TOWERS WATSON & CO. – 10-K – Management’s Discussion and Analysis of Financial Condition and Results of Operations.

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Executive Overview

General

We are a global consulting firm focusing on providing human capital and financial consulting services.

At Towers Watson, we bring together professionals from around the world - experts in their areas of specialty - to deliver the perspectives that give organizations a clear path forward. We do this by working with clients to develop solutions in the areas of employee benefits, risk and capital management, and talent and rewards.

  We help our clients enhance business performance by improving their ability to attract, retain and motivate qualified employees. We focus on delivering consulting services that help organizations anticipate, identify and capitalize on emerging opportunities in human capital management. We also provide independent financial advice regarding all aspects of life insurance and general insurance, as well as investment advice to help our clients develop disciplined and efficient strategies to meet their investment goals. We operate the largest private Medicare exchange in the United States. Through this exchange, we help our clients to move to a more sustainable economic model by capping and controlling the costs associated with retiree healthcare benefits.  As leading economies worldwide become more service-oriented, human resources and financial management have become increasingly important to companies and other organizations. The heightened competition for skilled employees, unprecedented changes in workforce demographics, regulatory changes related to compensation and retiree benefits, and rising employee-related costs have increased the importance of effective human capital management. Insurance and investment decisions have become increasingly complex and important in the face of changing economies and dynamic financial markets. Towers Watson helps its clients address these issues by combining expertise in human capital and financial management with consulting and technology solutions, to improve the design and implementation of various human resources and financial programs, including compensation, retirement, health care, and insurance and investment plans.  The human resources consulting industry, although highly fragmented, is highly competitive. It is composed of major human capital consulting firms, specialty firms, consulting arms of accounting firms and information technology consulting firms.  In the short term, our revenue is driven by many factors, including the general state of the global economy and the resulting level of discretionary spending, the continuing regulatory compliance requirements of our clients, changes in investment markets, the ability of our consultants to attract new clients or provide additional services to existing clients, the impact of new regulations in the legal and accounting fields and the impact of our ongoing cost saving initiatives. In the long term, we expect that our financial results will depend in large part upon how well we succeed in deepening our existing client relationships through thought leadership and a focus on developing cross-business solutions, actively pursuing new clients in our target markets, cross selling and making strategic acquisitions. We believe that the highly fragmented industry in which we operate offers us growth opportunities, because we provide a unique business combination of benefits and human capital consulting, as well as risk and capital management and strategic technology solutions.  

Segments

We provide services in four business segments: Benefits, Risk and Financial Services, Talent and Rewards, and Exchange Solutions.

Benefits Segment. The Benefits segment is our largest and most established segment. This segment has grown through business combinations as well as strong organic growth. It helps clients create and manage cost-effective benefits programs that help them attract, retain and motivate a talented workforce.

The Benefits segment provides benefits consulting and administration services through four lines of business:

     •   Retirement;       •   Health and Group Benefits;       •   Technology and Administration Solutions; and       •   International Consulting.   Retirement supports organizations worldwide in designing, managing, administering and communicating all types of retirement plans. Health and Group Benefits provides advice on the strategy, design, financing, delivery, ongoing plan management and communication of health and group benefit programs. Through our Technology and Administration Solutions line of business, we deliver cost-effective benefit outsourcing solutions. The International Consulting Group provides expertise in dealing with international human                                           31

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  capital management and related benefits and compensation advice for corporate headquarters and their subsidiaries. A significant portion of the revenue in this segment is from recurring work, driven in large part by the heavily regulated nature of employee benefits plans and our clients' annual needs for these services. For the fiscal year ended June 30, 2013, the Benefits segment contributed 57% of our segment revenue. For the same period, approximately 42% of the Benefits segment's revenue originates from outside the United States and is thus subject to translation exposure resulting from foreign exchange rate fluctuations.  

Risk and Financial Services Segment. Within the Risk and Financial Services segment, our second largest segment, we have three lines of business:

     •   Risk Consulting and Software ("RCS");       •   Investment; and       •   Reinsurance and Insurance Brokerage ("Brokerage").   The Risk and Financial Services segment accounted for 23% of our total revenue for the fiscal year ended June 30, 2013. Approximately 67% of the segment's revenue originates from outside the United States and is thus subject to translation exposure resulting from foreign exchange rate fluctuations. The segment has a strong base of recurring revenue, driven by long-term client relationships in reinsurance brokerage services, retainer investment consulting relationships, software solutions, consulting services on financial reporting, and actuarial opinions on property/casualty loss reserves. Some of these relationships have been in place for more than 20 years. A portion of the revenue is related to project work, which is more heavily dependent on the overall level of discretionary spending by clients. This work is favorably influenced by strong client relationships, particularly related to mergers and acquisitions consulting. Major revenue growth drivers include changes in regulations, the level of merger and acquisition activity in the insurance industry, growth in pension and other asset pools, and reinsurance retention and pricing trends.  

Talent and Rewards Segment. Our third largest segment, Talent and Rewards, is focused on three lines of business:

     •   Executive Compensation;       •   Rewards, Talent and Communication; and       •   Data, Surveys and Technology.   The Talent and Rewards segment accounted for approximately 17% of our total revenue for the fiscal year ended June 30, 2013. Few of the segment's projects have a recurring element. As a result, this segment is most sensitive to changes in discretionary spending due to cyclical economic fluctuations. Approximately 47% of the segment's revenue originates from outside the United States and is thus subject to translation exposure resulting from foreign exchange rate fluctuations. Revenue for Talent and Rewards consulting has increasing seasonality, with a meaningful amount of heightened activity in the second half of the calendar year during the annual compensation, benefits and survey cycles. Major revenue growth drivers in this group include demand for workforce productivity improvements and labor cost reductions, focus on high performance culture, globalization of the workforce, changes in regulations and benefits programs, merger and acquisition activity, and the demand for universal metrics related to workforce engagement.  

Exchange Solutions Segment.

  We established our fourth segment, Exchange Solutions, when we acquired Extend Health on May 29, 2012. The Exchange Solutions segment accounted for approximately 3% of our total revenue for the fiscal year ended June 30, 2013. Exchange Solutions operates the largest private Medicare insurance exchange in the United States. Our core solution enables employers to transition their retirees to individual, defined contribution health plans at an annual cost that the employer controls - versus group-based, defined benefit health plans, which have uncertain annual costs. By moving to a defined contribution approach, our clients can provide their retirees with the same or better health care benefits at a lower overall cost. Most Exchange Solutions revenues come from the commissions we receive from insurance carriers for enrolling individuals into their health plans. This revenue increases as the number of enrolled members grows. Exchange Solutions experiences seasonality due to the majority of policies beginning on January 1 following corporations' open enrollment periods. In addition, the annual enrollment period for Medicare-eligible individuals coincides with this period. It is expected that the majority of enrollments will occur in our second quarter and we will hire additional seasonal benefits advisors to supplement our full-time benefit advisors and incur higher costs. The associated commission revenue with these new enrollments is deferred until the policy effective date in our third quarter and is spread over the policy period.                                           32 

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Financial Statement Overview

Towers Watson's fiscal year ends June 30.

Shown below are Towers Watson's top five geographies based on percentage of consolidated revenue.

                                                    Fiscal Year                      Geographic Region   2013       2012       2011                      United States          53 %       48 %       49 %                      United Kingdom         22         23         22                      Canada                  6          6          6                      Germany                 4          5          4                      Netherlands             2          3          3   We derive the majority of our revenue from fees for consulting services. Approximately 60% of our client arrangements are billed at standard hourly rates and expense reimbursement, which we refer to as time and expense basis. The remaining 40% of our client arrangements are billed on a fixed-fee basis. Clients are typically invoiced on a monthly basis with revenue generally recognized as services are performed. No single client accounted for more than 1% of our consolidated revenues for any of our most recent three fiscal years.  Our most significant expense is compensation to associates, which typically comprises approximately 70% of total costs of providing services. We compensate our directors, executive officers and other select associates with incentive non-cash stock-based compensation plans which generally vest equally over three years. We use a graded vesting expense methodology that assumes the equity awards are issued to participants in equal amounts of shares that vest over one year, two years and three years giving the effect of more expense in the first year than the second and third. Our equity awards are settled in Towers Watson Class A common stock.  

Salaries and employee benefits are comprised of wages paid to associates, related taxes, severance, benefit expenses such as pension, medical and insurance costs, and fiscal year-end incentive bonuses.

  Professional and subcontracted services represent fees paid to external service providers for employment, marketing and other services. For the three most recent fiscal years, approximately 30 to 40% of the professional and subcontracted services were directly incurred on behalf of clients and were reimbursed by them, with such reimbursements being included in revenue. For the fiscal year ended June 30, 2013 for Towers Watson, approximately 33% of professional and subcontracted services represent these reimbursable services.  

Occupancy includes expenses for rent and utilities.

  General and administrative expenses include legal, marketing, supplies, telephone and networking costs to operate office locations as well as insurance, including premiums on excess insurance and losses on professional liability claims, non-client-reimbursed travel by associates, publications and professional development. This line item also includes miscellaneous expenses, including gains and losses on foreign currency transactions.  

Depreciation and amortization includes the depreciation of fixed assets and amortization of intangible assets and internally-developed software.

  Transaction and integration expenses include fees and charges associated with the Merger and with our other acquisitions. Transaction and integration expenses principally consist of investment banker fees, regulatory filing expenses, integration consultants, as well as legal, accounting, marketing, and information technology integration expenses.  

Critical Accounting Policies and Estimates

  The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Our estimates, judgments and assumptions are continually evaluated based on available information and experience. Because of the use of estimates inherent in the financial reporting process, actual results could differ from those estimates. The areas that we believe are critical accounting policies include revenue recognition, valuation of billed and unbilled receivables from clients, discretionary compensation, income taxes, pension assumptions, incurred but not reported claims, and goodwill and intangible assets. The critical accounting policies discussed below involve making difficult, subjective or complex accounting estimates that could have a material effect on our financial condition and results of operations. These critical accounting policies                                           33

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  require us to make assumptions about matters that are highly uncertain at the time of the estimate or assumption. Different estimates that we could have used, or changes in estimates that are reasonably likely to occur, may have a material effect on our financial condition and results of operations.  

Revenue Recognition

We recognize revenue when it is earned and realized or realizable as demonstrated by persuasive evidence of an arrangement with a client, a fixed or determinable price, services have been rendered or products delivered or available for use, and collectability is reasonably assured.

