Includes the impact of net restructuring costs of $44 million, $28 million, $12 million, $22 million and $78 million in 2016, 2015, 2014, 2013 and 2012, respectively.
Consulting includes health, retirement, talent and Investments consulting services and products, and specialized management, economic and brand consulting services. The Company conducts business in this segment through Mercer and Oliver Wyman Group.
We describe the primary sources of revenue and categories of expense for each segment below, in our discussion of segment financial results. A reconciliation of segment operating income to total operating income is included in Note 16 to the consolidated financial statements included in Part II, Item 8 in this report. The accounting policies used for each segment are the same as those used for the consolidated financial statements.
This Management's Discussion & Analysis ("MD&A") contains forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995. See "Information Concerning Forward-Looking Statements" at the outset of this report.
Consulting operating income increased $28 million, or 3%, to $1.1 billion in 2016 compared with 2015, reflecting the combined impact of 1% revenue growth, while expense was flat.
Risk and Insurance Services operating income increased $30 million, or 2%, in 2015 compared with 2014. Revenue decreased 1%, while expenses decreased 2%.
Underlying revenue measures the change in revenue using consistent currency exchange rates, excluding the impact of certain items that affect comparability such as: acquisitions, dispositions, transfers among businesses and the deconsolidation of Marsh India. For 2015, the impact of the gain from the disposal of Mercer's U.S. defined contribution recordkeeping business is included in acquisitions/dispositions in Mercer's Retirement business.
Consolidated operating expenses increased 1% in 2016 compared with the same period in 2015 on both a reported and underlying basis. The underlying expense increase reflects higher base salary costs, higher amortization of identified intangible assets and the impact of the net benefit from the termination of the Company's post-65 retiree medical reimbursement plan in the United States (the "RRA Plan"), which was recorded in the first quarter of 2015, partly offset by decreases in defined benefit plan pension expense and contingent acquisition consideration expense.
Consolidated operating expenses decreased 2% in 2015 compared with the same period in 2014, but increased 3% on an underlying basis. The increase in underlying expenses primarily reflects higher base salary, bonus, and higher defined benefit and defined contribution plan costs ("retirement benefit costs"), partly offset by the impact of the net benefit from the termination of the RRA plan.
The results of operations for the Risk and Insurance Services segment are presented below:
In Marsh, revenue of $6 billion increased 4% on a reported basis in 2016 as compared with 2015, reflecting a 3% increase on an underlying basis and a 4% increase from acquisitions, offset by a 2% decrease resulting from the impact of foreign currency translation. The underlying revenue increase reflects growth in all major geographies. International operations had underlying revenue growth of 3% reflecting increases of 2% in EMEA, 3% in Asia Pacific and 8% in Latin America, while U.S./Canada increased 2%.
Guy Carpenter’s revenue increased 2% to $1.1 billion in 2016 compared with 2015, reflecting an increase of 2% on an underlying basis.
Fiduciary interest income was $26 million in 2016 compared with $21 million in 2015 due to the combined effect of higher average invested funds and higher interest rates.
The Risk and Insurance Services segment completed nine acquisitions during 2016. Information regarding those acquisitions is included in Note 4 to the consolidated financial statements.
In Marsh, revenue of $5.7 billion, was essentially flat on a reported basis in 2015 as compared with 2014, reflecting a 3% increase on an underlying basis and a 3% increase from acquisitions, offset by a 7% decrease resulting from the impact of foreign currency translation. The underlying revenue increase reflects growth in all major geographies. International operations had underlying revenue growth of 3% reflecting increases of 2% in EMEA, 2% in Asia Pacific and 8% in Latin America, while U.S./Canada increased 3%.
Expense in the Risk and Insurance Services segment decreased 2% on a reported basis, but increased 2% on an underlying basis, in 2015 compared with 2014. The impact of foreign currency translation reduced expenses by 7%, partly offset by a 3% increase related to acquisitions. The increase in underlying expenses reflects higher base salaries, incentive compensation and retirement benefit costs, higher intangible asset amortization expense and charges for adjustments to acquisition-related
contingent consideration liabilities, partly offset by the impact of the net benefit from the termination of the RRA plan.
Effective January 1, 2017, Mercer merged its investment and retirement businesses into a newly-created wealth business. We believe this combination will align Mercer’s investment management capabilities globally. In addition, moving forward we will refer to our talent business as our career business.
Consulting revenue in 2016 increased 1% compared with 2015, reflecting a 3% increase on an underlying basis offset by a 2% decrease from the impact of foreign currency translation. Mercer’s revenue of $4.3 billion was flat when compared with 2015 but increased 3% on an underlying basis. Mercer's year over year revenue comparison reflects a decrease of 2% from the impact of foreign currency translation. The underlying revenue growth reflects an increase in Investments of 6%, Health of 3% and Talent of 5%, while Retirement remained flat. Oliver Wyman Group’s revenue increased 2% in 2016 compared with 2015, reflecting an increase of 3% on an underlying basis, partly offset by a decrease of 2% from the impact of foreign currency translation.
The Consulting segment completed six acquisitions during 2016. Information regarding those acquisitions is included in Note 4 to the consolidated financial statements.
Interest income earned on corporate funds amounted to $5 million in 2016 compared with $13 million in 2015. The decrease is due to the combined effects of a lower level of invested funds and lower interest rates. Interest expense was $189 million in 2016 compared with $163 million in 2015 due to higher average debt outstanding during 2015.
Interest income earned on corporate funds amounted to $13 million in 2015 compared with $21 million in 2014, primarily due to a lower level of invested funds in 2015. Interest expense was $163 million in 2015 compared with $165 million in 2014, due to lower average interest rates in 2015 compared with the prior year, partly offset by higher average debt outstanding during 2015.
The caption "Investment income (loss)" in the consolidated statements of income comprises realized and unrealized gains and losses from investments recognized in current earnings. It includes, when applicable, other-than-temporary declines in the value of debt and available-for-sale securities and equity method gains or losses on its investment in private equity funds. The Company's investments may include direct investments in insurance, consulting and related companies and investments in private equity funds. The Company recorded net investment income of less than $1 million in 2016 and $38 million in 2015. Net investment income in 2015 was primarily related to the general partner carried interest from Trident III. Stonepoint Capital, the investment manager of Trident III, substantially liquidated the remaining two investments of Trident III during the third quarter of 2015, which resulted in the Company recognizing its remaining deferred performance fees.
