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1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (U.S. GAAP) and include all normal recurring adjustments which Aon Corporation (Aon or the Company) considers necessary to present fairly the Companys consolidated financial statements for all periods presented. The consolidated financial statements include the accounts of Aon and its majority-owned subsidiaries and variable interest entities (VIEs) for which Aon is considered to be the primary beneficiary. The consolidated financial statements exclude VIEs for which Aon is not the primary beneficiary. All material intercompany accounts and transactions have been eliminated.
Certain information and footnote disclosures normally included in the financial statements prepared in accordance with U.S. GAAP have been condensed or omitted. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Companys Annual Report on Form 10-K for the year ended December 31, 2009. The results for the three and six months ended June 30, 2010 are not necessarily indicative of operating results that may be expected for the full year ending December 31, 2010.
Use of Estimates
The preparation of the accompanying condensed consolidated financial statements in conformity with U.S. GAAP 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 reserves and expenses. These estimates and assumptions are based on managements best estimates and judgments. Management evaluates its estimates and assumptions on an ongoing basis using historical experience and other factors, including the current economic environment, which management believes to be reasonable under the circumstances. Management adjusts such estimates and assumptions when facts and circumstances dictate. As future events and their effects cannot be determined with precision, actual results could differ significantly from these estimates. Changes in estimates resulting from continuing changes in the economic environment will be reflected in the financial statements in future periods. |
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2. Accounting Principles and Practices
Changes in Accounting Principles
On January 1, 2010, the Company adopted guidance amending current principles related to the transfers of financial assets and the consolidation of VIEs. This guidance eliminates the concept of a qualifying special-purpose entity (QSPE) and the related exception for applying consolidation guidance, creates more stringent conditions for reporting the transfer of a portion of a financial asset as a sale, clarifies other sale-accounting criteria, and changes the initial measurement of a transferors interest in transferred financial assets. Consequently, former QSPEs are evaluated for consolidation based on the updated VIE guidance. In addition, the new guidance requires companies to take a qualitative approach in determining a VIEs primary beneficiary and requires companies to more frequently reassess whether they must consolidate VIEs. Additional year-end and interim period disclosures are also required outlining a companys involvement with VIEs and any significant change in risk exposure due to that involvement, as well as how its involvement with VIEs impacts the Companys financial statements. See Note 9 regarding the consolidation of Private Equity Partnership Structures I, LLC (PEPS I).
On January 1, 2010, the Company adopted guidance requiring additional disclosures regarding fair value measurements. The amended guidance requires entities to disclose additional information regarding assets and liabilities that are transferred between levels of the fair value hierarchy. This guidance also clarifies existing guidance pertaining to the level of disaggregation at which fair value disclosures should be made and the requirements to disclose information about the valuation techniques and inputs used in estimating Level 2 and Level 3 fair value measurements. See Note 15 for these disclosures. The guidance also requires entities to disclose information in the Level 3 rollforward about purchases, sales, issuances and settlements on a gross basis. Aon will make the required disclosures beginning in the first quarter of 2011 when this part of the guidance becomes effective.
Recent Accounting Pronouncements
In September 2009, the Financial Accounting Standards Board (FASB) issued guidance updating current principles related to revenue recognition when there are multiple-element arrangements. This revised guidance relates to the determination of when the individual deliverables included in a multiple-element arrangement may be treated as separate units of accounting and modifies the manner in which the transaction consideration is allocated across the separately identifiable deliverables. The guidance also expands the disclosures required for multiple-element revenue arrangements. These changes will be effective for Aon beginning in the first quarter of 2011, and may be applied retrospectively for all periods presented or prospectively to arrangements entered into or modified after the adoption date. Early adoption is permitted. The Company believes that the adoption of this guidance will not have a material impact on its consolidated financial statements. |
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3. Cash and Cash Equivalents
Cash and cash equivalents include cash balances and all highly liquid investments with initial maturities of three months or less. Cash and cash equivalents included restricted balances of $79 million and $85 million at June 30, 2010 and December 31, 2009, respectively. |
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4. Other Income (Expense)
Other income (expense) consists of the following (in millions):
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5. Acquisitions and Dispositions
Acquisitions
In the first six months of 2010, the Company completed the acquisition of the JP Morgan Compensation and Benefit Strategies Division of JP Morgan Retirement Plan Services, LLC, which is included in the Consulting segment, as well as 13 other companies, which are included in the Risk and Insurance Brokerage Services segment. In the first six months of 2009, the Company completed the acquisition of 5 companies, all of which were included in the Risk and Insurance Brokerage Services segment. The following table includes the aggregate amount paid and the intangible assets recorded as a result of the acquisitions made during the first six months of 2010 and 2009. Approximately $40 million of future payments relating primarily to earn-outs will be made for acquisitions completed during the first six months of 2010. These amounts are recorded in Other current liabilities and Other non-current liabilities in the Condensed Consolidated Statements of Financial Position. For certain of the acquisitions made in the first six months of 2010, the Company is in the process of obtaining third-party valuations for the intangible assets other than goodwill, and therefore, at June 30, 2010 the allocation of the purchase prices are still subject to refinement.
The results of operations of these acquisitions are included in the condensed consolidated financial statements from the dates they were acquired. These acquisitions would not produce a materially different result if they had been reported from the beginning of the period.
Dispositions - Continuing Operations
Some of Aons U.S. (Cananwill), U.K., Canadian, and Australian subsidiaries (together Cananwill International) originated short-term loans (generally with terms of 12 months or less) to businesses to finance their insurance premium obligations, and then sold these premium finance agreements to unaffiliated companies, typically bank Special Purpose Entities (SPEs), in whole loan securitization transactions that met the criteria for sales accounting. Cananwills results were included in the Risk and Insurance Brokerage Services segment.
