We moved into our new London headquarters in Lime Street in April 2008. This 491,000 sq ft development occupies a prime site comprising a 29 story tower and adjoining 10 story building. We have entered into a 25 year lease for this building.
We provide a broad range of insurance brokerage and risk management consulting services to our worldwide clients. Our core businesses include Aerospace; Energy; Marine; Construction; Financial and Executive Risks; Fine Art, Jewelry and Specie; Special Contingency Risks; and Reinsurance.
In 2007, the market softened further and this has continued through 2008 with year on year premium rate decreases averaging approximately 10 percent across our market sectors during 2008.
It is possible that the market may harden in 2009 as insurers seek higher premiums to cover a combination of weak investment returns, significant losses in 2008 and three years of soft market underwriting. In the reinsurance market, we have seen stabilization in rates and early signs of market recovery going into 2009.
buying behavior of some of our clients as their businesses suffer from the current global market uncertainty. In particular, financial institutions, construction, aviation, and logistics businesses such as marine cargo are most likely to be affected. Further, the global economic activity is
Despite the difficult trading conditions in 2008, we reported 4 percent organic commissions and fee growth in 2008 compared with 2007, reflecting growth in our International and Global Specialties operations, partly offset by a 1 percent fall in North America organic commissions and fees.
Operating margin for full year 2008 was 18 percent compared with 24 percent for 2007, of which 4 percentage points were attributable to charges relating to our 2008 expense review and 2 percentage points were attributable to the impact of foreign exchange movements.
Net income in 2008 was $303 million, or $2.05 per diluted share, compared with $409 million, or $2.78 per diluted share, in 2007. The benefits of good organic revenue growth, improved margins in our International and Global operations and a lower effective tax rate were more than offset by a $0.45 per diluted share impact of charges for the 2008 expense review and a $0.27 per diluted share year on year impact from foreign exchange, discussed in detail within "General and administrative expenses" below.
HRH's fourth quarter results, net of related funding costs and intangible amortization, contributed $0.04 per diluted share. New shares
issued as part consideration for the HRH acquisition had an $0.11 dilutive impact on full year diluted earnings per share.
•an adverse year on year impact from foreign currency translation, equivalent to approximately 2 percentage points;
•our continued investment in targeted new hires and Shaping our Future initiatives; and
•increased productivity, with revenues per full time equivalent ("FTE") employee increasing to $190,000 in 2008 compared with $186,000 in 2007;
•HRH's $38 million operating income in fourth quarter 2008, equivalent to 1 percentage point; and
•greatly strengthen our position as a middle market broker and reinforce our large account presence; and
•enable the combined Willis HRH operation to deliver enhanced value to clients through a more robust and diversified platform. We also expect to achieve significant synergies by 2010 of approximately $140 million as we centralize HRH's dispersed back office processes and integrate these into Willis hubs, rationalize the combined office network and close down HRH's Richmond head office.
On acquisition we recognized an intangible asset of $639 million comprising:
HRH is being rapidly integrated into our North America segment. We complete our annual goodwill impairment review in the fourth quarter. Based on our forecasts of the combined Willis HRH's future revenue streams and anticipated synergies from the deal, we believe the combined goodwill for North America of $1,810 million was not impaired as of December 31, 2008. However, if we fail to recognize some or all of the strategic benefits and synergies expected from the HRH transaction, goodwill may be impaired in future periods.
•$42 million to buy out remuneration packages that no longer align with the Group's overall remuneration strategy;
•$24 million of severance costs relating to approximately 350 positions which have been eliminated; and
•$26 million of other operating expenses, including property and systems rationalization costs. In light of the current global economic uncertainty, we are vigorously reviewing our cost base and will continue our right-sizing initiatives in 2009. Our current right-sizing initiatives emphasize cost discipline including talent management, location optimization and aggressive reduction of discretionary spending. We now expect that the 2008 charges above, together with the benefits of the ongoing review, may lead to 2009 cost savings in excess of the $45 million to $55 million originally estimated.
In light of the current uncertainty in the global economy, we have suspended our practice of providing annual earnings guidance for the year ahead, as we cannot predict the potential impact of this uncertainty on insurance pricing or on potential changes in the buying decisions of clients with any degree of certainty.
In addition, our previously stated earnings per share targets should not be relied upon.
Net cash from operating activities of $211 million and net proceeds from the issuance of long and short-term debt totaling $1,669 million, together with a net $30 million benefit from other smaller cash flows less the impact of foreign exchange, were used to fund:
•repayments of outstanding debt of $641 million, of which $341 million related to HRH debt assumed on the acquisition;
•fixed asset additions of $94 million, of which $38 million related to our new London headquarters building; and
•share buybacks of $75 million. Total long-term debt at December 31, 2008 was $1,865 million (December 31, 2007: $1,250 million), total short-term debt was $785 million (December 31, 2007: nil) and total stockholders' equity was $1,845 million (December 31, 2007: $1,347 million) giving a capitalization ratio (total long-term and short-term debt to total long-term debt, short-term debt and stockholders' equity) of 59 percent at December 31, 2008 compared with 48 percent at December 31, 2007. The 11 percent increase in the capitalization ratio is mainly attributable to debt drawn down as part of the HRH acquisition, partly offset by the $792 million equity issued to fund the remainder of the transaction.
During fourth quarter 2008, we repaid $250 million of the then outstanding $1 billion balance on the interim credit facility funded by
using free cash flow (cash flow from operating and investing activities excluding acquisitions, disposals and additional pension contributions) of $75 million together with the draw down of the remaining $175 million available under the 5-year term loan facility.
In February 2009, we entered into an agreement with Goldman Sachs Mezzanine Partners to issue 12.875 percent senior unsecured notes due 2016 in an aggregate principal amount of $500 million. The transaction is subject to customary closing conditions and is expected to close during March 2009. The net proceeds of the issue will be used to repay approximately $480 million of the interim credit facility. We expect to be able to repay the approximately $270 million remaining balance on this short-term facility over the next two quarters from free cash flow and proceeds from the sale of non-core businesses.