As a U.S.-domiciled parent holding company, Marsh & McLennan Companies, Inc. is the issuer of essentially all of the Company's external indebtedness, and incurs the related interest expense in the U.S. Further, most senior executive and oversight functions are conducted in the U.S. and the associated costs are incurred primarily in the United States.
jurisdictionally by legal entity or filing group. Certain taxing jurisdictions allow or require combined or consolidated tax filings. The Company assessed the realizability of its deferred tax assets. The Company considered all available evidence, including the existence of a recent history of losses, placing particular weight on evidence that could be objectively verified. A valuation allowance was recorded to reduce deferred tax assets to the amount that the Company believes is more likely than not to be realized.
In the United States, contributions to the tax-qualified defined benefit plans are based on ERISA guidelines and the Company generally expects to maintain a funded status of 80% or more of the liability determined under the ERISA guidelines. There was no ERISA funding requirement for the U.S. qualified plan in 2016. The Company expects to fund approximately $32 million to its U.S. pension plans in 2017, including $6 million to its U.S. qualified plan to meet ERISA funding requirements.
Outside the United States, the Company has a large number of non-U.S. defined benefit pension plans, the largest of which are in the U.K., which comprise approximately 81% of non-U.S. plan assets at December 31, 2016. Contribution rates for non-U.S. plans are generally based on local funding practices and statutory requirements, which may differ significantly from measurements under U.S. GAAP. In the U.K., the assumptions used to determine pension contributions are the result of legally-prescribed negotiations between the Company and the plans' trustee that typically occurs every three years in conjunction with the actuarial valuation of the plans. Currently, this results in a lower funded status than under U.S. GAAP and may result in contributions irrespective of the U.S. GAAP funded status. In November 2016, the Company and the Trustee of the U.K. Defined Benefits Plans agreed to a funding deficit recovery plan for the U.K. defined benefit pension plans. The current agreement with the Trustee sets out the annual deficit contributions which would be due based on the deficit at December 31, 2015. The funding level is subject to re-assessment, in most cases on November 1 of each year. If the funding level on November 1 is sufficient, no deficit funding contributions will be required in the following year, and the contribution amount will be deferred. As part of a long-term strategy, which depends on having greater influence over asset allocation and overall investment decisions, in November 2016 the Company renewed its agreement to support annual deficit contributions by the U.K. operating companies under certain circumstances, up to GBP 450 million over a seven-year period.
In the aggregate, the Company expects to contribute approximately $224 million to its non-U.S. defined benefit plans in 2017, comprising approximately $99 million to plans outside of the U.K. and $125 million to the U.K. plans.
in December 2012. This gain was mostly offset by the cost of a transition benefit to certain employees most impacted by the amendment.
The year-over-year change in the funded status of the Company's pension plans is impacted by the difference between actual and assumed results, particularly with regard to return on assets, and changes in the discount rate, as well as the amount of Company contributions, if any. Unrecognized actuarial losses were approximately $1.7 billion and $3.1 billion at December 31, 2016 for the U.S. plans and non-U.S. plans, respectively, compared with $1.8 billion and $2.9 billion at December 31, 2015. The decrease in the U.S. was primarily due to the modification of the U.S. plans mentioned above. The increase in the non-U.S. plans was primarily due to the impact of decreases in the discount rates partly offset by actual returns on plan assets in 2016 that were higher than the estimated long-term rate of return on plan assets. In the past several years, the amount of actuarial losses has been significantly impacted, both positively and negatively, by actual asset performance and changes in discount rates. The discount rate used to measure plan liabilities decreased in both the U.S. and the U.K. (the Company's largest plans) in 2016 after increasing in 2015. The increase in 2015 followed a decrease in 2014. An increase in the discount rate decreases the measured plan benefit obligation, resulting in actuarial gains, while a decrease in the discount rate increases the measured plan obligation, resulting in actuarial losses. During 2016, the Company's defined benefit pension plan assets had actual returns of 9.8% and 22.1% in the U.S. and U.K., respectively. During 2015, the Company's defined benefit pension plan assets had a loss of 3.9% in the U.S. and gain of 1.2% in the U.K. During 2014, the Company's defined benefit pension plan assets had actual returns of 9.8% and 19.4% in the U.S. and U.K., respectively.
In March 2015, the Company amended the RRA, resulting in its termination, with benefits to certain participants to be paid through December 31, 2016. As a result of the termination of the RRA plan, the Company recognized a net credit of approximately $125 million in the first quarter of 2015.
The Company increased outstanding debt by approximately $400 million in 2016 and $1 billion in 2015.
The Company has established a short-term debt financing program of up to $1.5 billion through the issuance of commercial paper. The proceeds from the issuance of commercial paper are used for general corporate purposes. The Company had $50 million of commercial paper outstanding at December 31, 2016 at an effective interest rate of 1%.
During 2016, the Company repurchased 12.7 million shares of its common stock for total consideration of $800 million at an average price per share of $63.18. In November 2016, the Board of Directors authorized an increase in the Company’s share repurchase program, which supersedes any prior authorization, allowing management to buy back up to $2.5 billion of the Company’s common stock going forward. As of December 31, 2016, the Company remained authorized to purchase additional shares of its common stock up to a value of approximately $2.4 billion. There is no time limit on this authorization.
The Company paid total dividends of $682 million in 2016 ($1.30 per share), $632 million in 2015 ($1.18 per share) and $582 million in 2014 ($1.06 per share).
During 2016, the Company paid $86 million of contingent payments related to acquisitions made in prior years. These payments are split between financing and operating cash flows in the consolidated statements of cash flows. Payments of $44 million related to the contingent consideration liability that was recorded on the date of acquisition are reflected as financing cash flows. Payments related to increases in the contingent consideration liability subsequent to the date of acquisition of $42 million are reflected as operating cash flows. Remaining estimated future contingent consideration payments of $241 million for acquisitions completed in 2016 and in prior years are included in accounts payable and accrued liabilities or other liabilities in the consolidated balance sheet at December 31, 2016. The Company paid deferred purchase consideration related to prior years' acquisitions of $54 million, $36 million and $25 million in the years ended December 31, 2016, 2015 and 2014, respectively. Remaining deferred cash payments of approximately $113 million are included in accounts payable and accrued liabilities or other liabilities in the consolidated balance sheet at December 31, 2016.
