This discussion includes forward-looking statements. See ‘Disclaimer Regarding Forward-looking Statements’ for certain cautionary information regarding forward-looking statements and ‘Risk Factors’ in Item 1A for a list of factors that could cause actual results to differ materially from those predicted in those statements.
Market conditions in our broking industry are generally defined by factors such as the strength of the economies in the various geographic regions in which we serve around the world, insurance rate movements, and insurance and reinsurance buying patterns of our clients.
Management has considered the U.K. referendum vote on June 23, 2016 to depart from the E.U., the triggering of Article 50 of the Treaty of Lisbon (providing the right to and procedures for a member to leave the E.U.) on March 29, 2017, the early general election held on June 8, 2017, and the uncertainties about the near-term and longer-term effects of Brexit on the Company. The terms of Brexit, and its impact, are highly uncertain. For a further discussion of the risks of Brexit to the Company, see Part I, Item 1A. Risk Factors within this Annual Report on Form 10-K.
See Part I, Item 1A. Risk Factors in this Annual Report on Form 10-K for discussions of risks that may affect our ability to compete.
We operate in attractive markets - both growing and mature - with a diversified platform across geographies, industries, segments and lines of business. We aim to create and become the premier advisory, broking and solutions company of choice globally. We design and deliver solutions that manage risk, optimize benefits, cultivate talent, and expand the power of capital to protect and strengthen institutions and individuals. We also help organizations improve performance through effective people, risk and financial management by focusing on providing human capital and financial consulting services.
Delivering a powerful client proposition with an integrated global platform. Our combined offerings provide comprehensive advice, analytics, specialty capabilities and solutions covering benefits, benefits delivery solutions, brokerage and advisory, risk and capital management, and talent and rewards;
Leveraging our combined distribution strength and global footprint to enhance market penetration and provide a platform for further innovation; and
Underpinning this growth through continuous operational improvement initiatives that help make us more effective and efficient and drive cost synergies. We do this by:
making the necessary changes to our processes, our IT, our real estate and workforce locations; and
targeting and delivering identified, highly achievable cost savings as a direct consequence of the Merger.
We care as much about how we work as we do about the impact that we make. This means commitment to shared values, a framework that guides how we run our business and serve clients.
On January 4, 2016, pursuant to the Agreement and Plan of Merger, dated June 29, 2015, as amended on November 19, 2015, between Willis, Towers Watson, and Citadel Merger Sub, Inc., a wholly-owned subsidiary of Willis formed for the purpose of facilitating this transaction (‘Merger Sub’), Merger Sub merged with and into Towers Watson, with Towers Watson continuing as the surviving corporation and a wholly-owned subsidiary of Willis.
At the effective time of the Merger (the ‘Effective Time’), each issued and outstanding share of Towers Watson common stock (the ‘Towers Watson shares’), was converted into the right to receive 2.6490 validly issued, fully paid and nonassessable ordinary shares of Willis (the ‘Willis ordinary shares’), $0.000115 nominal value per share, other than any Towers Watson shares owned by Towers Watson, Willis or Merger Sub at the Effective Time and the Towers Watson shares held by stockholders who are entitled to, and who properly exercised, dissenter’s rights under Delaware law.
We are continuing our integration of Legacy Willis and Legacy Towers Watson, creating a unified platform for global growth, including positioning the Company to leverage our mutual distribution strength to enhance market penetration, expand our global footprint and create a strong platform for further innovation.
The Merger affects the comparability of this data between 2015 and other periods presented. See ‘Supplementary Pro Forma Financial Information’ for additional analysis.
We derive the majority of our revenues from commissions from our brokerage businesses and fees for consulting services. Brokerage commissions and fees negotiated in lieu of commissions are recognized at the later of the policy inception date or when the policy placement is complete or as the fees are otherwise determined. Commissions on additional premiums and adjustments are recognized when approved by or agreed between the parties and collectability is reasonably assured. Consulting revenue is generally recognized as services are performed. No single client represented a significant concentration of our consolidated revenues for any of our three most recent fiscal years.
The table below details our revenues and expenses by transactional currency for the year ended December 31, 2017.
The following table sets forth the total revenues for the years ended December 31, 2017 and 2016 and the components of the change in total revenues for the year ended December 31, 2017, as compared to the prior year:
The impact of acquisitions and divestitures did not have a significant impact on the change in total revenues for the year ended December 31, 2017 since most of these transactions happened in the latter part of the year. Prospectively, our 2018 revenues will exclude a net $65 million related to the impact of various acquisitions and divestitures initiated or completed in 2017.
The following table sets out the total revenues for the years ended December 31, 2016 and 2015 and the components of the change in total revenues for the year ended December 31, 2016, as compared to the prior year:
Beginning in 2017, we made certain changes that affect our segment results. These changes, which are detailed in the Current Report on Form 8-K filed with the SEC on April 7, 2017, include the realignment of certain businesses within our segments, as well as changes to certain allocation methodologies to better reflect the ongoing nature of our businesses. The prior period comparatives reflected in the tables below have been retrospectively adjusted to reflect our current segment presentation. See Note 4 - Segment Information within Item 8 in this Annual Report on Form 10-K for a further discussion of these changes.
The Merger affects the comparability of this data between 2015 and other periods presented. See ‘Supplementary Pro Forma Segment Revenues Analysis’ for additional analysis.
Health and Benefits - The Health & Benefits (‘H&B’) business provides plan management consulting, broking and administration across the full spectrum of health and group benefit programs, including medical, dental, disability, life and other coverage.
Talent & Rewards - Our Talent & Rewards (‘T&R’) business provides advice, data, software and products to address clients’ total rewards and talent issues.
HCB commissions and fees, and total segment revenues, for the year ended December 31, 2017 were $3.2 billion, compared to $3.1 billion for the year ended December 31, 2016. Retirement revenues increased in Western Europe, International and Great Britain and were partially offset by a decline in North America. The decline in North America was expected as bulk lump sum projects declined year over year. Actuarial consulting projects in Great Britain were strong due to regulation changes. The growth in Talent & Rewards was flat. Healthcare consulting revenues in Health and Benefits were up significantly for all markets globally. North America grew due to increased consulting and product demand and Great Britain grew due to global benefits solutions implementations. Revenue in the Technology and Administration Solutions business in Great Britain experienced strong growth as a result of new administration clients and project activity.
The table below presents segment commissions and fees and segment interest and other income for HCB for the years ended December 31, 2016 and 2015.
HCB total segment revenues for the year ended December 31, 2016 were $3.1 billion, compared to $584 million for the year ended December 31, 2015, an increase of $2.5 billion or 434%. This growth in revenues was driven by our Merger and our acquisition of Gras Savoye. See the ‘Supplementary Pro Forma Segment Revenues’ section below for additional discussion of our 2016 results.
CRB generated approximately 33% of Willis Towers Watson segment revenues for the year ended December 31, 2017, and places more than $20 billion of premiums into the insurance markets, annually.
Financial Lines - Financial Lines specializes in brokerage services for financial, political and credit risks.
The table below presents segment commissions and fees, and segment interest and other income for CRB for the years ended December 31, 2017 and 2016.
This segment is our third largest segment and generated approximately 19% of segment revenues for the Company for the year ended December 31, 2017. With approximately 75% of the revenues for this segment split between North America and the U.K., this segment includes the following businesses and offerings:
Insurance Consulting and Technology - Insurance Consulting and Technology, formerly Risk Consulting and Software, is a global business that provides advice and technology solutions to the insurance industry, as well as to corporate clients with respect to their insurance programs. Services include software and technology, risk and capital management, products and pricing, financial and regulatory reporting, financial and capital modeling, M&A, outsourcing and business management.
Investment - Investment provides advice to improve investment outcomes for asset owners using a broad and sophisticated framework for managing risk.
Wholesale Insurance Broking - Wholesale Insurance Broking provides wholesale and specialist broking services to retail brokers.
Willis Towers Watson Securities - Willis Towers Watson Securities, formerly Capital Markets & Advisory, provides investment banking services to companies involved in the insurance and reinsurance industries for a broad array of merger and acquisition transactions as well as capital markets products.
The table below presents segment commissions and fees and segment interest and other income for IRR for the years ended December 31, 2016 and 2015.
The BDA segment, formerly Exchange Solutions, provides primary medical and ancillary benefit exchange and outsourcing services to active employees and retirees across both the group and individual markets. A significant portion of the revenues in this segment is recurring in nature, driven by either the commissions from the policies we sell, or from long-term service contracts with our clients that typically range from three to five years. Revenues across this segment may be seasonal, driven by the magnitude and timing of client transition activities, and we typically increase our membership levels significantly effective January 1, after calendar year-end benefits elections.
Group Marketplace (formerly Active Exchanges) - This business is focused on delivering group benefit exchanges, serving the active employees of employers across the United States through our proprietary BenefitConnect or Bright Choices exchange platforms.
Benefits Outsourcing (formerly Technology and Administration Solutions) - Through our proprietary BenefitConnect technology, this business provides a broad suite of health and welfare outsourcing services as well as decision support and modeling tools for pension users within the U.S.
Benefits Accounts (formerly Consumer-Directed Accounts) - This business uses its SaaS-based technology and related services to deliver consumer-driven healthcare and reimbursement accounts, including health savings accounts, health reimbursement arrangements and other consumer-directed accounts.
BDA total segment revenues for the years ended December 31, 2017 and 2016 were $729 million and $654 million, respectively. Individual Marketplace revenues increased by 10%, and the rest of the segment grew by 14%, led by Group Marketplace and Benefits Outsourcing. Growth in the Individual and Group Marketplaces resulted from the additional 2017 enrollments, and Benefits Outsourcing’s growth was a result of new client wins and special projects.
Salaries and benefits for the years ended December 31, 2017 and December 31, 2016 were $4.7 billion and $4.6 billion, respectively, an increase of $99 million. The increase was primarily a result of a $36 million pension settlement charge related to our U.K. pension plan as well as higher incentive accruals as compared to the prior year. Salaries and benefits for the years ended December 31, 2016 and December 31, 2015 were $4.6 billion and $2.3 billion, respectively, an increase of $2.3 billion. The increase in expenses was primarily driven by the Merger and our acquisition of Gras Savoye. As a percentage of revenues, salaries and benefits expenses represented 58%, 59% and 60% for the years ended December 31, 2017, 2016 and 2015, respectively.
Other operating expenses for the years ended December 31, 2017 and December 31, 2016 were $1.5 billion and $1.6 billion, respectively, a decrease of $17 million. The decrease was due primarily to the Stanford litigation provision of $50 million in 2016, partially offset by reserves for the City of Houston and CalPERS litigations and increases in other litigation reserves and professional services in 2017. Other operating expenses for the years ended December 31, 2016 and December 31, 2015 were $1.6 billion and $718 million, respectively, an increase of $833 million. The increase was primarily driven by the Merger and our acquisition of Gras Savoye.
Depreciation represents the expense incurred over the useful life of our tangible fixed assets and internally developed software. Depreciation for the years ended December 31, 2017 and December 31, 2016 was $203 million and $178 million, respectively, an increase of $25 million. This increase was due primarily to a higher depreciable base of assets resulting from additional assets placed in service in 2016. Depreciation expense for the years ended December 31, 2016 and December 31, 2015 was $178 million and $95 million, respectively, an increase of $83 million. This increase was primarily driven by the Merger and our acquisition of Gras Savoye.