In December 2008, Aon signed a definitive agreement to sell the U.S. Cananwill operations. This disposition was completed in February 2009. A pretax loss of $7 million was recorded, of which $2 million was recorded in first quarter 2009 and $5 million in 2008, and is included in Other income (expense) in the Condensed Consolidated Statements of Income. Aon may receive up to $10 million from the buyer over the two years following the sale, based on the amount of insurance premiums and related obligations financed by the buyer over this period that are generated from certain of Cananwills producers. As of June 30, 2010, Aon had received $5 million from the buyer, which is recorded in Other income (expense) in the Condensed Consolidated Statements of Income.
In connection with this sale, Aon has guaranteed the collection of the principal amount of the premium finance notes sold to the buyer, which, at June 30, 2010, was $2 million, if losses exceed the historical credit loss reserve for the business. Historical losses in this business have been very low since the premium finance notes are generally fully collateralized by the lenders right, in the event of non-payment, to cancel the underlying insurance contract and collect the unearned premium from the insurance carrier. The Company does not expect to incur any significant losses related to this guarantee.
In June and July of 2009, the Company entered into agreements with third parties with respect to Aons Cananwill International operations. As a result of these agreements, these third parties began originating, financing and servicing premium finance loans generated by referrals from Aons brokerage operations. The third parties did not acquire the existing portfolio of Aons premium finance loans, and as such, the Company did not extend any guarantees under these agreements.
Dispositions - Discontinued Operations
AIS Management Corporation
In 2008, Aon reached a definitive agreement to sell AIS Management Corporation (AIS), which was previously included in the Risk and Insurance Brokerage Services segment, to Mercury General Corporation, for $120 million in cash at closing, plus a potential earn-out of up to $35 million payable over the two years following the completion of the agreement. The disposition was completed in January 2009 and resulted in a pretax gain of $86 million in first quarter 2009. As of June 30, 2010, Aon had not received any of the potential earn-out.
The operating results of all businesses classified as discontinued operations are as follows (in millions):
Included in Other Gain (loss) on sale for the three and six months ended June 30, 2010 is a $38 million expense for the settlement of legacy litigation related to the Buckner vs. Resource Life matter. See Note 16 Commitments and Contingencies for further information. |
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6. Goodwill and Other Intangible Assets
The changes in the net carrying amount of goodwill by operating segment for the six months ended June 30, 2010 are as follows (in millions):
Other intangible assets by asset class are as follows (in millions):
Amortization expense on intangible assets was $29 million and $56 million for the three and six months ended June 30, 2010, respectively. Amortization expense on intangible assets was $22 million and $45 million for the three and six months ended June 30, 2009, respectively. As of June 30, 2010, the estimated amortization for intangible assets is as follows (in millions):
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7. Restructuring
Aon Benfield Restructuring Plan
The Company announced a global restructuring plan (Aon Benfield Plan) in conjunction with its acquisition of Benfield in 2008. The restructuring plan is intended to integrate and streamline operations across the combined Aon Benfield organization. The Aon Benfield Plan includes an estimated 700 job eliminations, of which approximately 595 jobs have been eliminated as of June 30, 2010. Additionally, duplicate space and assets will be abandoned. The Company currently estimates the Plan will result in cumulative costs totaling approximately $155 million, of which $55 million was recorded as part of the purchase price allocation, $70 million has been recorded in earnings to date, and an estimated additional $30 million will be recorded in future earnings. Expenses include workforce reduction, lease consolidation costs, asset impairments, as well as other expenses necessary to implement the restructuring initiative. The Company recorded $6 million and $15 million of restructuring and related charges in the three and six months ended June 30, 2010, respectively. The Company recorded $21 million and $30 million of restructuring and related charges in the three and six months ended June 30, 2009, respectively. Total payments of $90 million have been made under this Plan to date.
All costs associated with the Aon Benfield Plan are included in the Risk and Insurance Brokerage Services segment. Costs related to the restructuring are included in Compensation and benefits and Other general expenses in the Condensed Consolidated Statements of Income. The Company expects these restructuring activities and related expenses to affect continuing operations into 2011.
The following summarizes the restructuring and related costs by type that have been incurred and are estimated to be incurred through the end of the restructuring initiative related to the Aon Benfield plan (in millions):
(1) Actual costs, when incurred, will vary due to changes in the assumptions built into this plan. Significant assumptions likely to change when plans are finalized and implemented include, but are not limited to, changes in severance calculations, changes in the assumptions underlying sublease loss calculations due to changing market conditions, and changes in the overall analysis that might cause the Company to add or cancel component initiatives.
(2) Other costs associated with restructuring initiatives, including moving costs and consulting and legal fees, are recognized when incurred.
2007 Restructuring Plan
In 2007, the Company announced a global restructuring plan intended to create a more streamlined organization and reduce future expense growth to better serve clients (2007 Plan). The 2007 Plan is substantially complete. The Company expects to incur additional expenses of $4 million in 2010. The 2007 Plan includes an estimated 4,600 job eliminations. As of June 30, 2010, approximately 4,170 positions have been eliminated. The Company has closed or consolidated several offices resulting in sublease losses or lease buy-outs. Expenses include workforce reduction, lease consolidation costs, asset impairments, as well as other expenses necessary to implement the restructuring initiative. The Company recorded $25 million and $92 million of restructuring and related charges in the three and six months ended June 30, 2010, respectively. The Company recorded $74 million and $108 million of restructuring and related charges in the three and six months ended June 30, 2009, respectively. Costs related to the restructuring are included in Compensation and benefits and Other general expenses in the Condensed Consolidated Statements of Income.