In 2015, the Company paid $47 million of contingent payments related to acquisitions made in prior periods, of which $13 million was reported as financing cash flows and $34 million as operating cash flows. In 2014, the Company made $42 million of contingent payments related to acquisitions made in prior periods, of which $30 million was reported as financing cash flows and $12 million as operating cash flows.
On February 24, 2015, Mercer purchased shares of common stock of Benefitfocus (NASDAQ:BNFT) constituting approximately 9.9% of BNFT's outstanding capital stock as of the acquisition date. The purchase price for the BNFT shares and certain other rights and other consideration was approximately $75 million. In 2015, the Company elected to account for this investment under the cost method of accounting as the shares purchased were categorized as restricted. Effective December 31, 2016, these shares are no longer considered restricted for the purpose of determining if they are marketable securities under GAAP, and are accounted for as available for sale securities and included in other assets in the consolidated balance sheets.
The Company has commitments for potential future investments of approximately $45 million in four private equity funds that invest primarily in financial services companies.
The Company and its subsidiaries are subject to numerous claims, lawsuits and proceedings including claims for errors and omissions ("E&O"). GAAP requires that a liability be recorded when a loss is both probable and reasonably estimable. Significant management judgment is required to apply this guidance. The Company utilizes case level reviews by inside and outside counsel, an internal actuarial analysis by Oliver Wyman Group, a subsidiary of the Company, and other analyses to estimate potential losses. The liability is reviewed quarterly and adjusted as developments warrant. In many cases, the Company has not recorded a liability, other than for legal fees to defend the claim, because we are unable, at the present time, to make a determination that a loss is both probable and reasonably estimable. Given the unpredictability of E&O claims and of litigation that could flow from them, it is possible that an adverse outcome in a particular matter could have a material adverse effect on the Company’s businesses, results of operations, financial condition or cash flow in a given quarterly or annual period.
The Company recognizes the funded status of its over-funded defined benefit pension and retiree medical plans as a net benefit plan asset and its unfunded and underfunded plans as a net benefit plan liability. The gains or losses and prior service costs or credits that have not been recognized as components of net periodic costs are recorded as a component of Accumulated Other Comprehensive Income ("AOCI"), net of tax, in the Company’s consolidated balance sheets. The gains and losses that exceed specified corridors are amortized prospectively out of AOCI over a period that approximates the remaining life expectancy of participants in plans where substantially all participants are inactive or the average remaining service period of active participants for plans with active participants.
The long-term rate of return on plan assets assumption is determined for each plan based on the facts and circumstances that exist as of the measurement date, and the specific portfolio mix of each plan’s assets. The Company utilizes a model developed by Mercer, a subsidiary of the Company, to assist in the determination of this assumption. The model takes into account several factors, including: actual and target portfolio allocation; investment, administrative and trading expenses incurred directly by the plan trust; historical portfolio performance; relevant forward-looking economic analysis; and expected returns, variances and correlations for different asset classes. These measures are used to determine probabilities using standard statistical techniques to calculate a range of expected returns on the portfolio.
The table below shows the weighted average assumed rate of return and the discount rate at the December 31, 2016 measurement date (for measuring pension expense in 2017) for the total Company, the U.S. and the Rest of World ("ROW").
as the impact on the market value of the plans’ assets. Changing the discount rate and leaving the other assumptions constant also may not be representative of the impact on expense, because the long-term rates of inflation and salary increases are often correlated with the discount rate. Changes in these assumptions will not necessarily have a linear impact on the net periodic pension cost.
The Company contributes to certain health care and life insurance benefits provided to its retired employees. The cost of these post-retirement benefits for employees in the U.S. is accrued during the period up to the date employees are eligible to retire, but is funded by the Company as incurred. The key assumptions and sensitivity to changes in the assumed health care cost trend rate are discussed in Note 8 to the consolidated financial statements.
Uncertain tax positions are evaluated based upon the facts and circumstances that exist at each reporting period and involve significant management judgment. Subsequent changes in judgment based upon new information may lead to changes in recognition, derecognition, and measurement. Adjustments may result, for example, upon resolution of an issue with the taxing authorities, or expiration of a statute of limitations barring an assessment for an issue.
The Company completed its qualitative assessment in the third quarter of 2016 and concluded that a two-step goodwill impairment test was not required in 2016 and that goodwill was not impaired.
The Risk and Insurance Services segment provides risk management activities and insurance broking, reinsurance broking and insurance program management services for businesses, public entities, insurance companies, associations, professional services organizations, and private clients. The Company conducts business in this segment through Marsh and Guy Carpenter.
Net uncollected premiums and claims and the related payables were $7 billion and $6.9 billion at December 31, 2016 and 2015, respectively. The Company is not a principal to the contracts under which the right to receive premiums or the right to receive reimbursement of insured losses arises. Accordingly, net uncollected premiums and claims and the related payables are not assets and liabilities of the Company and are not included in the accompanying consolidated balance sheets.
certain performance thresholds are recorded when such levels are attained and such fees are not subject to forfeiture.
Consulting revenue includes fees paid by clients for advice and services and commissions from insurance companies for the placement of individual and group contracts. Fee revenue for engagements where remuneration is based on time plus out-of-pocket expenses is recognized based on the amount of time consulting professionals expend on the engagement. For fixed fee engagements, revenue is recognized using a proportional performance model. Revenue from insurance commissions not subject to a fee arrangement is recorded over the effective period of the applicable policies. Revenue for asset based fees is recognized on an accrual basis by applying the daily/monthly rate as contractually agreed with the client to the applicable net asset value. On a limited number of engagements, performance fees may also be earned for achieving certain prescribed performance criteria. Such fees are recognized when the performance criteria have been achieved and, when required, agreed to by the client. Reimbursable expenses incurred by professional staff in the generation of revenue and sub-advisory fees related to the majority of funds in the investment management business are included in revenue and the related expenses are included in other operating expenses.