  The majority of our revenue consists of fees earned from providing consulting services. We recognize revenue from these consulting engagements when hours are worked, either on a time-and-expense basis or on a fixed-fee basis, depending on the terms and conditions defined at the inception of an engagement with a client. We have engagement letters with our clients that specify the terms and conditions upon which the engagements are based. These terms and conditions can only be changed upon agreement by both parties. Individual associates' billing rates are principally based on a multiple of salary and compensation costs.  Revenue for fixed-fee arrangements is based upon the proportional performance method. We typically have three types of fixed-fee arrangements: annual recurring projects, projects of a short duration, and non-recurring system projects. Annual recurring projects and the projects of short duration are typically straightforward and highly predictable in nature. As a result, the project manager and financial staff are able to identify, as the project status is reviewed and bills are prepared monthly, the occasions when cost overruns could lead to the recording of a loss accrual.  We have non-recurring system projects that are longer in duration and subject to more changes in scope as the project progresses. We evaluate at least quarterly, and more often as needed, project managers' estimates-to-complete to assure that the projects' current statuses are accounted for properly. Certain software contracts generally provide that if the client terminates a contract, we are entitled to payment for services performed through termination.  Revenue recognition for fixed-fee engagements is affected by a number of factors that change the estimated amount of work required to complete the project such as changes in scope, the staffing on the engagement and/or the level of client participation. The periodic engagement evaluations require us to make judgments and estimates regarding the overall profitability and stage of project completion that, in turn, affect how we recognize revenue. We recognize a loss on an engagement when estimated revenue to be received for that engagement is less than the total estimated costs associated with the engagement. Losses are recognized in the period in which the loss becomes probable and the amount of the loss is reasonably estimable. We have experienced certain costs in excess of estimates from time to time. Management believes it is rare, however, for these excess costs to result in overall project losses.  We have developed various software programs and technologies that we provide to clients in connection with consulting services. In most instances, such software is hosted and maintained by us and ownership of the technology and rights to the related code remain with us. We defer costs for software developed to be utilized in providing services to a client, but for which the client does not have the contractual right to take possession, during the implementation stage. We recognize these deferred costs from the go live date, signaling the end of the implementation stage, until the end of the initial term of the contract with the client. We determined that the system implementation and customized ongoing administrative services are one combined service. Revenue is recognized over the service period, after the go live date, in proportion to the services performed. As a result, we do not recognize revenue during the implementation phase of an engagement.  We deliver software under arrangements with clients that take possession of our software. The maintenance associated with the initial software fees is a fixed percentage which enables us to determine the stand-alone value of the delivered software separate from the maintenance. We recognize the initial software fees as software is delivered to the client and we recognize the maintenance ratably over the contract period based on each element's relative fair value. For software arrangements in which initial fees are received in connection with mandatory maintenance for the initial software license to remain active, we determined that the initial maintenance period is substantive. Therefore, we recognize the fees for the initial license and maintenance bundle ratably over the initial contract term, which is generally one year. Each subsequent renewal fee is recognized ratably over the contractually stated renewal period.  We collect, analyze and compile data in the form of surveys for our clients who have the option of participating in the survey. The surveys are published online via a web tool which provides simplistic functionality. We have determined that the web tool is inconsequential to the overall arrangement. We record the survey revenue when the results are delivered online and made available to our clients that have a contractual right to the data. If the data is updated more frequently than annually, we recognize the survey revenue ratably over the contractually stated period.  In our capacity as a reinsurance broker, we collect premiums from our reinsurance clients and, after deducting our brokerage commissions, we remit the premiums to the respective reinsurance underwriters on behalf of our reinsurance clients. In general, compensation for reinsurance brokerage services is earned on a commission basis. Commissions are calculated as a percentage of a                                           34

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  reinsurance premium as stipulated in the reinsurance contracts with our clients and reinsurers. We recognize brokerage services revenue on the later of the contract's inception or billing date as fees become known or as our services are provided for premium processing. In addition, we hold cash needed to settle amounts due reinsurers or our reinsurance clients, net of any commissions due to us, pending remittance to the ultimate recipient. We are permitted to invest these funds in high quality liquid instruments.  As an insurance exchange, we generate revenue from commission paid to us by insurance carriers for health insurance policies issued through our enrollment services. Under our contracts with insurance carriers, once an application has been accepted by an insurance carrier and a policy has been issued, we will receive commission payments from the policy effective date until the end of the annual policy period as long as the policy is not cancelled by the insured or the carrier. We defer upfront fees and recognize revenue ratably from the policy effective date over the policy period, generally one year. The commission fee per policy placed with a carrier could vary by whether the insured was previously a Medicare participant and whether the policy is in its first or subsequent year. Due to the uncertainty of the commission fee per policy, we do not recognize revenue until the policy is accepted by the carrier, the policy is effective and a communication is received from the carrier of the fee per insured. As the commission fee is cancellable on a pro rata basis related to the underlying insurance policy which we are not party to, we recognize the commission fee ratably over the policy period. Our carrier contracts entitle us to receive commission fees per policy for the life of the policy unless limited by legislation or cancelled by the carrier or insured. As a result, the majority of the revenue is recurring in nature and grows in direct proportion to the number of new policies added each year.  Revenue recognized in excess of billings is recorded as unbilled accounts receivable. Cash collections in excess of revenue recognized are recorded as deferred revenue until the revenue recognition criteria are met. Client reimbursable expenses, including those relating to travel, other out-of-pocket expenses and any third-party costs, are included in revenue, and an equivalent amount of reimbursable expenses are included in professional and subcontracted services as a cost of revenue.  

Valuation of Billed and Unbilled Receivables from Clients

  We maintain allowances for doubtful accounts to reflect estimated losses resulting from the clients' failure to pay for the services after the services have been rendered, including allowances when customer disputes may exist. The related provision is recorded as a reduction to revenue. Our allowance policy is based on the aging of the billed and unbilled client receivables and has been developed based on the write-off history. Facts and circumstances such as the average length of time the receivables are past due, general market conditions, current economic trends and our clients' ability to pay may cause fluctuations in our valuation of billed and unbilled receivables.  

Discretionary Compensation

  Our compensation program includes a discretionary bonus that is determined by management and has historically been paid once per fiscal year in the form of cash and/or deferred stock units after our annual operating results are finalized.  An estimated annual bonus amount is initially developed at the beginning of each fiscal year in conjunction with our budgeting process. Estimated annual operating performance is reviewed quarterly and the discretionary annual bonus amount is then adjusted, if necessary, by management to reflect changes in the forecast of pre-bonus profitability for the year.  

Income Taxes

  We account for income taxes in accordance with Accounting Standards Codification ("ASC") 740, Income Taxes, which prescribes the use of the asset and liability approach to the recognition of deferred tax assets and liabilities related to the expected future tax consequences of events that have been recognized in our financial statements or income tax returns. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Valuation allowances are established, when necessary, to reduce deferred tax assets when it is more likely than not that a portion or all of a given deferred tax asset will not be realized. In accordance with ASC 740, income tax expense includes (i) deferred tax expense, which generally represents the net change in the deferred tax asset or liability balance during the year plus any change in valuation allowances and (ii) current tax expense, which represents the amount of tax currently payable to or receivable from a taxing authority plus amounts accrued for expected tax contingencies (including both tax and interest). ASC 740 prescribes a recognition threshold of more-likely-than-not, and a measurement attribute for all tax positions taken or expected to be taken on a tax return, in order for those positions to be recognized in the financial statements. We continually review tax laws, regulations and related guidance in order to properly record any uncertain tax positions. We adjust these reserves in light of changing facts and circumstances, such as the outcome of tax audits.  

Incurred But Not Reported (IBNR) Claims

We accrue for IBNR professional liability claims that are probable and estimable, and for which we have not yet contracted for insurance coverage. We use actuarial assumptions to estimate and record a liability for IBNR professional liability claims. Our

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  estimated IBNR liability is based on long-term trends and averages, and considers a number of factors, including changes in claim reporting patterns, claim settlement patterns, judicial decisions, and legislation and economic decisions. Our estimated IBNR liability does not include actuarial projections for the effect of claims data for large cases due to the insufficiency of actuarial experience with such cases. Our estimated IBNR liability will fluctuate if claims experience changes over time. As of June 30, 2013, we had a $184.1 million IBNR liability, net of recoverable receivables of our captive insurance companies. This net liability decreased from $202.2 million as of June 30, 2012 as the result of improved claims experience. To the extent our captive insurance companies, PCIC and SMIC, expect losses to be covered by a third party, they record a receivable for the amount expected to be recovered. This receivable is classified in other current or other noncurrent assets in our consolidated balance sheet.  

Pension Assumptions

Towers Watson sponsors both qualified and non-qualified defined benefit pension plans and other post-retirement benefit plan ("OPEB") plans in North America and Europe. As of June 30, 2013, these funded and unfunded plans represented 98 percent of Towers Watson's pension and OPEB obligations and are disclosed herein. Towers Watson also sponsors funded and unfunded defined benefit pension plans in certain other countries, representing an additional $87.6 million in projected benefit obligations, $62.6 million in assets and a net liability of $25.0 million.  North AmericaUnited States - Beginning January 1, 2012, all associates, including named executive officers, accrue qualified and non-qualified benefits under a new stable value pension design. Prior to this date, associates hired prior to December 31, 2010 earned benefits under their legacy plan formulas, which were frozen on December 31, 2011. The non-qualified plan is unfunded. Retiree medical benefits provided under our U.S. postretirement benefit plans were closed to new hires effective January 1, 2011. Life insurance benefits under the same plans were frozen with respect to service, eligibility and amounts as of January 1, 2012 for active associates.  Canada - Effective on January 1, 2011, associates hired on or after January 1, 2011 and effective on January 1, 2012 for associates hired prior to January 1, 2011, accrue qualified and non-qualified benefits based on a career average benefit formula. Additionally, participants can choose to make voluntary contributions to purchase enhancements to their pension. Prior to the January 1, 2011, associates earned benefits under their legacy plan formulas.  

The non-qualified plans in North America provide for the additional pension benefits that would be covered under the qualified plan in the respective country were it not for statutory maximums. The non-qualified plans are unfunded.