Restructuring costs for the year ended December 31, 2017 were $132 million, all of which related to the final year of the Operational Improvement Program (‘OIP’). Restructuring costs for the year ended December 31, 2016 were $193 million, of which $145 million related to the OIP and $48 million related to the Business Restructuring Program. Restructuring costs for the year ended December 31, 2015 were $126 million, all of which was related to the OIP. See our discussion in the Operational Improvement Program and Business Restructuring Program section herein and Note 5 - Restructuring Costs within Item 8 of this Annual Report on Form 10-K for additional details about these expenses.
December 31, 2015 was income of $55 million, which included gains on disposals of operations of $25 million, and a gain on re-measurement of equity interests related to the Gras Savoye acquisition of $59 million, partially offset by the $30 million impact of the Venezuelan currency devaluation.
Benefit from income taxes for the years ended December 31, 2017, 2016 and 2015 was $100 million, $96 million and $33 million, respectively. The benefit in 2017 was primarily due to the impact of U.S. Tax Reform. The provisional net benefit of $204 million includes a $208 million net benefit due to the reduction in the federal corporate tax rate and re-measurement of net U.S. deferred tax liabilities primarily related to acquisition-based intangibles. The benefit from income taxes in 2016 was primarily due to the release of a portion of U.S. valuation allowances and shifts in the global mix of income as a result of the Merger. This shift resulted in additional deductions in jurisdictions with high statutory income tax rates, which reduced the global effective tax rate. The benefit from income taxes in 2015 was primarily due to an income tax benefit from the release of a portion of U.S. valuation allowances.
To assist the reader in understanding our comparative analysis, we have included discussion and analysis of pro forma financial information for Willis Towers Watson as if the Towers Watson Merger had occurred on January 1, 2015.
Pro forma financial information is for illustrative purposes only, and is based on adjustments that are estimates based upon available information and certain assumptions that Willis Towers Watson management believes are reasonable under the circumstances, as described in ‘Pro Forma Adjustments’ below. The pro forma financial information has not been adjusted to give effect to certain expected financial benefits of the Merger, such as revenue synergies, tax savings and cost synergies, or the anticipated costs to achieve these benefits, including the cost of integration activities. The pro forma financial information does not purport to represent what the actual consolidated results of operations of Willis Towers Watson would have been had the Merger occurred on the date indicated, nor is it necessarily indicative of future consolidated results of operations. The actual results of operations will differ, potentially significantly, from the pro forma amounts reflected herein due to a variety of factors, including access to additional information, changes in value not currently identified and changes in operating results following the date of the unaudited pro forma financial information.
Depreciation. Adjustment related to depreciation on internally developed software of $57 million partially offset by an increase of $11 million for the year ended December 31, 2015 due to an increase in the estimated fair value for leasehold improvements, furniture and fixtures and computer hardware and software.
Amortization. Historical amortization expense of $71 million was removed and amortization expense of $459 million has been recorded to reflect the estimated fair values of Towers Watson’s identifiable intangible assets and related
amortization. See Item 8, Note 3 - Merger, Acquisitions and Divestitures and Note 8 - Goodwill and Other Intangible Assets.
Transaction and integration expenses. Transaction and integration costs related to the Merger and have been eliminated.
The following table sets out the total revenues generated for the year ended December 31, 2016, pro forma revenues generated for the year ended December 31, 2015, and the components of the change for the year ended December 31, 2016, as compared to the pro forma prior year.
Total revenues for the year ended December 31, 2016 were $7.9 billion, compared to $7.5 billion pro forma revenues for the year ended December 31, 2015, an increase of $395 million, or 5%. This growth was driven by a 7% increase due to our acquisitions of Gras Savoye and Miller and 1% organic revenue growth, partially offset by adverse foreign currency exchange movements of 3%. The primary drivers of our growth were within our Corporate Risk and Broking and Benefits Delivery and
Administration, formerly Exchange Solutions, segments. See our segment revenues analysis for a further discussion of our segment results.
Total costs of providing services were $7.3 billion for the year ended December 31, 2016, compared to $6.7 billion for the pro forma year ended December 31, 2015, an increase of $609 million or 9%. See the analysis below for further information.
Other operating expenses for the year ended December 31, 2016 were $1.6 billion, compared to $1.4 billion for the pro forma year ended December 31, 2015, an increase of $105 million or 7%. The increase was primarily related to our acquisitions of Gras Savoye and Miller, which contributed approximately $135 million of the increase. In 2016, we accrued $50 million for the Stanford litigation, which was $20 million less than the $70 million accrued in 2015.
Amortization includes amortization of acquired intangible assets, including acquired internally developed software. Amortization was $591 million for the year ended December 31, 2016, an increase of $56 million, or 10%, compared to $535 million for the pro forma year ended December 31, 2015. The increase in amortization in 2016 is primarily due to amortization of the intangible assets acquired in our acquisitions of Gras Savoye and Miller. We acquired approximately $231 million and $440 million in intangible assets in our acquisitions of Miller and Gras Savoye, respectively. These intangible assets are amortized over their expected lives which range from 4 to 25 years. See Note 3 - Merger, Acquisitions and Divestitures and Note 8 - Goodwill and Other Intangible Assets within Item 8 of this Annual Report on Form 10-K for additional information about our intangible assets.
Transaction and integration expenses were $177 million for the year ended December 31, 2016, an increase of $147 million compared to $30 million for the pro forma year ended December 31, 2015. The increase in 2016 is primarily due to integration expenses incurred subsequent to the Merger. For the year ended December 31, 2016, approximately $162 million of these
BDA total segment revenues for the year ended December 31, 2016 were $654 million, compared to pro forma $487 million for the year ended December 31, 2015; and commissions and fees for the year ended December 31, 2016 were $652 million, compared to pro forma $484 million for the year ended December 31, 2015. Individual Marketplace commissions and fees increased by 41%, primarily as a result of the record 2016 annual enrollment season. The rest of the segment commissions and fees increased by 27%, primarily due to Benefits Outsourcing adding new clients and experiencing higher project activity.
Reduction of the federal corporate tax rate - Beginning January 1, 2018, the Company’s U.S. income will be taxed at a 21% federal corporate tax rate. Under ASC 740, deferred tax assets and liabilities must be recalculated as of the enactment date using current tax laws and rates expected to be in effect when the deferred tax items reverse in future periods, which is 21%. Consequently, the Company has recorded a provisional decrease in its net deferred tax liabilities of $208 million, with a corresponding deferred income tax benefit of $208 million. While the Company is able to make a reasonable estimate of the impact of the reduction in the federal corporate tax rate, it may be affected by other analyses related to U.S. Tax Reform that could result in other adjustments to U.S. federal deferred tax balances, including analysis of tax amounts in other comprehensive income and any future guidance issued.
Indefinite reinvestment assertion - Beginning in 2018, U.S. Tax Reform provides a 100% deduction for dividends received from 10-percent owned foreign corporations by U.S. corporate shareholders, subject to a one-year holding period. Although dividend income is now exempt from U.S. federal tax for U.S. corporate shareholders, companies must still account for the tax consequences of outside basis differences and other tax impacts of their investments in non-U.S. subsidiaries. As a result of U.S. Tax Reform we have analyzed our global working capital and cash requirements and the potential tax liabilities attributable to a repatriation and have determined that we may repatriate up to $219 million, the majority of which was previously deemed indefinitely reinvested. For those investments from which we were able to make a reasonable estimate of the tax effects of such repatriation, we have recorded a provisional estimate for foreign withholding and state income taxes of $1 million. In addition, we re-measured the existing deferred tax liability accrued on certain acquired Towers Watson subsidiaries and released the deferred tax liability relating to the outside basis difference. This resulted in an income tax benefit of $76 million as these foreign earnings were subject to the one-time transition tax which reduced the outside basis difference.
Bonus Depreciation - While the Company has not completed its determination of all capital expenditures that qualify for immediate expensing, for the year ended December 31, 2017, the Company recorded a provisional tax deduction of $40 million based on its current intent to fully expense all qualifying expenditures. The Company will analyze the dates all capital expenditures were placed in service or acquired and consider any future guidance within the next twelve months to finalize the deduction. This resulted in an increase of approximately $14 million to the Company's U.S. federal current income taxes receivable and a corresponding increase in its net deferred tax liabilities of approximately $14 million.
Other includes salary and benefits, premises, and other expenses incurred to support the ongoing management and facilitation of the programs.
During the year ended December 31, 2017, we (i) entered into a $1.25 billion revolving credit facility to replace our previous $800 million revolving credit facility. Borrowings against the $1.25 billion facility of $409 million and €45 million were used to repay all outstanding borrowings against the $800 million facility and the 7-year term loan due July 23, 2018; (ii) repaid our 6.200% senior notes due 2017 totaling $407 million, including accrued interest; and (iii) completed an offering of $650 million of 3.600% Senior Notes due 2024. Net proceeds of $644 million were used to pay down amounts outstanding under our revolving credit facility and for general corporate purposes.
Included within cash and cash equivalents at December 31, 2017 and December 31, 2016 are amounts held for regulatory capital adequacy requirements, including $90 million and $87 million, respectively, held within our regulated U.K. entities.
Cash flows from operating activities were $933 million for 2016, compared to cash flows of from operating activities of $244 million for 2015. The $933 million net cash from operating activities for 2016 included net income of $438 million, adjusted for $590 million of non-cash adjustments, partially offset by changes in operating assets and liabilities of $95 million. The $590 million of non-cash adjustments primarily include depreciation, amortization, net defined benefit pension credits, share-based compensation, and the benefit from deferred income taxes. The $689 million increase in cash from operations in 2016 compared to 2015 was primarily due to cash from operations from Legacy Towers Watson and Gras Savoye.
Cash flows from operating activities for 2015 was $244 million, which included net income of $384 million, adjusted for $38 million of non-cash adjustments to reconcile net income to cash used in operating activities, offset by changes in operating assets and liabilities of $178 million.
Cash flows used in investing activities for 2017 were $335 million, largely driven by $375 million of capital expenditures and capitalized software costs.
Cash flows from investing activities for 2016 were $195 million, largely driven by $476 million of cash acquired as a result of our Merger with Towers Watson, which was a non-cash transaction as it was consummated through the issuance of shares. Cash inflows were partially offset by $303 million of fixed assets and software for internal use and capitalized costs of developing software.
Cash flows used in financing activities for 2017 were $479 million. The significant financing activities included the payment of $177 million related to the cancellation of Towers Watson shares in connection with the settlement of the Merger-related appraisal demand lawsuit (consisting of the portion of the settlement equal to the value of consideration that would have been
due to the shareholders at the closing of the Merger if they had exchanged their shares; see Part II, Item 8. Note 13 - Commitments and Contingencies - Legal Proceedings for additional information), share repurchases of $532 million and dividend payments of $277 million, which were partially offset by net borrowings of $580 million.
In March 2017, we entered into a $1.25 billion revolving credit facility replacing our previous $800 million revolving credit facility. Borrowings against the $1.25 billion facility of $409 million and €45 million were used to repay all outstanding borrowings against the $800 million facility and the 7-year term loan due July 23, 2018.
In May 2017, we completed an offering of $650 million of 3.600% senior notes due 2024. Net proceeds of $644 million were used to pay down amounts outstanding under our revolving credit facility and for general corporate purposes.
At December 31, 2017 and December 31, 2016, we were in compliance with all financial covenants.
At December 31, 2017 and 2016, we had fiduciary funds of $3.3 billion and $2.5 billion, respectively.
The Company has no material commitments for capital expenditures. Our capital expenditures for fixed assets and software for internal use were $300 million for the year ended December 31, 2017. Expected capital expenditures for fixed assets and software for internal use are approximately $285 million for the year ended December 31, 2018. We expect cash from operations to adequately provide for these cash needs.
