We own and lease a number of properties for use as offices throughout the world and believe that our properties are generally suitable and adequate for the purposes for which they are used. The principal properties are located in the United Kingdom and the United States. Our principal executive office at Ten Trinity Square, London is a landmark building which we sold in 2006 to developers. We will lease back this facility until we move into our new UK headquarters in 2008. In November 2004 we entered into an Agreement for Lease with long-time client British Land plc relating to our new UK headquarters in London. Construction commenced in April 2005 and Willis occupancy is targeted for early 2008.
· defining our core segments and how we will deliver value to our clients;
Through this strategy, we expect to deliver significant financial growth over the next five years; in particular we have set ourselves the following targets by the end of 2010:
· adjusted operating margin (operating margin excluding net gains and losses on disposals and other one-time items) to be 28 percent or better; and
The insurance market remained highly competitive throughout 2006, although the aggressive fee cutting and competition for new staff seen in 2005 moderated slightly. Outside of catastrophe-exposed markets, rates in most sectors have declined throughout the year. Against this background, we are pleased that we achieved our earlier forecasts for 2006 with the full year results reflecting the benefit of strong organic revenue growth, improved operating margin and a decrease in the salaries and benefits ratio (salaries and benefits as a percentage of revenues).
· a $102 million profit on the sale of our UK head office in second half 2006 (equivalent to 4 percent of revenues);
· $105 million of expenditure in 2006 in support of our “Shaping Our Future’’ strategic initiatives, see “Strategic initiative expenditure’’ below (equivalent to 4 percent of revenues);
· a $78 million gain on the sale of Stewart Smith in second quarter 2005 (equivalent to 3 percent of revenues); and
Net income in 2005 was $281 million, or $1.72 per diluted share, compared with $402 million, or $2.42 per diluted share, in 2004. Total revenues at $2,267 million were $8 million lower than in 2004 as net new business growth and improved client retention rates in all divisions were more than offset by a sharp reduction in market remuneration and falling insurance premium rates.
In September 2006, we completed the sale of Ten Trinity Square, our UK head office building. The building has been leased back until we move into our new head office on Lime Street in early 2008. Gross proceeds were $202 million. The total pre-tax gain on disposal was $121 million of which $99 million was recognized on completion in third quarter 2006. The remaining $22 million (equivalent to the net present value of the leaseback rentals) is being recognized over the two year expected life of the lease, with $3 million having been recognized in fourth quarter 2006. While there is no cash tax payable on the
Including severance costs, property closure costs and external fees for specialist cost reduction assistance
Including professional fees for the design of new London Market processes
We expect this expenditure will lead directly to annualized benefits of approximately $65 million pre-tax by 2009. These benefits include cost reductions attributable to the elimination of nearly 500 positions. The benefit of these will be partly offset by additional real estate costs related to our new London and New York headquarters. Net of these real estate costs, we expect the net benefit from these strategic initiatives to be approximately $20 million in 2007, $30 million in 2008 and $45 million by 2009.
In the longer term, we expect to deliver breakout financial performance in the next four years. Specifically, by full year 2010, we have set financial targets of salaries and benefits as a percentage of revenues to be below 54 percent; adjusted operating margin (operating margin excluding net gains and losses on disposals and other one-time items) to be 28 percent or better; and to have industry leading organic revenue growth.
Total long-term debt at December 31, 2006 was $800 million and stockholders’ equity was $1.5 billion. The capitalization ratio (total long-term debt to total long-term debt and stockholders’ equity) was 35 percent at December 31, 2006 compared with 32 percent at December 31, 2005, with the net increase including a 2 percent increase attributable to the adoption of FAS 158, see “Accounting Changes’’ below.
Effective January 1, 2007, we changed our management structure. Our UK and Irish retail operations, Willis UK and Ireland, which were previously within our Global division have been combined with our previously existing international units to create a single International segment. The new International segment incorporates all our retail operations outside North America.
We provide a broad range of insurance brokerage and risk management consulting services to our worldwide clients. Our core businesses include Aerospace; Captives; Construction; Employee Benefits; Energy; Financial Institutions; Fine Art, Jewelry and Specie; Healthcare; Marine; Programs; Real Estate and Reinsurance.
In our capacity as an advisor and insurance broker, we act as an intermediary between our clients and insurance carriers by advising our clients on their risk management requirements, assisting clients to determine the best means of managing risk, and negotiating and placing insurance risk with insurance carriers through our global distribution network.
During 2006, the insurance market has remained highly competitive and, outside of catastrophe-exposed markets, rates in most sectors have declined. However, Marine, Energy and catastrophe-exposed American and Caribbean Property reinsurance terms and conditions have significantly tightened. Capacity in these markets remains inadequate which, together with the shortage of retrocessional reinsurance, has led to significant rate increases. However, in many other sectors of the insurance and reinsurance market, pricing and terms continue to soften.
(i) Effective January 1, 2006 we changed our reporting structure: North America Global Markets and International Global Markets revenues, which were previously reported within our Global division, are now reported in the North America and International divisions respectively. In addition we refined our method for allocating revenues between our Global and North America divisions. We have retrospectively adjusted our 2005 revenue analysis to reflect our 2006 structure.
2006 revenues at $2,428 million were $161 million, or 7 percent, higher than in 2005 with organic revenue growth of 8 percent, reflecting strong net new business growth, more than offsetting a 1 percent decrease attributable to market remuneration.
Our Global and International operations earn a significant portion of their revenues in currencies other than the US dollar. In 2006, whilst there was no net impact on total reported revenues from the year on year effect of foreign currency translation, Global revenues benefited by a net 1 percent which mainly reflected stronger average sterling exchange rates against the dollar, compared with 2005.