We believe that existing cash and cash equivalents at December 31, 2008 of $176 million, the consummation of the agreement with Goldman Sachs Mezzanine Partners to issue $500 million of senior unsecured notes, availability under our $300 million revolving credit facility together with future generation of free cash flow and proceeds from the sale of non-core businesses should be adequate to meet our cash needs for at least the next 12 months. These sources of liquidity should also be adequate to finance full repayment of the $750 million outstanding balance on our interim credit facility, current portions of our long-term debt and other contractual obligations and presently known operating needs.
Long-term liquidity for debt service and other contractual obligations will be dependent on continued generation of free cash flow and,
In first quarter 2008, we repurchased 2.3 million shares at a cost of $75 million under the new authorization of which $925 million is outstanding.
Our International and Global operations earn a significant portion of their revenues in currencies other than the US dollar. For the year ended December 31, 2008, reported revenues in International benefited from the year on year weakening of the US dollar against the euro, compared with 2007. However, in our Global operations the revenue line benefit of the stronger euro was offset by sterling weakening against the US dollar, compared with 2007.
from a higher than usual level of proceeds from the sale of books of business.
Our 2007 total revenues of $2,578 million were $150 million, or 6 percent, higher than in 2006 of which 2 percent was attributable to foreign currency translation and 1 percent to net acquisitions and disposals.
Net acquisitions and disposals added a net 1 percent to total revenues in 2007 which was primarily attributable to the acquisitions of: InsuranceNoodle in Chicago; Burkart Risk Consulting and Partner in Switzerland; and Gras Savoye Re, a new venture with Gras Savoye & Cie.
Organic growth in commissions and fees in 2007 was 3 percent compared with 2006, reflecting
•net new business growth of 4 percent, together with the benefit of maintaining client retention levels in excess of 90 percent; partly offset by
•a negative 1 percent impact from premium rates and other market factors, with the impact of the significant rate decreases largely offset by the benefit of other market factors, including higher commission rates, client profitability analyses, higher insured values and changes in limits or exposures. Organic revenue growth by segment is discussed further in "Operating Results-Segment Information" below.
•$92 million, or 5 percentage points, was attributable to the charge for the 2008 expense review discussed above, of which $66 million related to salaries and benefits and $26 million to other expenses; and
•a foreign exchange loss of $68 million, or 4 percentage points, including $34 million related to the revaluation of our UK pension benefits asset as discussed below together with $23 million relating to pound sterling purchases to fund the Company's contributions to the plan. Salaries and benefits were 58 percent of 2008 revenues, compared with 56 percent in 2007, with the increase reflecting:
•continued hiring in targeted development areas including selected US regions; targeted International growth areas such as Spain, Italy, Denmark and Brazil; and a number of our London specialty businesses; partly offset by
•increased productivity: average revenues per FTE employee at constant exchange rates were approximately $190,000 in 2008 compared with $186,000 in 2007;
•the benefits of cost controls and previous Shaping our Future initiatives; and
General and administrative expenses at $1,908 million for 2007 were $3 million lower than in 2006. This decrease was mainly attributable to:
•a $36 million reduction in pension charges, equivalent to approximately 1 percentage point. This decrease was mainly attributable to an increase in the expected return on assets in the UK plan reflecting higher asset levels due to the significant additional contributions we have made in 2007 and 2006; partly offset by
•continued hiring in targeted development areas, including energy, construction, marine, financial institutions, reinsurance analytics and employee benefits. Other expenses were 18 percent of revenues in 2007 compared with 19 percent in 2006, with the decrease reflecting:
•a $17 million additional rental expense recognized in second half 2007, following practical completion of our new London headquarters in June 2007 which gave us control of the building. Other expenses in 2007 also included $13 million of rent on our then existing London headquarters building, following its sale and leaseback in September 2006. We terminated this lease when we completed the move to our new London headquarters in April 2008. Of the $121 million pre-tax gain on the sale of the building, $22 million was deferred and subsquently recognized over the revised life of the lease, of which $14 million was recognized in 2007.
Depreciation and amortization of $90 million in 2008 was $24 million higher than in 2007 with the increase primarily attributable to a $21 million charge in fourth quarter 2008 in respect of intangible assets recognized on the HRH acquisition.
Depreciation and amortization was $66 million in 2007 compared to $63 million in 2006 with the increase mainly attributable to the initial depreciation of assets associated with World Financial Center, our new lease in New York.
Operating income and margin (operating income as a percentage of revenues)
•the $92 million charge for the 2008 expense review, equivalent to 4 percentage points;
•a $22 million increase in intangibles amortization, of which $21 million related to HRH;
•our continued investments in targeted new hires and Shaping our Future initiatives; and
•increased productivity, with revenues at constant exchange rates per FTE employee increasing to $190,000 in 2008 compared with $186,000 in 2007;
•good cost control, the realization of savings from Shaping our Future initiatives and lower pension costs.
•a $9 million charge for amortization of debt fees associated with the above facilities;
•increased interest relating to higher average drawings under our revolving credit facilities. Interest expense was $66 million in 2007 compared with $38 million in 2006, with the increase due to higher average levels of debt at higher interest rates following the issuance of $600 million of senior notes in March 2007. Interest expense will increase in 2009 as a result of higher average levels of debt due to the HRH acquisition and higher rates of interest on the anticipated Goldman Sachs financing.
•a decrease in the statutory rate of corporation tax in the UK from 30 percent in 2007 to an effective rate of 28.5 percent in 2008; partly offset by
•a one-off benefit of $4 million in 2007 relating to the restatement of the closing UK deferred tax liabilities to reflect the reduced rate of corporation tax applicable on the reversal of those liabilities. 2007 compared with 2006
Net income for 2008 was $303 million, or $2.05 per diluted share, compared to $409 million, or $2.78 per diluted share, in 2007 with the decrease mainly reflecting the impact of:
repurchased under accelerated share repurchase programs in first half 2007 was more than offset by the additional 24.4 million shares issued on October 1, 2008 as part consideration for the HRH acquisition. The additional shares issued had a negative $0.11 cent impact on earnings per diluted share in 2008.
