevention, and
administrative services to businesses and consumers; and manage captive
insurance companies.
Revenue
Risk Solutions commissions, fees and other revenue were as follows (in
millions):
Years ended December 31 2012 2011 2010
Retail brokerage:
Americas $ 3,071 $ 3,001 $ 2,676
International 3,018 3,021 2,815
Total retail brokerage 6,089 6,022 5,491
Reinsurance brokerage 1,505 1,463 1,444
Total $ 7,594 $ 7,485 $ 6,935
In 2012, commissions, fees and other revenue increased $109 million, or 1%,
from 2011 driven primarily by 4% organic revenue growth, partially offset by a
3% unfavorable impact of foreign currency exchange rates. Organic revenue growth
was driven primarily by strong growth in Asia and emerging markets, solid growth
across Latin America and U.S. retail, as well as modest growth in continental
Europe.
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Reconciliation of organic revenue growth to reported commissions, fees and
other revenue growth for 2012 versus 2011 is as follows:
Less:
Less: Acquisitions,
Percent Currency Divestitures Organic
Change Impact & Other Revenue
Retail brokerage:
Americas 2 % (1 )% - % 3 %
International - (4 ) 1 3
Total retail brokerage 1 (3 ) 1 3
Reinsurance brokerage 3 (2 ) - 5
Total 1 % (3 )% - % 4 %
Retail brokerage Commissions, fees and other revenue increased 1% driven by
3% growth in organic revenue in both the Americas and International operations
and a 1% increase related to acquisitions, net of dispositions, partially offset
by a 3% impact from unfavorable foreign currency exchange rates.
Americas Commissions, fees and other revenue increased 2% reflecting 3%
organic revenue growth driven by strong growth in Latin America and solid
management of the renewal book portfolio across the region, partially offset by
a 1% impact from unfavorable foreign currency exchange rates.
International commissions, fees and other revenue was flat versus the prior
year, driven by a 3% organic revenue increase primarily reflecting growth in
Asia and emerging markets and a 1% impact from acquisitions, net of
divestitures, offset by a 4% unfavorable impact from foreign currency exchange
rates.
Reinsurance commissions, fees and other revenue increased 3% driven by 5%
organic revenue growth, partially offset by a 2% unfavorable impact from foreign
currency exchange rates. Organic revenue increased primarily resulting from
strong growth in the global treaty business and a favorable market pricing
impact in the near-term.
Operating Income
Operating income increased $80 million, or 6%, from 2011 to $1.5 billion in
2012. In 2012, operating income margins in this segment were 19.6%, up 90 basis
points from 18.7% in 2011. Operating margin improvement was primarily driven by
revenue growth, reduced costs of restructuring initiatives and realization of
the benefits of those restructuring plans, which was partially offset by the
negative impact of expense increases related to investment in the business.
HR Solutions
Years ended December 31 2012 2011 2010
Revenue $ 3,925 $ 3,781 $ 1,545
Operating income 289 336 121
Operating margin 7.4% 8.9% 7.8%
In October 2010, we completed the acquisition of Hewitt, one of the world's
leading human resource consulting and outsourcing companies. Hewitt operates
globally together with Aon's existing consulting and outsourcing operations
under the Aon Hewitt brand. Hewitt's operating results are included in Aon's
results of operations beginning October 1, 2010.
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Our HR Solutions segment generated approximately 34% of our consolidated
total revenues in 2012 and provides a broad range of human capital services, as
follows:
º •
º Retirement specializes in global actuarial services, defined
contribution consulting, tax and ERISA consulting, and pension
administration.
º •
º Compensation focuses on compensatory advisory/counsel including:
compensation planning design, executive reward strategies, salary
survey and benchmarking, market share studies and sales force
effectiveness, with special expertise in the financial services and
technology industries.
º •
º Strategic Human Capital delivers advice to complex global
organizations on talent, change and organizational effectiveness
issues, including talent strategy and acquisition, executive
on-boarding, performance management, leadership assessment and
development, communication strategy, workforce training and change
management.
º •
º Investment consulting advises public and private companies, other
institutions and trustees on developing and maintaining investment
programs across a broad range of plan types, including defined benefit
plans, defined contribution plans, endowments and foundations.
º •
º Benefits Administration applies our HR expertise primarily through
defined benefit, defined contribution, and health and welfare
administrative services. Our model replaces the resource-intensive
processes once required to administer benefit plans with more
efficient, effective, and less costly solutions.