Europe

United Kingdom - For associates previously participating under the legacy Watson Wyatt defined benefit plan, benefits accrue based on the number of years of service and the associate's average compensation during the associate's term of service since January 2008 (prior to this date, benefits accrued under a different formula). Benefit accruals earned under the legacy Towers Perrin defined benefit plan were frozen on March 31, 2008, and the plan predominantly provides lump sum benefits. All associates not earning benefits under the legacy Watson Wyatt defined benefit component of the plan accrue benefits under a defined contribution component.  Germany - Effective January 1, 2011, all new associates participate in a defined contribution plan. Associates hired prior to this date continue to participate in various defined contribution and defined benefit arrangements according to legacy plan formulas. The legacy defined benefit plans are primarily account-based, with some long-service associates continuing to accrue benefits according to grandfathered final-average-pay formulas.  Netherlands - Benefits under the Netherlands plan used to accrue on a final pay basis on earnings up to a maximum amount each year. The benefit accrual under the final pay plan stopped at December 31, 2010. The accrued benefits will receive conditional indexation each year.  The determination of Towers Watson's obligations and annual expense under the plans is based on a number of assumptions that, given the longevity of the plans, are long-term in focus. A change in one or a combination of these assumptions could have a material impact on Towers Watson's pension benefit obligation and related cost. Any difference between actual and assumed results is amortized into Towers Watson's pension cost over the average remaining service period of participating associates. Towers Watson considers several factors prior to the start of each fiscal year when determining the appropriate annual assumptions, including economic forecasts, relevant benchmarks, historical trends, portfolio composition and peer company comparisons.                                           36

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Funding is based on actuarially determined contributions and is limited to amounts that are currently deductible for tax purposes. Since funding calculations are based on different measurements than those used for accounting purposes, pension contributions are not equal to net periodic pension cost.

The assumptions used to determine net periodic benefit cost for the fiscal years ended June 30, 2013, 2012 and 2011 were as follows:

                                                                      Year Ended June 30,                                                2013                        2012                        2011                                         North                       North                       North                                        America       Europe        America       Europe        America       Europe Discount rate                              4.86 %       4.80 %         5.79 %       5.59 %         5.80 %       5.25 % Expected long-term rate of return on assets                                  8.11 %       6.07 %         8.14 %       6.78 %         8.16 %       6.79 % Rate of increase in compensation levels                                     4.35 %       3.93 %         3.82 

% 3.93 % 3.88 % 3.88 %

   The following table presents the assumptions used in the valuation to determine the projected benefit obligation for the fiscal years ended June 30, 2013 and 2012:                                                  June 30, 2013               June 30, 2012                                             North                       North                                            America       Europe        America       Europe Discount rate                                  5.32 %       4.41 %        

4.86 % 4.80 % Rate of increase in compensation levels 4.36 % 3.93 % 4.35 % 3.93 %

   As a result of plan changes adopted during the first quarter of fiscal year 2011, the legacy Watson Wyatt U.S. Pension Plans were remeasured as of September 30, 2010. Upon remeasurement the discount rate assumption was changed for these plans and the net periodic benefit cost for the remainder of fiscal year 2011 was calculated using a weighted average discount rate of 5.79%.  Towers Watson's discount rate assumptions were determined by matching expected future pension benefit payments with current AA corporate bond yields from the respective countries for the same periods. In the United States, specific bonds were selected to match plan cash flows. In Canada, yields were taken from a corporate bond yield curve. In Europe, the discount rate was set based on yields on European AA corporate bonds at the measurement date. The U.K. is based on the U.K. AA corporate bonds, while Germany and the Netherlands are based on European AA corporate bonds.  

The expected rates of return assumptions for North America and Europe were supported by an analysis performed by Towers Watson of the weighted-average yield expected to be achieved with the anticipated makeup of investments.

The following information illustrates the sensitivity to a change in certain assumptions for the North American pension plans for fiscal year 2014:

                                                              Effect on FY 2014 Change in Assumption                                    Pre-Tax Pension  Expense 25 basis point decrease in discount rate               +$             8.8 

million

 25 basis point increase in discount rate               -$             8.5 

million

 25 basis point decrease in expected return on assets   +$             6.1 

million

 25 basis point increase in expected return on assets   -$             6.1 

million

   The above sensitivities reflect the impact of changing one assumption at a time. Economic factors and conditions often affect multiple assumptions simultaneously and the effects of changes in key assumptions are not necessarily linear.                                           37

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The following information illustrates the sensitivity to a change in certain assumptions for the European pension plans for fiscal year 2014:

                                                              Effect on FY 2014 Change in Assumption                                    Pre-Tax Pension  Expense 25 basis point decrease in discount rate               +$             4.0 

million

 25 basis point increase in discount rate               -$             3.8 

million

 25 basis point decrease in expected return on assets   +$             1.9 

million

 25 basis point increase in expected return on assets   -$             1.9 

million

   The differences in the discount rate and compensation level assumption used for the North American and European plans above can be attributed to the differing interest rate environments associated with the currencies and economies to which the plans are subject. The differences in the expected return on assets are primarily driven by the respective asset allocation in each plan, coupled with the return expectations for assets in the respective currencies.  

Goodwill and Intangible Assets

  In applying the acquisition method of accounting for business combinations, amounts assigned to identifiable assets and liabilities acquired were based on estimated fair values as of the date of acquisition, with the remainder recorded as goodwill. Intangible assets are initially valued at fair value using generally accepted valuation methods appropriate for the type of intangible asset. Intangible assets with definite lives are amortized over their estimated useful lives and are reviewed for impairment if indicators of impairment arise. Intangible assets with indefinite lives are tested for impairment annually as of April 1</chron>, and whenever indicators of impairment exist. The fair value of the intangible assets is compared with their carrying value and an impairment loss would be recognized for the amount by which the carrying amount exceeds the fair value. Goodwill is tested for impairment annually as of April 1, and whenever indicators of impairment exist. Goodwill is tested at the reporting unit level which is one level below our operating segments. The Company had ten reporting units on April 1, 2013.  During fiscal 2013, the Company adopted ASU 2012-02, Intangibles-Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment ("ASU-2012-02"), which gives entities testing indefinite-lived intangible assets for impairment the option of performing a qualitative assessment to determine whether it is more likely than not that the fair value of the indefinite-lived intangible asset is less than its carrying amount. During this assessment, we first assess qualitative factors to determine whether it is more likely than not that the fair value of an indefinite-lived intangible asset, specifically some of our trade names, is less than its carrying amount. Qualitative factors we consider include, but are not limited to, cost factors; financial performance; legal, regulatory, contractual, political, business and other factors, including asset-specific factors; industry and market conditions; and macroeconomic conditions. If the qualitative factors indicate that it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying amount, we perform the two-step process to assess our indefinite-lived intangible asset for impairment. During fiscal year 2013, we assessed the qualitative factors and determined that the two-step impairment test was not required for our indefinite-lived intangible assets.  During fiscal 2013, the Company also performed a qualitative assessment for seven of our ten reporting units. Similar to our indefinite-lived intangible assets, during this assessment, we first assessed qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Qualitative factors we consider include, but are not limited to, macroeconomic conditions, industry and market conditions, company specific events, changes in circumstances, after tax cash flows and market capitalization. If the qualitative factors indicate that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, we perform the two step process to assess our goodwill for impairment. During fiscal year 2013, we assessed the qualitative factors and determined that the two-step impairment test was not required for the seven reporting units reviewed.  During fiscal 2013, the Company performed Step 1 of the two-step impairment test for three of our ten reporting units. To perform this test, we used Level 3 valuation techniques to estimate the fair value of a reporting unit that fall under income or market approaches. Under the discounted cash flow method, an income approach, the business enterprise value is determined by discounting to present value the terminal value which is calculated using debt-free after-tax cash flows for a finite period of years. Key estimates in this approach were internal financial projection estimates prepared by management, business risk, and expected rate of return on capital. The guideline company method, a market approach, develops valuation multiples by comparing our reporting units to similar publicly traded companies. Key estimates and selection of valuation multiples rely on the selection of similar companies, obtaining estimates of forecasted revenue and EBITDA estimates for the similar companies and selection of valuation multiples as they apply to the reporting unit characteristics. Under the similar transactions method, a market approach, actual transaction prices and operating data from companies deemed reasonably similar to the reporting units is used to develop valuation multiples as an indication of how much a knowledgeable investor in the marketplace would be willing to pay for the business units.                                           38 

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  If the Company was required to perform Step 2, we would determine the implied fair value of the reporting unit used in step one to all the assets and liabilities of that reporting unit (including any recognized or unrecognized intangible assets) as if the reporting unit had been acquired in a business combination. Then the implied fair value of goodwill would be compared to the carrying amount of goodwill to determine if goodwill is impaired. For the fiscal year ended June 30, 2013, we did not record any impairment losses of goodwill or intangibles.  Results of Operations 

The table below sets forth our consolidated statements of operations and data as a percentage of revenue for the periods indicated.

                       Consolidated Statements of Operations                            (Thousands of U.S. dollars)                                                                      Fiscal Year Ended June 30,                                                  2013                        2012                        2011 Revenue                                 $ 3,596,784        100 %    $ 3,417,736        100 %    $ 3,259,451        100 %   Costs of providing services: Salaries and employee benefits            2,176,038         60 %      

2,067,689 60 % 2,043,063 63 % Professional and subcontracted services

                                    269,251          7 %        285,063          8 %        246,348          8 % Occupancy                                   143,948          4 %        141,053          4 %        144,191          4 % General and administrative expenses         329,467          9 %        284,994          8 %        281,576          9 % Depreciation and amortization               175,720          5 %        152,891          4 %        130,575          4 % Transaction and integration expenses         30,753          1 %         86,130          3 %        100,535          3 %                                            3,125,177         87 %      3,017,820         88 %      2,946,288         90 %   Income from operations                      471,607         13 %        399,916         12 %        313,163         10 %  (Loss) / income from affiliates                 (56 )       -  %            262         -  %          1,081         -  % Interest income                               2,400         -  %          3,860         -  %          5,523         -  % Interest expense                            (12,676 )       -  %         (9,156 )       -  %        (12,475 )       -  % Other non-operating income                    6,928         -  %         

11,350 - % 19,349 1 %

   Income before income taxes                  468,203         13 %        

406,232 12 % 326,641 10 %

  Provision for income taxes                  152,551          4 %        

145,756 4 % 129,916 4 %

   Net income before non-controlling interests                                   315,652          9 %        260,476          8 %        196,725          6 % Net (loss) / income attributable to non-controlling interests                    (3,160 )       -  %            