Net acquisitions and disposals had a neutral impact on total revenues in 2006 as the benefit of acquisitions in: International, including MGT Corredores de Seguros in Chile, Nicon in Sweden, Asesores in Peru, Athos in Brazil and acquisitions of minority interests in Sweden, Norway and Columbia; and Global, including Gueits Adams and International Insurance Brokers Inc; was offset by the impact of the Stewart Smith sale in April 2005.
Market remuneration continues to decline and at $10 million in 2006 was $19 million lower than in 2005, equivalent to a 1 percent revenue reduction.
Global: Organic revenues were 8 percent higher in 2006 compared with 2005 reflecting net new business growth and a $9 million benefit from the Shaping our Future client profitability project that was piloted in the global specialty business in the second half of 2006. Finex, which is our financial and executive risk division, Niche, Aerospace and Construction all continued to show strong growth.
After a mixed first quarter, there has been strong growth in the rest of the year in Reinsurance compared with 2005. In Marine, Energy and catastrophe-exposed American and Caribbean Property, terms and conditions have significantly tightened. Capacity in these markets remains inadequate which, together with the shortage of retrocessional reinsurance, has led to significant rate increases. However, in many other sectors of the reinsurance market, pricing and terms continue to soften.
Elsewhere our Global Employee Benefits practice and Global Energy practice performed well. These are two areas we have identified as high growth potential and are investing in. Our UK and Ireland business also performed well; in particular Corporate Risk Solutions showed good growth.
International: Organic revenue growth in commissions and fees was 8 percent for 2006 compared with 2005 reflecting good business growth despite a declining rate environment. Latin America (in particular Venezuela, Mexico and Brazil), Asia (Singapore, Hong Kong, Korea and China), Iberia and Italy all performed well.
(i) Following a change to our internal reporting structure effective January 1, 2006, North America Global Markets and International Global Markets revenues, which were previously reported within our Global division, are now reported in the North America and International divisions, respectively. In addition, we refined our method of allocating revenues between the Global and North America divisions. As a result of these changes, $109 million of revenues previously reported within our Global division in 2005 (2004: $123 million) have been reclassified between the North America ($45 million) and International divisions ($64 million) (2004: North America $46 million and International $77 million).
2005 revenues at $2,267 million were broadly in line with 2004 with the benefit of an increase from net new business growth and an increase attributable to net acquisitions and disposals being offset by the reduction in market remuneration.
General and administrative expenses have been adversely impacted by significant charges in both 2006 and 2005. In 2006 we incurred $96 million of expenditure on strategic initiatives, as discussed above, and in 2005 we incurred significant first quarter charges relating to: the first quarter 2005 headcount reduction program, $28 million; a $20 million additional charge for legal provisions; and $9 million of costs related to regulatory settlements.
Salaries and benefits were $1,457 million in 2006 compared with $1,384 million in 2005. The compensation ratio (salaries and benefits as a percentage of revenues) at 60 percent was down from 61 percent in 2005 and was mainly impacted by:
· the benefit of net new business and an increased revenue contribution from our recent hires;
Other expenses at $454 million were $49 million, or 12 percent, higher than in 2005 of which 1 percent was attributable to the impact of net acquisitions and disposals and 1 percent to foreign currency translation.
Other expenses were 19 percent of revenues in 2006 compared with 18 percent in 2005 with the net increase mainly attributable to:
General and administrative expenses at $1,789 million in 2005 were $180 million, or 11 percent, higher than in 2004 of which 3 percent was attributable to acquisitions net of disposals and foreign currency translation.
Salaries and benefits were $1,384 million, or 61 percent of revenues, in 2005 compared with $1,218 million, or 54 percent of revenues, in 2004. The increase in the compensation ratio (salaries and benefits as a percentage of revenues) was mainly attributable to the $119 million reduction in market remuneration and the incremental cost of net new hires and higher costs to retain and incentivize existing staff, together with a $20 million increase in severance costs, primarily relating to the first quarter 2005 headcount reduction program, and the impact of foreign currency translation. Excluding severance costs relating to the first quarter headcount reduction program, the compensation ratio was 60 percent in 2005.
· the $78 million gain on the sale of Stewart Smith in 2005 (equivalent to 3 percent of revenues); and
· a $20 million increase in severance costs primarily as a result of the first quarter 2005 headcount reduction program;
· a $67 million increase in net gains on disposal compared with 2004 mainly reflecting the $78 million gain on the sale of Stewart Smith in second quarter 2005.
The effective tax rate in 2005 was 34 percent. The net impact of the effect of tax on net disposals, the amortization of intangibles, and the $60 million of regulatory settlements and related costs was 2 percent, of which approximately 3 percent was attributable to the $78 million profit on disposal of Stewart Smith and a negative 1 percent to the tax effect of the regulatory settlements and related costs. Excluding the effect of tax on net disposals of operations, the amortization of intangible assets, and regulatory settlements and related costs, the underlying tax rate was 32 percent compared with 33 percent in 2004 which contributed approximately $0.04 to diluted earnings per share in 2005.
Net income for 2006 was $449 million, or $2.84 per diluted share, compared with $281 million, or $1.72 per diluted share in 2005. Net income in both 2006 and 2005 has been impacted by a number of significant items: the third quarter 2006 sale of our London head office building, less related leaseback costs, equivalent to $0.58 per diluted share; the 2006 “Shaping our Future’’ expenditure, equivalent to $0.47 per diluted share; the $71 million tax credit in fourth quarter 2006, equivalent to $0.45 per diluted share; the gain on the sale of Stewart Smith in second quarter 2005, equivalent to $0.25 per diluted share; and the first quarter 2005 charges for regulatory settlements and related costs, the headcount reduction program and the March 31, 2005 review of legal proceedings, equivalent to $0.43 per diluted share.
Foreign currency translation had a negative $0.02 impact on earnings per diluted share in 2006 compared with 2005. A five million reduction in average diluted share count contributed $0.09 to 2006 diluted earnings per share.