•the $71 million tax credit in 2006 as discussed above, equivalent to $0.45 per diluted share; and
We organize our business into three segments: Global, North America and International. Our Global business provides specialist brokerage and consulting services to clients worldwide for risks arising from specific industries and activities. North America and International
The following table is a summary of our operating results by segment for the three years ending December 31, 2008:
(i)In 2008, the Company changed its basis of segmental allocation for central costs. All accounting adjustments for foreign exchange hedging activities and foreign exchange movements on the UK pension plan asset or liability are held at the Corporate level, together with legal costs that are managed centrally. As a result of this change, $nil in 2007 and $2 million net operating loss for full year 2006, previously allocated to the operating segments, has been reported within Corporate.
(ii)Corporate and other includes the $92 million cost of the 2008 expense review (2007: $nil, 2006: $101 million of expenditure on second half 2006 Shaping our Future initiatives), foreign exchange hedging activities and foreign exchange on the UK pension plan asset of $47 million loss in 2008 (2007: $7 million, 2006: $10 million), amortization of intangible assets of $36 million (2007: $14 million, 2006: $12 million), net gains and losses on disposal of operations, certain legal costs, and in 2006 a $99 million gain on disposal of the Company's London headquarters net of leaseback costs.
(iii)Effective October 1, 2008, we changed how we calculate organic growth in commissions and fees. Previously, organic growth included growth from acquisitions from the date of acquisition. Under the new method, the first twelve months of commissions and fees generated from acquisitions are excluded from organic growth in commissions and fees.
Commissions and fees were $34 million, or 5 percent, higher in 2008 compared with 2007 of which 3 percent was attributable to the net impact of acquisitions and disposals, mainly due to HRH's UK-based specialty business. There was no net impact from foreign currency translation as a benefit from the euro strengthening year on year against the dollar was offset by a negative impact from sterling weakening against the dollar.
Client retention levels in Global improved to 90 percent in 2008 compared with 89 percent in 2007.
Operating margin in our Global operations was 28 percent in 2007 compared with 31 percent in 2006. Revenues in our Global operations are largely US dollar denominated while our expense base is primarily sterling denominated. The weakening of average dollar rates against sterling generated a negative 2 percentage point impact on Global's margin.
(i)Other income represents gains on disposals of intangible assets, including books of business. Prior to January 1, 2008 these gains were reported within total commissions and fees but were excluded from organic revenue growth with effect from April 1, 2007. As a result of this change, $17 million previously reported within North America's commissions and fees in 2007, has been transferred to other income (2006: $12 million).
Commissions and fees in North America were $161 million, or 21 percent, higher in 2008 compared with 2007, of which $181 million was attributable to HRH's fourth quarter 2008 revenues. Excluding HRH, organic commissions and fees declined by 1 percent reflecting the soft market conditions.
Chicago, Georgia, Houston, Boston and Knoxville all generated growth in excess of 5 percent though several offices recorded significant declines in the difficult market conditions.
Commissions and fees in North America were $7 million, or 1 percent, higher in 2007 compared with 2006 which was attributable to organic growth. The organic revenue growth was achieved in the face of declining rates across most regions of the United States: MarketScout data for 2007 showed average property and casualty rate declines in the year of 13 percent. Despite the declining rates, we saw good growth in the Southeast, Central and New York regions and in our program business and employee benefits.
•a $15 million decrease in other income compared with 2007 which benefited from higher than usual proceeds from the sale of books of business; and
•the acquisition of HRH which contributed $38 million of operating income in fourth quarter 2008; and
•the benefit of increased revenue per FTE employee and other cost savings. Operating margin: 2007 compared with 2006
(iv)Effective October 1, 2008, we changed how we calculate organic growth in commissions and fees. Previously, organic growth included growth from acquisitions from the date of acquisition. Under the new method, the first twelve months of commissions and fees generated from acquisitions are excluded from organic growth in commissions and fees.
Commissions and fees in International were $93 million, or 10 percent, higher than in 2008 compared with 2007.
Organic revenue growth of 9 percent in 2008 was achieved despite declining rates in most countries.
We have seen consistent growth in our International business over the last three years, with all twelve quarters in this period showing growth of 5 percent or higher, with Spain, Denmark and Latin America continuing to contribute significantly.
Commissions and fees in International were $115 million, or 14 percent, higher in 2007 compared with 2006. Some 6 percent of this increase was attributable to foreign currency translation as a significant part of International's revenues are earned in currencies that have strengthened against the dollar on a year on year basis, in particular the euro. Organic growth of 8 percent was achieved despite declining rates in most countries, with decreases of between 5 and 20 percent.
Significant operating margin improvement was reported across most areas of our International segment as the effect of strong organic revenue growth, our productivity efficiencies and joint focus more than offset the adverse impact of declining rates in most countries.
and the Netherlands: these schemes have combined total assets of $89 million and a combined liability for pension benefits of $29 million as of December 31, 2008. Elsewhere, pension benefits are typically provided through defined contribution plans.
We recorded a net pension credit on our UK and US defined benefit pension plans in 2008 of $25 million, compared to a net pension credit of $10 million in 2007, an increase of $15 million.
Based on December 31, 2008 assumptions, we expect the net pension credit in 2008 to decrease to a net pension expense in 2009 of between $50 to $60 million due to lower expected asset returns and increased amortization following the significant asset losses in the UK and US during 2008.