The following summarizes the restructuring and related expenses by type that have been incurred and are estimated to be incurred through the end of the restructuring initiative related to the 2007 Plan (in millions):
(1) Other costs associated with restructuring initiatives, including moving costs and consulting and legal fees, are recognized when incurred.
The following summarizes the restructuring and related expenses by segment that have been incurred and are estimated to be incurred through the end of the restructuring initiative, related to the 2007 Plan (in millions):
Restructuring Liabilities
As of June 30, 2010, the Companys liabilities for its restructuring plans are as follows (in millions):
Aons unpaid restructuring liabilities are included in Accounts payable and accrued liabilities and Other non-current liabilities in the Condensed Consolidated Statements of Financial Position. |
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8. Investments
The Company earns income on cash balances and investments, as well as on premium trust balances that Aon maintains for premiums collected from insureds but not yet remitted to insurance companies. The premium trust balances are not owned by Aon, and cannot be used for general corporate purposes. These balances, because of their nature, are required to be invested in very liquid securities with highly-rated, credit-worthy financial institutions. Premium trust balances are included in Fiduciary assets in the Condensed Consolidated Statements of Financial Position. Fiduciary assets included cash and investments of $3.8 billion and fiduciary receivables of $8.4 billion at June 30, 2010. Fiduciary assets included cash and investments of $3.3 billion and fiduciary receivables of $7.5 billion at December 31, 2009.
The Companys interest-bearing assets are included in the following categories in the Condensed Consolidated Statements of Financial Position (in millions):
The Companys investments are as follows (in millions):
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9. Variable Interest Entities
Consolidated Variable Interest Entities
In 2001, Aon sold the vast majority of its limited partnership (LP) portfolio, valued at $450 million, to PEPS I, a QSPE. In accordance with the recently issued VIE guidance, former QSPEs must now be assessed to determine if they are VIEs. Aon concluded that PEPS I is a VIE and that it holds a variable interest in PEPS I. Aon also concluded that it is the primary beneficiary of PEPS I, as it has the power to direct the activities that most significantly impact economic performance and it has the obligation or right to absorb losses or receive benefits that could potentially be significant to PEPS I. As a result of adopting this new guidance, Aon consolidated PEPS I effective January 1, 2010. The financial statement impact of consolidating PEPS I resulted in:
· the removal of the $87 million PEPS I preferred stock, previously reported in investments, and · the addition of $77 million of equity method investments in LPs; cash of $57 million, of which $52 million is restricted; long-term debt of $47 million; a decrease in accumulated other comprehensive income net of tax of $44 million; and an increase in retained earnings of $44 million.
As part of the original transaction, Aon is required to purchase from PEPS I additional securities equal to the unfunded LP commitments, as they are requested. These securities are rated below investment grade. Aon funded $1 million of commitments for both the second quarter and the first six months of 2010. As of June 30, 2010, the unfunded commitments were $41 million. The commitments have specific expiration dates and the general partners may decide not to draw on these commitments.
Unconsolidated Variable Interest Entities
At June 30, 2010, Aon held a 36% interest in Juniperus Insurance Opportunity Fund Limited (Juniperus), which is an investment vehicle that invests in an actively managed and diversified portfolio of insurance risks. Aon has concluded that Juniperus is a VIE. However, Aon has concluded that it is not the primary beneficiary as it lacks the power to direct the activities of Juniperus that most significantly impact economic performance. The investment in Juniperus is accounted for using the equity method of accounting.
Aons potential loss at June 30, 2010 is limited to its investment in Juniperus of $67 million, which is recorded in Investments in the Condensed Consolidated Statements of Financial Position. Aon has not provided any financing to Juniperus other than previously contractually required amounts. |
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10. Debt
As a result of adopting the new guidance on VIEs and consolidating PEPS I effective January 1, 2010, Aon recorded $47 million of long-term debt in the Condensed Consolidated Statements of Financial Position as of June 30, 2010.
At June 30, 2010, Aon reclassified its 5.05% CAD 375 million ($362 million) debt securities to Short-term debt and current portion of long-term debt in the Condensed Consolidated Statements of Financial Position as the due date of the securities, April 2011, is less than one year from the balance sheet date. |
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11. Stockholders Equity
Common Stock
Under the share repurchase program begun in 2005, Aons Board of Directors has authorized the Company to repurchase up to $4.6 billion of its outstanding common stock. Shares may be repurchased through the open market or in privately negotiated transactions from time to time, based on prevailing market conditions, and will be funded from available cash. Any repurchased shares will be available for employee stock plans and for other corporate purposes. In second quarter 2010, Aon repurchased 1.2 million shares at a cost of $50 million, at an average price of $41.03 per share. In the first six months of 2010, Aon repurchased 2.4 million shares at a cost of $100 million. Since the inception of this share repurchase program, the Company has repurchased a total of 108.3 million shares for an aggregate cost of $4.4 billion. As of June 30, 2010, the Company was authorized to purchase up to $165 million of additional shares under this stock repurchase program. The timing and amount of future purchases will be based on market and other conditions.
In January 2010, the Companys Board of Directors authorized a new share repurchase program under which up to $2 billion of common stock may be repurchased from time to time depending on market conditions or other factors through open market or privately negotiated transactions. Repurchases will commence under the new share repurchase program upon conclusion of the existing program.
In connection with the acquisition of two entities controlled by Aons then-Chairman and Chief Executive Officer in 2001, Aon obtained approximately 22.4 million shares of its common stock. These treasury shares are restricted as to their reissuance.
In the first six months of 2010, Aon reissued 5.7 million shares of treasury stock for employee benefit plans and 186,000 shares of treasury stock in connection with employee stock purchase plans. No new shares were issued for employee benefit plans during the first six months of 2010. In the first six months of 2009, Aon issued 966,000 new shares of common stock for employee benefit plans and reissued approximately 5.0 million shares of treasury stock for employee benefit plans and 157,000 shares in connection with employee stock purchase plans.