Effective January 1, 2006, the Company adopted the fair value recognition provisions of FAS 123R, using the modified-retrospective transition method. Under that transition method, compensation cost recognized from January 1, 2006 includes: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of FAS 123, Accounting for Stock-Based Compensation, and (b) compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of FAS 123R.
Results for all prior periods have been retrospectively adjusted to recognize the compensation cost previously reported in the pro forma footnote disclosures under the provisions of FAS 123.
As a consequence of the adoption of FAS 123R, we recognized share-based compensation of $18 million in both 2006 and 2005.
In addition to the income statement, the adoption of FAS 123R impacted our prior period diluted sharecount with diluted sharecount for 2005 being reduced by 1 million to 163 million and 2004 diluted sharecount by 2 million to 166 million as proceeds under the treasury stock method were adjusted. The proceeds were adjusted to include average unrecognized compensation cost outstanding in the period and for changes to the calculation of future tax consequences. When we reported previously under APB 25, time options granted at market value gave no rise to an accounting charge and hence there was no increase from unrecognized compensation cost to assumed proceeds under the treasury stock method.
Effective January 1, 2006, the Company changed the methodology used to determine the market-related value of UK pension plan assets.
FAS 87, Employers’ Accounting for Pensions, requires the expected return on plan assets to be determined based on the expected long-term rate of return on plan assets and the market-related value of plan assets. The market-related value of plan assets may either be a fair value or a calculated value that recognizes changes in a systematic and rational manner over not more than five years.
In accordance with FAS 154, Accounting Changes and Error Corrections, the change in method of determining the market-related value of plan assets has been applied retrospectively by adjusting all prior periods presented.
· reduces the market related value of assets at January 1, 2005 and 2004 which consequentially reduces the return on assets leading to an increase in the 2005 and 2004 pension charges; and
· increases actuarial losses at January 1, 2005 and 2004 which leads to an increased amortization charge and consequently a further increase in the 2005 and 2004 pension charges.
· increased the market related value of assets at January 1, 2006 which consequentially increased the return on assets leading to a decrease in the 2006 pension charge; and
· reduced actuarial losses at January 1, 2006 which led to a lower amortization charge and consequently a further decrease in the 2006 pension charge.
· recognize in its statement of financial position the funded status of a benefit plan measured as the difference between the fair value of plan assets and the benefit obligation;
The Company’s accounting policies are described in Note 2 to the Consolidated Financial Statements. Management considers that the following accounting estimates or assumptions are the most important to the presentation of the Company’s financial condition or operating performance. Management has discussed its critical accounting estimates and associated disclosures with our Audit Committee.
levels, reflecting the good returns in 2005 and increased contributions by the Company, and an increase in the expected rate of return assumption from 7.25 percent to 7.75 percent. The US pension charge was $8 million lower in 2006 with the decrease mainly due to savings attributable to the 2005 headcount reduction program.
Based on December 31, 2006 assumptions, we expect our net pension expense in 2007 to decrease by approximately $35 million compared with 2006 principally attributable to a $25 million increase in the expected return on UK plan assets partly reflecting higher asset levels following the incremental contributions made in 2006.
Expected long-term rates of return on plan assets are developed from the expected future returns of the various asset classes using the target asset allocations. The expected long-term rate of return used for determining the net UK pension expense in 2006 was 7.75 percent, up from 7.25 percent in 2005, and equivalent to an expected return in 2006 of $143 million. The actual return in 2006 was $141 million.
Rates used to discount pension plan liabilities at December 31, 2006 were based on yields prevailing at that date of high quality corporate bonds of appropriate maturity. The selected rate used to discount UK plan liabilities was 5.3 percent compared with 4.9 percent at December 31, 2005 with the increase reflecting an increase in long term bond rates in the United Kingdom during 2006. The higher discount rate at December 31, 2006 generated an actuarial gain of $151 million at December 31, 2006 which was partly offset by a $53 million actuarial loss attributable to an increase in the inflation assumption.
The mortality assumption for the US plan at December 31, 2006 was unchanged from 2005. As an indication of the longevity assumed, our calculations assume that a US male retiree aged 65 at December 31, 2006 would have a life expectancy of 18 years.
At December 31, 2006, the Company had gross deferred tax assets of $247 million (2005: $319 million) against which a valuation allowance of $73 million (2005: $110 million) had been recognized. To the extent that the actual future taxable income in the periods during which the temporary differences are expected to reverse differs from current projections, or assumed prudent and feasible tax planning strategies fail to materialize, or new tax planning strategies are developed, or material changes occur in actual tax rates or loss carry forward time limits, the Company may adjust the deferred tax asset considered realizable in future periods. Such adjustments could result in a significant increase or decrease in the effective tax rate and have a material impact on our net income.
In July 2006, the Financial Accounting Standards Board (“FASB’’) issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109 (“FIN 48’’), which clarifies the accounting for uncertainty in tax positions.
FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006 and will be adopted by the Company as of January 1, 2007.
Net cash provided by operating activities, which excludes fiduciary cash movements, was $147 million in 2006 compared with $95 million in 2005 and $360 million in 2004. In 2006, we paid contributions into our UK and US pension funds of $268 million compared with $104 million in 2005 and $51 million in 2004. Compared with 2004, both 2006 and 2005 cash inflows have been lower as a result of the abolition of volume and profit-based contingent commissions and the significant reduction in other market remuneration.
Net cash provided by operations in 2005 was also adversely impacted by a reclassification of approximately $134 million own funds to fiduciary funds under Financial Services Authority (“FSA”) regulations in the United Kingdom which came into force in January 2005 and affected the timing of transferring commissions from fiduciary funds to own funds. The regulations changed the basis for the withdrawal of commissions from fiduciary funds to own funds from an earned to a receipts basis, with a consequential increase in fiduciary funds and decrease in own funds.
Total net cash provided by investing activities was $67 million in 2006 compared with $32 million in 2005 and a $183 million outflow in 2004.