Rates used to discount pension plan liabilities at December 31, 2008 were based on yields prevailing at that date of high quality corporate bonds of appropriate maturity. The selected rate used to discount UK plan liabilities was 6.5 percent compared with 5.9 percent at December 31, 2007 with the increase reflecting an increase in UK long-term bond rates in the latter part of 2008. The higher discount rate and reduced inflation assumption generated an actuarial gain of $248 million at December 31, 2008.
Mortality assumptions at December 31, 2008 were changed from December 31, 2007. The new mortality assumption is the 100 percent PNA00 table without an age adjustment. As an
indication of the longevity assumed, our calculations assume that a UK male retiree aged 65 at December 31, 2008 would have a life expectancy of 22 years.
Intangible assets represent the excess of cost over the value of net tangible assets of
We review all our intangible assets for impairment periodically (at least annually) or whenever events or circumstances indicate impairment may have occurred. Application of the impairment test requires judgment, including:
•the estimation of the useful life over which cash flows will occur; and
Our annual goodwill impairment analysis, which we performed during the fourth quarter of 2008, did not result in an impairment charge (2007: $nil, 2006: $nil).
expected to be recovered or settled taking into account our business plans and tax planning strategies.
•the actual future taxable income in the periods during which the temporary differences are expected to reverse differs from current projections;
We purchase professional indemnity insurance for errors and insurance claims. The terms of this insurance vary by policy year and self-insured risks have increased significantly over recent years. We have established provisions against various actual and potential claims, lawsuits and other proceedings relating
principally to alleged errors and omissions in connection with the placement of insurance and reinsurance in the ordinary course of business. Such provisions cover claims that have been reported but not paid and also claims that have
On October 1, 2008, the Company completed the acquisition of HRH.
We funded the transaction on October 1, 2008 from committed bank financing, with a $1 billion drawdown from an interim credit facility and a $525 million draw down from a $700 million 5-year term loan facility. In addition, we repaid approximately $340 million of HRH existing debt and the $170 million outstanding balance on our existing revolving credit facility, which has been replaced by a new $300 million facility, all of which remains available to draw at December 31, 2008.
close during March 2009. The net proceeds of the issue will be used to repay approximately $480 million of the interim credit facility. We expect to be able to repay the approximately $270 million remaining balance on this short-term facility over the next two quarters from free cash flow and proceeds from the sale of non-core businesses.
credit markets, the level, if any, of these financing sources cannot be assured.
On November 1, 2007, the Board authorized a new share buyback program for $1 billion. This replaced our previous $1 billion buyback program and its remaining $308 million authorization. In first quarter 2008, we repurchased 2.3 million shares at a cost of $75 million under the new authorization.
Over time, following full repayment of the interim credit facility, and subject to limitations in our debt facilities, we also plan to repurchase the majority of the shares issued in connection with the acquisition of HRH under our existing $1 billion buyback authorization.
As of December 31, 2008, we had cash and cash equivalents of $176 million, compared with $200 million at December 31, 2007, and all of
Net cash from operations in 2008 was $57 million lower than in 2007, mainly reflecting:
•a $46 million reduction in additional contributions to our UK and US defined benefit pension plans;
•the benefit of a $14 million reduction in taxes paid; and
•the timing of cash collections and other working capital movements. Net cash from operations in 2007 was $121 million higher than in 2006, mainly reflecting:
•the benefit of a $13 million reduction in taxes paid. Investing activities
Total net cash used in investing activities was $1,040 million in 2008 compared with $221 million in 2007 and an inflow of $67 million in 2006.
•an $896 million net increase in the cost of acquisitions, primarily reflecting $926 million attributable to the HRH acquisition; and
•a reduction in fixed asset spend of $91 million, principally attributable to sharply reduced expenditure on our new London and US headquarters buildings following their completion. The net increase in cash used in investing activities of $288 million in 2007 compared with 2006 was mainly attributable to:
•a $130 million increased investment in fixed assets primarily relating to $106 million of expenditure on the fit-outs of our new US and UK headquarters buildings; and
As at December 31, 2008, total short-term debt was $785 million and total long-term debt was $1,865 million.
We also repaid the previously existing HRH debt of $341 million assumed with the acquisition.
On October 1, 2008, we funded the HRH acquisition with $1 billion from an interim credit facility and $525 million from a $700 million 5-year term loan facility. In addition, we repaid the outstanding balance on our existing revolving credit facility and replaced this with a new $300 million line of credit. In fourth quarter 2008, we repaid $250 million of the interim credit facility and at the same time drew down a further $175 million under the 5-year term loan facility.
We moved from Ten Trinity Square into our new London headquarters in Lime Street in April 2008. In November 2004, we entered into an agreement to lease the Lime Street building and took control of the building in June 2007 under a 25 year operating lease. Annual rentals are $35 million per year and we have subleased approximately 30 percent of the premises under leases up to 15 years long. The outstanding
contractual obligation for lease rentals at December 31, 2008 was $720 million and the amounts receivable from committed subleases was $106 million.
Management shareholders of Gras Savoye (representing approximately 10 percent of shares) do not have general put rights before 2011, but have certain put rights on their death, disability or retirement from which payments, at December 31, 2008 based on the formula would not have exceeded $67 million. The shareholders may put their shares individually at any time during the put period.
We recently received a notification from one of the shareholders of Gras Savoye, namely AXA Corporate Solutions, informing us of its intention to put its shares in Gras Savoye to us, subject to the pre-emption provisions set out in bye-laws of Gras Savoye. The shares held by AXA represent approximately 4 percent of the share capital of Gras Savoye. Notwithstanding that we have received this notice from AXA we believe that it is likely that we will not be required to acquire all of the AXA shares in the immediate future or, in some circumstances, at all. We believe that either:-
In the event that none of the above occurred or an alternative arrangement was agreed, we would be required to acquire the AXA shares on 23 March 2009. The amount payable by us for the AXA shares would be approximately $25 million.