Participating Securities
Unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents, whether paid or unpaid, are participating securities, as defined, and therefore should be included in computing basic and diluted earnings per share using the two class method. Certain of Aons restricted stock awards allow the holder to receive a non-forfeitable dividend equivalent. Income from continuing operations, Income (loss) from discontinued operations and Net income, attributable to participating securities, were as follows (in millions):
Weighted average shares outstanding are as follows (in millions):
(1) Includes 6.3 million and 7.1 million of participating securities for the three months ended June 30, 2010 and 2009, respectively, and 6.3 million and 7.2 million of participating securities for the six months ended June 30, 2010 and 2009, respectively.
Certain common stock equivalents, primarily related to options, were not included in the computation of diluted net income per share because their inclusion would have been antidilutive. The number of shares excluded from the calculation was 4 million and 5 million for the three months ended June 30, 2010 and 2009, respectively, and 5 million for both the six months ended June 30, 2010 and 2009.
Comprehensive Income (Loss)
The components of comprehensive income, net of related tax, are as follows (in millions):
The components of Accumulated other comprehensive loss, net of related tax, are as follows (in millions):
(1) Reflects impact of adopting new accounting guidance which resulted in the consolidation of PEPS I effective January 1, 2010. |
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12. Employee Benefits
The following table provides the components of the net periodic benefit cost for Aons U.S. pension plans, along with the material international plans, which are located in the U.K., the Netherlands, and Canada (in millions):
In addition to the net periodic benefit cost shown above, during the second quarter of 2010, the Company recorded a non-cash charge to pension expense of $49 million, ($29 million after tax), with a corresponding credit to accumulated other comprehensive income. This charge is reported in Compensation and benefits in the Condensed Consolidated Statements of Income and represents the correction of an error in the calculation of pension expense for the Companys U.S. pension plan for the period from 1999 to the end of the first quarter of 2010. The error was the result of an overstatement of the market-related value (MRV) of plan assets beginning in 1999 in conjunction with the merger of two U.S. pension plans. MRV is used to determine both the expected return on assets and the amortization of gains and losses which are included in the calculation of the Companys net periodic pension expense. As a result of the overstatement of MRV, aggregate pension expense was understated in the period from 1999 to first quarter 2010. However, as MRV is only used to determine pension expense, the funded status of the U.S. plan and the reported liability position has not been impacted in the period from 1999 to 2010. The Company evaluated the impact of this error in relation to its reported results and financial position for the individual years in the period from 1999 to 2009 and also in relation to the expected full year results for 2010. The Company concluded, in accordance with the guidance related to accounting for error corrections, that the impact was not material and, therefore, no restatement of any of the prior periods presented was required.
In first quarter 2009, a curtailment gain of $83 million was recognized as a result of the Company ceasing crediting future benefits relating to salary and service for the U.S. defined benefit pension plan, which is reported in Compensation and benefits in the Condensed Consolidated Statements of Income.
Also in first quarter 2009, a curtailment gain of $10 million was recognized in discontinued operations resulting from the sale of the Companys Combined Insurance Company of America (CICA) subsidiary. The curtailment gain related to the Companys U.S. Retiree Health and Welfare Plan, in which CICA employees were allowed to participate through the end of 2008, pursuant to the terms of the sale.
During the second quarter 2009, Aon recorded a $5 million curtailment charge attributable to a remeasurement resulting from the decision to cease service accruals in the Canadian plans, which is reported in Compensation and benefits in the Condensed Consolidated Statements of Income.
Based on current assumptions, in 2010, Aon plans to contribute $30 million and $248 million to its U.S. and material international defined benefit pension plans, respectively. Projected contributions to the international plans have been lowered due to the completion of negotiations with certain U.K. pension plan trustees as well as the effects of foreign exchange rates. As of June 30, 2010, contributions of $14 million and $126 million have been made to its U.S. and material international pension plans, respectively. |
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13. Stock Compensation Plans
The following table summarizes stock compensation expense recognized in continuing operations in the Condensed Consolidated Statements of Income in Compensation and benefits (in millions):
During the first half of 2009, the Company converted its stock administration system to a new service provider. In connection with this conversion, a reconciliation of the methodologies utilized was performed, which resulted in a $10 million reduction of expense for the six months ended June 30, 2009.
Stock Awards
During the first six months of 2010, the Company granted approximately 1.6 million shares in connection with the completion of the 2007 Leadership Performance Plan (LPP) cycle. During the first six months of 2009, the Company granted approximately 2.0 million shares in connection with the completion of the 2006 LPP cycle. In addition, the Company granted approximately 3.1 million restricted shares in connection with the Companys incentive compensation plans in each of the first six months of 2010 and 2009.
A summary of the status of Aons non-vested stock awards is as follows (shares in thousands):
(1) Represents weighted average fair value per share of award at date of grant.
Information regarding Aons performance-based plans is as follows (shares in thousands, dollars in millions):
Stock Options
The weighted average assumptions used to determine fair values, the weighted average expected life and weighted average estimated fair value per share of employee stock options granted are summarized as follows:
Beginning in the first quarter 2010, the Company eliminated the grant of options under two of its key equity award programs, the LPP and the Special Stock Plan, in order to manage share usage and expense. During the first six months of 2009, the Company granted 1.0 million stock options at $39 per share in connection with the 2009 LPP Plan and approximately 0.4 million stock options at $37 per share in connection with the Companys incentive compensation plans.
A summary of the status of Aons stock options and related information is as follows (shares in thousands):
The weighted average remaining contractual life of outstanding options was 3.9 years and 4.5 years at June 30, 2010 and 2009, respectively.