263 - % 2,288 - %

 Net income attributable to controlling interests                   $   318,812          9 %    $   260,213          8 %    $   194,437          6 %   

         Results of Operations for the Fiscal Year Ended June 30, 2013                    Compared to Fiscal Year Ended June 30, 2012

Revenue

  Revenue for the fiscal year ended June 30, 2013 was $3.6 billion, an increase of $179 million, or 5%, compared to $3.4 billion for the fiscal year ended June 30, 2012. Our newest segment, Exchange Solutions, contributed 3% to our total revenue growth in fiscal year 2013 compared to 2012 due to a full fiscal year of operations in which we increased membership in the retiree exchange by more than 80%. In addition, several successes contributed to our growth in fiscal year 2013. We assisted companies with de-risking activities related to bulk lump sum projects. We enhanced our client development group outside the U.S. to better align our organization with our multi-national and global clients and expanded our global footprint into rapidly developing markets such as South Africa, India and Russia. On an organic basis, which excludes the effects of acquisitions and currency, revenue increased 4% for the fiscal year ended June 30, 2013 compared to the fiscal year ended June 30, 2012. All of our segments experienced constant currency revenue growth in fiscal year 2013 compared to 2012.                                           39

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  The average exchange rate used to translate our revenues earned in British pounds sterling decreased to 1.5686 for fiscal year 2013 from 1.5782 for fiscal year 2012, and the average exchange rate used to translate our revenues earned in Euros increased to 1.2941 for fiscal year 2013 from 1.2757 for fiscal 2012. Constant currency is calculated by translating prior year revenue at the current year average exchange rate.  

A comparison of segment revenue for the fiscal year ended June 30, 2013, as compared to the fiscal year ended June 30, 2012, is as follows:

• Benefits revenue increased $71.8 million, or 4%, and was $2.0 billion for

fiscal year 2013 compared to $1.9 billion for fiscal year 2012. On a

constant currency basis, Benefits revenue increased 5% due to increased

project work across all lines of business. The 5% increase in our

Retirement business revenue, which makes up the majority of the segment,

         was driven by 6% revenue growth in the Americas, primarily due to bulk          lump sum projects. We do not expect the same volume for bulk lump sum

projects in fiscal year 2014. The 2% increase in Retirement revenue in

EMEA was due to an increase in auto-enrollment project activity in the

U.K. Our Technology and Administration Solutions business experienced 8%

revenue growth primarily due to new client work in the U.K. and Germany.

The growth in EMEA was driven by new administration work, and the growth

in the Americas was due in part to call center support for the bulk lump

sum projects. Our International business experienced 2% revenue growth.

This group helps to address the issues multinationals face in their

compensation and benefits programs. Our Health and Group Benefits business

experienced 3% growth. In fiscal year 2014, we anticipate low-single digit

revenue growth for our Benefits segment led by Technology and

Administration Solutions while our Retirement business will be challenging

         because of the strong comparable in fiscal year 2013. Revenue in our          Benefits segment increased 5% on an organic basis, which excludes the          effects of acquisitions and currency.    

• Risk and Financial Services revenue was $811.5 million for fiscal year

2013 compared to $817.6 million for fiscal year 2012, a 1% decrease. Risk

and Financial Services revenue increased 1% on a constant currency basis.

Our lines of business experienced mixed results, with revenue growth in

the Americas, while EMEA remained flat. Our Investment business had 8%

constant currency revenue growth led by EMEA, due to an increase in

project work and performance fees. Our Risk Consulting and Software

business has two distinct offerings; software and consulting; each of

which experienced different results in fiscal year 2013. Our software

sales increased 11% due to our portfolio of software solutions for both

life and property and casualty insurance. Our consulting services revenue,

which is primarily project oriented, decreased due to tightening of

discretionary spending, principally in EMEA. In addition, it appears

likely that the timeline for European regulators to implement Solvency II

will slip beyond 2014 and related project work may not reappear for some

         time. As a result, our Risk Consulting and Software business had a 4%          constant currency decrease in revenue in fiscal year 2013 compared to

2012. Our Brokerage revenue increased 3% on a constant currency basis due

to strong renewals and new business wins during our January renewals. We

believe that Risk and Financial Services has moved into a more challenging

environment. We anticipate discretionary spending to continue to affect

the Risk Consulting and Software business and we expect the Investment

business to continue to deliver strong revenue growth. Revenue in our Risk

         and Financial Services segment increased 1% on an organic basis.    

• Talent and Rewards revenue remained consistent and was $573.3 million for

fiscal year 2013 compared to $570.5 million for fiscal year 2012. We

achieved organic growth in all regions and in the Executive Compensation

and Data, Surveys and Technology lines of business. The 5% organic revenue

growth in our Executive Compensation business was led by EMEA. This growth

was due to increased regulation and governance activity demand in all

regions, particularly Europe. Rewards, Talent and Communication business

revenue, which is primarily project oriented, decreased 1% compared to the

prior year due to tightening discretionary spending. In fiscal year 2013,

there were opportunities for project work related to health care reform

and other benefit changes in the Americas. We experienced 2% growth in

Data, Surveys and Technology revenue due to an increase in software

implementations in the Americas. We anticipate modest revenue growth for

our Talent and Rewards segment from several of our practice areas,

including Data, Surveys and Technology, due to a strong demand for

technology solutions. Revenue in our Talent and Rewards segment increased

         2% on an organic basis.    

• Exchange Solutions revenue increased $91.2 million, and was $94.9 million,

for fiscal year 2013 compared to $3.6 million for fiscal year 2012. As our

         newest segment, Exchange Solutions contributed 3% to the Company's total          revenue growth for fiscal year 2013 compared to fiscal year 2012. We

established our fourth segment in fiscal year 2012 when we acquired Extend

Health in May 2012. Our fiscal year 2012 revenue includes one month of

revenue compared to a full fiscal year in 2013. In addition, Exchange

Solutions segment revenue growth was due to the enrollment of new members,

lower than expected attrition of members and our carrier volume

incentives. During fiscal year 2013, we completed a very successful

enrollment period for January 1 effective policies, during which we

enrolled three times the number of new members compared to Extend Health's

         historical results for the past two comparable enrollment seasons. As a          result of purchase accounting, we did not recognize $12 million and $3

million of deferred revenue in fiscal year 2013 and 2012, respectively,

associated with cash received for commissions for policies placed prior to

the acquisition, as there is no subsequent performance obligation. In

fiscal year 2013, we launched OneExchange, our integrated health insurance

exchange solution for active employees and retirees. This new offering and

the strong performance of Exchange Solutions is expected to continue to

         grow revenue in fiscal year 2014.                                            40 

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Salaries and Employee Benefits

  Salaries and employee benefits were $2.2 billion for fiscal year 2013 compared to $2.1 billion for fiscal year 2012, an increase of $108.3 million, or 5%. On a constant currency basis, salaries and employee benefits increased by 7%. This increase was driven by an increase in base salary of $73.1 million attributable to a 3% increase in headcount, our annual salary merit increases and the impact of foreign currency translation. Our EMEA and APAC operations accounted for 2% of our headcount increase as of June 30, 2013, compared to June 30, 2012. Contributing to the increase, our Exchange Solutions segment had one month of operations in fiscal year 2012 compared to a full fiscal year of 2013. Our discretionary annual bonus is based on pre-bonus profitability and fluctuates based on our operating results, and as a result, our bonus expense for fiscal year 2013 increased by $21.6 million compared to fiscal year 2012. As a result of the increase in bonus and salary, our fringe benefits expense increased $20.7 million. The $17.5 million increase in our pension expense was due to decreases in discount rates. These increases were partially offset by a $25.6 million decrease in non-cash stock-based compensation primarily from the January 1, 2013 end of the service period and vesting of the restricted stock units issued to employees of Towers Perrin in the Merger. As a percentage of revenue, salaries and employee benefits was 60% for fiscal year 2013 compared to 60% for fiscal year 2012.  

Professional and Subcontracted Services

  Professional and subcontracted services for fiscal year 2013 was $269.3 million, compared to $285.1 million for fiscal year 2012, a decrease of $15.8 million, or 6%. Our external service provider fees decreased by $17.3 million compared to fiscal year 2012. We contracted with these service providers to supplement our day-to-day operations. In fiscal year 2013, our telecommunication, video conferencing, and internet services have been managed by our in-house information technology department, and these expenses are classified in general and administrative expenses. Our pass-through expenses, which are reimbursable under our contracts, increased by $1.5 million. As a percentage of revenue, professional and subcontracted services decreased to 7% for fiscal year 2013 from 8% for fiscal year 2012.  

Occupancy

  Occupancy expense for fiscal year 2013 was $143.9 million, compared to $141.1 million for fiscal year 2012, an increase of $2.9 million, or 2%. The increase was due to higher utilities, a decrease in sublease income and lower tenant improvement allowances, partially offset by a decrease in rent. As a percentage of revenue, occupancy expense was 4% for fiscal years 2013 and 2012.  

General and Administrative Expenses

  General and administrative expenses for fiscal year 2013 was $329.5 million, compared to $285.0 million for fiscal year 2012, an increase of $44.5 million, or 16%. Our professional liability and other claims expense increased $29.5 million in fiscal year 2013 compared to 2012 due to increases in our current legal reserves and reductions in prior year IBNR reserves. We also experienced an increase of $13.6 million in our telecommunications, video conferencing, internet and general office expenses for fiscal year 2013 compared to 2012. These expenses were classified in professional and subcontracted services in fiscal year 2012, as we previously contracted with an external service provider for these services. In addition, our newest segment Exchange Solutions was formed in the fourth quarter of fiscal year 2012, contributing to higher general and administrative expenses in fiscal year 2013. As a percentage of revenue, general and administrative expenses was 9% for fiscal year 2013, compared to 8% for fiscal year 2012.  

Depreciation and Amortization

  Depreciation and amortization expense for fiscal year 2013 was $175.7 million, compared to $152.9 million for fiscal year 2012, an increase of $22.8 million, or 15%. The increase is primarily due to the amortization of intangibles related to our acquisition of Extend Health in the fourth quarter of fiscal year 2012. In addition, we accelerated amortization for a software application that we acquired in the Merger, as management determined that its use would be primarily discontinued in the next two to three years. A portion of the increase is also attributable to increased depreciation on the computer hardware that was placed in service in fiscal years 2011 and 2012. As a percentage of revenue, depreciation and amortization expenses was 5% for fiscal year 2013 and 4% for fiscal year 2012.  