º •
º Exchanges is building and operating health care exchanges that provide
employers with a cost effective alternative to traditional employee
and retiree healthcare, while helping individuals select the insurance
that best meets their needs.
º •
º HR BPO provides market-leading solutions to manage employee data;
administer benefits, payroll and other human resources processes; and
record and manage talent, workforce and other core HR process
transactions as well as other complementary services such as absence
management, flexible spending, dependent audit and participant
advocacy.
Beginning in late 2008, the disruption in the global credit markets and the
deterioration of the financial markets created significant uncertainty in the
marketplace. Weak economic conditions globally continued throughout 2012. The
prolonged economic downturn is adversely impacting our clients' financial
condition and therefore the levels of business activities in the industries and
geographies where we operate. While we believe that the majority of our
practices are well positioned to manage through this time, these challenges are
reducing demand for some of our services and putting continued pressure on
pricing of those services, which is having an adverse effect on our new business
and results of operations.
Revenue
Commissions, fees and other revenue were as follows (in millions):
Years ended December 31 2012 2011 2010
Consulting services $ 1,585 $ 1,546 $ 821
Outsourcing 2,372 2,258 731
Intersegment (32 ) (23 ) (8 )
Total $ 3,925 $ 3,781 $ 1,544
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Organic revenue growth in 2012, as detailed in the following reconciliation:
Less:
Less: Acquisitions,
Percent Currency Divestitures Organic
Year ended December 31 Change Impact & Other Revenue
Consulting services 3 % (1) % - % 4 %
Outsourcing 5 (1) 1 5
Intersegment N/A N/A N/A N/A
Total 4 % (1) % 1 % 4 %
Consulting services increased $39 million, or 3%, due primarily to organic
revenue growth of 4%, driven by solid growth across all businesses with strength
in investment consulting, pension administration services for certain
project-related work, talent and rewards, and communication consulting,
partially offset by a 1% unfavorable impact from foreign currency exchange
rates.
Outsourcing revenue increased $114 million, or 5%, due primarily to 5%
organic revenue growth driven by client wins in the HR BPO business and growth
in the health care exchanges were partially offset by a modest decline in
benefits administration.
Operating Income
Operating income was $289 million, a decrease of $47 million, or 14%, from
2011. This decrease was primarily driven by investments in long-term growth
opportunities in the first half of 2012. Margins in this segment for 2012 were
7.4%, a decrease of 150 basis points from 8.9% in 2011 driven by the impact of
investments in the business, higher intangible amortization expense related to
the acquisition of Hewitt, and higher restructuring costs, partially offset by
organic revenue growth and the realization of the benefits of those
restructuring plans and operational improvement.
Unallocated Income and Expense
A reconciliation of our operating income to income from continuing
operations before income taxes is as follows (in millions):
Years ended December 31 2012 2011 2010
Operating income (loss):
Risk Solutions $ 1,493 $ 1,413 $ 1,328
HR Solutions 289 336 121
Unallocated (186 ) (153 ) (205 )
Operating income 1,596 1,596 1,244
Interest income 10 18 15
Interest expense (228 ) (245 ) (182 )
Other income (expense) 3 15 (18 )
Income from continuing operations before income taxes $ 1,381 $ 1,384 $ 1,059
Unallocated operating expense includes corporate governance costs not
allocated to the operating segments. Net unallocated expenses increased
$33 million to $186 million from $153 million in 2011, driven primarily by an
increase in costs of $21 million related to the relocation of the Company's
headquarters to London.
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Interest income represents income earned on operating cash balances and
other income-producing investments. It does not include interest earned on funds
held on behalf of clients. Interest income decreased $8 million, or 44%, from
2011, due to a lower average rate and lower cash balances.
Interest expense, which represents the cost of our worldwide debt
obligations, decreased $17 million, or 7%, from 2011 due to a decrease in the
amount of debt outstanding for the full year.
Other income (expense) of $3 million in 2012 includes gains on certain
long-term investments and Company owned life insurance plans, partially offset
by losses due to the unfavourable impact of exchange rates on the remeasurement
of assets and liabilities on the balance sheet. Additionally, 2011 includes
death benefits on certain Company owned life insurance plans, partially offset
by losses and write-offs related to our ownership in certain insurance
investment funds and other long-term investments and a $19 million loss on the
extinguishment of debt.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our Consolidated Financial Statements and Notes thereto have been prepared
in accordance with U.S. GAAP. To prepare these financial statements, we made
estimates, assumptions and judgments that affect what we report as our assets
and liabilities, what we disclose as contingent assets and liabilities at the
date of the financial statements, and the reported amounts of revenues and
expenses during the periods presented.