Cash used for acquisitions of subsidiaries in 2006 amounted to $73 million (net of cash acquired), and was primarily incurred in acquiring Gueits, Adams & Company and International Insurance Brokers, Inc. in the United States, Reinsurance Consultants in South Africa, Nicon in Sweden, MGT Corredores de Seguros in Chile and acquisitions of minority interests in Sweden, Norway and Columbia.
Net cash proceeds from the sale of operations in 2005 totaled $90 million pre-tax and were mainly attributable to the sale of Stewart Smith on April 14, 2005. Cash used for acquisitions in 2005 amounted to $35 million (net of cash acquired) was primarily incurred in acquiring: CGI Consulting Group, Inc., now Willis Benefits of Pennsylvania, Inc., a US employee benefits firm and Primary Worldwide Corporation in the US; C.R. King and Partners Limited in the United Kingdom; J.H. Asesores y Corredores de Seguros S.A. a Peruvian broker; K.R. Athos Consultoria e Corretora de Seguros de Vida S/C Ltd, a Brazilian employee benefits firm; and Essence, a Taiwanese broker.
Capital expenditures for 2006, 2005 and 2004 were $55 million, $32 million and $49 million, respectively. We have funded our requirements for capital expenditures by cash generated internally from operations and expect to continue to do so in the future.
Cash used in financing activities amounted to $129 million in 2006, compared with $270 million in 2005 and $203 million in 2004.
Excess tax benefits from share-based payment arrangements were $11 million in 2006 compared with $45 million in 2005 and $130 million in 2004 reflecting a decrease in the level of options exercised over the period.
As of December 31, 2006, we had cash and cash equivalents of $288 million, compared with $193 million at December 31, 2005, and $100 million of our $300 million revolving credit facility remained available to draw.
(i) Our revolving credit facility expires in October 2010. Under the facility we have the ability to drawdown funds which reprice at LIBOR plus 0.375 for the drawdown period. Interest on this revolving credit facility has not been included in the above table as we are not able to predict when and how much we will draw on the facility in the future
price calculated pursuant to a formula based on revenues or earnings, to put some or all of their shares to us.
While neither we nor the management of Gras Savoye expect significant exercises of the puts, on a separate or aggregate basis, in the near to medium term, we nevertheless believe that, should the aggregate amount of shares be put to us, sufficient funds would be available to satisfy this obligation. In addition, we have a call option to move to majority ownership under certain circumstances and in any event by December 2009. Upon exercising this call option, the remaining Gras Savoye shareholders have a put option.
Apart from commitments, guarantees and contingencies, as disclosed in Note 9 of the Consolidated Financial Statements, the Company has no off-balance sheet arrangements that have, or are reasonably likely to have, a material effect on the Company’s financial condition, results of operations or liquidity.
We have audited the accompanying consolidated balance sheets of Willis Group Holdings Limited and subsidiaries (collectively, the ‘‘Company’’) as of December 31, 2006 and 2005, and the related consolidated statements of operations, stockholders’ equity and comprehensive income, and cash flows for each of the three years in the period ended December 31, 2006. Our audits also included the financial statement schedule listed in the index at Item 15. These financial statements and financial statement schedule are the responsibility of Willis Group Holdings Limited management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Willis Group Holdings Limited and subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2006, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
As discussed in Note 2 to the financial statements, in 2006 the Company changed its method of accounting for its defined benefit pension plans to adopt Statement of Financial Accounting Standards No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plan-an amendment of FASB Statements No. 87, 88, 106, and 132R.
Willis Group Holdings Limited (“Willis Group Holdings”) and subsidiaries (collectively, the “Company”) provide a broad range of value-added risk management consulting and insurance brokerage services, both directly and indirectly through their associates, to a diverse base of clients internationally. The Company provides specialized risk management advisory and other services on a global basis to clients in various industries, including aerospace, marine, energy and construction industries. In its capacity as an advisor and insurance broker, the Company acts as an intermediary between clients and insurance carriers by advising clients on risk management requirements, helping clients determine the best means of managing risk, and negotiating and placing insurance risk with insurance carriers through the Company’s global distribution network.
These consolidated financial statements conform to accounting principles generally accepted in the United States of America (“US GAAP”). Presented below are summaries of:
· Major accounting policies followed in the preparation of the accompanying consolidated financial statements.
· changed the methodology used to determine the market-related value of UK pension plan assets;
· adopted Financial Accounting Standard (“FAS”) 123R, Share-Based Payment, (“FAS 123R”) using the modified-retrospective transition method; and
· adopted FAS 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans-an amendment of FASB Statements No. 87, 88, 106 and 132(R) (“FAS 158”).
Each of these accounting changes is discussed in more detail below.
FAS 87, Employers’ Accounting for Pensions, (“FAS 87”) requires the expected return on plan assets to be determined based on the expected long-term rate of return on plan assets and the market-related value of plan assets. The market-related value of plan assets may either be a fair value or a calculated value that recognizes changes in a systematic and rational manner over not more than five years. Up to December 31, 2005, the market-related value of UK pension plan assets was determined using a calculated value that recognized asset gains or losses over five years. Effective January 1, 2006, the Company changed its method for determining the market-related value of UK pension plan assets to a fair value basis. The Company believes that fair value is a preferable measure of determining the market-related value of plan assets as it more fairly reflects the actual value of pension plan assets as of the balance sheet date. In addition, it brings the methodology used for calculating the market-related value of UK plan assets in line with the fair value methodology already used to value US plan assets.
In accordance with FAS 154, Accounting Changes and Error Corrections, (“FAS 154”) the change in method of determining the market-related value of plan assets has been applied retrospectively by adjusting all prior periods presented.
(b) compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of FAS 123R.
