As of December 31, 2016, we operated offices in many countries and territories throughout the world and believe that our properties are generally suitable and adequate for the purposes for which they are used. The principal properties are located in the United States and the United Kingdom. Operations of each of our segments are carried out in owned or leased offices under operating leases that typically do not exceed 10 years in length except for certain properties in key locations. We do not anticipate difficulty in meeting our space needs at lease expiration.
The fixed assets owned by us represented approximately 3% of total assets as of December 31, 2016 and consisted primarily of furniture and equipment, leasehold improvements, computer software, internally developed software and land and buildings.
See ‘Non-GAAP Financial Measures’ below for further discussion of our adjusted, constant currency and organic non-GAAP financial measures.
Willis Towers Watson is a global advisory, broking and solutions company that helps clients around the world turn risk into a path for growth. With roots dating to 1828, Willis Towers Watson has more than 41,000 employees and services clients in more than 140 countries and territories. We design and deliver solutions that manage risk, optimize benefits, cultivate talent, and expand the power of capital to protect and strengthen institutions and individuals. We believe our unique perspective allows us to see the critical intersections between talent, assets and ideas - the dynamic formula that drives business performance.
Although approximately 23% of our revenues are generated in the U.K. on an annual basis, only about 14% of revenues are denominated in Pounds sterling as much of the insurance business is transacted in U.S. dollars. Approximately 20% of our expenses are denominated in Pounds sterling, thus we generally benefit from a weakening Pound in our income from operations. However, we have a company hedging strategy for this aspect of our business, where revenues are generated in currencies different from the currency of the related expenses, which is designed to mitigate significant fluctuations in currency.
Through these strategies we aim to accelerate revenue, cash flow, EBITDA and earnings growth, and generate compelling returns for investors by delivering tangible growth in revenues and capitalizing on the identified cost synergies.
The Merger affects the comparability of this data between 2016 and other periods presented. See ‘Supplementary Pro Forma Financial Information’ for additional analysis.
We derive the majority of our revenues from commissions from our brokerage businesses and fees for consulting services. Brokerage income and fees negotiated in lieu of commissions are recognized at the later of the policy inception date or when the policy placement is complete or as the fees are otherwise determined. Commissions on additional premiums and adjustments are recognized when approved by or agreed between the parties and collectability is reasonably assured. Consulting revenue is generally recognized as services are performed. No single client represented a significant concentration of our consolidated revenues for any of our three most recent fiscal years.
The table below details our revenues and expenses by transactional currency for the year ended December 31, 2016.
These percentages exclude certain expenses for significant items which will not be settled in cash, or which we believe to be items that are not core to our current or future operations. These items include Merger-related amortization of intangible assets, restructuring costs, and transaction and integration expenses.
Total revenues for the year ended December 31, 2016 were $7.9 billion, compared to $3.8 billion for the year ended December 31, 2015, an increase of $4.1 billion or 106%. This growth in revenues was driven by our Merger with Towers Watson and our acquisition of Gras Savoye.
Our revenues can be materially impacted by changes in currency conversions, which can fluctuate significantly over the course of a calendar year. For the year ended December 31, 2016, currency translation decreased our consolidated revenues by $111 million. The primary currency driving the change was the Pound sterling, which weakened against the U.S. dollar during the year ended December 31, 2016.
Total salaries and benefits for the years ended December 31, 2016 and December 31, 2015 were $4.6 billion and $2.3 billion, respectively, an increase of $2.3 billion. The growth in expenses was primarily driven by the Merger and our acquisition of Gras Savoye. Salaries and benefits for the years ended December 31, 2015 and December 31, 2014 were $2.3 billion and $2.3 billion, respectively, a decrease of $11 million. The decrease was primarily related to an additional $109 million related to acquisitions and $31 million from increased headcount, pay reviews, and higher incentives, offset by $148 million of favorable foreign currency movements. As a percentage of commissions and fees revenues, salaries and benefits expenses represented 60%, 60% and 61% for the years ended December 31, 2016, 2015 and 2014, respectively.
Transaction and integration expenses include fees and charges associated with our mergers and acquisitions and principally consist of integration consultants and contract termination fees, as well as legal, accounting, marketing, and information technology transaction and integration expenses. These costs also include retention and severance costs and the write-off of software development as a direct consequence of the Merger. Transaction and integration expenses for the year ended December 31, 2016 were $177 million. Approximately $162 million of these expenses were related to the Merger and $15 million were related to the acquisition of Gras Savoye. Transaction and integration expenses for the year ended December 31, 2015 were $84 million. Approximately $58 million of these expenses were related to the Merger, $15 million were related to the acquisition of Gras Savoye and $11 million were related to our acquisition of Miller. Transaction and integration expenses for 2014 were included in other operating costs and are immaterial for reclassification.