In accordance with our policies, we regularly evaluate our estimates,
assumptions and judgments, including, but not limited to, those concerning
revenue recognition, restructuring, pensions, goodwill and other intangible
assets, contingencies, share-based payments, and income taxes, and base our
estimates, assumptions, and judgments on our historical experience and on
factors we believe reasonable under the circumstances. The results involve
judgments about the carrying values of assets and liabilities not readily
apparent from other sources. If our assumptions or conditions change, the actual
results we report may differ from these estimates. We believe the following
critical accounting policies affect the more significant estimates, assumptions,
and judgments we used to prepare these Consolidated Financial Statements.
Revenue Recognition
Risk Solutions segment revenues include insurance commissions and fees for
services rendered and investment income on funds held on behalf of clients.
Revenues are recognized when they are earned and realized or realizable. The
Company generally considers revenues to be earned and realized or realizable
when there is persuasive evidence of an arrangement with a client, there is a
fixed or determinable price, services have been rendered, and collectability is
reasonably assured. For brokerage commissions, revenue is typically considered
to be earned and realized or realizable at the completion of the placement
process, assuming all other criteria required to recognize revenue have been
met. The placement process is typically considered complete on the effective
date of the related policy. Commission revenues are recorded net of allowances
for estimated policy cancellations, which are determined based on an evaluation
of historical and current cancellation data. Commissions on premiums billed
directly by insurance carriers are recognized as revenue when the Company has
sufficient information to conclude the amount due is determinable, which may not
occur until cash is received from the insurance carrier. Investment income is
typically recognized as funds for clients are physically held by the company are
bearing interest that is deemed probable of collection.
HR Solutions segment revenues consist primarily of fees paid by clients for
consulting advice and outsourcing contracts. Fees paid by clients for consulting
services are typically charged on an hourly, project or fixed-fee basis.
Revenues from time-and-materials or cost-plus arrangements are recognized as
services are performed, assuming all other criteria for recognizing revenue have
been met. Revenues from fixed-fee contracts are recognized as services are
provided using a proportional-performance
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model or at the completion of a project based on facts and circumstances of the
client arrangement. Reimbursements received for out-of-pocket expenses are
recorded as a component of revenues. The Company's outsourcing contracts
typically have three-to-five year terms for benefits services and five-to-ten
year terms for human resources business process outsourcing ("HR BPO") services.
The Company recognizes revenues as services are performed, assuming all other
criteria for recognizing revenue have been met. The Company may also receive
implementation fees from clients either up-front or over the ongoing services
period as a component of the fee per participant. Lump sum implementation fees
received from a client are typically deferred and recognized ratably over the
ongoing contract services period. If a client terminates an outsourcing services
arrangement prior to the end of the contract, a loss on the contract may be
recorded, if necessary, and any remaining deferred implementation revenues would
typically be recognized over the remaining service period through the
termination date.
In connection with the Company's long-term outsourcing service agreements,
highly customized implementation efforts are often necessary to set up clients
and their human resource or benefit programs on the Company's systems and
operating processes. For outsourcing services sold separately or accounted for
as a separate unit of accounting, specific, incremental and direct costs of
implementation incurred prior to the services commencing are generally deferred
and amortized over the period that the related ongoing services revenue is
recognized. Deferred costs are assessed for recoverability on a periodic basis,
to the extent the deferred cost exceeds related deferred revenue.
Restructuring
Workforce reduction costs
The method used to recognize workforce reduction costs depends on whether
the benefits are provided under a one-time benefit arrangement or under an
ongoing benefit arrangement. We account for relevant expenses as an ongoing
benefit arrangement when we have an established termination benefit policy,
statutory requirements dictate the termination benefit amounts, or we have an
established pattern of providing similar termination benefits. The method to
estimate the amount of termination benefits is based on the benefits available
to the employees being terminated.
We recognize the workforce reduction costs related to restructuring
activities resulting from an ongoing benefit arrangement when we identify the
specific classification (or functions) and locations of the employees being
terminated and notify the employees.