Total cash dividends of $277 million were paid during the year ended December 31, 2017. In February 2018, the board of directors approved a quarterly cash dividend of $0.60 per share ($2.40 per share annualized rate), which will be paid on or about April 16, 2018 to shareholders of record as of March 31, 2018.
The Company’s material contractual obligations as of December 31, 2017 are as follows:
Pension Contributions - The Company has agreed with Trustees of certain plans in the U.K. to contribute deficit funding and minimum ongoing accrual of benefits funding and presented those obligations in the table above. These obligations exclude employee contributions and any potential funding level contributions, which are dependent on future funding level assessments. There are no contractual obligations for our U.S. pension plans. Our total expected contributions to all qualified pension plans, including amounts presented above, for the year ending December 31, 2018 are projected to be $150 million. Additionally, the Company expects to pay $54 million in benefits directly to participants for the year ended 2018.
Uncertain Tax Positions - The table above does not include liabilities for uncertain tax positions under ASC 740, Income Taxes. The settlement period for the $59 million liability, which excludes interest and penalties, cannot be reasonably estimated since it depends on the timing and possible outcomes of tax examinations with various tax authorities.
Within the measures referred to as “adjusted”, we have adjusted for significant items which will not be settled in cash, or which we believe to be items that are not core to our current or future operations. These items include the following:
Provision for Stanford and other significant litigation - The 2016 provision for the Stanford litigation matter, which we consider to be a non-ordinary course litigation matter. We will also include other litigation matters which we believe are not representative of our core business operations.
The pro forma financial information for 2015 is only for Willis and Towers Watson and does not include Gras Savoye or other M&A activity on a pro forma basis.
We evaluate our revenues on an as reported (U.S. GAAP), constant currency and organic basis. We believe providing constant currency and organic information provides valuable supplemental information regarding our comparable results, consistent with how we evaluate our performance internally.
The constant currency and organic change results, and a reconciliation from the reported results for consolidated revenues, are included in the Consolidated Revenues section within this Form 10-K. These measures are also reported by segment in the ‘As Reported Segment Revenues’ and ‘Supplementary Pro Forma Segment Revenues’ sections within this Form 10-K.
(i) Components of revenue change may not add due to rounding.
A reconciliation of total revenues to adjusted revenues for the year ended December 31, 2016 and pro forma 2015, and a reconciliation of the pro forma change to the constant currency and organic changes for the year ended December 31, 2016 from the prior year is as follows:
Adjusted operating income is defined as income from operations adjusted for amortization, restructuring costs, transaction and integration expenses, significant litigation settlements, significant pension settlement and curtailment activity, the fair value adjustment for deferred revenue and non-recurring items that, in management’s judgment, significantly affect the period-over-period assessment of operating results.
A reconciliation of income from operations to adjusted operating income for the years ended December 31, 2017 and 2016 is as follows:
Adjusted operating income for the year ended December 31, 2017 increased to $1.8 billion, from $1.6 billion for the year ended December 31, 2016, an increase of $147 million, or 9%. Income from operations increased by $187 million, largely due to revenue growth across all segments partially offset by higher salary and benefits costs. The prior year also included settlement income of £28 million ($41 million) related to the Fine Arts, Jewellery and Specie team.
A reconciliation of income from operations to adjusted operating income for the year ended December 31, 2016 and pro forma year ended December 31, 2015 is as follows:
We consider adjusted EBITDA to be an important financial measure, which is used to internally evaluate and assess our core operations, to benchmark our operating results against our competitors, and to evaluate and measure our performance-based compensation plans.
(i) Includes pro forma adjustments made in the Supplementary Pro Forma Financial Information section in this Form 10-K.
A reconciliation of net income attributable to Willis Towers Watson to adjusted diluted earnings per share for the years ended December 31, 2017 and 2016 is as follows:
Management believes the adjusted income tax rate presents a rate that is more closely aligned to the rate we would incur if not for the reduction of pre-tax income for the adjusted items, the tax effects of our internal reorganizations and the tax effect of U.S. Tax Reform, which are not core to our current and future operations.
(i) The tax effect was calculated using an effective tax rate for each item.
Our adjusted income tax rates were 21.9% and 20.8% for the years ended December 31, 2017 and 2016, respectively. The lower adjusted tax rate for the year ended December 31, 2016 was primarily due to a prior year tax benefit resulting from an enacted statutory tax rate reduction in the U.K.
Reconciliations of cash flows from operating activities to free cash flow for the years ended December 31, 2017, 2016 and 2015 are as follows:
See Note 13 - Commitments and Contingencies in Item 8 within this Annual Report on Form 10-K.
Legacy Willis - This plan covers approximately one third of the Legacy Willis employees in the United Kingdom. The plan is now closed to new entrants. New employees in the United Kingdom are offered the opportunity to join a defined contribution plan.
management and changed when appropriate. A discount rate will be changed annually if underlying rates have moved, whereas the expected long-term return on assets will be changed less frequently as longer term trends in asset returns emerge or long term target asset allocations are revised. To calculate the discount rate, we use the granular approach to determining service cost and interest cost. We began using this method to calculate the discount rate in 2016. This was treated as a change in accounting estimate, and resulted in a credit of $51 million included in our total net periodic benefit income. The expected rate of return assumptions for all plans are supported by an analysis of the weighted-average yield expected to be achieved with the anticipated makeup of investments. Other material assumptions include rates of participant mortality, and the expected long-term rate of compensation and pension increases.
During fiscal year 2017, the Company performed Step 1 of the two-step impairment test for all reporting units. Each of the reporting units' estimated fair values were in excess of their carrying values. To perform the test, we used valuation techniques to estimate the fair value of a reporting unit that fall under income or market approaches. Under the discounted cash flow method, an income approach, the business enterprise value is determined by discounting to present value the terminal value which is calculated using debt-free after-tax cash flows for a finite period of years. Key estimates in this approach were internal financial projection estimates prepared by management, business risk, and expected rates of return on capital. The guideline company method, a market approach, develops valuation multiples by comparing our reporting units to similar publicly traded companies. Key estimates and selection of valuation multiples rely on the selection of similar companies, obtaining estimates of forecast revenues and EBITDA estimates for the similar companies and selection of valuation multiples as they apply to the reporting unit characteristics. Under the similar transactions method, a market approach, actual transaction prices and operating data from companies deemed reasonably similar to the reporting units is used to develop valuation multiples as an indication of how much a knowledgeable investor in the marketplace would be willing to pay for the business units.
If the Company was required to perform Step 2, we would determine the implied fair value of the reporting unit used in Step 1 to all of the assets and liabilities of that reporting unit (including any recognized or unrecognized intangible assets) as if the reporting unit had been acquired in a business combination. Then the implied fair value of goodwill would be compared to the carrying amount of goodwill to determine if goodwill is impaired. For the year ended December 31, 2017, we did not record any impairment losses of goodwill or intangibles.
While we are still in the process of analyzing the various Accounting Standards Updates (‘ASU’) issued by the Financial Accounting Standards Board (‘FASB’), those which we believe will have a material impact to our financial statements are listed below. See Note 2 - Basis of Presentation, Significant Accounting Policies and Recent Accounting Pronouncements within Item 8 of this Form 10-K for additional information.
Revenue recognition for certain other revenue streams has changed from recognizing revenue at a point in time to recognizing revenue over time. Specifically, certain arrangements in our Health and Benefits broking business will now be recognized evenly over the year to reflect the nature of the ongoing obligations to our customers as well as receipt of the monthly commissions. These contracts are monthly or annual in nature and are considered complete as of the transition date. Therefore, no retained earnings adjustment is required.
Consolidated Statements of Changes in Equity for each of the three years in the period ended December 31, 2017
We have audited the accompanying consolidated balance sheet of Willis Towers Watson Public Limited Company and subsidiaries (the “Company”) as of December 31, 2017, the related consolidated statements of comprehensive income, changes in equity and cash flows for the period ended December 31, 2017, and the related notes (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2017, and the results of its operations and its cash flows for the period ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 28, 2018, expressed an unqualified opinion on the Company's internal control over financial reporting.
We have audited, before the effects of the adjustments to retrospectively apply the changes in accounting discussed in Note 2 and before the effects of the retrospective adjustments to the disclosures for a change in the composition of reportable segments discussed in Note 4 to the consolidated financial statements, the consolidated balance sheet of Willis Towers Watson Public Limited Company and subsidiaries (the “Company”) as of December 31, 2016, and the related consolidated statements of comprehensive income, changes in equity, and cash flows for the years ended December 31, 2016 and 2015 (the 2016 and 2015 consolidated financial statements before the effects of the adjustments discussed in Notes 2 and 4 to the consolidated financial statements are not presented herein). These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
In our opinion, such 2016 and 2015 consolidated financial statements, before the effects of the adjustments to retrospectively apply the changes in accounting discussed in Note 2 and before the effects of the retrospective adjustments to the disclosures for a change in the composition of reportable segments discussed in Note 4 to the consolidated financial statements, present fairly, in all material respects, the financial position of Willis Towers Watson Public Limited Company and subsidiaries as of December 31, 2016, and the results of their operations and their cash flows for the years ended December 31, 2016 and 2015, in conformity with accounting principles generally accepted in the United States of America.
Equity includes (a) Ordinary shares $0.000304635 nominal value; Authorized 1,510,003,775; Issued 132,139,581 (2017) and 137,075,068 (2016); Outstanding 132,139,581 (2017) and 136,296,771 (2016); (b) Ordinary shares, €1 nominal value; Authorized and Issued 40,000 shares in 2017 and 2016; and (c) Preference shares, $0.000115 nominal value; Authorized 1,000,000,000 and Issued none in 2017 and 2016.
(In millions of U.S. dollars and number of shares in thousands)
As an insurance broker, we act as an intermediary between our clients and insurance carriers by advising our clients on their risk management requirements, helping them determine the best means of managing risk and negotiating and placing insurance with insurance carriers through our global distribution network. We operate the largest private Medicare exchange in the United States (‘U.S.’). Through this exchange and those for active employees, we help our clients move to a more sustainable economic model by capping and controlling the costs associated with healthcare benefits.
Investments in Associates - Investments are accounted for using the equity method of accounting, included within other non-current assets in the consolidated balance sheets, if the Company has the ability to exercise significant influence, but not control, over the investee. Significant influence is generally deemed to exist if the Company has an equity ownership in the voting stock of the investee between 20 and 50 percent, although other factors, such as representation on the board of directors and the impact of commercial arrangements, are considered in determining whether the equity method of accounting is appropriate. Under the equity method of accounting, the investment is carried at the cost of acquisition, plus the Company’s equity in undistributed net income since acquisition, less any dividends received since acquisition.
Cash and Cash Equivalents - Cash and cash equivalents primarily consist of time deposits with original maturities of 90 days or less. Willis Limited, our U.K. brokerage subsidiary regulated by the Financial Conduct Authority, is currently required to maintain $140 million in unencumbered and available financial resources, of which at least $79 million must be in cash, for regulatory purposes. Term deposits and certificates of deposits with original maturities greater than 90 days are considered to be short-term investments. There is no restricted cash included in our cash and cash equivalents balance, as these amounts are included in fiduciary assets.
The Company recognizes interest and penalties relating to unrecognized tax benefits within income taxes. See Note 6 - Income Taxes for additional information regarding the Company’s income taxes.