Transaction and Integration Expenses

  Transaction and integration expense for fiscal year 2013 was $30.8 million, compared to $86.1 million for fiscal year 2012, a decrease of $55.4 million. The decrease was principally due to a reduction in expenses related to information technology integration projects that were ongoing in fiscal year 2012 and completed in fiscal year 2013. As a percentage of revenue, transaction and integration expenses was 1% for fiscal year 2013 and 3% for fiscal year 2012.                                           41 

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(Loss) / Income from Affiliates

  Loss from affiliates for fiscal year 2013 was $0.1 million compared to income from affiliates of $0.3 million for fiscal year 2012. In the second quarter of fiscal year 2012, we purchased a majority ownership in Fifth Quadrant Actuaries and Consultants Holdings (Pty) Ltd. ("Fifth Quadrant") and began to consolidate its operations. Fifth Quadrant has historically been the primary source of income from affiliates.  

Interest Income

Interest income was $2.4 million and $3.9 million for fiscal years 2013 and 2012, respectively.

Interest Expense

Interest expense was $12.7 million for fiscal year 2013, compared to $9.2 million for fiscal year 2012, which was in line with our outstanding principal balances during the fiscal years.

Other Non-Operating Income

  Other non-operating income for fiscal year 2013 was $6.9 million, compared to $11.4 million for fiscal year 2012. In fiscal year 2012, we recorded a $2.8 million gain resulting from the fair value adjustment to our investment in Fifth Quadrant upon the purchase of a controlling interest. We acquired an additional ownership in Fifth Quadrant and consolidated our former equity investee in our results of operations beginning in the second quarter of fiscal year 2012. In fiscal year 2012, we also recorded deferred payments from divestitures.  

Provision for Income Taxes

  The provision for income taxes for fiscal year 2013 is 32.6% compared with 35.9% in fiscal year 2012. Our effective tax rate decreased by 1.5% for fiscal year 2013 as compared to fiscal year 2012 primarily due to a current year income tax benefit for foreign exchange losses recognized from legal entity restructurings.  

Net Income Attributable to Controlling Interests

  Net income attributable to controlling interests for the fiscal year ended June 30, 2013 was $318.8 million, an increase of $58.6 million, or 23%, compared to $260.2 million for the fiscal year ended June 30, 2012. As a percentage of revenue, net income attributable to controlling interests was 9% for fiscal year 2013, compared to 8% for fiscal year 2012.  

Diluted Earnings Per Share

Diluted earnings per share for fiscal year 2013 was $4.46, compared to $3.59 for fiscal year 2012.

Results of Operations for the Fiscal Year Ended June 30, 2012

                  Compared to Fiscal Year Ended June 30, 2011

Revenue

  Revenue for the fiscal year ended June 30, 2012 was $3.4 billion, an increase of $158.3 million, or 5%, compared to $3.3 billion for the fiscal year ended June 30, 2011. Our revenue growth reflects the good opportunities and strong teams we have developed in our business as well as from the addition of our three recent acquisitions, Extend Health, Aliquant and EMB. On an organic basis, which excludes the effects of acquisitions and currency, revenue increased 3% for the fiscal year ended June 30, 2012 compared to the fiscal year ended June 30, 2011. All of our segments experienced organic growth in fiscal year 2012.  The average exchange rate used to translate our revenues earned in British pounds sterling increased to 1.5898 for fiscal year 2012 from 1.5878 for fiscal year 2011, and the average exchange rate used to translate our revenues earned in Euros decreased to 1.3457 for fiscal year 2012 from 1.3637 for fiscal 2011. Constant currency is calculated by translating prior year revenue at the current year average exchange rate.  In fiscal year 2012, we experienced significant billing delays related to our ERP transition, which increased reserves for our receivables. We have a phased deployment, and the U.S. business impacts were identified and mitigated in the early stages of the EMEA roll-out.                                           42

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A comparison of segment revenue for the fiscal year ended June 30, 2012, as compared to the fiscal year ended June 30, 2011, is as follows:

• Benefits revenue increased $65.6 million, or 4%, and was $1.9 billion for

fiscal year 2012 compared to $1.9 billion for fiscal year 2011. On a

constant currency basis, our Benefits segment revenue increased 4% due to

revenue growth in all of our businesses. Our Retirement business revenue,

which represents the majority of the segment's revenue, increased 1% on a

constant currency basis. This growth was strongest in North America as we

experienced growth in pension administration for new clients. Our

Technology and Administration Solutions business experienced low double

digit constant currency growth largely due to the addition of Aliquant and

due to demand for system modifications and new call center clients.

Revenue increased in our Health and Group Benefits business in the U.S.

driven by an increase in client demand for our strategy work, particularly

in the plan management and product sales. Our International business, with

high single digit revenue growth, helps to address the issues

multinationals face in their compensation and benefit programs. Revenue in

our Benefits segment increased 3% on an organic basis, which excludes the

          effects of acquisitions and currency.         •    Risk and Financial Services revenue increased 10% and was $817.6 million

for fiscal year 2012 compared to $740.7 million for fiscal year 2011. This

increase was due to revenue growth in all businesses. Our Risk Consulting

and Software business experienced low double digit constant currency

revenue growth due to the addition of EMB. In addition, regulatory changes

and merger and acquisition activity continue to drive demand. Our revenue

in EMEA was impacted by a decrease in demand and a delay of Solvency II

implementation. Revenue from property and casualty consulting increased in

the fourth quarter of fiscal year 2012. We experienced continued growth in

our Brokerage business revenue due to mid single digit growth in the

Americas. A strong renewal season with favorable pricing conditions and

high retention rates drove growth. Our Investment business experienced mid

single digit growth due to solid demand worldwide for advice on investment

strategy, delegated services and alternative assets and has a good global

pipeline. We remain cautious about Europe as discretionary spending seems

to be tightening. Revenue in our Risk and Financial Services segment

         increased 4% on an organic basis.    

• Talent and Rewards revenue increased 5% and was $570.5 million for fiscal

year 2012 compared to $543.5 million for fiscal year 2011. We achieved

organic growth in all regions and in all lines of business of Talent and

Rewards. We experienced high single digit revenue growth in our Executive

Compensation consulting business this year. The Executive Compensation

consulting environment continued focus on pay-performance alignment,

increased focus on risk mitigation and efforts to gauge shareholders'

opinions have driven demand for our services globally. Rewards, Talent and

Communication business revenue increased in the high single digits in all

regions, led by the Americas. This growth was due to a robust annual

benefits open enrollment period, where we assist clients in helping their

employees understand the value of their health and benefit packages.

         Merger and acquisition activity globally has created demand for change          management support and reward program design. We experienced low single          digit growth in Data, Surveys and Technology revenue from the

rationalization of our legacy product platforms over the past year. We saw

a decrease in European sales in the fourth quarter. Talent and Rewards

          experienced 6% organic revenue growth.         •    We established our fourth segment, Exchange Solutions, when we acquired

Extend Health on May 29, 2012. Exchange Solutions operates the largest

private Medicare insurance exchange in the United States. Our core

solution enables employers to transition their retirees to individual,

defined contribution health plans at an annual cost that the employer

controls. We generate revenue from the commissions we receive from

insurance carriers for enrolling individuals into their health plans. This

revenue increases as the number of enrolled members grows. For the quarter

and fiscal year ended June 30, 2012, the Exchange Solutions segment

revenue was $3.6 million for one month that it has been included in our

consolidated operations. As a result of purchase accounting, we will not

realize $15 million of deferred revenue associated with cash received for

commissions paid by carriers per policy placed prior to the acquisition as

there is no subsequent performance obligation.

Salaries and Employee Benefits

  Salaries and employee benefits were $2.1 billion for fiscal year 2012 compared to $2.0 billion for fiscal year 2011, an increase of $24.6 million, or 1%. This increase was primarily driven by an increase in base salary of $96.0 million attributed to an 8% increase in headcount and a 4% increase in base salary. Our EMEA and APAC operations accounted for 56% of our headcount increase as of June 30, 2012 compared to June 30, 2011 as a result of our acquisition of EMB in January 2011 and also as we have increased resources in certain of our businesses in response to new business opportunities. We expect to continue hiring new associates to address pockets of opportunities as they arise throughout our business. Our discretionary annual bonus decreased by $19.2 million for fiscal year 2012 compared to fiscal year 2011 and is based on pre-bonus profitability and can fluctuate based on the operating results of the Company. Our stock-based compensation decreased $23.5 million in the current year primarily due to our use of the graded-vesting method of recording expense related to the restricted stock units issued to employees of Towers Perrin in the Merger. Our pension and other employee benefits expense decreased $23.9 million due to the remeasurement of our U.S. pension and post-retirement plans in September 2010. The plan changes substantially reduced plan obligations associated with future pay and health care cost increases. In addition, our fringe benefits and taxes were reduced by $10.8 million. As a percentage of revenue, salaries and employee benefits decreased to 60% for the fiscal year 2012 from 63% for fiscal year 2011.                                           43

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Professional and Subcontracted Services

  Professional and subcontracted services for fiscal year 2012 were $285.1 million, compared to $246.3 million for fiscal year 2011, an increase of $38.7 million, or 16%. The increase is due to an increase of $32.7 million of external service provider fees to supplement our day-to-day operations including information technology consultants and recruiting fees. We also experienced an increase in $6.0 million of pass-through expenses, which are reimbursable under our contracts. As a percentage of revenue, professional and subcontracted services were 8% for fiscal year 2012 and 2011.  

Occupancy

  Occupancy expense for fiscal year 2012 was $141.1 million compared to $144.2 million for fiscal year 2011, a decrease of $3.1 million, or 2%. We experienced decreases in base rent related to consolidating locations and eliminating leases and for amortization of the fair value of acquired lease intangibles and tenant improvement allowances. As a percentage of revenue, occupancy expense was 4% for fiscal years 2012 and 2011.  

General and Administrative Expenses

  General and administrative expenses for fiscal year 2012 were $285.0 million, compared to $281.6 million for fiscal year 2011, an increase of $3.4 million, or 1%. The increase was principally due to increased non-billable travel costs and general office expenses to support an expanded employee base. As a percentage of revenue, general and administrative expenses decreased to 8% for fiscal year 2012 from 9% for fiscal year 2011.  