We recognize the workforce reduction costs related to restructuring
activities resulting from a one-time benefit arrangement when we identify the
specific classification (or functions) and locations of the employees being
terminated, notify the employees, and expect to terminate employees within the
legally required notification period. When employees receive incentives to stay
beyond the legally required notification period, we recognize the cost of their
termination benefits over the remaining service period.
Lease termination costs
Where we have provided notice of cancellation pursuant to a lease agreement
or abandoned space and have no intention of reoccupying it, we recognize a loss
and corresponding liability. The liability reflects our best estimate of the
fair value of the future cash flows associated with the lease at the date we
vacate the property or sign a sublease arrangement. To determine the loss and
corresponding liability, we estimate sublease income based on all information
that is reasonably available, which typically includes current market quotes for
similar properties.
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Useful lives on leasehold improvements or other assets associated with lease
abandonments may be revised to reflect a shorter useful life than originally
estimated, which results in accelerated depreciation.
Fair value concepts of severance arrangements and lease losses
Accounting guidance requires that the liabilities recorded related to our
restructuring activities be measured at fair value.
Where material, we discount the lease loss calculations to arrive at their
present value. Most workforce reductions happen over a short span of time and
therefore no discounting is necessary. However, we may discount the termination
benefit arrangement when we terminate employees who will provide no future
service and we pay their severance over an extended period. The discount
reflects our incremental borrowing rate, which matches the lifetime of the
liability. Significant changes in the discount rate selected or the estimations
of sublease income in the case of leases could impact the amounts recorded.
Other associated costs with restructuring activities
We recognize other costs associated with restructuring activities as they
are incurred, including moving costs and consulting and legal fees.
Pensions
We sponsor defined benefit pension plans throughout the world. Our most
significant plans are located in the U.S., the U.K., the Netherlands and Canada.
Our U.S., U.K. and Canadian pension plans are closed to new entrants. We have
ceased crediting future benefits relating to salary and service for our U.S.,
U.K. and Canadian plans.
Recognition of gains and losses and prior service
We defer the recognition of gains and losses that arise from events such as
changes in the discount rate and actuarial assumptions, actual demographic
experience and plan asset performance.
Unrecognized gains and losses are amortized as a component of periodic
pension expense based on the average expected future service of active employees
for our plans in the Netherlands and Canada, or the average life expectancy of
the U.S. and U.K. plan members. After the effective date of the plan amendments
to cease crediting future benefits relating to service, unrecognized gains and
losses are also be based on the average life expectancy of members in the
Canadian plans. We amortize any prior service expense or credits that arise as a
result of plan changes over a period consistent with the amortization of gains
and losses.
As of December 31, 2012, our pension plans have deferred losses that have
not yet been recognized through income in the Consolidated Financial Statements.
We amortize unrecognized actuarial losses outside of a corridor, which is
defined as 10% of the greater of market-related value of plan assets or
projected benefit obligation. To the extent not offset by future gains,
incremental amortization as calculated above will continue to affect future
pension expense similarly until fully amortized.
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The following table discloses our combined experience loss, the number of
years over which we are amortizing the experience loss, and the estimated 2013
amortization of loss by country (amounts in millions):
U.K. and
U.S. Non U.S.
Combined experience loss $ 1,591 $ 2,472
Amortization period (in years) 27 66
Estimated 2013 amortization of loss $ 52 $ 76
The unrecognized prior service cost at December 31, 2012 was $29 million in
the U.K. and non-U.S. plans.
For the U.S. pension plans we use a market-related valuation of assets
approach to determine the expected return on assets, which is a component of net
periodic benefit cost recognized in the Consolidated Statements of Income. This
approach recognizes 20% of any gains or losses in the current year's value of
market-related assets, with the remaining 80% spread over the next four years.
As this approach recognizes gains or losses over a five-year period, the future
value of assets and therefore, our net periodic benefit cost will be impacted as
previously deferred gains or losses are recorded. As of December 31, 2012, the
market-related value of assets was $1.6 billion. We do not use the
market-related valuation approach to determine the funded status of the U.S.
plans recorded in the Consolidated Statements of Financial Position which is
based on the fair value of the plan assets. As of December 31, 2012, the fair
value of plan assets was $1.6 billion.
Our non-U.S. plans use fair value to determine expected return on assets.