Commitments, Contingencies and Provisions for Liabilities - The Company establishes provisions against various actual and potential claims, lawsuits and other proceedings relating principally to alleged errors and omissions in the ordinary course of business. Such provisions cover claims that have been reported but not paid and also unasserted claims and related legal fees. These provisions are established based on actuarial estimates together with individual case reviews and are believed to be adequate in light of current information and legal advice. In certain cases, where a range of loss exists, we accrue the minimum amount in the range if no amount within the range is a better estimate than any other amount. To the extent such losses can be recovered under the Company’s insurance programs, estimated recoveries are recorded when losses for insured events are recognized and the recoveries are likely to be realized. Significant management judgment is required to estimate the amounts of such unasserted claims and the related insurance recoveries. The Company analyzes its litigation exposure based on available
Goodwill is tested for impairment annually as of October 1, and whenever indicators of impairment exist. Goodwill is tested at the reporting unit level, and the Company had nine reporting units as of October 1, 2017. In the first step of the impairment test, the fair value of each reporting unit is compared with its carrying value, including goodwill. If the carrying value of a reporting
unit exceeds its fair value, the amount of an impairment loss, if any, is calculated in the second step of the impairment test by comparing the implied fair value of reporting unit goodwill with the carrying amount of that goodwill. The Company’s goodwill impairment tests for the years ended December 31, 2017 and 2016 have not resulted in any impairment charges. See Note 8 - Goodwill and Other Intangible Assets for additional information about our goodwill and other intangible assets.
Annual recurring projects and projects of short duration. These projects are typically straightforward and highly predictable in nature. As a result, the project manager and financial staff are able to identify, as the project status is reviewed and bills are prepared monthly, the occasions when cost overruns could lead to the recording of a loss accrual.
Delivered software. We deliver software under arrangements with clients who take possession of our software. The maintenance associated with the initial software fees is a fixed percentage which enables us to determine the stand-alone value of the delivered software separate from the maintenance. We recognize the initial software fees as software is delivered to the client, and we recognize the maintenance fees ratably over the contract period based on each element’s relative fair value. For software arrangements in which initial fees are received in connection with mandatory maintenance for the initial software license to remain active, we determined that the initial maintenance period is substantive. Therefore, we recognize the fees for the initial license and maintenance bundle ratably over the initial contract term, which is generally one year. Each subsequent renewal fee is recognized ratably over the contractually stated renewal period.
Other Income. Other income includes gains on disposal of intangible assets, which primarily arise from settlements through enforcing non-compete agreements in the event of losing accounts through producer defection or the disposal of books of business.
Certain revenue streams have accelerated revenue recognition timing. In particular, the revenue recognition for our Individual Marketplace (formerly Retiree & Access Exchanges) has moved from monthly ratable recognition over the policy period, to the recognition upon placement of the policy. Consequently, the Company will now recognize the majority of one calendar year of expected commissions during its fourth quarter of the preceding calendar year. Therefore, at the adoption date, we have reflected an adjustment to retained earnings for the portion of the revenue that would otherwise have been recognized during our 2018 calendar year since our earnings process was largely completed during the fourth quarter of 2017.
In February 2016, the FASB issued ASU No. 2016-02, Leases, which requires a lessee to recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. The ASU becomes effective for the Company at the beginning of its 2019 calendar year, at which time the Company will adopt it, although early adoption is permitted. While the Company continues to assess the impact of the ASU to its consolidated financial statements, the majority of its leases are currently considered operating leases and will be capitalized as a lease asset on its balance sheet with a related lease liability for the obligated lease payments.
In March 2017, the FASB issued ASU No. 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost, which requires entities to (1) disaggregate the current service-cost component from the other components of net benefit cost (the ‘other components’) and present it in the income statement with other current compensation costs for related employees and (2) present the other components elsewhere in the income statement and outside of income from operations if that subtotal is presented. In addition, the ASU requires entities to disclose the income statement lines that contain the other components if they are not presented or included in appropriately described separate lines. The ASU became effective for the Company on January 1, 2018, at which time the Company adopted it, and will apply the standard retrospectively beginning in its 2018 first quarter Form 10-Q. The Company has determined that, while the classification of some components of net benefit cost will change within the accompanying consolidated statement of comprehensive income, there is no material impact on its consolidated financial statements.
In May 2017, the FASB issued ASU No. 2017-09, Stock Compensation - Scope of Modification Accounting, which provides guidance on which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. The ASU requires that an entity should account for the effects of a modification unless the fair value (or calculated value or intrinsic value, if used), vesting conditions and classification (as equity or liability) of the modified award are all the same as for the original award immediately before the modification. The ASU became effective for the Company on January 1, 2018, at which time the Company adopted it, and should be applied prospectively to an award modified on or after the adoption date. There is no immediate impact to the accompanying consolidated financial statements, until such time as an award may be modified in 2018 or forward.
In February 2018, the FASB issued ASU No. 2018-02, Income Statement - Reporting Comprehensive Income: Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which allows for a reclassification from accumulated other comprehensive income to retained earnings for ‘stranded’ tax effects (those tax effects of items within accumulated other comprehensive income resulting from the historical corporate income tax rate reduction) resulting from the Tax Cuts and Jobs Act. The amendments within this ASU also require certain disclosures about stranded tax effects. The ASU becomes effective for the Company on January 1, 2019. Early adoption is permitted, and any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. The Company is currently assessing when it will adopt this standard, and the impact that this standard will have on its consolidated financial statements.
In October 2016, the FASB issued ASU No. 2016-16, Accounting for Income Taxes: Intra-Entity Asset Transfers of Assets Other than Inventory, which amends guidance regarding the recognition of current and deferred income taxes for intra-entity
At the effective time of the Merger (the ‘Effective Time’), each issued and outstanding share of Towers Watson common stock (the ‘Towers Watson shares’), was converted into the right to receive 2.6490 validly issued, fully paid and nonassessable ordinary shares of Willis (the ‘Willis ordinary shares’), $0.000115 nominal value per share, other than any Towers Watson shares owned by Towers Watson, Willis or Merger Sub at the Effective Time and the Towers Watson shares held by stockholders who are entitled to and who properly exercised dissenter’s rights under Delaware law.
On December 29, 2015, the third business day immediately prior to the closing date of the Merger, Towers Watson declared and paid a pre-merger special dividend of $10.00 per share of its common stock, and approximately $694 million in the aggregate based on approximately 69 million Towers Watson shares issued and outstanding at December 29, 2015.
The purchase price allocation as of the date of acquisition was based on a valuation of the assets acquired and liabilities assumed in the acquisition. The purchase price allocation was complete as of December 31, 2016.
Goodwill was calculated as the difference between the aggregate Merger consideration and the acquisition date fair value of the net assets acquired, and represents the value of the Legacy Towers Watson assembled workforce and the future economic benefits that we expect to realize as a result of the Merger. None of the goodwill recognized on the transaction is tax deductible.
The following pro forma financial information is unaudited and is intended to reflect the impact of the Merger on Willis Towers Watson’s consolidated financial statements as if the Merger had taken place on January 1, 2015 and presents the results of operations of Willis Towers Watson based on the historical financial statements of Willis and Towers Watson after giving effect to the Merger and pro forma adjustments. Pro forma adjustments are included only to the extent they are (i) directly attributable to the Merger, (ii) factually supportable and (iii) with respect to the consolidated statement of comprehensive income, expected to have a continuing impact on the combined results. The accompanying unaudited pro forma financial information is presented for illustrative purposes only and has not been adjusted to give effect to certain expected financial benefits of the Merger, such as revenue synergies, tax savings and cost synergies, or the anticipated costs to achieve these benefits, including the cost of integration activities. The unaudited pro forma results are not indicative of what would have occurred had the Merger taken place on the indicated date.
Revenues attributable to Towers Watson for the year ended December 31, 2016 were $3.6 billion. Net income attributable to Towers Watson for the year ended December 31, 2016 was $111 million.
remaining portion of options related to the post-acquisition employee services was $13 million, and will be recognized over the future vesting periods.
Restricted Stock Units. The outstanding unvested RSUs were converted into 597,307 Willis Towers Watson RSUs using the conversion ratios as stated in the Merger agreement. The fair value of these RSUs was calculated using Willis Towers Watson’s closing share price on the date of acquisition. We determined the fair value of the portion of the outstanding RSUs related to pre-acquisition employee service using the straight-line expense methodology from the date of grant to the acquisition date to be $30 million, which was added to the transaction consideration. The fair value of the remaining portion of RSUs related to the post-acquisition employee services was $32 million, and will be recognized over the future vesting periods.
On December 29, 2015, Legacy Willis completed the transaction to acquire substantially all of the remaining 70% of the outstanding share capital of Gras Savoye, the leading insurance broker in France, for total consideration of €544 million ($592 million) of which $582 million in cash was paid at closing. Additionally, the previously held equity interest in Gras Savoye was re-measured to a fair value of €221 million ($241 million) giving a total fair value on a 100% basis of €765 million ($833 million).
The Company funded the cash consideration with a 1-year term loan. The term loan was repaid in its entirety on May 26, 2016, from the proceeds from the issuance of new senior notes discussed in Note 10 - Debt to these consolidated financial statements.
Deferred consideration is payable at the first, second and third anniversaries of the acquisition. Contingent consideration is payable at the third anniversary of the acquisition and is contingent on meeting certain earnings before interest, taxes, depreciation and amortization (‘EBITDA’) performance targets. At December 31, 2017, the discounted fair values of the deferred consideration related to the third anniversary and contingent consideration were $38 million and $40 million, respectively. At December 31, 2016, the discounted fair values of the deferred consideration related to the second and third anniversaries and contingent consideration were $69 million and $26 million, respectively.
The Company recognized assets and liabilities acquired of $1.1 billion and $844 million, respectively. Included within the acquired assets are identifiable intangible assets of $231 million and goodwill of $184 million.
The purchase price allocation as of the date of acquisition was based on a valuation of the assets acquired, liabilities assumed, and contingent consideration associated with the acquisition. There were no material revisions to the purchase price allocation during the year ended December 31, 2016, as the purchase price allocation is final.
Related Party Transaction - In the third quarter of 2017, the Company divested its Global Wealth Solutions business through a sale to an employee of the business. As part of that transaction, we financed a $50 million note payable from the employee to purchase the business. The note amortizes over 10 years, bears interest at a weighted-average rate of 3% and is guaranteed by $3 million in assets. Following the sale, employees of this business are no longer employees of the Company, and the purchasing employee is no longer considered a related party. The current and non-current portions of the note receivable are included in the tables found in Note 14 - Supplementary Information for Certain Balance Sheet Accounts to these consolidated financial statements as Other current assets and Other non-current assets.
This segment and the businesses within the segment were renamed to better reflect the nature of the services we offer.
Willis Towers Watson’s chief operating decision maker is its chief executive officer. We determined that the operational data used by the chief operating decision maker is at the segment level. Management bases strategic goals and decisions on these segments and the data presented below is used to assess the adequacy of strategic decisions, the method of achieving these
strategies and related financial results. Management evaluates the performance of its segments and allocates resources to them based on net operating income on a pre-bonus, pre-tax basis.
Second, we recast operating income to better reflect the new segment reporting basis. As part of the further integration of our Willis Towers Watson businesses, we updated our corporate expense allocations to standardize our methodologies and allocate those expenses which are directly related to the business segment operations. Additionally, we revised the presentation of certain adjustments which arose from the purchase accounting for the Merger. Due to the long-term nature of these adjustments, which impact fixed assets and internally-developed software, we aligned the presentation within the respective segments and consolidated operating income, thereby eliminating a reconciling adjustment.
The prior period comparatives reflected in the tables below have been retroactively adjusted to reflect our current segment presentation.