Depreciation and Amortization

  Depreciation and amortization expense for fiscal year 2012 was $152.9 million, compared to $130.6 million for fiscal year 2011, an increase of $22.3 million, or 17%. The increase is primarily due to amortization of intangible assets related to our three new acquisitions, Extend Health in fiscal year 2012 and EMB and Aliquant in fiscal year 2011. In addition, we accelerated amortization for a software application that we acquired in the merger as management determined that its use would be discontinued in the next three to four years. A portion of the increase is also attributable to increased depreciation on the computer hardware that has been placed in service in fiscal years 2011 and 2012. As a percentage of revenue, depreciation and amortization expenses were 4% for fiscal year 2012 and 2011.  

Transaction and Integration Expenses

  Transaction and integration expense for fiscal year 2012 was $86.1 million, compared to $100.5 million for fiscal year 2011, a decrease of $14.4 million, or 14%. The decrease was principally due to fees paid in fiscal year 2011 to terminate our external information technology service provider relationship and to terminate leases for our office integration, offset by increased expenses associated with information technology integration projects in the current year. As a percentage of revenue, transaction and integration expenses were 3% for fiscal years 2012 and 2011.  

(Loss) / Income from Affiliates

  Income from affiliates for fiscal year 2012 was $0.3 million compared to income from affiliates of $1.1 million for fiscal year 2011. In the second quarter of fiscal year 2012, we purchased a majority ownership in Fifth Quadrant and began to consolidate its operations. Fifth Quadrant Actuaries and Consultants Holdings (Pty) Ltd. ("Fifth Quadrant") has historically been the primary source of income from affiliates.  Interest Income 

Interest income was $3.9 million and $5.5 million for fiscal years 2012 and 2011, respectively.

Interest Expense

Interest expense was $9.2 million for fiscal year 2012, compared to $12.5 million for fiscal year 2011.

Other Non-Operating Income

  Other non-operating income for fiscal year 2012 was $11.4 million, compared to $19.3 million for fiscal year 2011. In fiscal year 2012, we recorded a $2.8 million gain resulting from the fair value adjustment to our investment in Fifth Quadrant upon the purchase of a controlling interest. We acquired an additional ownership in Fifth Quadrant and consolidated our former equity investee in our                                           44 

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  results of operations beginning in the second quarter of fiscal year 2012. Included in fiscal year 2011 is $9.4 million received for a deferred payment on the sale of an investment. In both fiscal years 2012 and 2011, we also recorded deferred payments from divestitures.  

Provision for Income Taxes

  Provision for income taxes for fiscal year 2012 was $145.8 million, compared to $129.9 million for fiscal year 2011. The effective tax rate was 35.9% for fiscal year 2012 compared to 39.8% for fiscal year 2011. Our effective tax rate decreased for fiscal year 2012 as compared to fiscal year 2011 primarily due to a change in the mix of income between foreign and U.S. operations, and the release of valuation allowance in foreign jurisdictions, offset by the reduction of tax loss carryforwards that cannot be utilized following legal entity restructurings. Beginning in fiscal year 2012, the Company no longer provides deferred taxes on current or future earnings with respect to the acquired Towers Perrin Canadian subsidiary. If future events, including material changes in estimates of cash, working capital and long-term investments requirements, necessitate that foreign earnings be distributed, an additional provision for U.S. income and foreign withholding taxes, net of foreign tax credits, may be necessary.  

Net Income Attributable to Controlling Interests

Net income attributable to controlling interests for the fiscal year ended June 30, 2012 was $260.2 million, an increase of $65.8 million, or 34%, compared to $194.4 million for the fiscal year ended June 30, 2011.

Diluted Earnings Per Share

Diluted earnings per share for fiscal year 2012 was $3.59, compared to $2.62 for fiscal year 2011.

Liquidity and Capital Resources

Our most significant sources of liquidity are funds generated by operating activities, available cash and cash equivalents, and our credit facility. Consistent with our liquidity position, management considers various alternative strategic uses of cash reserves including acquisitions, dividends and stock buybacks, or any combination of these options.

  We believe that we have sufficient resources to fund operations beyond the next 12 months. The key variables that we manage in response to current and projected capital resource needs include credit facilities and short-term borrowing arrangements, working capital and our stock repurchase program.  Our cash and cash equivalents at June 30, 2013 totaled $532.8 million, compared to $478.2 million at June 30, 2012. The increase in cash flows in fiscal 2013 was due to higher net income and from less cash used in business acquisitions. These increases were partially offset by lower cash inflows from borrowings. In fiscal year 2012, we paid $435.9 million in cash in conjunction with the acquisition of Extend Health, which was financed by borrowings under the Senior Credit Facility and a new $250.0 million term loan facility (the "Term Loan").  Our cash and cash equivalents balance includes $71.4 million from the consolidated balance sheets of PCIC and SMIC, which is available for payment of professional liability and other claims reserves. As a result, we have a net $461.4 million of cash that is available for our general use.  Our fiduciary assets totaled $148.4 million at June 30, 2013, compared to $171.4 million at June 30, 2012. Of this amount, $142.6 million is related to our reinsurance brokerage business and $5.8 million is related to our health and welfare benefits administration outsourcing business. While we are permitted to invest such cash in high-quality investments and earn investment income on these holdings, all amounts are held in a fiduciary capacity on behalf of insureds, reinsurers or clients and are not available for other general use by the Company.  Our non-U.S. operations are substantially self-sufficient for their working capital needs. As of June 30, 2013, $330.1 million of Towers Watson's total cash and cash equivalents balance of $532.8 million was held outside of the United States. Should we require more capital in the U.S. than is generated by our U.S. operations, we may decide to make additional borrowings under our Senior Credit Facility, repatriate funds held in foreign jurisdictions or raise capital in the U.S. through debt or equity issuances. These alternatives could result in higher effective tax rates or increased interest expense. We do not expect restrictions or taxes on repatriation of cash held outside the U.S. to have a material effect on the Company's overall liquidity, financial condition or results of operations.  During Fiscal 2013, the company changed its ASC 740, Income Taxes, assertion with respect to our U.K. subsidiary and repatriated $165 million from its U.K. subsidiary. The change in assertion is primarily due to changes in foreign cash and liquidity requirements.                                           45 

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  ASC 740, Income Taxes, requires a Company to recognize income tax expense when it becomes apparent that some or all of the undistributed earnings of a foreign subsidiary will be remitted in the foreseeable future. The U.S. tax cost from the UK repatriation was insignificant due to available foreign tax credits from the dividend equivalent to the U.S. statutory tax rate. We have not provided U.S. federal income taxes on undistributed foreign earnings of our other foreign subsidiaries because such earnings are considered indefinitely reinvested outside the United States. It is not practicable to estimate the U.S. federal income tax liability that might be payable if such earnings are not invested indefinitely. If future events, including material changes in estimates of cash, working capital and long-term investment requirements, necessitate that these earnings be repatriated, an additional provision for U.S. income and foreign withholding taxes, net of foreign tax credits, may be necessary.  Assets and liabilities associated with non-U.S. entities have been translated into U.S. dollars as of June 30, 2013, at U.S. dollar rates that fluctuate compared to historical periods. As a result, cash flows derived from changes in the consolidated balance sheets include the impact of the change in foreign exchange translation rates.  Events that could change the historical cash flow dynamics discussed above include significant changes in operating results, potential future acquisitions, material changes in geographic sources of cash, unexpected adverse impacts from litigation or future pension funding during periods of severe downturn in the capital markets.  

Cash Flows From Operating Activities.

  Cash flows from operating activities were $531.3 million for fiscal year 2013 compared to cash flows from operating activities of $316.1 million for fiscal year 2012. This increase of $215.3 million is primarily attributable to an increase in net income before non-controlling interests of $55.2 million and the increase in cash flows from accounts receivable collections of $189.3 million in fiscal year 2013 compared to fiscal year 2012. Our billed and unbilled accounts receivable balances decreased $58.5 million from June 30, 2012 to June 30, 2013 despite our revenue growth for the same period. Our ERP system has been fully implemented and our number of days of accounts receivable outstanding has returned to expected levels.  The allowance for doubtful accounts decreased $8.1 million from June 30, 2012 to June 30, 2013. The number of days of accounts receivable outstanding decreased to 81 at June 30, 2013 compared to 90 at June 30, 2012.  

Cash Flows Used in Investing Activities.

  Cash flows used in investing activities for fiscal year 2013 were $137.8 million, compared to $542.3 million for fiscal year 2012. This decrease in cash used is primarily due to $435.9 million of cash paid in fiscal year 2012 for the acquisition of Extend Health.  

Cash Flows (Used in) / From Financing Activities.

  Cash flows used in financing activities in fiscal year 2013 were $326.7 million, compared to cash flows from financing activities of $188.8 million in fiscal year 2012. The decrease in cash flows of $515.5 million was primarily due to higher repayments and lower borrowings under our Senior Credit Facility and our Term Loan in fiscal 2013 compared to fiscal 2012.  

During fiscal 2013, the average outstanding balance on our Senior Credit Facility was $197.1 million, and the largest outstanding balance was $365.9 million.

Capital Commitments

  Expenditures of capital were $77.9 million for fiscal year 2013. Additionally, during fiscal 2013, we spent $50.1 million for internally-developed capitalized software for external use by our clients.  