The aggregate intrinsic value represents the total pretax intrinsic value, based on options with an exercise price less than the Companys closing stock price of $37.12 as of June 30, 2010, which would have been received by the option holders had those option holders exercised their options as of that date. At June 30, 2010, the aggregate intrinsic value of options outstanding was $75 million, of which $54 million was exercisable.
Other information related to the Companys stock options is as follows (in millions):
Unamortized deferred compensation expense, which includes both options and awards, amounted to $316 million as of June 30, 2010, with a remaining weighted average amortization period of approximately 2.0 years. |
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14. Derivatives and Hedging
Aon is exposed to market risk primarily from changes in foreign currency exchange rates and interest rates. To manage the risk related to these exposures, Aon enters into various derivative transactions that reduce Aons market risks by creating offsetting market exposures. Aon does not enter into derivative transactions for trading purposes.
Derivative transactions are governed by a uniform set of policies and procedures covering areas such as authorization, counterparty exposure and hedging practices. Positions are monitored using techniques such as sensitivity analyses.
Certain derivatives also give rise to credit risks from the possible non-performance by counterparties. The credit risk is generally limited to the fair value of those contracts that are favorable to Aon. Aon has limited its credit risk by using International Swaps and Derivatives Association (ISDA) master agreements and credit support arrangements, entering into non-exchange-traded derivatives with highly-rated major financial institutions, and by using exchange-traded instruments. Aon monitors the credit-worthiness of, and exposure to, its counterparties. As of June 30, 2010, all derivative liability positions were entered into pursuant to terms of ISDA master agreements, and were free of credit risk contingent features. In addition, Aon has received collateral of $169 million from counterparties and pledged collateral of $84 million to counterparties for derivatives subject to collateral support arrangements as of June 30, 2010, which are recorded in Other long-term liabilities in the Condensed Consolidated Statement of Financial Position.
Foreign Exchange Risk Management
Aon and its subsidiaries are exposed to foreign exchange risk when they receive revenues, pay expenses, or enter into intercompany loans denominated in a currency that differs from their functional currency. Aon uses foreign exchange derivatives, typically forward contracts, options and cross currency swaps, to reduce its overall exposure to the effects of currency fluctuations on cash flows. Aon has hedged these exposures up to six years in the future. Aon has designated foreign exchange derivatives with a notional amount of $2.2 billion at June 30, 2010 as cash flow hedges of these exposures. As of June 30, 2010, a $48 million pretax loss has been deferred to Other comprehensive income (OCI) related to these hedges, of which $28 million is expected to be reclassified to earnings in the next twelve months. These hedges had no material ineffectiveness in either the first six months of 2010 or 2009. As of June 30, 2010, Aon also has $161 million notional amount of foreign exchange derivatives not designated or qualifying as cash flow hedges offsetting its exposures to foreign exchange risks.
Aon also uses foreign exchange derivatives, typically forward contracts and options, to hedge its net investments in foreign operations for up to four years in the future. As of June 30, 2010, the notional amount outstanding was $1.5 billion and a $205 million gain has been deferred to OCI related to this hedge. This hedge had no ineffectiveness in either the first six months of 2010 or 2009.
Aon also uses foreign exchange derivatives, typically forward contracts and options, with a notional amount of $63 million at June 30, 2010, to reduce the impact of foreign currency fluctuations on the translation of the financial statements of Aons foreign operations and to manage the currency exposure of Aons global liquidity profile for one year in the future. These derivatives are not eligible for hedge accounting treatment.
Interest Rate Risk Management
Aon holds variable rate short-term brokerage and other operating deposits. Aon uses interest rate derivatives, typically swaps, to reduce its exposure to the effects of interest rate fluctuations on the forecasted interest receipts from these deposits for up to three years in the future. Aon has designated interest rate derivatives with a notional amount of $1.1 billion at June 30, 2010 as cash flow hedges of this exposure. As of June 30, 2010, a $5 million pretax gain has been deferred to OCI related to this hedge, all of which is expected to be reclassified to earnings during the next twelve months. This hedge had no material ineffectiveness in either the first six months of 2010 or 2009.
In 2009, a subsidiary of Aon issued 500 million ($618 million at June 30, 2010 exchange rates) of fixed rate debt due on July 1, 2014. Aon is exposed to changes in the fair value of the debt due to interest rate fluctuations. Aon uses receive-fixed-pay-floating interest rate swaps to reduce its exposure to the effects of interest rate fluctuations on the fair value of the debt. Aon has designated interest rate swaps with a notional amount of 250 million ($309 million at June 30, 2010 exchange rates) at June 30, 2010 as a fair value hedge of this exposure. This hedge did not have any ineffectiveness in either the first six months of 2010 or 2009.
As of June 30, 2010, the fair values of derivative instruments are as follows (in millions):
The amounts of derivative gains (losses) recognized in the Condensed Consolidated Statements of Income for the three and six months ended June 30, 2010 are as follows (in millions):
The amounts of derivative gains (losses) recognized in the Condensed Consolidated Statements of Income for the three and six months ended June 30, 2009 are as follows (in millions):
The amount of gain (loss) recognized in income on the ineffective portion of derivatives for both the three months and six months ended June 30, 2010 and 2009 was negligible.
Aon recorded a gain of $4 million and a loss of $5 million in Other general expenses for foreign exchange derivatives not designated or qualifying as hedges for the three months ended June 30, 2010 and 2009, respectively. Aon recorded a gain of $3 million and $6 million in Other general expenses for foreign exchange derivatives not designated or qualifying as hedges for the six months ended June 30, 2010 and 2009, respectively. |
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15. Fair Value and Financial Instruments
Accounting standards establish a three tier fair value hierarchy which prioritizes the inputs used in measuring fair values as follows:
· Level 1 observable inputs such as quoted prices for identical assets in active markets; · Level 2 inputs other than quoted prices for identical assets in active markets, that are observable either directly or indirectly; and · Level 3 unobservable inputs in which there is little or no market data which requires the use of valuation techniques and the development of assumptions.