· recognize, net of tax, the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit cost;
· measure defined benefit plan assets and obligations as of the date of the employer’s statement of financial position; and
· the line items in the consolidated financial statements and any affected per-share amounts that have been retrospectively adjusted to reflect the adoption of FAS 123R and the change in the methodology for determining the market-related value of the UK pension plan assets (‘‘Effect of pension accounting change’’);
The following tables present the line items on the consolidated statements of cash flows for the years ended December 31, 2005 and 2004, which were retrospectively adjusted to reflect the accounting changes:
The following tables present the line items on the consolidated statements of comprehensive income at December 31, 2005 and 2004, which were retrospectively adjusted to reflect the accounting changes:
In addition to retrospectively adjusting prior accounting periods, FAS 154 also requires disclosure of the current year effect on financial statement line items of a change in accounting principle. The following table presents the line items on the consolidated statement of operations for the year ended December 31, 2006 that were affected by the change in the method for determining the market related value of plan assets:
The following table presents the line items on the consolidated balance sheet at December 31, 2006 that were affected by the change in the method for determining the market related value of plan assets:
The following table presents the line items on the consolidated statement of cash flows for the year ended December 31, 2006 that were affected by the change in the method for determining the market related value of plan assets:
The following table illustrates the incremental effect of applying FAS 158 on individual line items on the consolidated balance sheet for the year ended December 31, 2006.
FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006 and is effective for the Company in the first quarter of the year beginning January 1, 2007.
The Company has evaluated the impact of FIN 48 and has concluded that it will not have a material effect on its financial position or results of operations.
The accompanying consolidated financial statements include the accounts of Willis Group Holdings and its subsidiaries, all of which are controlled through the ownership of a majority voting interest. Intercompany balances and transactions have been eliminated on consolidation.
The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of the dates of the financial statements and the reported amounts of revenues and expenses during the year. In the preparation of these consolidated financial statements, estimates and assumptions have been made by management concerning; the selection of useful lives of fixed assets and intangible assets; provisions necessary for trade receivables, commitments and contingencies and accrued liabilities; the long-term asset returns, discount rates and mortality rates in order to estimate pension liabilities and pension expense; income tax valuation allowances; and other similar evaluations. Actual results could differ from those estimates.
The Company classifies all short-term investments as available-for-sale in accordance with the provisions of FAS 115, Accounting for Certain Investments in Debt and Equity Securities. These securities are carried at fair market value, with unrealized gains and losses reported in other comprehensive income. Realized gains and losses on investments sold are included in net income and are derived using the specific identification method for determining the cost of securities.
Accounts receivable are stated at estimated net realizable values. Allowances are recorded, when necessary, in an amount considered by management to be sufficient to meet probable future losses related to uncollectible accounts.
Goodwill represents the excess of the cost of businesses acquired over the fair market value of identifiable net assets at the dates of acquisition. The Company reviews goodwill for impairment annually and whenever facts or circumstances indicate that the carrying amounts may not be recoverable. As part of the evaluation the estimated future undiscounted cash flows associated with the underlying business operation are compared to the carrying amount of goodwill to determine if a write-down is required. If such an assessment indicates that the undiscounted future cash flows will not be recovered, the carrying amount is reduced to the estimated fair value. Acquired intangible assets are being amortized on a straight-line basis over their estimated useful life.
Investments in entities less than 50% owned in which the Company has the ability to exercise significant influence are accounted for by the equity method of accounting whereby the investment is carried at cost of acquisition, plus the Company’s equity in undistributed net income since acquisition, less dividends received. Investments in entities less than 20% owned are accounted for by the cost method. Such investments are not publicly traded. The Company periodically reviews its investments in associates for which fair value is less than cost to determine if the decline in value is other than temporary. If the decline in value is judged to be other than temporary, the cost basis of the investment is written down to fair value. The amount of any write-down is included in the statement of operations as a realized loss.
The Company uses derivative financial instruments for other than trading purposes to alter the risk profile of an existing underlying exposure. Interest rate swaps are used to manage interest risk exposures. Forward foreign currency exchange contracts are used to manage currency exposures arising from future
income. The fair values of derivative contracts are recorded in other assets and other liabilities with changes in fair value of derivatives that qualify for hedge accounting recorded in other comprehensive income and changes in fair value of derivatives that do not qualify for hedge accounting, together with any hedge ineffectiveness, recorded in other operating expenses. Amounts are reclassified from other comprehensive income into earnings when the hedged exposure affects earnings.
The Company has two principal defined benefit pension plans which cover almost all employees in the United States and United Kingdom. The UK plan was closed to new entrants in January 2006. New entrants in the United Kingdom are now offered the opportunity to join a defined contribution plan. Elsewhere, pension benefits are typically provided through defined contribution plans.
In accordance with FAS 158, the Company records on balance sheet the funded status of its pension plans based on the projected benefit obligation.
Further details of the Company’s pension plans are set out in Note 14 to the Consolidated Financial Statements.
· the cost resulting from all equity awards be recognized in the financial statements at fair value estimated at the grant date;
Further details on how the Company applies FAS 123R are set out in Note 6 to the Consolidated Financial Statements.
The Company takes credit for commissions (or fees negotiated in lieu of commission) in respect of insurance placements at the date when the insured is billed or at the inception date of the policy, whichever is later. Commissions on additional premiums and adjustments are recognized as and when advised. Fees for risk management and other services are recognized as the services are provided. Negotiated fee arrangements for an agreed period covering multiple insurance placements, the provision of risk management and/or other services are determined, contract by contract, on the basis of the relative fair value of the services completed and the services yet to be rendered. The Company establishes contract cancellation reserves where appropriate; at December 31, 2006, 2005 and 2004, such amounts were not material.