Dividends

  During November 2012, our board of directors approved the payment of a quarterly cash dividend in the amount of $0.115 per share which was paid in December 2012. Additionally, the board of directors declared an acceleration for calendar year 2013 of dividends otherwise payable in April 2013, July 2013 and October 2013. The $0.345 per share accelerated dividend was paid in December 2012. Since all dividends that would have been otherwise payable in calendar year 2013 were paid in December 2012, there were no dividend payments for the six months ended June 30, 2013. Total dividends paid in fiscal year 2013 and in fiscal year 2012 were $48.1 million and $26.4 million, respectively.                                           46

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Off-Balance Sheet Arrangements and Contractual Obligations

                                                            Remaining payments 

by fiscal year due as of June 30, 2013

                                                                   Less than                                      More Than Contractual Cash Obligations (in thousands)      Total              1 Year         1-3 Years      3-5 Years       5 Years Term loan                                     $    250,000$     25,000$   50,000$  175,000     $       - Lease commitments                                  575,374            107,910         182,919        126,982        157,563                                                $    825,374$    132,910$  232,919$  301,982$  157,563    Operating Leases. We lease office space under operating lease agreements with terms typically averaging 10 years. We have determined that there is not a large concentration of leases that will expire in any one fiscal year. Consequently, management anticipates that any increase in future rent expense on leases will be mainly market driven. While the future operating lease payments presented above are not recognized on our balance sheet, we do have certain assets and liabilities related to these leases in the form of deferred rent accruals and intangible assets and liabilities. The intangible assets and liabilities were recognized for the difference between the contractual cash obligations shown above and the estimated market rates at the time of certain past acquisitions. The resulting intangibles will amortize to rent expense but do not impact the amounts shown above since there is no change to our contractual cash obligations.  Pension Contribution. Contributions to our qualified pension plans for fiscal year 2014 are projected to be $86.6 million. Additionally, the Company expects to pay $68.6 million in benefits directly to participants under our non-qualified plans for fiscal 2014.  Uncertain Tax Positions. The table above does not include liabilities for uncertain tax positions under ASC 740, Income Taxes. The settlement period for the $40.7 million liability, which excludes interest and penalties, cannot be reasonably estimated since it depends on the timing and possible outcomes of tax examinations with various tax authorities.  Contingent Consideration from Acquisitions. The table above does not include liabilities for contingent consideration for our EMB acquisition in fiscal year 2011 and our DaVinci acquisition in fiscal 2013. As of June 30, 2013, we still expect to pay out £2.4 million per year for fiscal year 2014 through fiscal year 2016 related to the EMB contingent consideration provisions in our agreements and subject to performance requirements on behalf of the sellers. Related to the DaVinci acquisition, we expect to pay out approximately $125 thousand per year for fiscal year 2014 through fiscal year 2017.  

Indebtedness

Towers Watson Senior Credit Facility

  On November 7, 2011, Towers Watson and certain subsidiaries entered into a five-year, $500 million revolving credit facility, which amount may be increased by an aggregate amount of $250 million, subject to the satisfaction of customary terms and conditions, with a syndicate of banks (the "Senior Credit Facility"). Borrowings under the Senior Credit Facility bear interest at a spread to either LIBOR or the Prime Rate. During fiscal 2013, the weighted-average interest rate on the Senior Credit Facility was 1.49%. We are charged a quarterly commitment fee, currently 0.175% of the Senior Credit Facility, which varies with our financial leverage and is paid on the unused portion of the Senior Credit Facility. Obligations under the Senior Credit Facility are guaranteed by Towers Watson and all of its domestic subsidiaries (other than our captive insurance companies).  The Senior Credit Facility contains customary representations and warranties and affirmative and negative covenants. The Senior Credit Facility requires Towers Watson to maintain certain financial covenants that include a minimum Consolidated Interest Coverage Ratio and a maximum Consolidated Leverage Ratio (which terms in each case are defined in the Senior Credit Facility). In addition, the Senior Credit Facility contains restrictions on the ability of Towers Watson to, among other things, incur additional indebtedness; pay dividends; make distributions; create liens on assets; make acquisitions; dispose of property; engage in sale-leaseback transactions; engage in mergers or consolidations, liquidations and dissolutions; engage in certain transactions with affiliates; and make changes in lines of businesses. As of June 30, 2013, we were in compliance with our covenants.  

As of June 30, 2013, Towers Watson had no borrowings outstanding under the Senior Credit Facility.

Letters of Credit under the Senior Credit Facility

  As of June 30, 2013, Towers Watson had standby letters of credit totaling $21.4 million associated with our captive insurance companies in the event that we fail to meet our financial obligations. Additionally, Towers Watson had $1.7 million of standby letters of credit covering various other existing or potential business obligations. The aforementioned letters of credit are issued under the Senior Credit Facility, and therefore reduce the amount that can be borrowed under the Senior Credit Facility by the outstanding amount of these standby letters of credit.                                           47 

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Additional Borrowings, Letters of Credit and Guarantees not part of the Senior Credit Facility

  Towers Watson Consultoria Ltda. (Brazil) has a bilateral credit facility with a major bank totaling Brazilian Real (BRL) 6.5 million (U.S. $2.9 million). As of June 30, 2013, no borrowings were outstanding under this facility.  Towers Watson has also provided a $5.0 million Australian dollar-denominated letter of credit (U.S. $4.6 million) to an Australian governmental agency as required by local regulations. The estimated fair market value of this letter of credit is immaterial because it has never been used, and we believe that the likelihood of future usage is remote.  

Towers Watson also has $4.3 million of letters of guarantee from major banks in support of office leases and performance under existing or prospective contracts.

Term Loan Agreement Due June 2017

  On June 1, 2012, the Company entered into a five-year $250 million amortizing Term Loan with a consortium of banks. The interest rate on the term loan is based on the Company's choice of one, three or six month LIBOR plus a spread of 1.25% to 1.75%, or alternatively the bank base rate plus 0.25% to 0.75%. The spread to each index is dependent on the Company's consolidated leverage ratio. The weighted-average of the interest rates elected on the Term Loan during fiscal 2013 was 1.46%. The Term Loan amortizes at a rate of $6.25 million per quarter, beginning in September 2013, with a final maturity of June 1, 2017. The Company has the right to prepay a portion or all of the outstanding Term Loan balance on any interest payment date without penalty.  

This agreement contains substantially the same terms and conditions as our existing Senior Credit Facility dated November 7, 2011, including guarantees from all of the domestic subsidiaries of Towers Watson (other than PCIC and SMIC).

The Company entered into the Term Loan as part of the financing of our acquisition of Extend Health (see Note 2).

                             Non-U.S. GAAP Measures  In order to assist readers of our financial statements in understanding the core operating results that the Company's management uses to evaluate the business and for financial planning, we present (1) Adjusted Earnings Before Interest Tax Depreciation and Amortization, ("EBITDA"), (2) Adjusted Net Income Attributable to Controlling Interests, and (3) Adjusted Diluted Earnings Per Share (which are all non-U.S. GAAP measures), to eliminate the effect of acquisition-related expenses from the financial results of our operations. We use Adjusted Net Income Attributable to Controlling Interests (the numerator) for the purpose of calculating Adjusted Diluted Earnings Per Share. The Company believes that Adjusted EBITDA and Adjusted Diluted Earnings Per Share are relevant and useful information widely used by analysts, investors and other interested parties in our industry to provide a baseline for evaluating and comparing our operating results.  We incurred significant acquisition-related expenses related to our merger and integration activities necessary to combine Watson Wyatt and Towers Perrin from the Merger in January 2010 through fiscal year 2013. These acquisition-related expenses included transaction and integration costs, severance costs, non-cash charges for amortization of intangible assets and merger-related stock-based compensation costs from the issuance of merger-related restricted shares. Acquisition-related gains include a gain resulting from the fair value adjustment to our investment in Fifth Quadrant upon the purchase of a controlling interest. Included in our acquisition-related transaction and integration costs were integration consultant fees and legal, accounting, marketing and information technology integration expenses.  Although our merger and integration activities have been completed, we will continue to provide adjusted measures as we incur a significant amount of amortization from acquired intangibles. We expect that this amortization will continue over the estimated useful lives of the related intangibles. We consider Adjusted EBITDA and Adjusted Diluted Earnings Per Share to be important financial measures, which we use to internally evaluate and assess our core operations, and benchmark our operating results against our competitors. We use Adjusted EBITDA to evaluate and measure our performance-based compensation plans. Adjusted EBITDA and Adjusted Diluted Earnings Per Share are important in illustrating what our operating results would have been had we not incurred these acquisition-related expenses.  We define Adjusted EBITDA as net income before non-controlling interests adjusted for provision for income taxes, interest, net, depreciation and amortization, transaction and integration expenses, stock-based compensation, change in accounting method for pension, Extend Health stock-based compensation and other non-operating income. These non-U.S. GAAP measures are not defined in the same manner by all companies and may not be comparable to other similarly titled measures of other companies. Non-U.S. GAAP measures should be considered in addition to, and not as a substitute for, the information contained within our financial statements.                                           48 

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Reconciliation of Adjusted EBITDA to net income before non-controlling interests, Adjusted Net Income Attributable to Controlling Interests to net income attributable to controlling interests and Adjusted Diluted Earnings Per Share to diluted earnings per share are included in the tables below.

                                                                   Year Ended June 30,                                                       2013             2012             2011                                                                   (in thousands) Reconciliation of net income before non-controlling interests to Adjusted EBITDA is as follows: Net income before non-controlling interests         $ 315,652$ 260,476 Provision for income taxes                            152,551          145,756          129,916 Interest, net                                          10,276            5,296            6,952 Depreciation and amortization                         175,720          152,891          130,575 Transaction and integration expenses                   30,753           86,130          100,535 Stock-based compensation (a)                            9,868           31,152           71,715 Change in accounting method for pension                    -             2,963               - Extend Health stock-based compensation                     -               931               - Other non-operating income (b)                         (6,872 )        

(11,612 ) (20,430 )

  Adjusted EBITDA                                     $ 687,948$ 673,983$ 615,988

(a) Stock-based compensation is included in salary and employee benefits expense

and relates to Towers Watson Restricted Class A shares held by our current

associates which were awarded to them in connection with the Merger in 2010

and Extend Health stock options held by our current associates which were

assumed by the Company in connection with the acquisition.