Cash and Cash Equivalents: Cash and cash equivalents primarily consist of certificates of deposit and time deposits, with original maturities of three months or less, and money market funds. The estimated fair value of the Company's cash and cash equivalents approximates their carrying value. The Company is required to maintain operating funds primarily related to regulatory requirements outside the United States or as collateral under captive insurance arrangements. At December 31, 2016, the Company maintained $159 million related to these regulatory requirements.
Goodwill and Other Intangible Assets: Goodwill represents acquisition costs in excess of the fair value of net assets acquired. Goodwill is reviewed at least annually for impairment. The Company performs an annual impairment test for each of its reporting units during the third quarter of each year. When a step 1 test is performed, fair values of the reporting units are estimated using either a market approach or a discounted cash flow model. Carrying values for the reporting units are based on balances at the prior quarter end and include directly identified assets and liabilities as well as an allocation of those assets and liabilities not recorded at the reporting unit level. As discussed in Note 6, the Company may elect to assess qualitative factors to determine if a step 1 test is necessary. Other intangible assets, which primarily consist of acquired customer lists, that are not deemed to have an indefinite life, are amortized over their estimated lives, typically ranging from 10 to 15 years, and reviewed for impairment upon the occurrence of certain triggering events in accordance with applicable accounting literature. The Company had no indefinite lived identified intangible assets at December 31, 2016 and 2015.
Capitalized Software Costs: The Company capitalizes certain costs to develop, purchase or modify software for the internal use of the Company. These costs are amortized on a straight-line basis over periods ranging from 3 to 10 years. Costs incurred during the preliminary project stage and post implementation stage, are expensed as incurred. Costs incurred during the application development stage are capitalized. Costs related to updates and enhancements are only capitalized if they will result in additional functionality. Capitalized computer software costs of $482 million and $498 million, net of accumulated amortization of $1.1 billion and $958 million at December 31, 2016 and 2015, respectively, are included in other assets in the consolidated balance sheets.
Legal and Other Loss Contingencies: The Company and its subsidiaries are subject to a significant number of claims, lawsuits and proceedings including claims for errors and omissions ("E&O"). The preparation of financial statements in conformity with accounting principles generally accepted in the United States ("GAAP") requires that a liability be recorded when a loss is both probable and reasonably estimable. Significant management judgment is required to apply this guidance. The Company utilizes case level reviews by inside and outside counsel, an internal actuarial analysis by Oliver Wyman Group, a subsidiary of the Company, and other analysis to estimate potential losses. The liability is reviewed quarterly and adjusted as developments warrant. In many cases, the Company has not recorded a liability, other than for legal fees to defend the claim, because we are unable, at the present time, to make a determination that a loss is both probable and reasonably estimable. Given the unpredictability of E&O claims and of litigation that could flow from them, it is possible that an adverse outcome in a particular matter could have a material adverse effect on the Company’s businesses, results of operations, financial condition or cash flow in a given quarterly or annual period.
The Company reports a liability for unrecognized tax benefits resulting from uncertain tax positions taken or expected to be taken in a tax return. The evaluation of a tax position is a two-step process. The first step involves recognition. The Company determines whether it is more likely than not that a tax position will be sustained upon tax examination, including resolution of any related appeals or litigation, based on only the technical merits of the position. The technical merits of a tax position derive from both statutory and judicial authority (legislation and statutes, legislative intent, regulations, rulings, and case law) and their applicability to the facts and circumstances of the tax position. If a tax position does not meet the more-likely-than-not recognition threshold, the benefit of that position is not recognized in the financial
statements. The second step is measurement. A tax position that meets the more-likely-than-not-recognition threshold is measured to determine the amount of benefit to recognize in the financial statements. The tax position is measured as the largest amount of benefit that is greater than 50 percent likely to be realized upon ultimate resolution with a taxing authority. Uncertain tax positions are evaluated based upon the facts and circumstances that exist at each reporting period. Subsequent changes in judgment based upon new information may lead to changes in recognition, de-recognition, and measurement. Adjustments may result, for example, upon resolution of an issue with the taxing authorities, or expiration of a statute of limitations barring an assessment for an issue. The Company recognizes interest and penalties, if any, related to unrecognized tax benefits in income tax expense.
In April 2016, the FASB issued new guidance which simplifies several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures and statutory tax withholding requirements, as well as classification in the statement of cash flows. The guidance is effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early adoption is permitted for any organization in any interim or annual period. Based on the Company’s stock price during January and through February 21, 2017, the Company expects the adoption of this standard to reduce the Company’s reported income tax expense and increase its net income and earnings per share in the first quarter of 2017. However, the specific impact will depend on the number of outstanding options exercised (which the Company does not control) and the Company’s stock price on the dates shares vest and options are exercised.
In March 2016, the FASB issued new guidance which eliminates the requirement that when an investment qualifies for use of the equity method as a result of an increase in the level of ownership interest or degree of influence, an investor must adjust the investment, results of operations and retained earnings retroactively on a step-by-step basis as if the equity method had been in effect during all previous periods that the investment had been held. The amendments require that the equity method investor add the cost of acquiring the additional interest in the investee to the current basis of the investor’s previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting. Therefore, upon qualifying for the equity method of accounting, no retroactive adjustment of the investment is required. The amendments require that an entity that has an available-for-sale equity security that becomes qualified for the equity method of accounting recognize through earnings the unrealized holding gain or loss in accumulated other comprehensive income at the date the investment becomes qualified for use of the equity method. The new guidance is effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. Early application will be permitted. The Company is currently evaluating the impact the adoption of this standard will have on its financial position or results of operations.
In January 2016, the FASB issued new guidance intended to improve the recognition and measurement of financial instruments. The new guidance requires equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income; requires public business
entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (i.e., securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements; eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; and requires a reporting organization to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk (also referred to as "own credit") when the organization has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. The new guidance is effective for public companies for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is currently evaluating the impact of the adoption of the guidance on its financial position and results of operations.