Under the segment structure and for internal and segment reporting, Willis Towers Watson segment revenues include commissions and fees, interest and other income. U.S. GAAP revenues include amounts that were directly incurred on behalf of our clients and reimbursed by them (reimbursable expenses), which are removed from segment revenues. Segment commissions and fees excludes interest and other income. Segment operating income excludes certain costs, including (i) amortization of intangibles; (ii) restructuring costs; (iii) certain transaction and integration expenses; (iv) certain litigation provisions; (v) significant pension settlement and curtailment gains or losses; and (vi) to the extent that the actual expense based upon which allocations are made differs from the forecast/budget amount, a reconciling item will be created between internally allocated expenses and the actual expense that we report for U.S. GAAP purposes.
During 2016, segment revenues and operating income both include revenue that was deferred by Towers Watson at the time of the Merger, and eliminated due to purchase accounting. The impact of the elimination from purchase accounting (which is the reduction to 2016 consolidated revenues and operating income) has been included in the reconciliation to our consolidated results in order to provide the actual revenues that the segments would have recognized on an unadjusted basis.
The table below presents a reconciliation of the information reported by segment to the consolidated amounts reported for the years ended December 31, 2017, 2016, and 2015, respectively:
Includes transaction and integration expenses related to the Merger and the acquisition of Gras Savoye.
Includes certain costs, primarily related to corporate functions which are not directly related to the segments, and certain differences between budgeted expenses determined at the beginning of the year and actual expenses that we report for U.S. GAAP purposes.
None of the Company’s customers represented a significant amount of the Company’s consolidated commissions and fees for the years ended December 31, 2017, 2016 and 2015.
Business Restructure Program - In the second quarter of 2016, we began planning targeted staffing reductions in certain portions of the business due to a reduction in business demand or change in business focus (hereinafter referred to as the Business Restructure Program). The main element of the program included workforce reductions, and was completed in 2016. During the year ended December 31, 2017, the Company recognized a $2 million reversal of expense related to an estimate of previously incurred termination benefits. The Company recognized restructuring costs of $48 million for the year ended December 31, 2016.
An analysis of total restructuring costs recognized in the consolidated statements of comprehensive income, and the costs by segment, and costs attributable to corporate functions, for the years ended December 31, 2017, 2016 and 2015 are as follows:
Other includes salary and benefits, premises, and other expenses incurred to support the ongoing management and facilitation of the program.
On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (hereafter ‘U.S. Tax Reform’). U.S. Tax Reform makes broad and complex changes to the U.S. tax code, including, but not limited to: (1) requiring a one-time transition tax on certain unremitted earnings of foreign subsidiaries that may be payable over eight years; (2) bonus depreciation that will allow for a full expensing of qualified property; (3) reduction of the federal corporate tax rate from 35% to 21%; (4) a new provision designed to tax global intangible low-taxed income (‘GILTI’), which allows for the possibility of using foreign tax credits (‘FTCs’) and a deduction of up to 50% to offset the income tax liability (subject to some limitations); (5) a new limitation on deductible interest expense; (6) limitations on the deductibility of certain executive compensation; (7) limitations on the use of FTCs to reduce the U.S. income tax liability; (8) the creation of the base erosion anti-abuse tax (‘BEAT’), a new minimum tax; and (9) a general elimination of U.S. federal income taxes on dividends from foreign subsidiaries.
Also on December 22, 2017, the SEC staff issued Staff Accounting Bulletin No. 118 (‘SAB 118’), which provides guidance on accounting for the tax effects of the U.S. Tax Reform. SAB 118 provides for a measurement period that should not extend beyond one year from the U.S. Tax Reform enactment date for companies to complete the accounting under ASC 740, Income Taxes (‘ASC 740’). In accordance with SAB 118, a company must reflect the income tax effects of those aspects of U.S. Tax Reform for which the accounting under ASC 740 is complete. Adjustments to incomplete and unknown amounts will be recorded and disclosed prospectively during the measurement period. To the extent that a company’s accounting for certain income tax effects of U.S. Tax Reform is incomplete but it is able to determine a reasonable estimate, it must record a provisional estimate in the financial statements. If a company cannot determine a provisional estimate to be included in the financial statements, it should continue to apply ASC 740 on the basis of the provisions of the tax laws that were in effect immediately before the enactment of U.S. Tax Reform.
One-time transition tax - The one-time transition tax is based on the Company’s total post-1986 earnings and profits (‘E&P’) that it previously deferred from U.S. income taxes. The Company recorded a provisional amount for the one-time transition tax liability for its foreign subsidiaries owned by U.S. corporate shareholders, resulting in an increase in U.S. Federal income tax expense of $70 million and state income tax expense of $2 million. The Company has a significant number of foreign subsidiaries and therefore has not yet completed its calculation of the total post-1986 E&P as well as non-U.S. income taxes paid for these foreign subsidiaries. Further, the transition tax is based in part on the amount of those earnings held in cash and other specified assets, including trade receivables, based on estimates. The Company expects to revise its estimates of E&P, non-U.S. income taxes and cash balances throughout 2018 when actual results are available. In addition, guidance may be released which could also impact these estimates.
Bonus Depreciation - While the Company has not completed its determination of all capital expenditures that qualify for immediate expensing for the year ended December 31, 2017, the Company recorded a provisional tax deduction of $40 million based on its current intent to fully expense all qualifying expenditures. The Company will analyze the dates all capital expenditures were placed in service or acquired and consider any future guidance within the next twelve months to finalize the deduction. This resulted in an increase of approximately $14 million to the Company's U.S. federal current income taxes receivable and a corresponding increase in its net deferred tax liabilities of approximately $14 million.
GILTI - U.S. Tax Reform creates a new requirement that certain income (i.e., GILTI) earned by controlled foreign corporations (‘CFCs’) must be included currently in the gross income of the CFCs’ U.S. shareholder. GILTI is the excess of the shareholder’s ‘net CFC tested income’ over the net deemed tangible income return, which is currently defined as the excess of (1) 10 percent of the aggregate of the U.S. shareholder’s pro rata share of the qualified business asset investment of each CFC with respect to which it is a U.S. shareholder over (2) the amount of certain interest expense taken into account in the determination of net CFC-tested income. Because of the complexity of the new GILTI tax rules,
Willis Towers Watson plc is a non-trading holding company tax resident in Ireland where it is taxed at the statutory rate of 25%. The provision for income tax on operations has been reconciled above to the U.S. federal statutory tax rate of 35% due to significant operations in the U.S.
Deferred income tax assets and liabilities included in the consolidated balance sheets at December 31, 2017 and 2016 are comprised of the following:
As a result of U.S. Tax Reform, we have analyzed our global working capital and cash requirements and the potential tax liabilities attributable to a repatriation and have determined that we may repatriate up to $219 million, the majority of which was previously deemed indefinitely reinvested. For those investments from which we were able to make a reasonable estimate of the tax effects of such repatriation, we have recorded a provisional estimate for foreign withholding taxes and state income taxes of $1 million. In addition, we re-measured the existing deferred tax liability accrued on certain acquired Towers Watson subsidiaries and released the deferred tax liability relating to the outside basis difference. This resulted in an income tax benefit of $76 million as these foreign earnings were subject to the one-time transition tax which reduced the outside basis difference.
Interest and penalties related to unrecognized tax benefits are included as a component of income tax expense. At December 31, 2017, we had cumulative accrued interest of $5 million. At December 31, 2016, the cumulative accrued interest was $4 million. Penalties accrued in 2017 were $2 million and immaterial in 2016.
The Company believes that the outcomes which are reasonably possible within the next 12 months may result in a reduction in the liability for unrecognized tax benefits in the range of $4 million to $6 million, excluding interest and penalties.
Willis North America Inc. is not currently under examination by the U.S. Internal Revenue Service (‘IRS’). We have ongoing state income tax examinations in certain states for tax years ranging from fiscal year ended June 30, 2012 through calendar year ended December 31, 2015. The statute of limitations in certain states extends back to the fiscal year ended June 30, 2012 as a result of changes to taxable income resulting from prior year federal tax examinations.
The following table reflects changes in the net carrying amount of the components of fixed assets for the year ended December 31, 2017 and 2016:
Depreciation expense included here does not equal the depreciation expense on the statement of comprehensive income for the year ended December 31, 2017 due to the inclusion of $49 million which has been classified as transaction and integration expenses.
The components of goodwill are outlined below for the years ended December 31, 2017 and 2016:
Represents the reallocation of goodwill related to certain businesses which were realigned among the segments as of January 1, 2017. See Note 4 - Segment Information for further information.
Amortization associated with favorable lease agreements is recorded in Other operating expenses in the consolidated statements of comprehensive income.
Amortization associated with favorable agreements is recorded in Other operating expenses in the consolidated statements of comprehensive income.
We recorded amortization related to our finite-lived intangible assets, exclusive of the amortization of our favorable lease agreements, of $581 million, $591 million, and $76 million for the years ended December 31, 2017, 2016 and 2015, respectively.
Our acquired unfavorable lease liabilities were $26 million and $29 million as of December 31, 2017 and December 31, 2016, respectively, and are recorded in other non-current liabilities in the consolidated balance sheet.
The following table reflects the carrying value of finite-lived intangible assets and liabilities at December 31, 2017 and December 31, 2016:
The weighted average remaining life of amortizable intangible assets and liabilities at December 31, 2017 was 14.3 years.
We are exposed to certain interest rate and foreign currency risks. Where possible, we identify exposures in our business that can be offset internally. Where no natural offset is identified, we may choose to enter into various derivative transactions. These instruments have the effect of reducing our exposure to unfavorable changes in interest and foreign currency rates. The Company’s board of directors reviews and approves policies for managing each of these risks as summarized below. Additional information regarding our derivative financial instruments can be found in Note 2 - Basis of Presentation, Significant Accounting Policies and Recent Accounting Pronouncements, Note 11 - Fair Value Measurements and Note 16 - Accumulated Other Comprehensive Loss.
At December 31, 2017, the Company estimates, based on current interest and exchange rates, there will be $26 million of net derivative losses on forward exchange rates, interest rate swaps, and treasury locks reclassified from accumulated other comprehensive income/(loss) into earnings within the next twelve months as the forecast transactions affect earnings. At December 31, 2017, our longest outstanding maturity was 2.9 years.
The effects of the material derivative instruments that are designated as hedging instruments on the consolidated statements of comprehensive income for the years ended December 31, 2017, 2016 and 2015 are as follows:
We also enter into foreign currency transactions, primarily to hedge certain intercompany loans. These derivatives are not generally designated as hedging instruments and at December 31, 2017 and December 31, 2016, we had notional amounts of $971 million and $630 million, respectively, and had a net fair value asset of $3 million, and a net fair value liability of $8 million, respectively.
The effects of derivatives that have not been designated as hedging instruments on the consolidated statements of comprehensive income for the years ended December 31, 2017, 2016 and 2015 are as follows:
All direct obligations under the 5.750% senior notes are issued by the Company and guaranteed by Trinity Acquisition plc, Willis Netherlands Holdings B.V., Willis Investment U.K. Holdings Limited, TA I Limited, Willis North America Inc., Willis Group Limited, Willis Towers Watson Sub Holdings Unlimited Company and Willis Towers Watson UK Holdings Limited. See Note 22 - Financial Information for Parent Issuer, Guarantor Subsidiaries and Non-Guarantor Subsidiaries.