Apart from commitments, guarantees and contingencies, as disclosed in Note 17 of the Consolidated Financial Statements, the Company has no off-balance sheet arrangements that have, or are reasonably likely to have, a material effect on the Company's financial condition, results of operations or liquidity.
Consolidated Statements of Stockholders' Equity and Comprehensive Income for each of the three years in the period ended December 31,
To the Board of Directors and Stockholders of Willis Group Holdings Limited
We have audited the accompanying consolidated balance sheets of Willis Group Holdings Limited and subsidiaries (the "Company") as of December 31, 2008 and 2007, and the related consolidated statements of operations, stockholders' equity and comprehensive income, and cash flows for each of the three years in the period ended December 31, 2008. Our audits also included the consolidated financial statement schedule listed in the Index at Item 15. These financial statements and financial statement schedule are the responsibility of Willis Group Holdings Limited management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of December 31, 2008, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 27, 2009 expressed an unqualified opinion on the Company's internal control over financial reporting.
These consolidated financial statements conform to accounting principles generally accepted in the United States of America ("US GAAP"). Presented below are summaries of:
The Company adopted Financial Accounting Standards No. 157 Fair Value Measurement ("FAS 157") on January 1, 2008. FAS 157:
•enables the reader of the financial statements to assess the inputs used to develop those measurements by establishing a hierarchy for ranking the quality and reliability of the information used to determine fair values.
•Level 2: Observable market based inputs or unobservable inputs that are corroborated by market data.
•Level 3: Unobservable inputs that are not corroborated by market data.
The following table summarizes the valuation of the Company's assets and liabilities by the FAS 157 fair value hierarchy at December 31, 2008:
Other income comprises gains on the disposals of intangible assets, which primarily arise on the disposal of books of business. Prior to January 1, 2008, the Company reported these gains within "Commissions and fees". Comparatives have been adjusted accordingly.
In December 2007, the FASB issued Financial Accounting Standard No. 141 (revised 2007) Business Combinations ("FAS 141R"). FAS 141R makes substantial changes to how entities account for business combinations, establishing principles and requirements for how the acquirer:
•recognizes and measures the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree;
•determines what information to disclose to enable users of financial statements to evaluate the nature and financial effects of the business combination.
FAS 141R is effective for financial years beginning after December 15, 2008 and is effective for the Company from January 1, 2009. Adoption is prospective and early adoption is not permitted. Assets and liabilities that arose from business combinations with acquisition dates prior to the effective date of FAS 141R are not adjusted upon adoption of FAS 141R with certain exceptions for acquired deferred tax assets and acquired income tax positions.
In December 2007, the FASB issued FAS No. 160, Noncontrolling Interests in Consolidated Financial Statements-an amendment of ARB No. 51, (SFAS No. 160). FAS No. 160 establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the retained interest and gain or loss when a subsidiary is deconsolidated. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity and should be reported as equity in the Consolidated Financial Statements. This statement is effective for financial statements issued for fiscal years beginning on or after December 15, 2008. Upon the initial adoption of this statement on January 1, 2009, the Company will change the classification and presentation of Noncontrolling Interest in the financial statements, which is currently referred to as Minority Interest to within stockholders' equity. At December 31, 2008, the Company reported minority interest of $50 million as a mezzanine item on the balance sheet.
The Company classifies all short-term investments as available-for-sale. These securities are carried at fair market value, with unrealized gains and losses reported in other comprehensive income. Realized gains and losses on investments sold are included in net income.
uncollected claims or refunds from insurers are recorded as accounts receivable on the Company's consolidated balance sheets. Unremitted insurance premiums and claims are held in a fiduciary capacity. The obligation to remit these funds is recorded as accounts payable on the Company's consolidated balance sheets. The period for which the Company holds such funds is dependent upon the date the insured remits the payment of the premium to the Company and the date the Company is required to forward such payment to the insurer. Balances arising from insurance brokerage transactions are reported as separate assets or liabilities unless such balances are due to or from the same party and a right of offset exists, in which case the balances are recorded net.
Depreciation on buildings and long leaseholds is calculated over the lesser of 50 years or the lease term. Depreciation on leasehold improvements is calculated over the lesser of the useful life of the assets or the lease term. Depreciation on furniture and equipment is calculated based on a range of 3 to 10 years.
Rentals payable on operating leases are charged straight line to expense over the lease term as the rentals become payable.
being amortized on a straight-line basis over their estimated useful life with the exception of customer relationships for HRH which are amortized in line with the underlying cash flows.
Investments are accounted for using the equity method of accounting 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 cost of acquisition, plus the Company's equity in undistributed net income since acquisition, less any dividends received.
All other equity investments where the Company does not have the ability to exercise significant influence are accounted for by the cost method. Such investments are not publicly traded.
The Company recognizes deferred tax assets and liabilities for the estimated future tax consequences of events attributable to differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases and operating and capital loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted rates in effect for the year in which the differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of changes in tax rates is recognized in the statement of operations in the period in which the enactment date changes. Deferred tax assets are reduced through the establishment of a valuation allowance at such time as, based on available evidence, it is more likely than not that the deferred tax assets will not be realized.
In accordance with FAS 158, the Company records on the balance sheet the funded status of its pension plans based on the projected benefit obligation.
Brokerage income and fees negotiated instead of brokerage are recognised at the later of policy inception date or when the policy placement is complete. Commissions on additional premiums and adjustments are recognized as and when advised.
On December 31, 2008, the Company had three share-based compensation plans, under which options and other share based grants may be made to employees. All of the Company's share-based compensation plans under which any options or other share-based grants are outstanding as at December 31, 2008 are described below. The compensation cost that has been charged against income for those plans for the year ended December 31, 2008 was $40 million (2007: $33 million; 2006: $18 million). The total income tax benefit recognized in the statement of operations for share-based compensation arrangements for the year ended December 31, 2008 was $12 million (2007: $10 million; 2006: $6 million).
