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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 that Aon Corporation (“Aon” or the “Company”) considers necessary to present fairly the Company’s Condensed Consolidated Financial Statements for all periods presented. The Condensed Consolidated Financial Statements include the accounts of Aon and its wholly and majority-owned subsidiaries and variable interest entities (“VIEs”) for which Aon is considered to be the primary beneficiary. The consolidated financial statements exclude special-purpose entities (“SPEs”) considered 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 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 Company’s Annual Report on Form 10-K for the year ended December 31, 2010. The presentation of certain amounts in the financial statements and related notes for prior periods has been changed to conform to the presentation in the Annual Report on Form 10-K for the year ended December 31, 2010. The purchase of shares from noncontrolling interests and dividends paid to noncontrolling interests are now shown separately within financing activities. These amounts were shown in operating activities in the prior year’s presentation. The results for the three and nine months ended September 30, 2011 are not necessarily indicative of operating results that may be expected for the full year ending December 31, 2011.
Use of Estimates
The preparation of the accompanying unaudited 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 management’s 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. Aon adjusts such estimates and assumptions when facts and circumstances dictate. Illiquid credit markets, volatile equity markets, and foreign currency movements have combined to increase the uncertainty inherent in such estimates and assumptions. 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
In September 2011, the Financial Accounting Standards Board (“FASB”) issued final guidance on goodwill impairment that gives an entity the option to perform a qualitative assessment that may eliminate the requirement to perform the annual two-step test. The current two-step test requires an entity to assess goodwill for impairment by quantitatively comparing the fair value of a reporting unit with its carrying amount, including goodwill (Step 1). If the reporting unit’s fair value is less than its carrying amount, Step 2 of the test must be performed to measure the amount of goodwill impairment, if any. The recently issued guidance gives an entity the option to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If an entity concludes that this is the case, it must perform the two-step test. Otherwise, the two-step test is not required. The guidance is effective for Aon beginning in the first quarter 2012, with earlier adoption permitted. The adoption of this guidance is not expected to have a material impact on the Company’s financial statements.
In June 2011, the FASB issued guidance that updated principles related to the presentation of comprehensive income. The revised guidance will require companies to present the components of net income and other comprehensive income either as one continuous statement or as two consecutive statements and eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity. The guidance, which must be applied retroactively, is effective for Aon beginning in the first quarter 2012, with earlier adoption permitted. The adoption of this guidance is expected to affect only the presentation of the consolidated financial statements, and will have no effect on the financial condition, results of operations or cash flows of the Company.
On January 1, 2010, the Company adopted guidance requiring additional disclosures for fair value measurements. The amended guidance required entities to disclose additional information for assets and liabilities that are transferred between levels of the fair value hierarchy. This guidance also clarified 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. The guidance also required entities to disclose information in the Level 3 rollforward about purchases, sales, issuances and settlements on a gross basis. See Note 15 “Fair Value Measurements and Financial Instruments” for these disclosures.
In September 2009, the FASB issued guidance that updated principles related to revenue recognition when there are multiple-element arrangements. This guidance related to the determination of when the individual deliverables included in a multiple-element arrangement may be treated as separate units of accounting and modified the manner in which the transaction consideration is allocated across the separately identifiable deliverables. The guidance also expanded the disclosures required for multiple-element revenue arrangements. The effective date for this guidance was January 1, 2011. The Company early adopted this guidance in the fourth quarter 2010 and applied its requirements to all revenue arrangements entered into or materially modified after January 1, 2010. The adoption of this guidance did not have a material impact on the Company’s 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 $183 million and $60 million at September 30, 2011 and December 31, 2010, respectively. The increase in the restricted balances is primarily due to a requirement for the Company to hold approximately $123 million of operating funds in the U.K. |
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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 nine months ended September 30, 2011, the Company completed the acquisition of one company in the HR Solutions segment and two companies in the Risk Solutions segment, including Glenrand MIB Limited (“Glenrand”). For the same period in 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 HR Solutions segment, as well as 13 other companies, which are included in the Risk Solutions segment.
The following table includes the aggregate consideration transferred and the preliminary value of intangible assets recorded as a result of the Company’s acquisitions.