In May 2014, the FASB issued new accounting guidance to clarify the principles for revenue recognition. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve that principle, the entity should apply the following steps: identify the contract(s) with the customer, identify the performance obligations in the contract(s), determine the transaction price, allocate the transaction price to the performance obligations in the contract and recognize revenue when (or as) the entity satisfies a performance obligation. Entities are permitted to adopt the guidance under one of the following methods: the "full retrospective" method, which applies the guidance to each period presented (prior years restated) or the "modified retrospective" method in which the guidance is only applied to the year of adoption, with the cumulative effect of initially applying the guidance recognized as an adjustment to retained earnings. The Company will adopt the new guidance effective January 1, 2018. The Company is evaluating the transition method it will use, but currently expects to use the modified retrospective method.
The Company's initial review and preliminary conclusions for the Consulting segment indicate the impact on the existing pattern of revenue recognition in quarterly or annual periods will be less significant than for RIS. The conclusions will be completed following a final review of customer arrangement legal terms and conditions in certain of our non-U.S. locations.
The Company continues to evaluate the extent to which certain costs it incurs that are currently expensed under GAAP must be capitalized as costs to obtain or costs to fulfill customer contracts under guidance issued as part of the revenue recognition update. Any capitalized costs would be amortized on a basis consistent with the transfer of services to which they relate. Such expenses related to Risk and Insurance Services would generally be "amortized" over a period of one year or less. In the Consulting segment, certain expenses that are currently deferred may be amortized over a longer period than our current amortization policy, to reflect the amortization over the expected life of the contract including anticipated renewal periods.
The Company has not yet quantified the impact of the changes discussed above.
any, as a result of the change to the estimated amounts, calculated as if the accounting had been completed as of the acquisition date. The guidance also includes additional disclosures required for the amounts recorded in current period earnings arising from such adjustments. The guidance was adopted on January 1, 2016 and did not have a material impact on the Company's financial position or results of operations.
In February 2015, the FASB issued new accounting guidance intended to improve targeted areas of consolidation guidance for legal entities such as limited partnerships, limited liability corporations and securitization structures. The guidance focuses on the consolidation evaluation for reporting organizations that are required to evaluate whether they should consolidate certain legal entities. The guidance is effective for periods beginning after December 15, 2015. The adoption of this guidance did not have a material impact on the Company's financial statements.
In January 2015, the FASB issued new accounting guidance that eliminated the concept of extraordinary items. The guidance is effective for annual periods beginning after December 15, 2015. Adoption of the guidance did not materially affect the Company's financial condition, results of operations or cash flows.
In June 2014, the FASB issued new accounting guidance to clarify the treatment of share-based payment awards that require a specific performance target to be achieved in order for employees to be eligible to vest in the awards which include terms that may provide that the performance conditions could be achieved after an employee completes the requisite service period. The guidance requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. As such, a reporting entity should apply the existing guidance as it relates to awards with performance conditions that affect vesting. The guidance is effective for annual periods beginning after December 15, 2015. Adoption of the guidance did not materially affect the Company's financial condition, results of operations or cash flows.
In April 2014, the FASB issued new accounting guidance which changed the criteria for reporting discontinued operations and enhances disclosures in this area. Under the new guidance, only disposals representing a strategic shift in operations, such as disposal of a major geographic area or a major line of business, should be presented as discontinued operations. Those strategic shifts should have a major impact on the organization's operations and financial results. In addition, the new guidance requires expanded disclosures about discontinued operations. The guidance is effective for fiscal years beginning on or after December 15, 2014. Adoption of the guidance did not have a material effect on the Company's financial condition, results of operations or cash flows.
The classification of deferred or contingent consideration in the statement of cash flows is dependent upon whether the payment was part of the initial liability established on the acquisition date (financing) or an adjustment to the acquisition date liability (operating).
The Company had non-cash issuances of common stock under its share-based payment plan of $73 million, $72 million and $108 million for the years ended December 31, 2016, 2015 and 2014, respectively. The Company recorded stock-based compensation expense related to equity awards of $87 million, $67 million and $75 million for the years ended December 31, 2016, 2015 and 2014, respectively.
The consolidated statement of cash flows includes the cash flow impact of discontinued operations related to indemnification payments from the Putnam disposition that reduced the net cash flow provided by operations by $82 million in 2015.
The changes in the balances of each component of Accumulated Other Comprehensive Income ("AOCI") for the years ended December 31, 2016 and 2015, including amounts reclassified out of AOCI, are as follows:
The Risk and Insurance Services segment completed nine acquisitions during 2016.
February - Marsh & McLennan Agency ("MMA") acquired The Celedinas Agency, Inc., a Florida-based brokerage firm providing property and casualty and marine insurance as well as employee benefits services, and Aviation Solutions, LLC, a Missouri-based aviation risk advisor and insurance broker.
May - Marsh acquired Sylvite Financial Services, Inc., a Canada-based insurance consulting firm and Sumitomo Life Insurance Agency America, Inc., an employee benefits brokerage and consulting firm providing employee benefit and other services to U.S.-based subsidiaries of Japanese companies.
July - MMA acquired Vezina, a Canada-based independent insurance brokerage firm, Tequesta Insurance Advisors, an employee benefits insurance provider based in Florida, Cline Wood Agency, a Kansas City-based independent specialty insurance agency and J.W. Terrill, a Missouri-based independent insurance agency. Marsh acquired SMEI Group Ltd., a U.K.-based insurance broker providing specialist commercial insurance to small and medium-sized firms.
October - MMA acquired Dawson Insurance Agency, a North Dakota-based agency providing commercial and personal insurance, surety bonds, safety and loss control programs, and employee benefits services.
December - Marsh acquired Jelf Group, PLC, a U.K.-based insurance broking and financial consulting firm.
February - Oliver Wyman acquired TeamSAI, a Georgia-based provider of consulting and technical services to the transportation industry, and Mercer acquired Strategic Capital Management AG, a Switzerland-based institutional investment advisor.
December - Mercer acquired CPSG Partners, a Workday Services partner assisting clients worldwide to maximize the value of Workday Financial Management and Human Capital Management.