The following methods and assumptions are used to estimate the fair values of the Companys financial instruments:
Money market funds and highly liquid debt securities are carried at cost and amortized cost, respectively, as an approximation of fair value. Based on market convention, the Company considers cost a practical and expedient measure of fair value.
Fixed-maturity securities are carried at fair value, which is based on quoted market prices or on estimated values if they are not actively traded. In some cases where a market price is available, the Company will make use of acceptable expedients (such as matrix pricing) to estimate fair value.
Derivatives are carried at fair value, based upon industry standard valuation techniques that use, where possible, current market-based or independently sourced pricing inputs, such as interest rates, currency exchange rates, or implied volatilities.
Guarantees are carried at fair value, which is based on discounted estimated future cash flows using published historical cumulative default rates and discount rates commensurate with the underlying exposure.
Debt is carried at outstanding principal balance. Fair value is based on quoted market prices or estimates using discounted cash flow analyses based on current borrowing rates for similar types of borrowing arrangements.
The following table presents, for each of the fair-value hierarchy levels, the Companys assets and liabilities that are measured at fair value on a recurring basis at June 30, 2010 (in millions):
(1) Includes $2,018 million of money market funds and $27 million of highly liquid debt securities that are classified as Fiduciary assets, Short-term investments or Cash equivalents in the Condensed Consolidated Statements of Financial Position, depending on their nature and initial maturity. See Note 8 for additional information regarding the Companys investments.
The following table presents the changes in the Level 3 fair-value category for the three months ended June 30, 2010 (in millions):
The following table presents the changes in the Level 3 fair-value category for the six months ended June 30, 2010 (in millions):
(1) Transfers represent the removal of the investment in PEPS I preferred stock as a result of consolidating PEPS I on January 1, 2010. See Note 9 for further information.
There are no realized or unrealized gains or losses related to assets and liabilities measured at fair value using level three inputs included in income for either the three or six months ended June 30, 2010.
The following table discloses the Companys financial instruments where the carrying amounts and fair values differ (in millions):
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16. Commitments and Contingencies
Legal
Aon and its subsidiaries are subject to numerous claims, tax assessments, lawsuits and proceedings that arise in the ordinary course of business, which frequently include errors and omissions (E&O) claims. The damages claimed in these matters are or may be substantial, including, in many instances, claims for punitive, treble or extraordinary damages. Aon has historically purchased E&O insurance and other insurance to provide protection against certain losses that arise in such matters. Aon has exhausted or materially depleted its coverage under some of the policies that protect the Company and, consequently, is self-insured or materially self-insured for some historical claims. Accruals for these exposures, and related insurance receivables, when applicable, have been provided to the extent that losses are deemed probable and are reasonably estimable. These accruals and receivables are adjusted from time to time as developments warrant. Amounts related to settlement provisions are recorded in Other general expenses in the Condensed Consolidated Statements of Income.
At the time of the 2004-05 investigation of the insurance industry by the Attorney General of New York (NYAG) and other regulators, purported classes of clients filed civil litigation against Aon and other companies under a variety of legal theories, including state tort, contract, fiduciary duty, antitrust and statutory theories and federal antitrust and Racketeer Influenced and Corrupt Organizations Act (RICO) theories. The federal actions were consolidated in the U.S. District Court for the District of New Jersey, and a state court collective action was filed in California. In the New Jersey actions, the Court dismissed plaintiffs federal antitrust and RICO claims in separate orders in August and October 2007, respectively. Plaintiffs have appealed these dismissals. Aon believes it has meritorious defenses in all of these cases and intends to vigorously defend itself against these claims. The outcome of these lawsuits, and any losses or other payments that may occur as a result, cannot be predicted at this time.
Also at the time of the NYAG investigation, putative classes filed actions against Aon in the U.S. District Court for the Northern District of Illinois under the federal securities laws and ERISA. Plaintiffs in the federal securities class action originally submitted purported expert reports estimating a range of alleged damages of $353 million to $490 million, and plaintiffs in the ERISA class actions originally submitted revised purported expert reports estimating a range of alleged damages of $74 million to $349 million. To protect against the uncertain outcome of litigation and to contain exposure to the Company, Aon settled the securities suit for $30 million in 2009 and has reached an agreement to settle the ERISA suit for $1.8 million. On November 24, 2009, the Court entered a final order approving the securities settlement and dismissing the securities suit. On April 15, 2010, the Court granted preliminary approval of the ERISA settlement pending notice to the class, and set a hearing for final approval to occur in September, 2010.
Following inquiries from regulators, the Company commenced an internal review of its compliance with certain U.S. and non-U.S. anti-corruption laws, including the U.S. Foreign Corrupt Practices Act (FCPA). In January 2009, Aon Limited, Aons principal U.K. brokerage subsidiary, entered into a settlement agreement with the Financial Services Authority (FSA) to pay a £5.25 million fine arising from its failure to exercise reasonable care to establish and maintain effective systems and controls to counter the risks of bribery arising from the use of overseas firms and individuals who helped it win business. The U.S. Securities and Exchange Commission (SEC) and the U.S. Department of Justice (DOJ) continue to investigate these matters. Aon is fully cooperating with these investigations and has agreed with the U.S. agencies to toll any applicable statute of limitations pending completion of the investigations. Based on current information, the Company is unable to predict at this time when the SEC and DOJ matters will be concluded, or what regulatory or other outcomes may result.