All direct obligations under the 4.625%, 6.125%, 3.500%, 4.400%, and 2.125% senior notes are issued by Trinity Acquisition plc and guaranteed by Willis Towers Watson, Willis Netherlands Holdings B.V., Willis Investment U.K. Holdings Limited, TA I Limited, Willis North America Inc., Willis Group Limited, Willis Towers Watson Sub Holdings Unlimited Company and Willis Towers Watson UK Holdings Limited. See Note 23 - Financial Information for Issuer, Parent Guarantor, Other Guarantor Subsidiaries and Non-Guarantor Subsidiaries.
On March 7, 2017, Trinity Acquisition plc (see Note 23 for further information) entered into a $1.25 billion amended and restated revolving credit facility (the ‘RCF’), that will mature on March 7, 2022. The RCF replaced the previous $800 million revolving credit facility (see below for further information). Amounts outstanding under the RCF shall bear interest at LIBOR plus a margin of 1.00% to 1.75%, or alternatively, the base rate plus a margin of 0.00% to 0.75%, based upon the Company’s guaranteed senior unsecured long-term debt rating.
Additionally, on March 28, 2017, $407 million was used to repay the 6.200% senior notes due 2017, including accrued interest.
Drawings under the previous $800 million revolving credit facility bore interest at LIBOR plus a margin of 1.25% to 2.00%, or alternatively the base rate plus a margin of 0.25% to 1.00% based upon the Company’s guaranteed senior unsecured long-term debt rating; a 1.375% margin applied while the Company’s debt rating remained BBB/Baa3. At December 31, 2016, $238 million was outstanding under this revolving credit facility.
On May 16, 2017, Willis North America Inc. (see Note 21 for further information) issued $650 million of 3.600% senior notes due 2024 (‘2024 senior notes’). The effective interest rate of the 2024 senior notes is 3.614%, which includes the impact of the discount upon issuance. The 2024 senior notes will mature on May 15, 2024, and interest accrues on the 2024 senior notes from May 16, 2017 and will be paid in cash on May 15 and November 15 of each year. The net proceeds from this offering, after deducting underwriter discounts and commissions and estimated offering expenses, were $644 million, and were used to pay down amounts outstanding under the RCF and for general corporate purposes.
3.500% senior notes due 2021 and 4.400% senior notes due 2026
On March 22, 2016, Trinity Acquisition plc issued $450 million of 3.500% senior notes due 2021 (‘2021 senior notes’) and $550 million of 4.400% senior notes due 2026 (‘2026 senior notes’). The 2021 senior notes and the 2026 senior notes are fully and unconditionally guaranteed by the Company. The effective interest rates of these senior notes are 3.707% and 4.572%, respectively, which includes the impact of the discount upon issuance. The 2021 senior notes and the 2026 senior notes will mature on September 15, 2021 and March 15, 2026, respectively. Interest accrues on the notes from March 22, 2016 and will be paid in cash on March 15 and September 15 of each year. The net proceeds from these offerings, after deducting underwriter discounts and commissions and estimated offering expenses, were $988 million. We used the net proceeds of these offerings to: (i) repay $300 million principal under the prior $800 million revolving credit facility and related accrued interest, which was drawn to repay our previously issued 4.125% senior notes on March 15, 2016; (ii) repay $400 million principal on Tranche B of the previous 1-year term loan facility and related accrued interest; and (iii) pay down a portion of the remaining principal amount outstanding under the previous $800 million revolving credit facility and related accrued interest.
The 7-year term loan facility expiring 2018 bore interest at the same rate applicable to the previous $800 million revolving credit facility and was repayable in quarterly installments of $6 million with a final repayment of $186 million due in the third quarter of 2018. During 2017, we repaid in full and terminated the 7-year term loan with proceeds from borrowings against our $1.25 billion revolving credit facility.
The interest rate on the term loan is based on the Company’s choice of one, two, three or six-month LIBOR plus a spread of 1.25% to 1.75%, or alternatively the bank base rate plus 0.25% to 0.75%. The spread to each index is dependent on the Company’s consolidated leverage ratio. The weighted-average interest rate on this term loan for the year ended December 31, 2017 was 2.33%. The term loan amortizes at a rate of $21 million per quarter, beginning in March 2016, with a final maturity date of December 2019. The Company has the right to prepay a portion or all of the outstanding term loan balance on any interest payment date without penalty. At December 31, 2017, the balance outstanding on the term loan was $170 million, before reduction of $1 million in debt issuance fees.
On March 28, 2007, we issued $600 million of 10 year senior notes at 6.200%. The effective interest rate of these senior notes was 6.253%. In August 2013, $206 million of the 6.200% senior notes were repurchased. The final balance was repaid on March 28, 2017 from the RCF as discussed above.
The terms of our current financings also include certain limitations. For example, the agreements relating to the debt arrangements and credit facilities generally contain numerous operating and financial covenants, including requirements to maintain minimum ratios of consolidated EBITDA to consolidated cash interest expense and maximum levels of consolidated funded indebtedness in relation to consolidated EBITDA, in each case subject to certain adjustments. The operating restrictions and financial covenants in our credit facilities do, and any future financing agreements may, limit our ability to finance future operations or capital needs or to engage in other business activities. At December 31, 2017 and 2016, we were in compliance with all financial covenants.
The following table shows an analysis of the interest expense for the years ended December 31:
Market values for our derivative instruments have been used to determine the fair value of interest rate swaps and forward foreign exchange contracts based on estimated amounts the Company would receive or have to pay to terminate the agreements, taking into account observable information about the current interest rate environment or current foreign currency forward rates. Such financial instruments are classified as Level 2 in the fair value hierarchy.
The following tables present our liabilities not measured at fair value on a recurring basis at December 31, 2017 and 2016:
Willis Towers Watson sponsors both qualified and non-qualified defined benefit pension plans and other post-retirement welfare plans (‘PRW’) plans throughout the world. The majority of our plan assets and obligations are in the United States and the United Kingdom. We have also included disclosures related to defined benefit plans in certain other countries, including Canada, France, Germany, Ireland and the Netherlands. Together, these disclosed funded and unfunded plans represent 99% of Willis Towers Watson’s pension and PRW obligations and are disclosed herein.
On January 4, 2016, in connection with the Merger, we acquired additional defined benefit pension, PRW, and defined contribution plans. Total plan assets of approximately $3.7 billion and projected benefit obligations of approximately $4.6 billion were acquired. The funded status for each of the acquired plans has been included in the values of identifiable assets acquired, and liabilities assumed in Note 3 - Merger, Acquisitions and Divestitures and are recorded as $67 million in pension benefits assets and $923 million in liability for pension benefits.
Ireland (Legacy Towers Watson) - Benefit accruals earned under the scheme’s defined benefit plan ceased on May 1, 2015. Benefits earned prior to this date retain a link to salary until the employee leaves the Company.
Netherlands (Legacy Towers Watson) - Benefits under the plan used to accrue on a final pay basis on earnings up to a maximum amount each year. The benefit accrual under the final pay plan stopped at December 31, 2010. The accrued benefits will receive conditional indexation each year.
We provide certain healthcare and life insurance benefits for retired participants. The principal plans cover participants in the U.S. who have met certain eligibility requirements. Our principal post-retirement benefit plans are primarily unfunded. Retiree medical benefits provided under our U.S. post-retirement benefit plans were closed to new hires effective January 1, 2011. Life insurance benefits under the plans were frozen with respect to service, eligibility and amounts as of January 1, 2012 for active participants.
The following schedules provide information concerning the defined benefit pension plans and PRW plan as of and for the years ended December 31, 2017 and 2016:
The following table presents the projected benefit obligation and fair value of plan assets for our plans that have a projected benefit obligation in excess of plan assets as of December 31, 2017 and 2016:
The following table presents the projected benefit obligation, accumulated benefit obligation and fair value of plan assets for our plans that have an accumulated benefit obligation in excess of plan assets as of December 31, 2017 and 2016.
The estimated net actuarial loss and prior service gain for the defined benefit plans that will be amortized from accumulated other comprehensive loss into net periodic benefit cost over the next fiscal year are:
The determination of the Company’s obligations and annual expense under the plans is based on a number of assumptions that, given the longevity of the plans, are long-term in focus. A change in one or a combination of these assumptions could have a material impact on our projected benefit obligation. However, certain of these changes, such as changes in the discount rate and actuarial assumptions, are not recognized immediately in net income, but are instead recorded in other comprehensive income. The accumulated gains and losses not yet recognized in net income are amortized into net income as a component of the net periodic benefit cost/(credit) generally based on the average working life expectancy of the plan’s active participants to the extent that the net gains or losses as of the beginning of the year exceed 10% of the greater of the market-related value of plan assets or the projected benefit obligation. The average remaining service period of participants for the PRW plan is approximately 9.9 years.
A one percentage point change in the assumed healthcare cost trend rates would have an immaterial effect on the post-retirement benefit cost and obligation as of December 31, 2017.
Each pension plan seeks to achieve total returns sufficient to meet expected future obligations when considered in conjunction with expected future contributions and prudent levels of investment risk and diversification. Each plan’s targeted asset allocation is generally determined through a plan-specific Asset-Liability Modeling study. These comprehensive studies provide an evaluation of the projected status of asset and benefit obligation measures for each plan under a range of both
positive and negative environments. The studies include a number of different asset mixes, spanning a range of diversification and potential equity exposures.
The fair values of our U.S. plan assets by asset category at December 31, 2017 and 2016 are as follows:
The fair values of our U.K. plan assets by asset category at December 31, 2017 and 2016 are as follows:
The fair values of our Other plan assets by asset category at December 31, 2017 and 2016 are as follows:
We evaluate the need to transfer between levels based upon the nature of the financial instrument and size of the transfer relative to the total net assets of the plans. There were no significant transfers between Levels 1, 2 or 3 in the fiscal years ended December 31, 2017 and 2016.
Short-term securities: Valued at the net value of shares held by the Company at year end as reported by the sponsor of the funds.
Pooled / Commingled Funds and Mutual Funds: Valued at the net value of shares held by the Company at year end as reported by the manager of the funds. These funds are not exchange traded and are not reported by level in the tables above.
The following table sets forth a summary of changes in the fair value of the plans’ Level 3 assets for the fiscal year ended December 31, 2017:
The following table sets forth our projected pension contributions to our qualified plans for fiscal year 2018, as well as the pension contributions to our qualified plans in fiscal years 2017 and 2016:
We have defined contribution plans covering eligible employees in many countries. The most significant plans are in the U.S. and U.K. and are described here.
We have a U.S. defined contribution plan covering all eligible employees of Willis Towers Watson (the ‘Plan’). The Plan allows participants to make pre-tax and Roth after-tax contributions and provides a 100% match by us on the first 1% of employee contributions and 50% match on the next 5% of employee contributions. Employees vest in the employer match upon 2 years of service. All investment assets of the plan are held in a trust account administered by independent trustees.
We made contributions to our defined contribution plans for the years ended December 31, 2017, 2016, and 2015 amounting to $154 million, $152 million and $77 million, respectively.
The Company leases certain land, building and equipment under various operating lease commitments. The total amount of the minimum rent is expensed on a straight-line basis over the term of the lease. Rental expenses and sub-lease rental income for operating leases are recorded as part of other operating expenses in the consolidated statements of comprehensive income. Rental expense, exclusive of sublease income, was $302 million, $302 million, and $142 million for the years ended December 31, 2017, 2016 and 2015, respectively. We have entered into sublease agreements for some of our excess leased space. Sublease income was $21 million, $17 million and $17 million for the years ended December 31, 2017, 2016 and 2015, respectively.