In October 2004, the Company announced that it was voluntarily abolishing volume and profit-based contingent commissions. Such commissions were recognized at the earlier of the date when cash was
On September 27, 2006 Willis Group Services Limited, a subsidiary of Willis Group Holdings Limited, completed the sale of Ten Trinity Square, the Company’s London headquarters building. The building has been leased back at an annual rental of $12 million until the Company occupies its new London headquarters on Lime Street which is expected to be in early 2008. Gross proceeds were $202 million of which 25 percent was received in cash on completion and 75 percent was received on November 27, 2006. Of the total pre-tax gain on disposal of $121 million, $99 million was recognized in third quarter 2006 and $3 million in fourth quarter 2006; the remaining $19 million will be recognized over the life of the lease.
Total proceeds relating to 2005 dispositions of subsidiaries and associates amounted to $97 million, inclusive of deferred proceeds amounting to $1 million. A net gain of $78 million was recorded in the consolidated statement of operations which relates primarily to the gain arising on the sale of the Company’s US wholesale unit Stewart Smith on April 14, 2005. The carrying amounts of the Stewart Smith assets and liabilities disposed of were as follows:
The components of income before income taxes, interest in earnings of associates and minority interest are as follows:
At December 31, 2006, the Company had a valuation allowance of $73 million (2005: $110 million) to reduce its deferred tax assets to estimated realizable value. The valuation allowance at December 31, 2006 relates to the deferred tax assets arising from UK capital loss carryforwards (2005: UK tax operating loss carryforwards and UK capital loss carryforwards), which have no expiration date. Capital loss carryforwards can only be offset against future UK capital gains. During the year the Company reinstated and realized the deferred tax asset relating to UK operating losses following the resolution of tax authority enquiries. US tax operating loss carryforwards will largely expire in 2023 and 2024 unless otherwise utilized. Management expects to fully utilize these loss carryforwards prior to expiration.
At December 31, 2006, the Company had deferred tax assets of $174 million (2005: $209 million), net of the valuation allowance. Management believes, based upon the level of historical taxable income and projections for future taxable income over the periods in which the temporary differences are anticipated to reverse, and prudent and feasible tax-planning strategies, it is more likely than not that the Company will realize the benefits of these deductible differences, net of the valuation allowance. However, the amount of the deferred tax asset considered realizable could be adjusted in the future if estimates of taxable income are revised. In the event that the valuation allowance of $73 million at December 31,
On December 31, 2006, the Company had three share-based compensation plans, which are described below. The compensation cost that has been charged against income for those plans for the year ended December 31, 2006 was $18 million (2005: $18 million; 2004: $20 million). The total income tax benefit recognized in the statement of operations for share-based compensation arrangements for the year ended December 31, 2006 was $6 million (2005: $6 million; 2004: $6 million).
The total fair value of restricted stock units vested during the year ended December 31, 2006 was 47,704 shares at an average share price of $37.86 (2005: $nil). At December 31, 2006 there was $12 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements under the plan; that cost is expected to be recognized over a weighted average period of two years.
Cash received from option exercises under all share-based payment arrangements for the year ended December 31, 2006 was $10 million (2005: $26 million; 2004: $53 million). The actual tax benefit realized for the tax deductions from option exercise of the share-based payment arrangements totaled $11 million for the year ended December 31, 2006 (2005: $46 million; 2004: $134 million).
Basic and diluted earnings per share is calculated by dividing net income by the average number of shares outstanding during each period. The computation of diluted earnings per share reflects the potential dilution that could occur if dilutive securities and other contracts to issue shares were exercised or converted into shares or resulted in the issue of shares that then shared in the net income of the Company.
Rent expense amounted to $93 million, $77 million and $87 million for the years ended December 31, 2006, 2005 and 2004, respectively. The Company’s rental income from subleases was $11 million, $9 million and $9 million for the years ended December 31, 2006, 2005 and 2004, respectively.
Certain of Willis Group Holdings’ subsidiaries have given the landlords of some leasehold properties occupied by the Company in the United Kingdom and the United States guarantees in respect of the performance of the lease obligations of the subsidiary holding the lease. The operating lease obligations subject to such guarantees amounted to $1,033 million and $935 million at December 31, 2006 and 2005, respectively.
In addition, the Company has given guarantees to bankers and other third parties relating principally to letters of credit amounting to $3 million and $2 million at December 31, 2006 and 2005, respectively.
The Company is subject to various actual and potential claims, lawsuits and other proceedings relating principally to alleged errors and omissions in connection with the placement of insurance and reinsurance in the ordinary course of business. Similar to other corporations, the Company is also subject to a variety of other claims, including those relating to the Company’s employment practices. Some of those claims, lawsuits and other proceedings seek damages in amounts which could, if assessed, be significant.
Since August 2004, various plaintiffs have filed purported class actions in the United States District Court for the Southern District of New York, the Northern District of Illinois, the Northern District of California, the New Jersey District court, and the Circuit Court for the Eighteenth Judicial Circuit in and for Seminole County, Florida Civil Division, under a variety of legal theories, including state tort, contract, fiduciary duty and statutory theories, and federal antitrust and RICO theories. Other than a federal suit in Illinois that was voluntarily dismissed by the plaintiff in May 2005, all of the federal actions have been consolidated into two actions in federal court in New Jersey. One of the consolidated actions addresses employee benefits, while the other consolidated action addresses all other lines of insurance. In addition to the two federal actions, we were also named as a defendant in purported class actions in the Eighteenth Judicial Circuit in and for Seminole County, Florida Civil Division and Commonwealth of Massachusetts Superior Court Department of the Trial Court. In June 2006 the plaintiff in the Massachusetts state action voluntarily dismissed its complaint with prejudice. Both the consolidated federal actions and the Florida state action name various insurance carriers and insurance brokerage firms, including the Company, as defendants. The complaints seek monetary damages and equitable relief and make allegations regarding the practices and conduct that has been the subject of the investigation of state attorneys general and insurance commissioners, including allegations that the brokers have breached their duties to their clients by entering into contingent compensation agreements with either no disclosure or limited disclosure to clients and entered into other improper activities. The complaints also allege the existence of a conspiracy
among the insurance carriers and brokers and the federal court complaints allege violations of the federal RICO statute. The Company disputes these allegations and intends to defend itself vigorously against these actions. The outcomes of these lawsuits, however, including any losses or other payments that may occur as a result, cannot be predicted at this time.