Rate of return on plan assets and asset allocation
The following table summarizes the expected long-term rate of return on plan
assets for future pension expense and the related target asset mix:
U.K. and
U.S. Non-U.S.
Expected return (in total) 8.8 % 5.7 - 6.5 %
Expected return on equities (1) 10.2 % 7.9 - 8.4 %
Expected return on fixed income 6.1 % 4.1 - 4.8 %
Asset mix:
Target equity (1) 70.0 % 38.4 - 60.0 %
Target fixed income 30.0 % 40.0 - 61.6 %
º (1)
º Includes investments in infrastructure, real estate, limited partnerships
and hedge funds.
In determining the expected rate of return for the plan assets, we analyzed
investment community forecasts and current market conditions to develop expected
returns for each of the asset classes used by the plans. In particular, we
surveyed multiple third party financial institutions and consultants to obtain
long-term expected returns on each asset class, considered historical
performance data by asset class over long periods, and weighted the expected
returns for each asset class by target asset allocations of the plans.
The U.S. pension plan asset allocation is based on approved allocations
following adopted investment guidelines. The actual asset allocation at
December 31, 2012 was 65% equity and 35% fixed income securities for the
qualified plan.
The investment policy for each U.K. and non-U.S. pension plans is generally
determined by the plans' trustees. Because there are several pension plans
maintained in the U.K. and non-U.S. category,
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our target allocation presents a range of the target allocation of each plan.
Further, target allocations are subject to change. As of December 31, 2012, the
U.K. and non-U.S. plans were invested between 35% and 59% in equity and between
41% and 65% in fixed income securities.
Impact of changing economic assumptions
Changes in the discount rate and expected return on assets can have a
material impact on pension obligations and pension expense.
Holding all other assumptions constant, the following table reflects what a
one hundred basis point increase and decrease in our estimated liability
discount rate would have on our net underfunded status at December 31, 2012 (in
millions):
Estimated liability discount rate Change in discount rate
Increase (decrease) in net underfunded status of
December 31, 2012 (1) Increase Decrease
U.S. plans $ (262 ) $ 304
U.K. and non-U.S. plans (797 ) 925
º (1)
º Increases to the net underfunded status reflect increases to the Company's
pension obligations, while decreases in the net underfunded status are
recoveries toward fully funded status.
Holding all other assumptions constant, the following table reflects what a
one hundred basis point increase and decrease in our estimated liability
discount rate would have on our estimated 2013 pension expense (in millions):
Change in discount rate
Increase (decrease) in expense Increase Decrease
U.S. plans $ (1 ) $ -
U.K. and non-U.S. plans (37 ) 34
Holding other assumptions constant, the following table reflects what a one
hundred basis point increase and decrease in our estimated long-term rate of
return on plan assets would have on our estimated 2013 pension expense (in
millions):
Change in long-term rate
of return on plan assets
Increase (decrease) in expense Increase Decrease
U.S. plans $ (16 ) $ 16
U.K. and non-U.S. plans (59 ) 59
Estimated future contributions
We estimate contributions of approximately $548 million in 2013 as compared
with $638 million in 2012.
Goodwill and Other Intangible Assets
Goodwill represents the excess of cost over the fair market value of the net
assets acquired. We classify our intangible assets acquired as either
trademarks, customer relationships, technology, non-compete agreements, or other
purchased intangibles.
Goodwill is not amortized, but rather tested for impairment at least
annually in the fourth quarter. In September 2011, the Financial Accounting
Standards Board ("FASB") issued final guidance that gives an entity the option
to perform a qualitative assessment that may eliminate the requirement to
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perform the annual two-step test. We adopted this guidance in the fourth quarter
of 2011. In the fourth quarter, we also test the acquired tradenames (which also
are not amortized) for impairment. We test more frequently if there are
indicators of impairment or whenever business circumstances suggest that the
carrying value of goodwill or trademarks may not be recoverable. These
indicators may include a sustained significant decline in our share price and
market capitalization, a decline in our expected future cash flows, or a
significant adverse change in legal factors or in the business climate, among
others. No events occurred during 2012 that indicate the existence of an
impairment with respect to our reported goodwill or tradenames.
We perform impairment reviews at the reporting unit level. A reporting unit
is an operating segment or one level below an operating segment (referred to as
a "component"). A component of an operating segment is a reporting unit if the
component constitutes a business for which discrete financial information is
available and segment management regularly reviews the operating results of that
component. An operating segment shall be deemed to be a reporting unit if all of
its components are similar, if none of its components is a reporting unit, or if
the segment comprises only a single component.