On January 13, 2017, MMA entered into a definitive agreement to acquire J. Smith Lanier & Co. ("JSL"), one of the nation’s largest privately held insurance brokerage firms. The transaction is expected to close in the first quarter of 2017 pending customary approvals. JSL is a leading provider of insurance, risk management, and employee benefits solutions to businesses and individuals throughout the U.S. Upon completion of the transaction, JSL will operate as MMA’s Southeast regional hub.
Goodwill allocable to the Company’s reportable segments is as follows: Risk and Insurance Services, $5.9 billion and Consulting, $2.5 billion.
Net of valuation allowances of $17 million in 2016 and $19 million in 2015.
The Company’s consolidated effective tax rate was 27.6%, 29.1% and 28.5% in 2016, 2015 and 2014, respectively. The tax rate in each year reflects foreign operations, which are generally taxed at rates lower than the U.S. statutory tax rate.
As discussed in Note 5, the Company has provided certain indemnities related to contingent tax liabilities as part of the disposals of Putnam and Kroll. At December 31, 2016, 2015 and 2014, $0 million, $1 million and $2 million, respectively, included in the table above, relates to Putnam and Kroll positions included in consolidated Company tax returns.
The Company is routinely examined by tax authorities in the jurisdictions in which it has significant operations. In the US federal jurisdiction the Company participates in the Internal Revenue Service’s (IRS) Compliance Assurance Process (CAP), which is structured to conduct real-time compliance reviews. The IRS is currently examining the Company’s 2015 tax return and performing a pre-filing review of 2016. During 2016 the Company settled its federal tax audit with the IRS for the year 2014. In 2015, the Company settled its federal tax audit for the year 2013, and in 2014 settled the year 2012.
New York State and New York City have examinations underway for various entities covering the years 2007 through 2014. During 2016, California initiated and concluded an audit of years 2013 and 2014. Outside the United States, there are ongoing examinations in Germany for the years 2009 through 2012 and in France for the years 2013 and 2014. France closed examinations of years 2011 and 2012 in 2016. Canada closed its examination of year 2012 in 2016 and commenced examinations for years 2013 and 2014. The United Kingdom closed its 2011 and 2012 examination in 2016 and commenced an examination of year 2014. The Company regularly considers the likelihood of assessments in each of the taxing jurisdictions resulting from examinations. The Company has established liabilities for uncertain tax positions in relation to the potential assessments. The Company believes the resolution of tax matters will not have a material effect on the consolidated financial position of the Company, although a resolution of tax matters could have a material impact on the Company's net income or cash flows and on its effective tax rate in a particular future period. It is reasonably possible that the total amount of unrecognized tax benefits will decrease between zero and approximately $7 million within the next twelve months due to the settlement of audits and the expiration of statutes of limitation.
*The 2016 assumption does not include a rate of compensation increase for the U.S. defined benefit plans since those plans were frozen to future benefits after December 31, 2016.
The major categories of plan assets include equity securities, equity alternative investments, and fixed income securities. For the U.S. qualified plans, the category ranges are 59-69% for equities and equity alternatives, and 31-41% for fixed income. For the U.K. Plan, the category ranges are 45-51% for equities and equity alternatives, and 49-55% for fixed income. Asset allocation is monitored frequently and re-balancing actions are taken as appropriate.
In 2014, the Society of Actuaries in the United States issued a new mortality table (RP-2014) and an updated improvement scale. The Company considered the effect of RP-2014, along with other available information on mortality improvement and industry specific mortality studies, to select its assumptions for measurement of the plans’ benefit obligations at December 31, 2016 and 2015.
As of December 31, 2016, the U.S. qualified plans hold 4 million shares of the Company’s common stock which were contributed to the Plan by the Company in 2005. This represented approximately 6.2% of those plans' assets as of December 31, 2016. In addition, plan assets may be invested in funds managed by Mercer Investments, a subsidiary of the Company.
Effective September 1, 2015, the Company divided its U.S. qualified defined benefit plan to provide enhanced flexibility to manage the risk associated with those participants not receiving benefit accruals. The existing plan was amended to cover only the retirees currently receiving benefits and terminated vested participants as of August 1, 2015. The Company's active participants as of that date were transferred into a newly established, legally separate qualified defined benefit plan. The benefits offered to the plans' participants were unchanged. As a result of the plan amendment and establishment of the new plan, the Company re-measured the assets and liabilities of the two plans as required under U.S. GAAP, based on assumptions and market conditions at the amendment date. The net periodic pension
In October 2016, the Company modified its U.S. defined benefit pension plans to discontinue further benefit accruals for participants after December 31, 2016. At the same time, the Company amended its U.S. defined contribution retirement plans for most of its U.S. employees to add an automatic Company contribution equal to 4% of eligible base pay beginning on January 1, 2017. This new Company contribution, together with the Company’s current matching contribution, provides eligible U.S. employees with the opportunity to receive a total contribution of up to 7% of eligible base pay. As required under GAAP, the defined benefit plans that were significantly impacted by the modification were re-measured in October 2016 using market data and assumptions as of the modification date. The net periodic pension expense recognized in 2016 reflects the weighted average costs of the December 31, 2015 measurement and the October 2016 re-measurement. In addition, the U.S. qualified plans were merged effective December 30, 2016, since no participants would be receiving benefit accruals after December 31, 2016.
The assumed health care cost trend rate for Medicare eligibles and non-Medicare eligibles is approximately 6.9% in 2016, gradually declining to 4.5% in 2039. Assumed health care cost trend rates have a small effect on the amounts reported for the U.S. health care plans because the Company caps its share of health care trend at 5%. A one percentage point change in assumed health care cost trend rates would have no effect on the total service and interest cost components or the postretirement benefit obligation.
The Company expects to fund approximately $32 million for its U.S. plans in 2017, including an ERISA funding requirement of $6 million to the U.S. qualified plan. The Company’s policy for funding its tax-qualified defined benefit retirement plans is to contribute amounts at least sufficient to meet the funding requirements set forth in the U.S. and applicable foreign law.