Time-based options are earned upon the fulfillment of vesting requirements. Options are generally exercisable in equal installments of 20 percent per year over a five-year period commencing on or after December 18, 2000.
All options granted under this plan are exercisable at £2 per share ($2.92 using the year-end exchange rate of £1 = $1.46). The options vest immediately on the grant date and are exercisable any time up to July 13, 2010.
This plan, which was established on May 3, 2001, provides for the granting of time-based options and various other share-based grants at fair market value to employees of the Company. There are 25,000,000 shares available for grant under this plan. Options are exercisable on a variety of dates, including from the first, second, third, sixth or eighth anniversary of grant, although for certain options the exercisable date may accelerate depending on the achievement of certain performance goals. Unless terminated sooner by the Board of Directors, the 2001 Plan will expire 10 years after the date of its adoption. That termination will not affect the validity of any grant outstanding at that date.
Options granted under the Hilb, Rogal and Hamilton Company 2000 Stock Incentive Plan, the Hilb, Rogal & Hobbs Company 2007 Stock Incentive Plan and the Hilb Rogal & Hobbs Company Non-Employee Directors Stock Incentive Plan were converted into options to acquire shares of Willis common stock. No further grants are to be made under these plans.
A summary of option activity under the plans at December 31, 2008, and changes during the year then ended is presented below:
(1)Certain options are exercisable at £2 per share. The year-end exchange rate of £1 = $1.46 has been used as of December 31, 2008. The weighted average grant-date fair value of time-based options granted during the year ended December 31, 2008 was $6.20 (2007: $11.06; 2006: $9.82). The total intrinsic value of options exercised during the year ended December 31, 2008 was $7 million (2007: $24 million; 2006: $26 million). At December 31, 2008 there was $52 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 years.
A summary of restricted stock unit activity under the Plans at December 31, 2008, and changes during the year then ended is presented below:
Total proceeds for 2008 were $11 million, inclusive of $7 million relating to 2008 dispositions of subsidiaries and associates and $4 million of deferred proceeds relating to prior years, with a gain on disposal of $nil recorded in the consolidated statements of operations.
Total proceeds for 2007 were $2 million, inclusive of $nil relating to 2007 dispositions of subsidiaries and associates and $2 million of deferred proceeds relating to prior years, with a gain on disposal of $2 million recorded in the consolidated statements of operations.
At December 31, 2008, the Company had a valuation allowance of $85 million (2007: $69 million) to reduce its deferred tax assets to estimated realizable value. The valuation allowances at December 31, 2008 and 2007 relate to the deferred tax assets arising from UK capital loss carryforwards ($51 million), which have no expiration date and to the deferred tax assets arising from US State net operating losses ($34 million). Capital loss carryforwards can only be offset against future UK capital gains.
At December 31, 2008, the Company had deferred tax assets of $277 million (2007: $115 million), net of the valuation allowance. Management believes, based upon the level of historical taxable income and projections for future taxable income, it is more likely than not that the Company will realize the
benefits of these deductible differences, net of the valuation allowance. However, the amount of the deferred tax asset considered realizable could be adjusted in the future if estimates of taxable income are revised.
Options to purchase 22.1 million shares of Willis common stock for the year ended December 31, 2008 were not included in the computation of the dilutive effect of stock options because the effect was antidilutive (2007: 2.6 million shares; 2006: 5.7 million shares).
The acquisition of HRH has been accounted for using the purchase method in accordance with FAS No. 141. Under the purchase method of accounting, the assets and liabilities of HRH are recorded at their fair values at the acquisition date. The financial statements and reported results of the operations of Willis after the completion of the acquisition reflect these fair values. The results of HRH are included within the consolidated statement of operations from October 1, 2008.
Prior to the acquisition, the Company had targeted key US locations and practice areas where it wished to expand and had made a series of piecemeal acquisitions. The acquisition of HRH, the eighth largest insurance and risk management intermediary in the United States, enabled the Company to achieve many of these targets and with a relatively low level of geographical and client overlap.
•boost the contribution of North America to Willis' overall revenues from 30 percent in 2007 to an estimated 45 percent on a pro forma basis, enhancing the mix among its North America, International and Global segments; and
•positively rebalance Willis' business lines mix, with the Reinsurance businesses, which in 2007 accounted for 15 percent of Willis' revenues, going to 12 percent of the revenues of the combined company. Meanwhile, the Employee Benefits business will increase from 10 percent of Willis' current revenues to 13 percent of the revenues of the combined company.
Willis funded the cash consideration, the repayment of $341 million of existing HRH debt and the transaction costs with $1 billion from an interim credit facility and $525 million from a $700 million 5-year term loan facility. In addition, the Company repaid the $170 million outstanding at September 30, 2008 on its previously existing revolving credit facility and replaced this with a new $300 million facility, all of which remained available to draw at December 31, 2008. Over time the company plans to repurchase the majority of the shares issued in connection with the merger under the existing $1 billion buy back authorization.
Willis' cost of acquiring HRH of $1.8 billion has been allocated on a preliminary basis to the assets acquired and liabilities assumed according to their estimated fair values at the date of acquisition. However, the Company is still in the process of finalizing the valuation of certain assets and liabilities, thus the allocation of the purchase price is subject to refinement. The final determination of these fair values will be completed as soon as possible but no later than one year from the acquisition date.
Trade names have been valued using the relief from royalty method, whereby the fair value of the trademark is estimated as the present value of the after tax royalty income stream that could be derived by licensing out the trade names.
The total amount of goodwill recognized on the purchase of HRH is $1.6 billion of which $1,551 million is attributable to our North America operations and $52 million to our Global operations.
(i)An adjustment to recognize the interest expense of $104 million and $132 million for the year to December 31, 2008 and 2007 respectively, to reflect the interest expense and amortization of debt fees associated with the $1 billion interim credit facility and $700 million 5-year term loan facility drawn down for the purpose of financing the acquisition of HRH.