The goodwill impairment test is initially a qualitative analysis to
determine if it is "more likely than not" that the fair value of each reporting
unit exceeds the carrying value, including goodwill, of the corresponding
reporting unit. If the "more likely than not" threshold is not met, then the
goodwill impairment test becomes a two step analysis. Step One requires the fair
value of each reporting unit to be compared to its book value. Management must
apply judgment in determining the estimated fair value of the reporting units.
If the fair value of a reporting unit is determined to be greater than the
carrying value of the reporting unit, goodwill and trademarks are deemed not to
be impaired and no further testing is necessary. If the fair value of a
reporting unit is less than the carrying value, we perform Step Two. Step Two
uses the calculated fair value of the reporting unit to perform a hypothetical
purchase price allocation to the fair value of the assets and liabilities of the
reporting unit. The difference between the fair value of the reporting unit
calculated in Step One and the fair value of the underlying assets and
liabilities of the reporting unit is the implied fair value of the reporting
unit's goodwill. A charge is recorded in the financial statements if the
carrying value of the reporting unit's goodwill is greater than its implied fair
value.
In determining the fair value of our reporting units, we use a discounted
cash flow ("DCF") model based on our most current forecasts. We discount the
related cash flow forecasts using the weighted-average cost of capital method at
the date of evaluation. Preparation of forecasts and selection of the discount
rate for use in the DCF model involve significant judgments, and changes in
these estimates could affect the estimated fair value of one or more of our
reporting units and could result in a goodwill impairment charge in a future
period. We also use market multiples which are obtained from quoted prices of
comparable companies to corroborate our DCF model results. The combined
estimated fair value of our reporting units from our DCF model often results in
a premium over our market capitalization, commonly referred to as a control
premium. We believe the implied control premium determined by our impairment
analysis is reasonable based upon historic data of premiums paid on actual
transactions within our industry. Based on tests performed in both 2012 and
2011, there was no indication of goodwill impairment, and no further testing was
required.
We review intangible assets that are being amortized for impairment whenever
events or changes in circumstance indicate that their carrying amount may not be
recoverable. There were no indications that the carrying values of amortizable
intangible assets were impaired as of December 31, 2012. If we are required to
record impairment charges in the future, they could materially impact our
results of operations.
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Contingencies
We define a contingency as an existing condition that involves a degree of
uncertainty as to a possible gain or loss that will ultimately be resolved when
one ore more future events occur or fail to occur. Under U.S. GAAP, we are
required to establish reserves for loss contingencies when it is probable and we
can reasonably estimate its financial impact. We are required to assess the
likelihood of material adverse judgments or outcomes as well as potential ranges
or probability of losses. We determine the amount of reserves required, if any,
for contingencies after carefully analyzing each individual item. The required
reserves may change due to new developments in each issue. We do not recognize
gain contingencies until the contingency is resolved.
Share-based Payments
Share-based compensation expense is measured based on the estimated grant
date fair value and recognized over the requisite service period for awards that
we ultimately expect to vest. We estimate forfeitures at the time of grant based
on our actual experience to date and revise our estimates, if necessary, in
subsequent periods if actual forfeitures differ from those estimates.
Share Option Accounting
We generally use a lattice-binomial option-pricing model to value share
options granted. Lattice-based option valuation models use a range of
assumptions over the expected term of the options, and estimate expected
volatilities based on the average of the historical volatility of our share
price and the implied volatility of traded options on our shares.
In terms of the assumptions used in the lattice-based model, we:
º •
º use historical data to estimate option exercise and employee
terminations within the valuation model. We stratify employees between
those receiving Leadership Performance Plan ("LPP") options, Special
Share Plan options, and all other option grants. We believe that this
stratification better represents prospective stock option exercise
patterns,
º •
º base the expected dividend yield assumption on our current dividend
rate, and
º •
º base the risk-free rate for the contractual life of the option on the
U.S. Treasury yield curve in effect at the time of grant.
The expected life of employee share options represents the weighted-average
period share options are expected to remain outstanding, which is a derived
output of the lattice-binomial model.
Restricted Share Units
Restricted share units ("RSUs") are service-based awards for which we
recognize the associated compensation cost on a straight-line basis over the
service period. We estimate the fair value of the awards based on the market
price of the underlying share on the date of grant.