As of December 31, 2017, the aggregate future minimum rental commitments under all non-cancellable operating lease agreements are as follows:
Guarantees issued by certain of Willis Towers Watson’s subsidiaries with respect to the senior notes and revolving credit facilities are discussed in Note 10 - Debt.
For certain subsidiaries and associates, the Company has the right to purchase shares (a call option) from co-shareholders at various dates in the future. In addition, the co-shareholders of certain subsidiaries and associates have the right to sell their shares (a put option) to the Company at various dates in the future. Generally, the exercise price of such put options and call options is formula-based (using revenues and earnings) and is designed to reflect fair value. Based on current projections of profitability and exchange rates, and assuming the put options are exercised, the potential amount payable from these options is not expected to exceed $34 million.
Willis Towers Watson has various agreements which provide that it may be obligated to indemnify the other party to the agreement with respect to certain matters. Generally, these indemnification provisions are included in contracts arising in the normal course of business and in connection with the purchase and sale of certain businesses. Although it is not possible to predict the maximum potential amount of future payments that may become due under these indemnification agreements because of the conditional nature of Willis Towers Watson’s obligations and the unique facts of each particular agreement, Willis Towers Watson does not believe any potential liability that might arise from such indemnity provisions is probable or material. There are no provisions for recourse to third parties, nor are any assets held by any third parties that any guarantor can liquidate to recover amounts paid under such indemnities.
In the ordinary course of business, the Company is subject to various actual and potential claims, lawsuits, and other proceedings. Some of the claims, lawsuits and other proceedings seek damages in amounts which could, if assessed, be significant. We do not expect the impact of claims or demands not described below to be material to the Company’s consolidated financial statements. The Company also receives subpoenas in the ordinary course of business and, from time to time, receives requests for information in connection with governmental investigations.
On the basis of current information, the Company does not expect that the actual claims, lawsuits and other proceedings to which the Company is subject, or potential claims, lawsuits, and other proceedings relating to matters of which it is aware, will ultimately have a material adverse effect on the Company’s financial condition, results of operations or liquidity. Nonetheless, given the large or indeterminate amounts sought in certain of these actions, and the inherent unpredictability of litigation and disputes with insurance companies, it is possible that an adverse outcome or settlement in certain matters could, from time to time, have a material adverse effect on the Company’s results of operations or cash flows in particular quarterly or annual periods. In addition, given the early stages of some litigation or regulatory proceedings described below, it is not possible to predict their outcome or resolution, and it is possible that these events may have a material adverse effect on the Company.
Between November 12, 2015 and December 10, 2015, in connection with the then-proposed Merger, Towers Watson received demands for appraisal under Section 262 of the Delaware General Corporation Law on behalf of ten purported beneficial owners of an aggregate of approximately 2.4% of the shares of Towers Watson common stock outstanding at the time of the Merger. Between March 3, 2016 and March 23, 2016, three appraisal petitions were filed in the Court of Chancery for the State of Delaware on behalf of three purported beneficial owners of Towers Watson common stock, captioned Rangeley Capital LLC v. Towers Watson & Co., C.A. No. 12063-CB, Merion Capital L.P. v. Towers Watson & Co., C.A. No. 12064-CB, and College Retirement Equities Fund v. Towers Watson & Co., C.A. No. 12126-CB. The appraisal petitions seek, among other things, a determination of the fair value of the appraisal petitioners’ shares at the time of the Merger; an order that Towers Watson pay that value to the appraisal petitioners, together with interest at the statutory rate; and an award of costs, attorneys’ fees, and other expenses. Towers Watson answered the appraisal petitions between March 24, 2016 and April 18, 2016. On May 9, 2016, the court consolidated the three pending appraisal proceedings under the caption In re Appraisal of Towers Watson & Co., Consolidated C.A. No. 12064-CB. A fourth owner filed an appraisal demand, but did not file an appraisal petition. The aggregate amount of shares subject to appraisal from these four owners was 1,415,199. The court provisionally scheduled trial for October 2, 2017. On September 15, 2017, the Company reached a settlement with all shareholders who made demands for appraisal, resolving all claims related to the appraised shares. Under the terms of the settlement, these shareholders surrendered all rights to the Towers Watson shares and all potential Merger consideration issuable for the legacy shares. In exchange, the Company made a payment to these shareholders of approximately $211 million, which represented $134.75 per share plus accrued interest at the statutory rate of interest. As a result of the settlement, the Court, on September 18, 2017, dismissed all claims in the case with prejudice. The Company thereafter canceled all of the Towers Watson common shares at issue in the appraisal proceeding.
On November 21, 2017, a purported former stockholder of Legacy Towers Watson filed a putative class action complaint on behalf of a putative class consisting of all Legacy Towers Watson stockholders as of October 2, 2015 against the Company, Legacy Towers Watson, Legacy Willis, ValueAct Capital Management (‘ValueAct’), and certain current and former directors and officers of Legacy Towers Watson and Legacy Willis (John Haley, Dominic Casserley, and Jeffrey Ubben), in the United States District Court for the Eastern District of Virginia. The complaint asserts claims against certain defendants under Section 14(a) of the Securities Exchange Act of 1934 (the ‘Exchange Act’) for allegedly false and misleading statements in the proxy statement for the Merger; and against other defendants under Section 20(a) of the Exchange Act for alleged “control person” liability with respect to such allegedly false and misleading statements. The complaint further contends that the allegedly false and misleading statements caused stockholders of Legacy Towers Watson to accept inadequate Merger consideration. The complaint seeks damages in an unspecified amount. On February 20, 2018, the court appointed the Regents of the University of California as Lead Plaintiff and Bernstein Litowitz Berger & Grossman LLP as Lead Counsel for the putative class, consolidated all subsequently filed, removed, or transferred actions, and captioned the consolidated action “In re Willis Towers Watson plc Proxy Litigation,” Master File No. 1:17-cv-1338-AJT-JFA. Lead Plaintiff has indicated that it intends to file a consolidated amended complaint.
Florida suits: On February 14, 2013, five lawsuits were filed against Willis Group Holdings plc, Willis Limited and Willis of Colorado, Inc. in Florida state court (Miami-Dade County) alleging violations of Florida common law. The five suits are: (1) Barbar, et al. v. Willis Group Holdings Public Limited Company, et al., Case No. 13-05666CA27, filed on behalf of 35 Stanford investors seeking compensatory damages in excess of $30 million; (2) de Gadala-Maria, et al. v. Willis Group Holdings Public Limited Company, et al., Case No. 13-05669CA30, filed on behalf of 64 Stanford investors seeking compensatory damages in excess of $83.5 million; (3) Ranni, et ano. v. Willis Group Holdings Public Limited Company, et al., Case No. 13-05673CA06, filed on behalf of two Stanford investors seeking compensatory damages in excess of $3 million; (4) Tisminesky, et al. v. Willis Group Holdings Public Limited Company, et al., Case No. 13-05676CA09, filed on behalf of 11 Stanford investors seeking compensatory damages in excess of $6.5 million; and (5) Zacarias, et al. v. Willis Group Holdings Public Limited Company, et al., Case No. 13-05678CA11, filed on behalf of 10 Stanford investors seeking compensatory damages in excess of $12.5 million. On June 3, 2013, Willis of Colorado, Inc. removed all five cases to the Southern District of Florida and, on June 4, 2013, notified the JPML of the pendency of these related actions. On June 10, 2013, the court in Tisminesky issued an order sua sponte staying and administratively closing that action pending a determination by the JPML as to whether it should be transferred to the Northern District of Texas for consolidation and coordination with the other Stanford-related actions. On June 11, 2013, Willis of Colorado, Inc. moved to stay the other four actions pending the JPML’s transfer decision. On June 20, 2013, the JPML issued a conditional transfer order for the transfer of the five actions to the Northern District of Texas, the transmittal of which was stayed for seven days to allow for any opposition to be filed. On June 28, 2013, with no opposition having been filed, the JPML lifted the stay, enabling the transfer to go forward.
On September 30, 2014, the court denied the plaintiffs’ motion to remand in Zacarias, and, on October 3, 2014, the court denied the plaintiffs’ motions to remand in Tisminesky and de Gadala Maria. On December 3, 2014 and March 3, 2015, the court granted the plaintiffs’ motions to remand in Barbar and Ranni, respectively, remanded both actions to Florida state court (Miami-Dade County) and stayed both actions until further order of the court. On January 2, 2015 and April 1, 2015, the plaintiffs in Barbar and Ranni, respectively, appealed the court’s December 3, 2014 and March 3, 2015 decisions to the Fifth Circuit. On April 22, 2015 and July 22, 2015, respectively, the Fifth Circuit
dismissed the Barbar and Ranni appeals sua sponte for lack of jurisdiction. The defendants have not yet responded to the complaints in Ranni or Barbar.
As discussed above, on March 25, 2014, the parties in Troice and Janvey stipulated to the consolidation of the two actions for pre-trial purposes under Rule 42(a) of the Federal Rules of Civil Procedure. On March 28, 2014, the Court ‘so ordered’ that stipulation and, thus, consolidated Troice and Janvey for pre-trial purposes under Rule 42(a).
Abel, et al. v. Willis of Colorado, Inc., et al., C.A. No. 3:16-cv-2601, was filed on September 12, 2016, on behalf of more than 300 Stanford investors against Willis Group Holdings plc, Willis Limited, Willis of Colorado, Inc. and the same Willis associate, also in the Northern District of Texas. The complaint alleges claims under Texas statutory and common law and seeks actual damages in excess of $135 million, exemplary damages, attorneys’ fees and costs. On November 10, 2016, the plaintiffs filed an amended complaint, which, among other things, added several more Stanford investors as plaintiffs. The defendants have not yet responded to the complaint in Abel.
The settlement is contingent on a number of conditions, including court approval of the settlement and a bar order prohibiting any continued or future litigation against Willis related to Stanford, which may not be given. Therefore, the ultimate resolution of these matters may differ from the amount provided for. The Company continues to dispute the allegations and, to the extent litigation proceeds, to defend the lawsuits vigorously.
On September 7, 2016, Plaintiffs filed with the Court a motion to approve the settlement. On October 19, 2016, the Court preliminarily approved the settlement. Several of the plaintiffs in the other actions above objected to the settlement, and a hearing to consider final approval of the settlement was held on January 20, 2017, after which the Court reserved decision. On August 23, 2017, the Court approved the settlement, including the bar orders. Several of the objectors have since appealed the settlement approval and bar orders to the Fifth Circuit. The appeals are currently pending. The Company expects the briefing in connection with the appeals to be completed by early April 2018. There is no date certain for when the appeal will be decided. The Company will not make the $120 million settlement payment unless and until the appeals are decided in its favor and the settlement is not subject to any further appeal.
On January 9, 2018, Legacy Towers Watson and the City participated in a mediation and reached a settlement in principle. Pursuant to the settlement in principle, in exchange for a dismissal of the claims of the City related to Legacy Towers Watson’s pension actuarial advice to the Fund, and any potential claims the City may have related to Legacy Towers Watson’s pension actuarial advice to the Houston Municipal Employees Pension System and the Houston Police Officers Pension System, Legacy Towers Watson would pay a total of $40 million. The Company accrued $11 million during the three months ended December 31, 2017 in respect of this settlement. This settlement in principle remains subject to completion of settlement documentation between the City and Legacy Towers Watson and to approval by the City of Houston City Council.
In the event the settlement documentation is not finalized by the City and Legacy Towers Watson or the settlement is not approved by the City of Houston City Council, the Company is currently unable to provide an estimate of the reasonably possible loss or range of loss. The Company disputes the allegations, and in the event the settlement is not finalized or approved, the Company intends to defend the lawsuit vigorously.