(b) Other non-operating income includes income from affiliates and other

    non-operating income.                                            49 

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  Table of Contents                                                                       Year Ended                                                         2013             2012             2011                                                            (In thousands, except share and                                                                   per share amounts)  Net income attributable to controlling interests     $   318,812$ 260,213$ 194,437 Adjusted for certain Merger-related items (c) , (d): Amortization of intangible assets                         53,166          42,393           34,087 Transaction and integration expenses including severance                                                 20,733          54,110           64,799 Stock-based compensation (e)                               6,652          20,577           46,850 Deferred payment from divestiture                             -               -            (9,429 ) Change in accounting method for pension                       -            1,859               - Gain on investment in Fifth Quadrant                          -           (1,779 )             - Gain on investment in Extend Health                           -             (727 )             - Release of acquisition related liability                      -             (601 )             - Other merger-related tax items                                -             (698 )            603 Extend Health stock-based compensation                        -              615               -  Adjusted net income attributable to controlling interests                                            $   399,363       $ 

375,962 $ 331,347

   Weighted average shares of common stock - diluted (000)                                             71,555          72,542           74,139   Earnings per share - diluted, as reported            $      4.46$    3.59$    2.62 Adjusted for certain Merger-related items: Amortization of intangible assets                           0.73            0.59             0.46 Transaction and integration expenses including severance                                                   0.29            0.74             0.87 Stock-based compensation                                    0.09            0.28             0.63 Deferred payment from divestiture                             -               -             (0.13 ) Change in accounting method for pension                       -             0.03               - Gain on investment in Fifth Quadrant                          -            (0.03 )             - Gain on investment in Extend Health                           -            (0.01 )             - Release of acquisition related liability                      -            (0.01 )             - Other merger-related tax items                                -            (0.01 )             - Extend Health stock-based compensation                        -             0.01             0.01  Adjusted earnings per share - diluted                $      5.57$    5.18$    4.46

(c) The adjustments to net income attributable to controlling interests and

diluted earnings per share of certain Merger-related items are net of tax. In

calculating the net of tax amounts, all adjustments were tax effected at the

applicable effective tax rate (ETR) for the period, which was 32.6% for the

year ended June 30, 2013.

(d) In periods prior to fiscal 2013, there were significant variances between the

interim period ETR and the applicable ETR for each merger-related item. In

calculating the net of tax amounts for the years ended June 30, 2012 and

June 30, 2011, the ETRs applied were as follows:                                                                        Year-Ended                                                                2012         2011    Amortization of intangible assets                            35.40 %     

34.40 %

Transaction and integration expenses including severance 37.20 %

35.60 %

    Stock-based compensation                                     34.00 %     

34.70 %

    Deferred payment from divestiture                                        

34.50 %

   Change in accounting method for pension                      37.30 %    Gain on investment in Fifth Quadrant                         28.00 %    Gain on investment in Extend Health                          39.90 %    Release of acquisition related liability                     39.90 %    Extend Health stock-based compensation                       34.00 %                                            50 

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  Included in other merger-related tax items in 2012 is a $0.7 million benefit resulting from tax restructurings in Canada, Brazil, Mexico, Belgium, Sweden, Ireland and France. In 2011, the other merger-related tax items include a $1.1 million benefit resulting from a tax restructuring in Japan and $1.7 million expense resulting from incorporation of former Watson Wyatt branches. All merger-related tax items are included in the consolidated statement of operations under provision for income taxes for 2012 and 2011.    

(e) Stock-based compensation relates to shares of Restricted Class A common stock

held by our current associates which were awarded to them as former Towers

Perrin employees in connection with the Merger.

Risk Management

  As a part of our risk management program, we purchase customary commercial insurance policies, including commercial general liability and claims-made professional liability insurance. Our professional liability insurance currently includes a self-insured retention of $1 million per claim, together with a self-insured retention of $10 million aggregate, above the $1 million self-insured retention, and covers professional liability claims against us, including the cost of defending such claims.  Effective July 1, 2010 through July 1, 2011, Stone Mountain Insurance Company ("SMIC"), a wholly-owned captive insurance company, provided us with $50 million of professional liability insurance coverage per claim and in the aggregate, including the cost of defending such claims, above the $1 million self-insured retention. SMIC secured $25 million of reinsurance coverage from unaffiliated reinsurance companies in excess of the $25 million SMIC retained layer. Excess insurance attaching above the SMIC coverage is provided by various unaffiliated commercial insurance companies. Because we have a self-insured retention for each claim and because Stone Mountain is wholly-owned by us, our primary errors and omissions risk is borne by Towers Watson or the subsidiary SMIC. As stated above, commencing July 1, 2010, Towers Watson obtained primary insurance for errors and omissions professional liability risks from SMIC on a claims-made basis. SMIC has issued a policy of insurance substantially similar to the policies historically issued by PCIC.  For the policy period beginning July 1, 2011 and ending July 1, 2012, certain changes were made to our professional liability insurance program. These changes remain in-force for the policy periods beginning July 1, 2012 and ending July 1, 2013, and beginning July 1, 2013 and ending July 1, 2014. Our professional liability insurance includes a self-insured retention of $1 million per claim. Towers Watson also retains a $10 million aggregate self-insured retention above the $1 million self-insured retention per claim. SMIC provides us with $40 million of coverage per claim and in the aggregate, above these retentions. SMIC secured $25 million of reinsurance from unaffiliated reinsurance companies in excess of the $15 million SMIC retained layer. Excess insurance attaching above the SMIC coverage is provided by various unaffiliated commercial insurance companies. Because of the $1 million self-insured retention per claim and the additional $10 million aggregate self-insured retention above, and because Stone Mountain is wholly-owned by us, our primary errors and omissions risk is borne by Towers Watson and the subsidiary SMIC. We reserve for contingent liabilities based on ASC 450, Contingencies, when it is determined that a liability, inclusive of defense costs, is probable and reasonably estimable. The contingent liabilities recorded are primarily developed actuarially.  Before the Merger, Watson Wyatt and Towers Perrin each obtained substantial professional liability insurance from an affiliated captive insurance company, Professional Consultants Insurance Company ("PCIC"). A limit of $50 million per claim and in the aggregate was provided by PCIC subject to a $1 million per claim self-insured retention. PCIC secured reinsurance of $25 million attaching above the $25 million PCIC retained layer. In addition, both legacy companies carried excess insurance from unaffiliated commercial insurance companies above the self-insured retention and the coverage provided by PCIC.  Our ownership interest in PCIC is 72.86% post-Merger. As a consequence, PCIC's results of operations are consolidated into our results of operations. Although the PCIC insurance policies for Towers Watson's fiscal year 2010 continue to cover professional liability claims above a $1 million per claim self-insured retention, the consolidation of PCIC will effectively net PCIC's premium income against our premium expense for the first $25 million of loss above the self-insured retention for each legacy company. Accordingly, the impact of PCIC's reserve development may result in fluctuations in our earnings. PCIC ceased issuing insurance policies effective July 1, 2010 and at that time entered into a run-off mode of operation. Our shareholder agreements with PCIC could require additional payments to PCIC if development of claims significantly exceeds prior expectations.  We provide for the self-insured retention where specific estimated losses and loss expenses for known claims are considered probable and reasonably estimable. Although we maintain professional liability insurance coverage, this insurance does not cover claims made after expiration of our current policies of insurance. Generally accepted accounting principles require that we record a liability for incurred but not reported ("IBNR") professional liability claims if they are probable and reasonably estimable, and for which we have not yet contracted for insurance coverage. We use actuarial assumptions to estimate and record our IBNR liability. As of June 30, 2013, we had a $184.1 million IBNR liability, net of recoverable receivables of our captive insurance companies. This net liability decreased from $202.2 million as of June 30, 2012 as the result of improved claims experience. To the extent our captive insurance companies, PCIC and SMIC, expect losses to be covered by a third party, they record a receivable for the amount expected to be recovered. This receivable is classified in other current or other noncurrent assets in our consolidated balance sheet.  Insurance market conditions for us and our industry have varied in recent years, but the long-term trend has been increasing premium cost. Although the market for professional liability insurance is presently reasonably accessible, trends toward higher self-insured                                           51 

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  retentions, constraints on aggregate excess coverage for this class of professional liability risk and financial difficulties which have, over the past few years, been faced by several longstanding E&O carriers, are anticipated to recur periodically, and to be reflected in our future annual insurance renewals. As a result, we will continue to assess our ability to secure future insurance coverage, and we cannot assure that such coverage will continue to be available in the event of adverse claims experience, adverse loss trends, market capacity constraints or other factors.  In light of increasing litigation worldwide, including litigation against professionals, we have a policy that all client relationships be documented by engagement letters containing specific risk mitigation clauses that were not included in all historical client agreements. Certain contractual provisions designed to mitigate risk may not be legally enforceable in litigation involving breaches of fiduciary duty or certain other alleged errors or omissions, or in certain jurisdictions. We may incur significant legal expenses in defending against litigation.  

Recent Accounting Pronouncements

Not yet adopted

  On February 5, 2013, the FASB issued ASU 2013-02, "Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income," which requires entities to disclose additional information about items reclassified out of accumulated other comprehensive income ("AOCI"). The requirements include by component disclosures of changes in AOCI balances along with the related income tax benefit or expense and significant items reclassified out of AOCI. ASU 2013-2 is effective for annual periods, and interim periods within those years, beginning after December 15, 2012, and the amendments are to be applied prospectively. While early adoption is permitted, the Company plans to adopt the new requirements in its reporting for the first quarter of the Company's fiscal year 2014. The Company expects no material impact to its financial statements as a result of adopting this provision.  On June 7, 2013, the FASB issued ASU 2013-08, "Financial Services - Investment Companies (Topic 946): Amendments to the Scope, Measurement, and Disclosure Requirements," which amends the criteria an entity would need to meet to qualify as an investment company under ASC 946. The ASU (1) introduces new disclosure requirements that apply to all investment companies and (2) amends the measurement criteria for certain interests in other investment companies. The ASU also amends the requirements in ASC 810 related to qualifying for the "investment-company deferral" in ASU 2010-10 as well as the requirements in ASC 820 related to qualifying for the "net asset value practical expedient" in ASU 2009-12. We manage certain funds that are considered variable interest entities and for which our management fee is considered a variable interest. These funds qualify for the "investment-company deferral" in ASU 2010-10 and therefore are subject to the consolidation guidance prior to the issuance of ASU 2009-17. The ASU is effective for interim and annual periods that begin after December 15, 2013, and early adoption is prohibited. The Company is currently evaluating whether these funds will continue to qualify for the "investment-company deferral" based on the amended investment company criteria proscribed by ASU 2013-08.  On July 18, 2013, the FASB issued ASU 2013-11, "Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists," which requires an unrecognized tax benefit to be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, similar tax loss, or a tax credit carryforward. To the extent the tax benefit is not available at the reporting date under the governing tax law or if the entity does not intend to use the deferred tax asset for such purpose, the unrecognized tax benefit should be presented as a liability and not combined with deferred tax assets. ASU 2013-11 is effective for annual periods, and interim periods within those years, beginning after December 15, 2013. The amendments are to be applied to all unrecognized tax benefits that exist as of the effective date and may be applied retrospectively to each prior reporting period presented. While early adoption is permitted, the Company plans to adopt the new requirements in its reporting for the first quarter of the Company's fiscal year 2014. The Company expects no material impact to its financial statements as a result of adopting this provision. 

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