We acted through one of our subsidiaries as an independent captive manager for Pender from 1990 to 2003. In 2004, legal proceedings were commenced in the English Commercial Court by Cable & Wireless Plc and Pender Insurance Limited, its captive insurer, against six of their former employees and certain other individuals and entities, and two of our subsidiaries and one of our former employees and were settled in January 2006 for an undisclosed amount which was not material.The plaintiffs alleged a fraudulent conspiracy involving the manner in which Pender was managed, operated or advised by the defendants, which allegedly resulted in substantial damages to the plaintiffs. A second claim was brought by Pender in 2005, alleging negligence with respect to certain reinsurance policies. Pender Mutual Insurance Company Limited (“PMIC”) has recently indicated it has similar claims to Pender but no legal proceedings have yet been commenced by PMIC. If such proceedings are commenced, it is not expected the amount claimed will have a material adverse effect on our results of operations.
A federal district court action was commenced against us in 2001 on behalf of an alleged nationwide class of present and former female officer and officer equivalent employees alleging that we discriminated against them on the basis of their gender and seeking injunctive relief, money damages, attorneys’ fees and costs. To date the court has denied plaintiffs’ motions to certify a nationwide class or to grant nationwide discovery, but has certified a class of female officers and officer equivalent employees based in our Northeast (New York, New Jersey and Massachusetts) offices. We believe that the purported class consists of approximately 200 women. We filed a petition for an immediate appeal of the class certification ruling which was denied. The parties participated in mediation before a court appointed mediator which has not yet brought about a settlement. The trial in this matter has been scheduled in June 2007. We have filed a motion to decertify the class based on new standards set by a recent Second Circuit opinion for determining whether a class should be certified. A former female employee, whose motion to intervene in the class action was denied, has filed a purported class action with almost identical allegations as those contained in this suit, except seeking a class period of 1998 to the time of trial. We cannot predict at this time what, if any, damages might result from these actions.
The Company recognised a depreciation charge of $49 million, $43 million and $41 million in the years ended December 31, 2006, 2005 and 2004 respectively.
The debt securities are classified as available-for-sale. Accordingly, they are recorded at fair market value with unrealized holding gains and losses reported, net of tax, as a component of other comprehensive income. As of December 31, 2006 and 2005, the amortized cost of such securities approximated fair value.
Realized gains and losses, net of tax, on debt securities are included in net income. During years ended December 31, 2006, 2005 and 2004, sales of debt securities totaled $10 million, $47 million and $79 million, respectively, on which realized gains and losses were not material to the consolidated results of the Company. Fiduciary funds-restricted, consisting primarily of time deposits with original maturities of less than three months, were $1,772 million as of December 31, 2006 (2005: $1,563 million).
The following table summarizes the estimated fair value of investments in marketable securities designated as available-for-sale classified by the contractual maturity date of the security:
In accordance with FASB Interpretation No. 46(R), Consolidation of Variable Interest Entities an interpretation of ARB No. 51, the financial statements for the years ended December 31, 2006 and 2005 reflect the consolidation of one Variable Interest Entity (“VIE”), a UK non-statutory trust that was established in January 2005 following the introduction of statutory regulation of insurance in the UK by the Financial Services Authority. The regulation requires that all fiduciary funds collected by an insurance broker such as Willis be paid into a non-statutory trust designed to give additional credit protection to the insurance carriers and clients of Willis. This trust restricts the financial instruments in which such funds may be invested and affects the timing of transferring commission from fiduciary funds to own funds. As a result of the regulation, approximately $155 million of own funds were reclassified to fiduciary funds in January 2005. As of December 31, 2006, the fair value of the assets in the VIE was approximately $1,056 million (2005: $1,022 million) and the fair value of the associated liabilities was approximately $1,056 million (2005: $1,022 million). There are no assets of the Company that serve as collateral for the VIE.
Of those listed above, the Company’s principal investment as of December 31, 2006 and 2005 is Gras Savoye, France’s leading insurance broker. Included in the carrying amount of the Gras Savoye investment as of December 31, 2006 is goodwill of $93 million. Of this total, $21 million has been recognized in the year in respect of an additional 5% holding in Gras Savoye, with the remaining $72 million net of accumulated goodwill amortization of $7 million, recorded prior to the adoption of FAS 142, Goodwill and Other Intangible Assets (“FAS 142”), (2005: Goodwill of $72 million, net of accumulated goodwill amortization of $7 million).
As of December 31, 2006 and 2005, the Company’s other investments in associates individually and in the aggregate were not material to the Company’s operations.
On July 23, 1997, the Company entered into an agreement with Gras Savoye whereby, among other things, the co-shareholders of Gras Savoye (other than management) have the right to sell (put option)
On July 1, 2005, the Company completed a senior notes offering of $600 million, comprising $250 million, 5 year notes priced at 5.125 percent and $350 million, 10 year notes priced at 5.625 percent. The net proceeds from the offering were used to repay the then existing $450 million term loans on July 6, 2005 and for general corporate purposes including additional pension fund contributions of $50 million.
On October 17, 2005, the Company completed the re-financing of the then existing 2003 undrawn revolving credit facility. The $150 million revolving credit facility was replaced by a new $300 million revolving credit facility with a term of 5 years. $200 million was drawn as at December 31, 2006, bearing an interest rate of LIBOR plus 0.375 percent.
The Company has two principal defined benefit pension plans funded externally which cover all eligible employees. One plan exists in the United Kingdom and the other in the United States. It is the Company’s policy to fund pension costs as required by applicable laws and regulations.