A putative class action, Buckner v Resource Life, was filed in state court in Columbus, Georgia, against a former subsidiary of Aon, Resource Life Insurance Company. The complaint alleged that Resource Life, which wrote policies insuring repayment of auto loans, was obligated to identify and return unearned premiums to policyholders whose loans terminated before the end of their scheduled terms. In connection with the sale of Resource Life in 2006, Aon agreed to indemnify Resource Lifes buyer in certain respects relating to this action. In October 2009, the court certified a nationwide class of policyholders whose loans terminated before the end of their scheduled terms and who Resource Life cannot prove received a refund of unearned premium. Resource Life took an appeal from that decision. Also in October 2009, Aon filed a lawsuit in Illinois state court seeking a declaratory judgment with respect to the rights and obligations of Aon and Resource Life under the indemnity agreement. In July 2010, Aon entered into settlements of both cases, subject to providing notice to the Buckner class and obtaining court approval of the Buckner settlement. Aon agreed to pay $47,750,000 on Resource Lifes behalf in complete settlement with the plaintiff class in Buckner, of which a pretax expense of $37,750,000 was reflected in Income (loss) from discontinued operations before income taxes in both the second quarter and the first six months 2010 Condensed Consolidated Statements of Income. A portion of this payment may be returned to Aon if checks are undeliverable or some class members do not cash their settlement payments. Subject to certain limitations, the return payment, if any, would be divided 50% to Aon and 50% to a fund to be used for charitable purposes. Additionally, the settlement agreement with Resource Life provides potential future benefits from Resource Life. At this time, the amount of future payments to Aon, if any, cannot be determined and Aon will record any such amounts when they are received.
From time to time, Aons clients may bring claims and take legal action pertaining to the performance of fiduciary responsibilities. Whether client claims and legal action related to the Companys performance of fiduciary responsibilities are founded or unfounded, if such claims and legal actions are resolved in a manner unfavorable to the Company, they may adversely affect Aons financial results and materially impair the market perception of the Company and that of its products and services.
Although the ultimate outcome of all matters referred to above cannot be ascertained, and liabilities in indeterminate amounts may be imposed on Aon or its subsidiaries, on the basis of present information, amounts already provided, availability of insurance coverages and legal advice received, it is the opinion of management that the disposition or ultimate determination of such claims will not have a material adverse effect on the consolidated financial position of Aon. However, it is possible that future results of operations or cash flows for any particular quarterly or annual period could be materially affected by an unfavorable resolution of these matters.
Guarantees and Indemnifications
Aon provides a variety of guarantees and indemnifications to its customers and others. The maximum potential amount of future payments represents the notional amounts that could become payable under the guarantees and indemnifications if there were a total default by the guaranteed parties, without consideration of possible recoveries under recourse provisions or other methods. These amounts may bear no relationship to the expected future payments, if any, for these guarantees and indemnifications. Any anticipated amounts payable which are deemed to be probable and estimable are accrued in Aons consolidated financial statements.
Commitments associated with Aons limited partnership securitization are disclosed in Note 9. Guarantees associated with the collection of the principal amount of the premium finance notes sold to the buyer of the Companys U.S. premium finance business are disclosed in Note 5.
Aon has total letters of credit (LOCs) outstanding for $60 million at June 30, 2010. These LOCs secure deductible retentions for the Companys workers compensation program, cover the beneficiaries related to its Canadian pension plan scheme, secure one of its U.S. pension plans, and to cover contingent payments for taxes and other business obligations to third parties. Aon has also issued various other guarantees for miscellaneous purposes at its international subsidiaries. Amounts are accrued in the consolidated financial statements to the extent the guarantees are probable and estimable.
Aon has certain contractual contingent guarantees for premium payments owed by clients to certain insurance companies. Costs associated with these guarantees, to the extent estimable and probable, are provided in Aons allowance for doubtful accounts. The estimated exposure with respect to such contractual contingent guarantees was approximately $8 million at June 30, 2010.
Aon expects that as prudent business interests dictate, additional guarantees and indemnifications may be issued from time to time. |
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17. Segment Information
Aon classifies its businesses into two operating segments: Risk and Insurance Brokerage Services and Consulting. Unallocated income and expenses, when combined with the operating segments and after the elimination of intersegment revenues and expenses, total to the amounts in the Condensed Consolidated Financial Statements.
Operating segments have been determined using a management approach, which is consistent with the basis and manner in which Aons chief operating decision maker uses financial information for the purposes of allocating resources and evaluating performance. Aon evaluates performance based on stand-alone operating segment operating income and generally accounts for intersegment revenue as if the revenue were from third parties and at what management believes are current market prices.
The Risk and Insurance Brokerage Services business acts as an advisor and insurance broker, helping clients manage their risks, as well as negotiating and placing insurance risk with insurance carriers through the Companys global distribution network.
The Consulting business provides advice and services to clients related to health and benefits, retirement, compensation, strategic human capital, and human resource outsourcing.
Aons total revenue is as follows (in millions):
Commissions, fees and other revenue by product are as follows (in millions):
Fiduciary investment income by segment is as follows (in millions):
A reconciliation of segment operating income to total income from continuing operations before income taxes is as follows (in millions):
Revenues are generally attributed to geographic areas based on the location of the resources producing the revenues. Intercompany revenues are eliminated in computing consolidated revenues. Consolidated revenue by geographic area is as follows (in millions):
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18. Subsequent Event
On July 11, 2010, Aon entered into an Agreement and Plan of Merger (the Merger Agreement) with Hewitt Associates, Inc., a Delaware corporation (Hewitt), Alps Merger Corp., a Delaware corporation and wholly owned subsidiary of Aon (Merger Sub), and Alps Merger LLC, a Delaware limited liability company and wholly owned subsidiary of Aon (Merger LLC). The Merger Agreement provides, among other things, that, upon the terms and subject to the conditions set forth in the Merger Agreement, (i) Merger Sub will merge with and into Hewitt, with Hewitt surviving as a wholly owned subsidiary of Aon (the Merger), and (ii) following the completion of the Merger, the surviving corporation from the Merger will merge with and into Merger LLC (the Subsequent Merger), with Merger LLC surviving the Subsequent Merger and continuing as a wholly owned subsidiary of Aon.