(ii)An adjustment to eliminate the interest expense in HRH on existing long-term debt that was repaid by Willis on acquisition.
(iv)An adjustment to increase amortization expense based on the estimated fair value of identifiable intangible assets from the purchase price allocation, which are being amortized over their estimated useful lives over a range of 2 to 20 years, of $80 million and $83 million for the year to December 31, 2008 and 2007.
(v)An adjustment to the weighted average number of shares used in the pro forma EPS calculation to reflect the issuance of 24.4 million new shares of Willis common stock on October 1, 2008 as if it took place on January 1, 2007.
(vi)The above adjustments have been tax effected where appropriate at a rate of 40%.
Once the proposed acquisition of HRH was announced, the Company worked with HRH management to develop a plan to integrate HRH and its previously existing North America operations. This plan was substantially complete at the time of the acquisition. The plan seeks to centralize HRH's dispersed back office processes and integrate these with Willis' existing service hubs and to close down HRH's Richmond Head Office. The plan also identified locations where office space was duplicated or could be rationalized. In implementing the integration plan, the Company has incurred or expects to incur $34 million of severance expenses and vacant space provisions relating to HRH staff and premises. This has been recognized as a liability assumed in the purchase business combination within Accounts payable and accrued expenses.
Realized gains and losses, net of tax, on debt securities are included in net income. During the years ended December 31, 2008, 2007 and 2006, sales of debt securities totaled $15 million, $19 million and $10 million, respectively, on which realized gains and losses were not material to the consolidated results of the Company. Fiduciary funds-restricted, consisting primarily of time deposits with original maturities of less than or equal to three months, were $1,854 million as of December 31, 2008 (2007: $1,520 million).
(1)Debt securities classified as available-for-sale. The following table summarizes the estimated fair value of investments in marketable securities designated as available-for-sale classified by the contractual maturity date of the security:
In accordance with FASB Interpretation No. 46(R), Consolidation of Variable Interest Entities an interpretation of ARB No. 51, the financial statements for the years ended December 31, 2008 and 2007 reflect the consolidation of one Variable Interest Entity ("VIE"), a UK non-statutory trust that was established in January 2005 following the introduction of statutory regulation of insurance in the UK by the Financial Services Authority. The regulation requires that all fiduciary funds collected by an insurance broker such as the Company be paid into a non-statutory trust designed to give additional credit protection to the clients and insurance carriers of the Company. This trust restricts the financial instruments in which such funds may be invested and affects the timing of transferring commission from fiduciary funds to own funds.
As of December 31, 2008, the fair value of the assets in the VIE was approximately $931 million (2007: $912 million) and the fair value of the associated liabilities was approximately $931 million (2007: $912 million). There are no assets of the Company that serve as collateral for the VIE.
The Company recognized a depreciation charge of $54 million, $52 million and $49 million in the years ended December 31, 2008, 2007 and 2006, respectively.
Goodwill represents the excess of the cost of businesses acquired over the fair market value of identifiable net assets at the dates of acquisition. Goodwill is not amortized but is subject to impairment testing annually and whenever facts or circumstances indicate that the carrying amounts may not be recoverable. As part of the evaluation the estimated future discounted cash flows associated with the underlying business operation are compared to the carrying amount of goodwill to determine if a write-down is required. If such an assessment indicates that the discounted future cash flows are not sufficient, the carrying amount is reduced to the estimated fair value.
The changes in the carrying amount of goodwill by operating segment for the years ended December 31, 2008 and 2007 are as follows:
•"Customer and Marketing related" includes client lists, client relationships and non-compete agreements; and
As of December 31, 2008 and 2007, the Company's other investments in associates individually and in the aggregate were not material to the Company's operations.
The Company maintains two principal defined benefit pension plans that cover almost all our employees in the United States and United Kingdom. Both these plans are now closed to new entrants. New entrants in the United Kingdom are offered the opportunity to join a defined contribution plan and in the United States are offered the opportunity to join a 401(k) plan. In addition to the Company's UK and US defined benefit pension plans, the Company has several smaller defined benefit
pension plans in Ireland, Germany, Denmark and the Netherlands. Elsewhere, pension benefits are typically provided through defined contribution plans. It is the Company's policy to fund pension costs as required by applicable laws and regulations.
At December 31, 2008, the Company recorded, on the Consolidated Balance Sheets:
The accumulated benefit obligations for the Company's UK and US defined benefit pension plans were $1,377 million and $635 million, respectively (2007: $2,014 million and $619 million, respectively).
The estimated net loss and prior service cost for the UK and US defined benefit plans that will be amortized from accumulated other comprehensive loss into net periodic benefit cost over the next fiscal year are $31 million loss and $4 million gain, respectively (using the year-end exchange rate of £1 = $1.46) for the UK plan and $19 million loss and $2 million gain for the US plan, respectively.
The following benefit payments, which reflect expected future service, as appropriate, are estimated to be paid by the UK and US defined benefit pension plans:
Willis North America has a 401(k) plan covering all eligible employees of Willis North America and its subsidiaries. The plan allows participants to make pre-tax contributions and the Company provides a matching contribution of 3 percent of employees' annual eligible compensation. All investment assets of the plan are held in a trust account administered by independent trustees. The Company's 401(k) matching contributions for 2008 were $8 million (2007: $6 million; 2006: $5 million).
In addition to the Company's UK and US defined benefit pension plans, the Company has several smaller defined benefit pension plans in Ireland, Germany, Denmark and the Netherlands. In prior years, management determined that these International plans were not material to the Company's results of operations, financial condition or liquidity: as at December 31, 2007 the net pension liability in respect of these schemes was $2 million. Consequently such plans were not included in the Company's pension plan disclosures.
The following schedules provide information concerning the Company's international defined benefit pension plans as of and for the year ended December 31, 2008. Comparative information has not been presented.
Amounts recognized in accumulated other comprehensive loss consist of a net actuarial loss of $27 million.