The results of operations of these acquisitions are included in the Condensed Consolidated Financial Statements from the dates they were acquired. The results of operations of the Company would not have been materially different if these acquisitions had been reported from the beginning of the period.
Hewitt Associates, Inc.
On October 1, 2010, the Company completed its acquisition of Hewitt Associates, Inc. (“Hewitt”), one of the world’s leading human resource consulting and outsourcing companies. Aon purchased all of the outstanding shares of Hewitt common stock in a cash-and-stock transaction valued at approximately $4.9 billion, of which the total amount of cash paid and the total number of shares of stock issued by Aon each represented approximately 50% of the aggregate consideration.
The Company incurred certain acquisition and integration costs associated with the transaction that were expensed as incurred. In the three and nine months ended September 30, 2011, the Company’s HR Solutions segment incurred $22 million and $42 million, respectively, of these Hewitt related costs that are recorded in Other general expenses in the Condensed Consolidated Statements of Income.
The transaction has been accounted for using the acquisition method of accounting which requires, among other things, that most assets acquired and liabilities assumed be recognized at their fair values as of the acquisition date.
The following table summarizes the recording of assets acquired and liabilities assumed as of the acquisition date (in millions):
(1) Includes cash and cash equivalents, short-term investments, client receivables, other current assets, accounts payable and other current liabilities.
(2) Includes primarily deferred contract costs and long-term investments.
(3) Includes primarily unfavorable lease obligations and deferred contract revenues.
(4) As of the acquisition date, included in Other current assets ($31 million), Other non-current assets ($30 million), Other current liabilities ($7 million) and Other non-current liabilities ($1.1 billion) in the Company’s Condensed Consolidated Statements of Financial Position.
The acquired customer relationships are being amortized over a weighted average life of 12 years. The technology asset is being amortized over 7 years and trademarks were determined to have indefinite useful lives.
A single estimate of fair value results from a complex series of the Company’s judgments about future events and uncertainties and relies heavily on estimates and assumptions. The Company’s judgments used to determine the fair value assigned to each class of assets acquired and liabilities assumed, as well as asset lives, can materially impact the Company’s results of operations.
Dispositions — Continuing Operations
In the nine months ended September 30, 2011, the Company completed the sale of two companies in the Risk Solutions segment. A pretax loss of $1.8 million was recognized on these sales, which is included in Other income (expense) in the Condensed Consolidated Statements of Income.
Dispositions — Discontinued Operations
Income from discontinued operations of $4 million, which represents proceeds from the sale of businesses in prior periods, was recorded for the nine months ended September 30, 2011. A loss from discontinued operations of $26 million, related primarily to the settlement of legacy litigation, was incurred in the nine months ended September 30, 2010. | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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6. Goodwill and Other Intangible Assets
The change in the net carrying amount of goodwill by operating segment for the nine months ended September 30, 2011 is as follows (in millions):
Other intangible assets by asset class are as follows (in millions):
Amortization expense on intangible assets with finite lives was $91 million and $273 million for the three and nine months ended September 30, 2011, respectively. Amortization expense on intangible assets with finite lives was $30 million and $86 million for the three and nine months ended September 30, 2010, respectively.
The estimated future amortization for intangible assets as of September 30, 2011 is as follows (in millions):
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7. Restructuring
Aon Hewitt Restructuring Plan
On October 14, 2010, Aon announced a global restructuring plan (“Aon Hewitt Plan”) in connection with the acquisition of Hewitt. The Aon Hewitt Plan is intended to streamline operations across the combined Aon Hewitt organization and includes an estimated 1,500 to 1,800 job eliminations. The Company expects these restructuring activities and related expenses to affect continuing operations into 2013. The Aon Hewitt Plan is expected to result in cumulative costs of approximately $325 million through the end of the plan, consisting of approximately $180 million in employee termination costs and approximately $145 million in real estate realization costs.
From the inception of the Aon Hewitt Plan through September 30, 2011, approximately 1,030 jobs have been eliminated and total expenses of $132 million have been incurred. The Company recorded $26 million and $80 million of restructuring and related charges in the three and nine months ended September 30, 2011, respectively. All costs associated with the Aon Hewitt Plan are included in the HR Solutions segment. Charges related to the restructuring are included in Compensation and benefits and Other general expenses in the accompanying Condensed Consolidated Statements of Income.