The projected benefit obligation, accumulated benefit obligation and fair value of plan assets for the non-U.S. pension plans with accumulated benefit obligations in excess of plan assets were $1.2 billion, $1.2 billion and $0.9 billion, respectively, as of December 31, 2016 and $1.7 billion, $1.6 billion and $1.3 billion, respectively, as of December 31, 2015.
After completion of a consultation period with affected colleagues, in January 2014, the Company amended its U.K. defined benefit pension plans to close those plans to future benefit accruals effective August 1, 2014 and replaced those plans, along with its existing defined contribution plans, with a new, comprehensive defined contribution arrangement. This change resulted in a curtailment of the U.K. defined benefit plans and, as required under GAAP, the Company re-measured the defined benefit plans’ assets and liabilities at the amendment date, based on assumptions and market conditions at that date. The net periodic benefit costs recognized in 2014 are the weighted average resulting from the December 31, 2013 measurement and the January 2014 re-measurement. The Company recognized a curtailment gain of $65 million in the first quarter of 2014, primarily resulting from the recognition of the remaining unamortized prior service credit related to a plan amendment made in December 2012. This gain was mostly offset by the cost of a transition benefit for certain employees most impacted by the amendment, which is not part of net periodic pension cost.
The components of the net periodic benefit cost for the non-U.S. defined benefit and other postretirement benefit plans and the curtailment, settlement and termination expenses are as follows:
The U.S. and non-U.S. plan investments are classified into Level 1, which refers to investments valued using quoted prices from active markets for identical assets; Level 2, which refers to investments not traded on an active market but for which observable market inputs are readily available; and Level 3, which refers to investments valued based on significant unobservable inputs. Assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.
In 2016, the Company adopted new guidance issued by the FASB, which removes the requirement to present certain investments for which the practical expedient is used to measure fair value at net asset value ("NAV") within the fair value hierarchy table. Instead, an entity is required to include those investments as a reconciling item so that the total fair value amount of investments in the disclosure is consistent with the fair value investment balance on the statement of net assets. The adoption of the new guidance, which requires retrospective application, resulted in the reclassifications of $6.6 billion and $1.4 billion from Level 2 and Level 3, respectively, to NAV categorization within the hierarchy table as of December 31, 2015.
The Company maintains multiple stock-based payment arrangements under which employees are awarded grants of restricted stock units, stock options and other forms of stock-based benefits.
Stock Options: Options granted under the 2011 Plan may be designated as either incentive stock options or non-qualified stock options. The Compensation Committee determines the terms and conditions of the option, including the time or times at which an option may be exercised, the methods by which such exercise price may be paid, and the form of such payment. Options are generally granted with an exercise price equal to the market value of the Company's common stock on the date of grant. These option awards generally vest 25% per annum and have a contractual term of 10 years.
The assumptions used in the Black-Scholes option pricing valuation model for options granted by the Company in 2016, 2015 and 2014 are as follows:
A summary of the status of the Company’s stock option awards as of December 31, 2016 and changes during the year then ended is presented below:
In the above table, forfeited options are unvested options whose requisite service period has not been met. Expired options are vested options that were not exercised. The weighted-average grant-date fair value of the Company's option awards granted during the years ended December 31, 2016, 2015 and 2014 was $11.57, $11.34 and $9.66, respectively. The total intrinsic value of options exercised during the same periods was $137.7 million, $124.6 million and $174.3 million, respectively.
A summary of the status of the Company's restricted stock units and performance stock units as of December 31, 2016 and changes during the period then ended is presented below:
The weighted-average grant-date fair value of the Company's restricted stock units granted during the years ended December 31, 2015 and 2014 was $56.81 and $48.16, respectively. The weighted average grant date fair value of the Company's performance stock units granted during the years ended December 31, 2015 and 2014 was $57.33 and $48.00, respectively. The total fair value of the shares distributed during the years ended December 31, 2016, 2015 and 2014 in connection with the Company's non-option equity awards was $91.4 million, $114.3 million and $165.3 million, respectively.
The payout of shares in 2016 with respect to the PSUs awarded in 2013 was 180% of target based on performance for the three-year performance period. The payout of shares with respect to the PSUs that vested in 2016 due to certain types of termination was based on performance for the abbreviated performance period. In aggregate, 468,858 shares became distributable in respect to PSUs vested in 2016.
The Company does not have any assets or liabilities that use Level 2 inputs.
Equity Securities, Money Market Funds and Mutual Funds - Level 1
The fair value of the contingent purchase consideration liability is based on projections of revenue and earnings for the acquired entities that are reassessed on a quarterly basis. As set forth in the table above, based on the Company's ongoing assessment of the fair value of contingent consideration, the Company recorded a net increase in the estimated fair value of such liabilities for prior period acquisitions of $9 million for the year ended December 31, 2016. A 5% increase in the above mentioned projections would increase the liability by approximately $21 million. A 5% decrease in the above mentioned projections would decrease the liability by approximately $22 million.
The Company's investments in private equity funds were $79 million and $76 million at December 31, 2016 and December 31, 2015, respectively. The carrying values of these private equity investments approximates fair value. The underlying private equity funds follow investment company accounting, where investments within the fund are carried at fair value. The Company records in earnings, investment gains/losses for its proportionate share of the change in fair value of the funds. These investments are included in other assets in the consolidated balance sheets.
Benefitfocus: On February 24, 2015, Mercer purchased shares of common stock of Benefitfocus (NASDAQ:BNFT) constituting approximately 9.9% of BNFT's outstanding capital stock as of the acquisition date. The purchase price for the BNFT shares and certain other rights and other consideration was approximately $75 million. In 2015, the Company elected to account for this investment under the cost method of accounting as the shares purchased were categorized as restricted. Effective December 31, 2016, these shares are no longer considered restricted for the purpose of determining if they are marketable securities under GAAP, and are accounted for as available for sale securities and included in other assets in the consolidated balance sheets. The value of the BNFT shares based on the closing price on the NASDAQ at December 31, 2016 was approximately $84 million. Related unrealized gains of approximately $21 million have been recorded in other comprehensive income.