The accumulated benefit obligation for the Company's International defined benefit pension plans was $104 million.
The components of the net periodic benefit cost and other amounts recognized in other comprehensive loss for the International defined benefit plans for the year ended December 31, 2008 are as follows:
The investment policies for the International plans vary by jurisdiction but are typically established by the local pension plan trustees, where applicable, and seek to maintain the plans' ability to meet liabilities of the plans as they fall due and to comply with local minimum funding requirements.
The $1 billion interim credit facility bears interest at LIBOR plus 2.250% and is repayable on September 30, 2009. Duration fees of 0.50% of any balance then outstanding are payable on March 31, 2009 and June 30, 2009.
The $1 billion interim credit facility bears interest at LIBOR plus 2.250% and is repayable on September 30, 2009; the 5-year term loan facility and the revolving credit facility also bear interest at LIBOR plus 2.250%. 1 month LIBOR at December 31, 2008 was 0.436%.
All obligations of Willis North America Inc. ("Willis North America") (the borrower) under the credit agreements and under the senior notes listed above are guaranteed by Willis Group Holdings Limited, Willis Investment UK Holdings Limited, Trinity Acquisition Limited, Willis Group Limited, TA I Limited, TA II Limited, TA III Limited and TA IV Limited.
Excluding the $300 million revolving credit facility, the Company also has available $10 million (2007: $8 million) in lines of credit, of which $1 million was drawn as of December 31, 2008 (2007: $nil).
We moved from Ten Trinity Square into our new London headquarters in Lime Street in April 2008. In November 2004, the Company entered into an agreement with long time client British Land plc to lease the Lime Street building and took control of the building in June 2007 under a 25-year operating lease. The Company's contractual obligations in relation to this commitment total $720 million and are included in the table above.
The Company is subject to various actual and potential claims, lawsuits and other proceedings relating principally to alleged errors and omissions in connection with the placement of insurance and reinsurance in the ordinary course of business. Similar to other corporations, the Company is also subject to a variety of other claims, including those relating to the Company's employment practices. Some of the claims, lawsuits and other proceedings seek damages in amounts which could, if assessed, be significant.
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, it is possible that an adverse outcome 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.
The European Commission issued questionnaires pursuant to its Sector Inquiry or, in respect of Norway, the European Free Trade Association Surveillance Authority, related to insurance business practices, including compensation arrangements for brokers, to at least 150 European brokers including our operations in nine European countries. The Company responded to the European Commission questionnaires and has filed the European Free Trade Association Surveillance Authority for two of its Norwegian entities. The European Commission reported on a final basis on September 25, 2007, expressing concerns over potential conflicts of interest in the industry relating to remuneration and binding authorities when assuming a dual role for clients and insurers and also over the nature of the coinsurance market. The Company continues to co-operate with both the European Commission and the European Free Trade Association Surveillance Authority.
outcomes of these lawsuits, however, including any losses or other payments that may occur as a result, cannot be predicted at this time.
(1)Under the terms of the programs, the shares were subject to a price adjustment based on the volume weighted average share price of Willis' stock and dividend payments during the term of the program. The $481 million excess of the initial purchase price over nominal value for the two 2007 programs, together with the price adjustments in respect of the completed November 2006 and March 2007 programs has been charged to stockholders' equity; $432 million was charged against additional paid-in capital and $49 million against retained earnings.
The Company's principal financial instruments, other than derivatives, comprise the fixed rate senior notes, the new 5-year term loan and interim credit facilities, a revolving credit facility, cash deposits and short-term investments. The Company also enters into derivative transactions (principally interest rate swaps and forward foreign currency contracts) in order to manage interest rate and currency risks arising from the Company's operations and its sources of finance. The Company does not hold financial or derivative instruments for trading purposes.
A summary of the Company's forward rate agreements by major currency is as follows:
(1)Notional amounts represent US dollar equivalents translated at the spot rate as of December 31. Liquidity Risk
•To the extent the UK operations earn significant revenues in euros and Japanese Yen, the Company limits its exposure to changes in the exchange rate between the US dollar and these currencies by the use of forward contracts matched to a percentage of forecast cash inflows in specific currencies and periods; and
collateral or other security to support financial instruments with credit risk; however, it is the Company's policy to enter into master netting arrangements with counterparties as practical.
Concentrations of credit risk with respect to receivables are limited due to the large number of clients and markets in which the Company does business, as well as the dispersion across many geographic areas. Management does not believe significant risk exists in connection with the Company's concentrations of credit as of December 31, 2008.
The estimated fair value of the Company's financial instruments held or issued to finance the Company's operations is summarized below. Certain estimates and judgments were required to develop the fair value amounts. The fair value amounts shown below are not necessarily indicative of the amounts that the Company would realize upon disposition nor do they indicate the Company's intent or ability to dispose of the financial instrument.
The accounting policies of the operating segments are consistent with those described in Note 2-Basis of Presentation and Significant Accounting Policies. There are no inter-segment revenues, with segments operating on a revenue-sharing basis equivalent to that used when sharing business with other third-party brokers.
In 2008, the Company changed its basis of segmental allocation for central costs. All accounting adjustments for foreign exchange hedging activities and foreign exchange movements on the UK pension plan asset or liability are held at the Corporate level, together with legal costs that are managed centrally. As a result of this change, $nil in 2007 and $2 million net operating loss for full year 2006, previously allocated to the operating segments, has been reported within Corporate.
The following table reconciles total consolidated operating income, as disclosed in the operating segment tables above, to consolidated income before income taxes, interest in earnings of associates and minority interest.
None of the Company's customers represented more than 10 percent of the Company's consolidated commissions and fees for the years ended December 31, 2008, 2007 and 2006.
23. FINANCIAL INFORMATION FOR PARENT GUARANTOR, OTHER GUARANTOR SUBSIDIARIES AND NON-GUARANTOR SUBSIDIARIES