The following summarizes restructuring and related costs by type that have been incurred and are estimated to be incurred through the end of the restructuring initiative related to the Aon Hewitt Plan (in millions):
(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.
Following the Hewitt acquisition and the associated increase in personnel and property portfolio, the Company continues to review the propriety of its existing leasehold restructuring accruals based on its current plans. In the second quarter of 2011, the Company reoccupied some of its previously vacated leasehold space and therefore determined that certain amounts previously accrued for this space were no longer necessary. The reversal of these accruals for each of the Company’s restructuring plans is discussed below. In addition, the reoccupation of this space resulted in expenses that had previously been included as part of lease consolidation costs being reversed and included within Other general expenses. The impact on each of the Company’s restructuring plans is discussed below.
Aon Benfield Restructuring Plan
The Company announced a global restructuring plan (“Aon Benfield Plan”) in conjunction with its acquisition of Benfield in 2008. The Aon Benfield Plan is intended to integrate and streamline operations across the combined Aon Benfield organization. The Aon Benfield Plan includes an estimated 875 job eliminations. Additionally, duplicate space and assets will be abandoned. The Company originally estimated that the Aon Benfield Plan would result in cumulative costs totaling approximately $185 million over a three-year period, of which $104 million was recorded as part of the Benfield purchase price allocation and $81 million of which was expected to result in future charges to earnings. The Company currently estimates the Aon Benfield Plan will result in cumulative costs totaling approximately $160 million, of which $53 million was recorded as part of the purchase price allocation, $79 million has been recorded in earnings from inception to date, and an estimated additional $28 million will be recorded in future earnings. The Company expects to incur all remaining costs for the Aon Benfield Plan in the fourth quarter 2011.
The Company recorded $3 million of restructuring and related charges in the three months ended September 30, 2011, and a net restructuring benefit of $2 million in the nine months ended September 30, 2011. Included in this nine month net benefit is $18 million related to the reversal of accruals associated with reoccupying leasehold space. In addition, in the three and nine months ended September 30, 2011, a benefit of $2 million and charges of $4 million, respectively, related to lease expenses were recorded as part of Other general expenses that were previously included as lease restructuring consolidation costs.
The Company recorded $5 million and $20 million of restructuring and related charges in the three and nine months ended September 30, 2010, respectively.
As of September 30, 2011, approximately 715 jobs have been eliminated under the Aon Benfield Plan. Total payments of $119 million have been made under the Aon Benfield Plan, from inception to date.
All costs associated with the Aon Benfield Plan are included in the Risk Solutions segment. Charges related to the restructuring are included in Compensation and benefits and Other general expenses in the accompanying Condensed Consolidated Statements of Income.
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 plan was completed in the fourth quarter of 2010 and the Company does not expect to incur any further expenses. In the three and nine months ended September 30, 2011, the Company recorded a restructuring benefit of $3 million and $8 million, respectively, related to the reversal of accruals associated with reoccupied leasehold space. In addition, in the three and nine months ended September 30, 2011, $2 million and $5 million, respectively, of lease expenses were recorded as part of Other general expenses that were previously included as restructuring lease consolidation costs.
The Company recorded $3 million and $95 million of restructuring and related charges in the three and nine months ended September 30, 2010, respectively.
The total cumulative pretax charges for the 2007 Plan are $740 million including costs related to workforce reduction, lease consolidation costs, asset impairments, as well as other expenses necessary to implement the restructuring.
As of September 30, 2011, the Company’s liabilities for its restructuring plans are as follows (in millions):
(1) The Company assumed a $43 million net real estate related restructuring liability in connection with the Hewitt acquisition. (2) Includes impact of reoccupying previously vacated leased properties.
Aon’s restructuring liabilities are included in both 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, and funds held under the terms of certain outsourcing agreements to pay certain obligations on behalf of clients. Premium trust balances and a corresponding liability are included in Fiduciary assets and Fiduciary liabilities in the accompanying Condensed Consolidated Statements of Financial Position.
The Company’s interest-bearing assets and other investments are included in the following categories in the Condensed Consolidated Statements of Financial Position (in millions):
The Company’s investments are as follows (in millions):
(1) The reduction in other investments is primarily due to sales and redemptions. | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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9. Debt
At September 30, 2011, the Company had $100 million in commercial paper outstanding as compared to no commercial paper outstanding at September 30, 2010. The Company utilizes the proceeds from the commercial paper market from time to time in order to meet short term working capital needs.