Performance Share Awards
Performance share awards ("PSAs") are performance-based awards for which
vesting is dependent on the achievement of certain objectives. Such objectives
may be made on a personal, group or company level. We estimate the fair value of
the awards based on the market price of the underlying stock on the date of
grant, reduced by the present value of estimated dividends foregone during the
vesting period.
PSAs may immediately vest at the end of the performance period or may have
an additional service period. Compensation cost is recognized over the
performance or additional service period,
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whichever is longer. The number of shares issued on the vesting date will vary
depending on the actual performance objectives achieved. We make assessments of
future performance using subjective estimates, such as long-term plans. As a
result, changes in the underlying assumptions could have a material impact on
the compensation expense recognized.
The largest performance-based share-based payment award plan is the LPP,
which has a three-year performance period. The 2010 to 2012 performance period
ended on December 31, 2012, the 2009 to 2011 performance period ended on
December 31, 2011, and the 2008 to 2010 performance period ended on December 31,
2010. The LPP currently has two open performance periods: 2011 to 2013 and 2012
to 2014. A 10% upward adjustment in our estimated performance achievement
percentage for both LPP plans would have increased our 2012 expense by
approximately $5.3 million, while a 10% downward adjustment would have decreased
our expense by approximately $5.3 million. As the percent of expected
performance increases or decreases, the potential change in expense can go from
0% to 200% of the targeted total expense.
Income Taxes
We earn income in numerous countries and this income is subject to the laws
of taxing jurisdictions within those countries. The estimated effective tax rate
for the year is applied to our quarterly operating results. In the event that
there is a significant unusual or discrete item recognized, or expected to be
recognized, in our quarterly operating results, the tax attributable to that
item would be separately calculated and recorded at the same time as the unusual
or discrete item, such as the resolution of prior-year tax matters.
The carrying values of deferred income tax assets and liabilities reflect
the application of our income tax accounting policies, and are based on
management's assumptions and estimates about future operating results and levels
of taxable income, and judgments regarding the interpretation of the provisions
of current accounting principles.
Deferred tax assets are reduced by valuation allowances if, based on the
consideration of all available evidence, it is more likely than not that some
portion of the deferred tax asset will not be realized. In this assessment,
significant weight is given to evidence that can be objectively verified.
We assess carryforwards and tax credits for realization as a reduction of
future taxable income by using a "more likely than not" determination. We have
not recognized a U.S. deferred tax liability for permanently reinvested earnings
of certain non-U.S. subsidiaries. Additional U.S. income taxes could be recorded
(or incurred) if we change our investment strategy relating to these
subsidiaries, which could materially affect our future effective tax rate.
We base the carrying values of liabilities for income taxes currently
payable on management's interpretation of applicable tax laws, and incorporate
management's assumptions and judgments about using tax planning strategies in
various taxing jurisdictions. Using different estimates, assumptions and
judgments in accounting for income taxes, especially those that deploy tax
planning strategies, may result in materially different carrying values of
income tax assets and liabilities and changes in our results of operations.
We operate in many jurisdictions where tax laws relating to our businesses
are not well developed. In such jurisdictions, we obtain professional guidance,
when available, and consider existing industry practices before using tax
planning strategies and meeting our tax obligations. Tax returns are routinely
subject to audit in most jurisdictions, and tax liabilities are frequently
finalized through negotiations. In addition, several factors could increase the
future level of uncertainty over our tax liabilities, including the following:
º •
º the portion of our overall operations conducted in non-U.S. tax
jurisdictions has been increasing, and we anticipate this trend will
continue,
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º •
º to deploy tax planning strategies and conduct global operations
efficiently, our subsidiaries frequently enter into transactions with
affiliates, which are generally subject to complex tax regulations and
are frequently reviewed by tax authorities,
º •
º tax laws, regulations, agreements and treaties change frequently,
requiring us to modify existing tax strategies to conform to such
changes, and
º •
º the move of the corporate headquarters to London.
NEW ACCOUNTING PRONOUNCEMENTS
Note 2 "Summary of Significant Accounting Principles and Practices" of the
Notes to Consolidated Financial Statements contains a summary of our significant
accounting policies, including a discussion of recently issued accounting
pronouncements and their impact or future potential impact on our financial
results, if determinable.