In September 2006, the FASB issued FAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans-an amendment of FASB Statements No. 87, 88, 106 and 132(R) (‘‘FAS 158’’). The requirements of FAS 158 are to be applied prospectively upon adoption. The requirements to recognize the funded status of a defined benefit postretirement plan and provide related disclosures are effective for fiscal years ending after December 15, 2006, and have been applied for the year ended December 31, 2006.
The estimated net loss and prior service cost for the UK and US defined benefit plans that will be amortized from accumulated other comprehensive loss into net periodic benefit cost over the next fiscal year are $4 million loss and $3 million gain respectively (using the year-end exchange rate of £1 = $1.96) for the UK plan and $nil and $1 million gain for the US plan respectively.
In 2007, the Company expects to contribute $138 million to the UK defined benefit pension plan and $17 million to the US plan.
Willis North America has a 401(k) plan covering all eligible employees of Willis North America and its subsidiaries. The plan allows participants to make pre-tax contributions and the Company provides a matching contribution of 3 percent of employees’ annual eligible compensation. All investment assets of the plan are held in a trust account administered by independent trustees. The Company’s 401(k) matching contributions for 2006, 2005 and 2004 were approximately $5 million, $5 million and $1 million, respectively.
The Company’s principal financial instruments, other than derivatives, comprise the fixed rate Senior Notes, a revolving credit facility, cash deposits and short-term investments. The Company also enters into derivative transactions (principally interest rate swaps and forward foreign currency contracts) in order to manage interest rate and currency risks arising from the Company’s operations and its sources of finance. The Company does not hold financial instruments for trading purposes.
Our operations are financed principally by $600 million fixed rate Senior Notes issued by a subsidiary which are split between $250 million due 2010 and $350 million due 2015. As of December 31, 2006 we had also drawn down $200 million on our $300 million Revolving Credit Facility which expires in 2010. The interest rate applicable to this borrowing is variable according to the period of each individual drawdown.
The changes in fair value of derivative financial instruments have been recorded as follows:
(1) Notional amounts represent US dollar equivalents translated at the spot rate as of December 31.
A summary of the Company’s forward rate agreements by major currency is as follows:
Generally the Company’s policy within the United Kingdom is to convert into sterling all revenues arising in currencies other than US dollars together with sufficient US dollar revenues to fund the remaining sterling expenses. Outside the United Kingdom, only those cash flows necessary to fund mismatches between revenues and expenses are converted into local currency. Amounts remitted to the United Kingdom are usually converted into sterling and the currency exposures managed by entering into forward exchange contracts.
FAS No. 131, Disclosures about Segments of an Enterprise and Related Information establishes standards for reporting information about operating segments and related disclosures, products and services, geographic areas and major customers. Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision-maker in deciding how to allocate resources and in assessing performance.
None of the Company’s customers represented more than 10 percent of the Company’s consolidated commissions and fees for the years ended December 31, 2006, 2005 and 2004.
The Company and Fisher Capital Corp. L.L.C. (“Fisher”), with which Mr. James R. Fisher, a former Director of the Company is affiliated, entered into a share option agreement dated January 27, 1999, whereby the Company granted to Fisher 422,501 options to purchase an equivalent number of shares. The options vested at the grant date and were exercisable any time up to January 27, 2014. During 2004, options over 174,462 shares were exercised; in November 2005, the remaining 56,697 options were exercised.
Concurrently with the secondary public offering by certain of its shareholders of 6,100,000 Shares in November 2005 (2004: 20,000,000), the Company purchased 1,488,810 (2004: 3,974,154) of its Shares from Profit Sharing (Overseas), Limited Partnership, an affiliate of KKR, with which Mr. P. Golkin, a Director of the Company, and Mr. S. C. Nuttall, a former Director of the Company are affiliated and 11,190 (2004: 25,846) of its Shares from Fisher at a price of $36.00 per Share (2004: $37.026), the net public offering price in the secondary offering, in a private non-underwritten transaction under the then $500 million share repurchase program.
On July 26, 2006 the Board authorized a new share buyback program for $1 billion. This replaces our previous $500 million buyback program and its remaining $140 million authorization. The program is an open-ended plan to buyback our shares from time to time in the open market or through negotiated sales with persons who are not affiliates of the company. As of December 31, 2006, the Company has repurchased 5.4 million shares for a total consideration of $211 million, including 3.8 million shares under an accelerated share repurchase program. Repurchased shares were subsequently canceled.
On July 1, 2005, Willis North America Inc. (“Willis North America”) issued debt securities totaling $600 million under its April 2003 registration statement. The debt securities are jointly and severally, irrevocably and fully and unconditionally guaranteed by Willis Group Holdings, Willis Group Limited, Trinity Acquisition Limited, TA 1 Limited, TA II Limited, TA III Limited and TA IV Limited.
21. FINANCIAL INFORMATION FOR PARENT GUARANTOR, OTHER GUARANTOR SUBSIDIARIES AND NON-GUARANTOR SUBSIDIARIES (Continued)
The Company filed a shelf registration on Form S-3 on June 21, 2006 under which Willis Group Holdings may offer debt securities, preferred stock, common stock and other securities. In addition, Trinity Acquisition Limited may offer debt securities (“the Subsidiary Debt Securities”). The Subsidiary Debt Securities, if issued, will be guaranteed by certain of the Company’s subsidiaries.
Previously the Company reported inter-company dividends received and paid on a net basis in the condensed consolidating statement of cash flows within the financial information for parent guarantor, other guarantor subsidiaries and non-guarantor subsidiaries. For the year ended December 31, 2006 the Company has reported inter-company dividends received and paid on a gross basis within the operating activities and the financing activities sections of the cash flow statement respectively. Prior year information has been adjusted to conform to this presentation.
Effective January 1, 2007, the Company changed its internal management structure. Willis UK and Ireland, which comprises the Company’s UK and Irish retail operations and was previously managed within our Global segment, has been combined with our existing international operations to create a new International segment. The new International segment incorporates all the Company’s retail operations outside of North America.