On May 24, 2011 Aon entered into an underwriting agreement for the sale of $500 million of 3.125% unsecured Senior Notes due 2016 (the “Notes”). On June 15, 2011, Aon entered into a Term Credit Agreement for unsecured term loan financing of $450 million (“2011 Term Loan Facility”) due on October 1, 2013. The 2011 Term Loan Facility is a variable rate loan that is based on LIBOR plus a margin and at September 30, 2011, the effective annualized rate was approximately 1.56%. The Company used the net proceeds from the Notes issuance and 2011 Term Loan Facility borrowings to repay all amounts outstanding under its $1.0 billion three-year credit agreement dated August 13, 2010 (“2010 Term Loan Facility”), which was entered into in connection with the acquisition of Hewitt. The Company recorded a $19 million loss on the extinguishment of the 2010 Term Loan Facility as a result of the write-off of the related deferred financing costs, which is included in Other income (expense) in the Condensed Consolidated Statements of Income.
On March 8, 2011, an indirect wholly-owned subsidiary of Aon issued CAD 375 million ($363 million at September 30, 2011 exchange rates) of 4.76% senior unsecured debt securities, which are due in March 2018 and are guaranteed by the Company. The Company used the net proceeds from this issuance to repay its CAD 375 million 5.05% debt securities upon their maturity on April 12, 2011. |
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10. Stockholders’ Equity
Common Stock
In 2007, Aon’s Board of Directors increased the Company’s authorized share repurchase program to $4.6 billion. In January 2010, the Company’s Board of Directors authorized a new share repurchase program under which up to $2 billion of common stock may be repurchased (“2010 Share Repurchase Program”). Repurchases under the 2010 Share Repurchase Program commenced in the first quarter 2011, upon conclusion of the prior program. Shares may be repurchased through the open market or in privately negotiated transactions, including structured repurchase programs, from time to time, based on prevailing market conditions, and will be funded from available capital. Any repurchased shares will be available for employee stock plans and for other corporate purposes.
In the third quarter 2011, Aon repurchased 3.8 million shares at an average price per share of $45.61 for a total cost of $175 million. In the first nine months of 2011, Aon repurchased 16.4 million shares at an average price per share of $50.39, for a total cost of $828 million. In the third quarter 2010, Aon did not repurchase any shares. In the first nine months of 2010, Aon repurchased 2.4 million shares for a total cost of $100 million. Since the inception of its share repurchase program in 2005, Aon has repurchased a total of 128.3 million shares for an aggregate cost of $5.4 billion. As of September 30, 2011, Aon was authorized to purchase up to $1.2 billion of additional shares under the 2010 Share Repurchase Program.
In the nine months ended September 30, 2011, Aon issued 0.5 million shares of common stock in relation to the exercise of options issued to former holders of Hewitt options as part of the Hewitt acquisition. In addition, in the nine months ended September 30, 2011 Aon reissued 6.7 million shares of treasury stock for employee benefit programs and 0.2 million shares in connection with employee stock purchase plans. In the nine months ended September 30, 2010, Aon reissued 6.8 million shares of treasury stock for employee benefit programs and 0.3 million 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, are included in computing basic and diluted earnings per share using the two class method. Certain of Aon’s 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 5.2 million and 5.8 million of participating securities for the three months ended September 30, 2011 and 2010, respectively, and 5.5 million and 6.1 million of participating securities for the nine months ended September 30, 2011 and 2010, respectively.
Certain common stock equivalents, primarily related to stock 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 1.0 million and 5.1 million for the three month periods ended September 30, 2011 and 2010, respectively. The number of shares excluded from the calculation was 0.1 million and 5.0 million for the nine month periods ended September 30, 2011 and 2010, respectively.