Subject to the terms and conditions of the Merger Agreement, which has been approved and adopted by the boards of directors of each of Aon and Hewitt, at the effective time of the Merger (the Effective Time), each share of Class A common stock, par value $0.01 per share, of Hewitt (Hewitt Common Stock) outstanding immediately prior to the Effective Time will convert into, at the election of each of the holders of Hewitt Common Stock, (i) 0.6362 of a share of common stock, par value $1.00 per share, of Aon (Aon Common Stock), and $25.61 in cash (the Mixed Consideration), (ii) an amount of cash (the Cash Consideration) equal to the sum of (a) $25.61 and (b) the product obtained by multiplying 0.6362 by the Closing Volume-Weighted Average Price (as defined in the Merger Agreement), or (iii) a number of shares of Aon Common Stock (the Stock Consideration) equal to the sum of (a) 0.6362 and (b) the quotient obtained by dividing $25.61 by the closing volume-weighted average price of Aon Common Stock for the period of ten consecutive trading days ending on the second full trading day prior to the Effective Time (the Exchange Ratio). Holders of Hewitt Common Stock who do not make an election will receive the Mixed Consideration. The consideration to be paid to holders of Hewitt Common Stock electing to receive the Cash Consideration or the Stock Consideration in connection with the Merger is subject, pursuant to the terms of the Merger Agreement, to automatic adjustment, as applicable, to ensure that the amount of cash paid and the number of shares of Aon Common Stock issued by Aon in the Merger each represents approximately 50% of the aggregate merger consideration (taking into account the roll-over of Hewitt options, as described below). No fractional shares of Aon Common Stock will be issued in the Merger, and holders of Hewitt Common Stock will receive cash in lieu of any fractional shares of Aon Common Stock.
In connection with the Merger, each outstanding unvested Hewitt stock option will fully vest, and, pursuant to the Merger Agreement, at the Effective Time, each outstanding Hewitt stock option will be converted into an option to purchase Aon Common Stock, with the same terms and conditions (but taking into account any changes, including any acceleration or vesting of such option, by reason of the Merger), with adjustments to reflect the Exchange Ratio. Shares of Hewitt restricted stock will vest and be converted into the Mixed Consideration, and restricted stock units of Hewitt and performance share units of Hewitt will be settled in Hewitt common stock and then converted into the Mixed Consideration.
The closing of the Merger is subject to various conditions, including Aon and Hewitt stockholder approval, governmental and regulatory approvals and other usual and customary closing conditions. The parties expect the Merger to close in mid-November 2010.
Concurrently, and in connection with entering into the Merger Agreement, Aon entered into a commitment letter (the Debt Commitment Letter) with Credit Suisse and Morgan Stanley Senior Funding, Inc. under which they committed to provide an unsecured term loan financing of up to $1.0 billion (the Term Loan Facility) and an unsecured bridge financing of up to $1.5 billion (the Bridge Facility and, together with the Term Loan Facility, the Facilities). Aon has the option to issue up to $1.5 billion in senior notes in lieu of all or a portion of the drawing under the Bridge Facility or to refinance all or a portion of the Bridge Facility at a later date. The proceeds from these borrowings or issuances will be used by Aon to pay a portion of the cash consideration to be paid in the Merger, to refinance existing indebtedness of Hewitt and its subsidiaries and to pay related fees and expenses. The Term Loan Facility will mature three years following the Effective Time, and the Bridge Facility will mature 364 days following the Effective Time. The Debt Commitment Letter provides, among other things, that the closings of the Term Loan Facility and the Bridge Facility are subject to certain conditions. |
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As of June 30, 2010, the estimated amortization for intangible assets is as follows (in millions):
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(1) Actual costs, when incurred, will vary due to changes in the assumptions built into this plan. Significant assumptions likely to change when plans are finalized and implemented include, but are not limited to, changes in severance calculations, changes in the assumptions underlying sublease loss calculations due to changing market conditions, and changes in the overall analysis that might cause the Company to add or cancel component initiatives.
(2) Other costs associated with restructuring initiatives, including moving costs and consulting and legal fees, are recognized when incurred. |
(1) Other costs associated with restructuring initiatives, including moving costs and consulting and legal fees, are recognized when incurred. |
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(1) Includes 6.3 million and 7.1 million of participating securities for the three months ended June 30, 2010 and 2009, respectively, and 6.3 million and 7.2 million of participating securities for the six months ended June 30, 2010 and 2009, respectively. |
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(1) Reflects impact of adopting new accounting guidance which resulted in the consolidation of PEPS I effective January 1, 2010. |
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(1) Represents weighted average fair value per share of award at date of grant. |
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As of June 30, 2010, the fair values of derivative instruments are as follows (in millions):
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(1) Includes $2,018 million of money market funds and $27 million of highly liquid debt securities that are classified as Fiduciary assets, Short-term investments or Cash equivalents in the Condensed Consolidated Statements of Financial Position, depending on their nature and initial maturity. See Note 8 for additional information regarding the Companys investments. |
(1) Transfers represent the removal of the investment in PEPS I preferred stock as a result of consolidating PEPS I on January 1, 2010. See Note 9 for further information. |
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