Marsh operates in India through Marsh India Insurance Brokers Limited (Marsh India), which is owned 26% by Marsh and 74% by local shareholders. Prior to the second quarter of 2016, under the terms of its shareholders’ agreement with the local shareholders, Marsh had a controlling financial interest in Marsh India and its results were consolidated as required under U.S. GAAP. Under the recently adopted Insurance Laws (Amendment) Act 2015 of India and related regulations issued by the Indian Insurance Regulatory and Development Authority, Indian insurance companies (including insurance intermediaries and brokers like Marsh India) must now be controlled by Indian promoters or Indian investors.
In the second quarter of 2016, the shareholders’ agreement among the shareholders of Marsh India was amended to comply with these new regulations, which resulted in Marsh no longer having a controlling financial interest under U.S. GAAP. In accordance with U.S. GAAP, the Company was required to deconsolidate Marsh India and recognize its interest in Marsh India at fair value, with the difference between the carrying value and fair value recognized in earnings. The Company estimated the fair value of its interest in Marsh India, primarily using a discounted cash flow approach, which considered various cash flow scenarios and a discount rate appropriate for the investment. Certain provisions relating to restrictions on sales and repurchase of shares of Marsh India owned by its employees were also required to be removed by the new regulations. As a result, the deferred compensation expense related to those shares was accelerated in the second quarter of 2016. The net gain on the Company’s pre-tax income as a result of these changes was approximately $11 million, which is included in revenue for the year ended 2016. Beginning on May 1, 2016, the Company accounted for its investment in Marsh India using the equity method of accounting.
The summarized financial information presented below reflects the aggregated financial information of all significant equity method investees as of and for the twelve months ended September 30 of each year (or
portion of those twelve months the Company owned its investment), consistent with the Company’s recognition of the results of its equity method investments on a one quarter lag. The investment income information presented below reflects the net realized and unrealized gains/losses, net of expenses, related to the Company's investments in several private equity funds. Certain of the Company’s equity method investments, including Alexander Forbes, have unclassified balance sheets. Therefore, the asset and liability information presented below are not split between current and non-current.
Below is a summary of the financial information for the Company's significant equity method investees:
(a) Net investment income in 2016 and 2015 includes approximately $1.9 billion and $1.5 billion, respectively, related to Alexander Forbes, substantially all of which is credited to policy holders.
At December 31, 2016, the aggregate future minimum rental commitments under all non-cancelable operating lease agreements are as follows:
The Company has entered into agreements, primarily with various service companies, to outsource certain information systems activities and responsibilities and processing activities. Under these agreements, the Company is required to pay minimum annual service charges. Additional fees may be payable depending upon the volume of transactions processed, with all future payments subject to increases for inflation. At December 31, 2016, the aggregate fixed future minimum commitments under these agreements are as follows:
In March 2016, the Company issued $350 million of 3.30% seven-year senior notes. In September 2015, the Company issued $600 million of 3.75% 10.5-year senior notes and in March 2015, the Company issued $500 million of 2.35% five-year senior notes. The Company used the net proceeds from these issuances for general corporate purposes.
Additional credit facilities, guarantees and letters of credit are maintained with various banks, primarily related to operations located outside the United States, aggregating $376 million at December 31, 2016 and $379 million at December 31, 2015. There was $1.6 million of outstanding borrowings under these facilities at December 31, 2016 and $0.4 million of outstanding borrowings under these facilities at December 31, 2015.
In January 2017, the Company issued $500 million of 2.75% senior notes due 2022 and $500 million of 4.35% senior notes due 2047. The Company intends to use the net proceeds for general corporate purposes, including the repayment of a $250 million debt maturity in April 2017.
The fair value of the Company’s short-term debt consists primarily of commercial paper and term debt maturing within the next year and its fair value approximates its carrying value. The estimated fair value of a primary portion of the Company's long-term debt is based on discounted future cash flows using current interest rates available for debt with similar terms and remaining maturities. Short- and long-term debt would be classified as Level 2 in the fair value hierarchy.
In 2016, the Company implemented restructuring actions which resulted in costs totaling $44 million. Restructuring costs consist primarily of severance and benefits, costs for future rent and other real estate costs. These costs were incurred as follows: Risk and Insurance Services-$3 million; Consulting-$34 million; and Corporate-$7 million.
During 2016, the Company repurchased 12.7 million shares of its common stock for total consideration of $800 million. In November 2016, the Board of Directors renewed the Company's share repurchase program, allowing management to buy back up to $2.5 billion of the Company's common stock. The Company remains authorized to purchase additional shares of its common stock up to a value of approximately $2.4 billion. There is no time limit on the authorization. During 2015, the Company purchased 24.8 million shares of its common stock for total consideration of $1.4 billion.
Our activities are regulated under the laws of the United States and its various states, the European Union and its member states, and the other jurisdictions in which the Company operates. In the ordinary course of business, the Company is also subject to subpoenas, investigations, lawsuits and other regulatory actions undertaken by governmental authorities. For example, the Financial Conduct Authority ("FCA") is conducting a market study of the U.K. asset management industry, which includes asset managers and investment consultants such as Mercer. In November 2016, the FCA published an interim report which contains preliminary findings relating to the investment consulting industry and a provisional reference to the U.K. Competition & Markets Authority for a market investigation.
The pending proceedings described above and other matters not explicitly described in this Note 15 on Claims, Lawsuits and Other Contingencies may expose the Company or its subsidiaries to liability for significant monetary damages and other forms of relief. Where a loss is both probable and reasonably estimable, the Company establishes liabilities in accordance with FASB ASC Subtopic No. 450-20 (Contingencies - Loss Contingencies). Except as described above, the Company is not able at this time to provide a reasonable estimate of the range of possible loss attributable to these matters or the impact they may have on the Company's consolidated results of operations, financial position or cash flows. This is primarily because these matters are still developing and involve complex issues subject to inherent uncertainty. Adverse determinations in one or more of these matters could have a material impact on the Company's consolidated results of operations, financial condition or cash flows in a future period.
Selected information about the Company’s segments and geographic areas of operation are as follows:
Includes inter-segment revenue of $6 million in both 2016 and 2015 and $4 million in 2014, interest income on fiduciary funds of $26 million, $21 million and $24 million in 2016, 2015 and 2014, respectively, and equity method income of $12 million, $6 million and $9 million in 2016, 2015 and 2014, respectively.