Other Comprehensive Income (Loss)
The components of other comprehensive income (loss), 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):
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11. Employee Benefits
The following table provides the components of the net periodic benefit cost for Aon’s U.S. pension plans, along with the material international plans, which are located in the U.K., the Netherlands, and Canada (in millions):
Based on current assumptions, in 2011, Aon plans to contribute $114 million and $365 million to its U.S. and material international defined benefit pension plans, respectively. For the first nine months of 2011, contributions of $96 million have been made to the Company’s U.S. pension plans and $292 million have been made to its material international pension plans. | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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12. Stock Compensation Plans
The following table summarizes stock-based compensation expense recognized in the Condensed Consolidated Statements of Income in Compensation and benefits (in millions):
Stock Awards
In the first nine months of 2011, the Company granted approximately 1.2 million shares in connection with the 2008 Leadership Performance Plan cycle, 0.3 million shares related to a 2006 performance plan, and restricted shares of approximately 3.3 million in connection with the Company’s incentive compensation plans. In the first nine months of 2010, the Company granted approximately 1.7 million shares in connection with the completion of the 2007 Leadership Performance Plan cycle and restricted shares of approximately 3.3 million in connection with the Company’s incentive compensation plans.
A summary of the status of Aon’s non-vested stock awards is as follows (shares in thousands):
(1) Represents per share weighted average fair value of award at date of grant
Information regarding Aon’s performance-based plans follows (shares in thousands, dollars in millions):
Stock Options
In connection with its incentive compensation plans, in the third quarter of 2011 the Company did not grant any options. In the first nine months of 2011 and 2010, the Company granted 80,000 stock options at $53 per share and 143,000 stock options at $38 per share, respectively.
The weighted average assumptions, the weighted average expected life and estimated fair value of employee stock options are summarized as follows:
A summary of the status of Aon’s stock options and related information is as follows (shares in thousands):
The weighted average remaining contractual life, in years, of outstanding options was 3.3 years and 3.6 years at September 30, 2011 and 2010, respectively.
The aggregate intrinsic value represents the total pretax intrinsic value, based on options with an exercise price less than the Company’s closing stock price of $41.98 as of September 30, 2011, which would have been received by the option holders had those option holders exercised their options as of that date. At September 30, 2011, the aggregate intrinsic value of options outstanding was $105 million, of which $101 million was exercisable.
Other information related to the Company’s stock options is as follows (in millions):
Unamortized deferred compensation expense, which includes both options and awards, amounted to $294 million as of September 30, 2011, with a remaining weighted-average amortization period of approximately 2.0 years. | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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13. Derivatives and Hedging
Aon is exposed to risk 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 Aon’s market risks by creating offsetting exposures. Aon does not enter into derivative transactions for trading or speculative purposes.
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 five years in the future. Aon also uses foreign exchange derivatives, typically forward contracts and options, to hedge its net investments in foreign operations for up to two years in the future and to reduce the impact of currency fluctuations on the translation of the financial statements for foreign operations and to manage the Company’s global liquidity profile for one year in the future.
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 two years in the future.
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, collateral 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 September 30, 2011, all net derivative positions were free of credit risk contingent features. In addition, Aon did not receive or pledge collateral for any derivatives as of September 30, 2011.
The notional and fair values of derivative instruments are as follows (in millions):
(1) Included within Other assets (2) Included within Other liabilities
The amounts of derivative gains (losses) recognized in the Condensed Consolidated Financial Statements for the three and nine months ended September 30, 2011 and 2010 are as follows (in millions):
(1) Included within Fiduciary investment income and Interest expense (2) Included within Other general expenses and Interest expense
(1) Relates to fixed rate debt (2) Included in Interest expense
It is estimated that approximately $27 million of pretax losses currently included within Accumulated other comprehensive loss will be reclassified into earnings in the next twelve months.
The amount of gain (loss) recognized in income on the ineffective portion of derivatives for the three and nine months ended September 30, 2011 and 2010 was inconsequential.
In both the three and nine months ended September 30, 2011, Aon recorded a loss of $9 million, respectively, in Other general expenses for foreign exchange derivatives not designated or qualifying as hedges. In the three and nine months ended September 30, 2010, Aon recorded a gain of $3 million and $7 million, respectively. | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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14. Variable Interest Entities
Unconsolidated Variable Interest Entities
Aon has an ownership 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, and therefore this entity is not consolidated. The investment in Juniperus is accounted for using the equity method of accounting.