In the Third Amended Complaint, served on April 12, 2016, Meriter alleged that Towers, Perrin, Forster & Crosby, Inc. (‘TPFC’) and Davis, Conder, Enderle & Sloan, Inc. (‘DCES’), and other entities and individuals, including Meriter’s former lawyers, acted negligently concerning the benefits consulting advice provided to Meriter; these allegations concern matters including TPFC and the lawyers’ involvement in the Plan design and drafting of the Plan document in 1987 by TPFC, and DCES and the lawyers’ Plan review, Plan redesign, Plan amendment, and drafting of ERISA section 204(h) notices in the early 2000s. Additionally, Meriter asserted that TPFC, DCES, and the individual actuary defendants breached alleged fiduciary duties to advise Meriter regarding the competency of Meriter’s then ERISA counsel. Meriter has asserted causes of action for contribution, indemnity, and equitable subrogation related to amounts paid to settle a class action lawsuit related to the Plan that was filed by Plan participants against Meriter in 2010, alleging a number of ERISA violations and related claims. Meriter settled that lawsuit in 2015 for $82 million. In this litigation, Meriter sought damages in a revised amount of approximately $190 million which includes amounts it claims to have paid to settle and defend the class action litigation, and amounts it claims to have incurred as a result of improper plan design. Meriter sought to recover these alleged damages from TWDE and the other defendants.
On January 12, 2016, TWDE and the other defendants filed a motion for partial summary judgment seeking dismissal of Meriter’s negligence and breach of fiduciary duty claims. On April 18, 2016, TWDE and the other defendants filed a motion to dismiss the contribution, indemnification, and equitable subrogation claims. On May 4, 2016, the parties appeared for oral argument on the motion for partial summary judgment, which the court granted in part and denied in part. The court dismissed the fiduciary duty claims, but not the negligence claims. Meriter subsequently moved for reconsideration of the dismissal of its breach of fiduciary duty claims, which motion was denied as to TWDE on August 16, 2016. On June 22, 2016, the court granted in part TWDE’s motion to dismiss, and dismissed the contribution and equitable subrogation claims, but denied the motion as to Meriter’s indemnification claim without prejudice to the right of any defendant to raise the issue again by later motion. On February 28, 2017, TWDE and the other defendants filed a motion to amend the scheduling order. The motion was granted on March 9, 2017, and the trial was re-scheduled to begin on December 11, 2017.
On August 6, 2013, three individual plaintiffs filed a putative class action suit against the California Public Employees’ Retirement System (‘CalPERS’) in Los Angeles County Superior Court. On January 10, 2014, plaintiffs filed an amended complaint, which added as defendants several members of CalPERS’ Board of Administration and three Legacy Towers Watson entities, Towers Watson & Co., Towers Perrin, and Tillinghast-Towers Perrin (‘Towers Perrin’).
Plaintiffs’ claims all relate to a self-funded, non-profit Long Term Care Program that CalPERS established in 1995 (the ‘LTC Program’). Plaintiffs’ claims seek unspecified damages allegedly resulting from CalPERS’ 2012 decision to implement in 2015 and 2016 an 85 percent increase in the premium rates of certain of the long term care policies it issued between 1995 and 2004 (the ‘85% Increase’).
In April 2017, the Financial Conduct Authority (‘FCA’) informed Willis Limited, our U.K. broking subsidiary, that it had opened a formal investigation into possible agreements/concerted practices in the aviation broking sector.
Now that the Commission has initiated proceedings, the FCA has closed its competition act investigation. However, it retains its jurisdiction over broking regulatory matters arising from the conduct being investigated.
The CMA investigation of the investment consulting market is expected to take at least 18 months to conclude. Provisional findings should be issued in the third quarter of 2018. Given the early stage of the investigation, the Company is currently unable to assess whether the CMA will find any adverse effects on competition, and, if the CMA does find any adverse effects on competition, what remedies it may impose on the industry. Given this, the Company is unable to provide an estimate of the reasonably possible loss or range of loss.
In November 2017, the FCA published its Terms of Reference for its Market Study into insurance broking activities in the London Wholesale Market including market power, conflicts of interest and broker conduct. This is an industry-wide inquiry and not particular to the Company. The FCA is using its powers under the UK Financial Services and Markets Act 2000 and will collate information and aims to issue an interim report in or about the fourth quarter of 2018. The Study is expected to take 2 years to conclude. Extensive data requests have been received by two of the Company’s subsidiaries with phased response times from March to April 2018. It is possible that outcomes of the Study could include new rules, changes to market practices, referral to the U.K. Competition & Markets Authority for a market investigation, and/or individual firm investigations on specific issues. Given the early stage of the Study, the Company is currently unable to assess whether the FCA will find that competition in the sector is working in the interests of clients or not, and, if the FCA does find that competition in the sector is not working in the interests of clients, what remedies it may impose on the industry or on any industry participants. Given this, the Company is unable to provide an estimate of the reasonably possible loss or range of loss.
Reclassification adjustments from accumulated other comprehensive income are included in Other expense/(income), net in the accompanying consolidated statements of comprehensive income. See Note 9 - Derivative Financial Instruments for additional details regarding the reclassification adjustments for the hedge settlements.
Reclassification adjustments from accumulated other comprehensive loss are included in the computation of net periodic pension cost (see Note 12 - Retirement Benefits) which is included in Salaries and benefits in the accompanying consolidated statements of comprehensive income.
On December 31, 2017, the Company had a number of open share-based compensation plans, which provide for the grant of time-based and performance-based options, time-based and performance-based restricted stock units, and various other share-based grants to employees. All of the Company’s share-based compensation plans under which any options, restricted stock units or other share-based grants are outstanding as of December 31, 2017 are described below. The compensation cost that has been recognized for these plans for the years ended December 31, 2017, 2016 and 2015 was $67 million, $123 million and $64 million, respectively. The total income tax benefit recognized in the consolidated statement of comprehensive income for share-based compensation arrangements for the years ended December 31, 2017, 2016, and 2015 was $22 million, $35 million and $15 million, respectively.
There were approximately 7 million shares remaining available for grant under this plan as of December 31, 2017. Options are exercisable on a variety of dates, including from the second, third, fourth or fifth anniversary of grant. Unless terminated sooner by the board of directors, the 2012 Plan will expire 10 years after the date of its adoption. That termination will not affect the validity of any grants outstanding at that date.
acquisition date to be $37 million, which was added to the transaction consideration. The fair value of the remaining portion of RSUs and options related to the post-acquisition employee services was $45 million, and is being recorded over the future vesting periods. For the years ended December 31, 2017 and 2016, we recorded $11 million and $31 million of non-cash stock based compensation, respectively.
The acquired awards include performance-vested RSUs. Under the RSU agreement, participants become vested in a number of RSUs based on the achievement of specified levels of financial performance during the performance period set forth in the Merger Agreement, provided that the participant remains in continuous service with us through the end of the performance period. Dividend equivalents will accrue on these RSUs and vest to the same extent as the underlying shares. The Compensation Committee of the board of directors may provide for continuation of vesting of RSUs upon an employee’s termination under certain circumstances such as qualified retirement. The definition of qualified retirement is age 55 with 15 years of service with the Company and a minimum of one year service in the performance period. Due to the terms of the RSU agreement, the achievement of the level of financial performance is determined at the higher of 100% or the level attained at the time of the Merger.
The weighted-average grant-date fair values of time-based options granted during the years ended December 31, 2017, 2016 and 2015 were $27.69, $16.88 and $14.77, respectively. The total intrinsic values of options exercised during the years ended December 31, 2017, 2016 and 2015 were $19 million, $25 million and $17 million, respectively. At December 31, 2017 there was $2 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements under time-based stock option plans; that cost is expected to be recognized over a weighted-average period of 2.4 years.
The fair value of each time-based RSU is based on the grant date fair value, or the fair value on the acquisition date in the case of acquired awards. The fair value of each performance-based RSU is estimated on the grant date using a Monte-Carlo simulation that uses the assumptions noted in the following table. Expected volatility is based on the historical volatility of the Company’s shares. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of the grant. The assumptions noted in the table below represent the weighted-average of each assumption for each grant during the year. There were no performance-based RSUs granted during the year ended December 31, 2015.
The total number of time-based RSUs that vested during the year ended December 31, 2017 was 178,574 shares at an average share price of $150.81. The total number of time-based RSUs that vested during the year ended December 31, 2016 was 459,838 shares at an average share price of $120.42.The total number of RSUs that vested during the year ended December 31, 2015 was 408,032 shares at an average share price of $117.72. At December 31, 2017 there was $11 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 0.8 years.
Cash received from option exercises under all share-based payment arrangements for the years ended December 31, 2017, 2016 and 2015 was $61 million, $63 million and $124 million, respectively. The actual tax benefit recognized for the tax deductions from option exercises of the share-based payment arrangements totaled $7 million, $6 million and $12 million for the years ended December 31, 2017, 2016 and 2015, respectively. The actual tax benefit recognized for the tax deductions from RSUs that vested totaled $19 million, $25 million and $13 million for the years ended December 31, 2017, 2016 and 2015, respectively.
Basic and diluted earnings per share are calculated by dividing net income attributable to Willis Towers Watson by the average number of ordinary 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 issuance of shares that then shared in the net income of the Company.
Shares outstanding, potentially issuable shares, basic and diluted earnings per share, and the dilutive effect of potentially issuable shares, for the year ended December 31, 2015 have been retroactively adjusted to reflect the reverse stock split effected on January 4, 2016. See Note 3 - Merger, Acquisitions and Divestitures for further details.
There were no anti-dilutive options for the year ended December 31, 2017. Options to purchase 0.5 million and 0.6 million shares for the years ended December 31, 2016 and 2015, respectively, were not included in the computation of the dilutive effect of stock options because their effect was anti-dilutive. There were no anti-dilutive RSUs for the years ended December 31, 2017 and 2016. For the year ended December 31, 2015, 0.5 million RSUs were not included in the computation of the dilutive effect of potentially issued shares because their effect was anti-dilutive. The number of options for 2015 has been retroactively adjusted to reflect the reverse stock split on January 4, 2016. See Note 3 - Merger, Acquisitions and Divestitures for further details.
Supplemental disclosures regarding cash flow information and non-cash investing and financing activities are as follows:
Note 21 - Financial Information for Parent Guarantor, Other Guarantor Subsidiaries and Non-Guarantor Subsidiaries
Willis North America Inc. (‘Willis North America’) has $837 million senior notes outstanding of which $187 million were issued on September 29, 2009, and $650 million were issued on May 16, 2017. Additionally, Willis North America had $394 million of senior notes issued on March 28, 2007; these were subsequently repaid on March 28, 2017.
On August 11, 2017 a newly formed entity, Willis Towers Watson UK Holdings Limited, became the successor to, and assumed all guarantees of, WTW Bermuda Holdings Ltd. under the outstanding indentures for the senior notes described above. As both entities are direct subsidiaries of TA I Limited, and sub-consolidate within the ‘Other Guarantors’ columns of the financial statements presented herein, there is no significant impact on the condensed consolidating financial statements from what has previously been disclosed.
the Other Guarantors, which are all wholly owned subsidiaries (directly or indirectly) of the parent. Willis Towers Watson Sub Holdings Unlimited Company, Willis Netherlands Holdings B.V, Willis Investment U.K. Holdings Limited, TA I Limited and Willis Towers Watson UK Holdings Limited are all direct or indirect parents of the issuer and Willis Group Limited and Willis North America Inc., are direct or indirect wholly owned subsidiaries of the issuer;