The Company’s potential loss at September 30, 2011 is limited to its investment in Juniperus of $60 million, which is recorded in Investments in the Condensed Consolidated Statements of Financial Position. |
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15. Fair Value Measurements and Financial Instruments
Accounting standards establish a three tier fair value hierarchy, which prioritizes the inputs used in measuring fair value 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 Company’s 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 investments 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 not 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.
Debt is carried at outstanding principal balance, less any unamortized discount or premium. 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 tables present the categorization of the Company’s assets and liabilities that are measured at fair value on a recurring basis at September 30, 2011 and December 31, 2010 (in millions):
(1) Includes $2,450 million of money market funds and $50 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 “Investments” for additional information regarding the Company’s investments.
(1) Includes $2,591 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 “Investments” for additional information regarding the Company’s investments.
The following table presents the changes in the Level 3 fair-value category (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.
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 September 30, 2011.
The following table discloses the Company’s 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 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. In August 2010, the U.S. Court of Appeals for the Third Circuit affirmed the dismissals of most, but not all, of the claims. In March 2011, Aon entered into a Memorandum of Understanding documenting a settlement of the civil cases consolidated in the U.S. District Court for the District of New Jersey. Under that agreement, Aon will pay $550,000 in exchange for dismissal of the class claims. This agreement remains subject to court approval. Several non-class claims brought by individual plaintiffs who opted out of the class action proceeding will remain pending, but the Company does not believe these present material exposure to the Company individually or in the aggregate. The outcome of these lawsuits, and any losses or other payments that may result, cannot be predicted at this time.
Following inquiries from regulators, the Company commenced an internal review of its compliance with certain U.S. and non-U.S. anti-corruption laws, including the U.S. Foreign Corrupt Practices Act (“FCPA”). In January 2009, Aon Limited, Aon’s 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 retail insurance brokerage subsidiary of Aon provides insurance brokerage services to Northrop Grumman Corporation (“Northrop”). This Aon subsidiary placed Northrop’s excess property insurance program for the period covering 2005. Northrop suffered a substantial loss in August 2005 when Hurricane Katrina damaged Northrop’s facilities in the Gulf states. Northrop’s excess insurance carrier, Factory Mutual Insurance Company (“Factory Mutual”), denied coverage for the claim pursuant to a flood exclusion. Northrop sued Factory Mutual in the United States District Court for the Central District of California and later sought to add this Aon subsidiary as a defendant, asserting that if Northrop’s policy with Factory Mutual does not cover the losses suffered by Northrop stemming from Hurricane Katrina, then this Aon subsidiary will be responsible for Northrop’s losses. On August 26, 2010, the court granted in large part Factory Mutual’s motion for partial summary judgment regarding the applicability of the flood exclusion and denied Northrop’s motion to add this Aon subsidiary as a defendant in the federal lawsuit. On January 27, 2011, Northrop filed suit against this Aon subsidiary in state court in Los Angeles, California, pleading claims for negligence, breach of contract and negligent misrepresentation. Aon believes that it has meritorious defenses and intends to vigorously defend itself against these claims. The outcome of this lawsuit, and the amount of any losses or other payments that may result, cannot be predicted at this time.
Another retail insurance brokerage subsidiary of Aon has been sued in Tennessee state court by a client, Opry Mills Mall Limited Partnership (“Opry Mills”), that sustained flood damage to its property in May 2010. The lawsuit seeks $200 million from numerous insurers with whom this Aon subsidiary placed the client’s property insurance coverage. The insurers contend that only $50 million in coverage is available for the loss because the flood event occurred on property in a high hazard flood zone. Opry Mills is seeking full coverage from the insurers for the loss and has sued this Aon subsidiary in the alternative for the same $150 million difference on various theories of professional liability if the court determines there is not full coverage. Aon believes it has meritorious defenses and intends to vigorously defend itself against these claims. The outcome of this lawsuit, and any losses or other payments that may result, cannot be predicted at this time.
From time to time, Aon’s clients may bring claims and take legal action pertaining to the performance of fiduciary responsibilities. Whether client claims and legal action related to the Company’s 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 Aon’s 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 Aon’s consolidated financial statements.
Aon had total letters of credit (“LOCs”) outstanding for approximately $76 million and $71 million at September 30, 2011 and December 31, 2010, respectively. These letters of credit cover the beneficiaries related to Aon’s Canadian pension plan scheme, secure deductible retentions on Aon’s own workers compensation program, an Aon Hewitt sublease agreement for office space, and one of the U.S. pension plans. Aon also has issued letters of credit to cover contingent payments for taxes and other business obligations to third parties, and other guarantees for miscellaneous purposes at its international subsidiaries. Amounts are accrued in the Condensed 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 Aon’s allowance for doubtful accounts. The maximum exposure with respect to such contractual contingent guarantees was approximately $8 million at September 30, 2011.
Aon has provided commitments to fund certain limited partnerships in which it has an interest in the event that the general partners request funding. Some of these commitments have specific expiration dates and the maximum potential funding under these commitments was $69 million at September 30, 2011. In the three and nine months ended September 30, 2011, the Company funded $1 million and $13 million, respectively, of these commitments.
Aon expects that, as prudent business interests dictate, additional guarantees and indemnifications may be issued from time to time. |
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17. Related Party Transactions
During the first nine months of 2011, the Company, in the ordinary course of business, provided retail brokerage, consulting and financial advisory services to, and received wholesale brokerage services from, an entity that is controlled by one of the Company’s stockholders. These transactions were negotiated on an arms-length basis and contain customary terms and conditions. In the three and nine months ended September 30, 2011, commissions and fee revenue from these transactions was approximately $3 million and $5 million, respectively. At September 30, 2011, an amount less than $0.1 million were due to the Company. |
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18. Segment Information
Aon classifies its businesses into two operating segments: Risk Solutions and HR Solutions. Unallocated income and expenses, when combined with the operating segments and after the elimination of intersegment revenues and expenses, equal 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 Aon’s 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 inter-segment revenue as if the revenue were from third parties and at what management believes are current market prices.
Risk Solutions acts as an advisor and insurance and reinsurance broker, helping clients manage their risks, via consultation, as well as negotiation and placement of insurance risk with insurance carriers through Aon’s global distribution network.
HR Solutions partners with organizations to solve their most complex benefits, talent and related financial challenges, and improve business performance by designing, implementing, communicating and administering a wide range of human capital, retirement, investment management, health care, compensation and talent management strategies.
Aon’s total revenue is as follows (in millions):
Commissions, fees and other revenues by product are as follows (in millions):
Fiduciary investment income by segment is as follows (in millions):
A reconciliation of segment operating income before tax to income from continuing operations before income taxes is as follows (in millions):
Unallocated expenses include administrative or other costs not attributable to the operating segments, such as corporate governance costs and the costs associated with corporate investments. Interest income represents income earned primarily on operating cash balances and certain income producing securities. Interest expense represents the cost of worldwide debt obligations.
Other income (expense) consists of equity earnings, realized gains or losses on the sale of investments, gains or losses on the disposal of businesses, and also includes the loss on extinguishment of debt. | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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(1) Includes cash and cash equivalents, short-term investments, client receivables, other current assets, accounts payable and other current liabilities.
(2) Includes primarily deferred contract costs and long-term investments.
(3) Includes primarily unfavorable lease obligations and deferred contract revenues.
(4) As of the acquisition date, included in Other current assets ($31 million), Other non-current assets ($30 million), Other current liabilities ($7 million) and Other non-current liabilities ($1.1 billion) in the Company’s Condensed Consolidated Statements of Financial Position. | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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The estimated future amortization for intangible assets as of September 30, 2011 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. | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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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. | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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(1) The Company assumed a $43 million net real estate related restructuring liability in connection with the Hewitt acquisition. (2) Includes impact of reoccupying previously vacated leased properties. | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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(1) Includes 5.2 million and 5.8 million of participating securities for the three months ended September 30, 2011 and 2010, respectively, and 5.5 million and 6.1 million of participating securities for the nine months ended September 30, 2011 and 2010, respectively. | ||||||||||||||||||||||||||||||||||||||||||||||||||
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(1) Included within Other assets (2) Included within Other liabilities | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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(1) Included within Fiduciary investment income and Interest expense (2) Included within Other general expenses and Interest expense
(1) Relates to fixed rate debt (2) Included in Interest expense | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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(1) Includes $2,450 million of money market funds and $50 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 “Investments” for additional information regarding the Company’s investments.
(1) Includes $2,591 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 “Investments” for additional information regarding the Company’s investments. | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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