Income from operations for the year ended December 31, 2016 was $551 million compared to $427 million for the year ended December 31, 2015, an increase of $124 million, or 29%. This growth in income from operations compared to that of 2015 was primarily driven by the Merger and our acquisition of Gras Savoye. Income from operations for the year ended December 31, 2015 was $427 million compared to $647 million for the year ended December 31, 2014, a decrease of $220 million. This was primarily due to the $90 million increase in restructuring costs related to the Operational Improvement Program, the $70 million increase in the litigation provision relating to the Stanford litigation and an increase in expenses as the mid-year
Other expense/(income), net for the year ended December 31, 2016 was an expense of $27 million, which was primarily foreign currency transaction losses. Other expense/(income), net for the year ended December 31, 2015 was income of $55 million, which included gains on disposal of operations of $25 million, gain on remeasurement of equity interests related to the Gras Savoye acquisition of $59 million, partially offset by the $30 million impact of the Venezuelan currency devaluation. Other expense/(income), net for the year ended December 31, 2014 was income of $6 million which included gains on disposals of operations of $12 million and gains related to foreign currency transactions of $8 million, partially offset by the $14 million impact of the Venezuelan currency devaluation.
Net income attributable to Willis Towers Watson for the year ended December 31, 2016 was $420 million, an increase of $47 million compared to $373 million for the year ended December 31, 2015. The growth was primarily driven by an improvement of $124 million in income from operations and an increase of $63 million in the benefit from income taxes, partially offset by a $42 million increase in interest expense and an $82 million increase to expense in other expense/(income), net. Net income attributable to Willis Towers Watson for the year ended December 31, 2015 was $373 million, an increase of $11 million compared to $362 million for the year ended December 31, 2014. This increase was primarily driven by a decrease of $192 million in the provision for income taxes and an increase of $49 million income from other expense/(income), net, partially offset by a decrease of $220 million in income from operations and a $7 million increase in interest expense.
HCB is the largest segment of the Company, generating approximately 41% of our revenues for the year ended December 31, 2016. HCB is focused on addressing our clients’ people and risk needs to help them take on the challenges of operating in a global marketplace. HCB is further strengthened with teams of international consultants that provide support through each of our business units to the global headquarters of multinational clients and their foreign subsidiaries.
Talent & Rewards - Our Talent & Rewards (‘T&R’) business covers three areas of specialty: Executive Compensation (‘EC’); Rewards, Talent & Communication (‘RTC’); and Data, Surveys and Technology (‘DST’). T&R provides advice, data, software and products to address clients’ total rewards and talent issues.
Technology and Administration Solutions - Our Technology and Administration Solutions (‘TAS’) business provides benefits outsourcing services to clients outside of the U.S.
The table below presents segment commissions and fees and segment interest and other income for HCB for the years ended December 31, 2016, 2015, and 2014.
HCB total segment revenues for the year ended December 31, 2016 were $3.2 billion, compared to $698 million for the year ended December 31, 2015, an increase of $2.5 billion or 362%. This growth in revenues was driven by our Merger and our acquisition of Gras Savoye. See the ‘Supplementary Pro Forma Segment Revenues Analysis’ section below for additional discussion of our 2016 results.
Our Corporate Risk & Broking (‘CRB’) segment provides a broad range of risk advice, insurance brokerage and consulting services to clients worldwide ranging from small businesses to multinational corporations. We deliver integrated global solutions tailored to client needs and underpinned by data and analytics.
CRB generated 32% of Willis Towers Watson revenues for the year ended December 31, 2016, and places more than $20 billion of premiums into the insurance markets, annually.
CRB operates as an integrated global team comprising both functional and geographic leadership with five global offerings:
The table below presents segment commissions and fees, and segment interest and other income for CRB for the years ended December 31, 2016, 2015, and 2014.
CRB total segment revenues for the year ended December 31, 2016 were $2.5 billion, compared to $2.3 billion for the year ended December 31, 2015, an increase of $213 million or 9%. The growth for the year ended December 31, 2016 was primarily due to the acquisition of Gras Savoye, which occurred on December 29, 2015. Great Britain led organic growth with solid revenue increases across all lines of business. Western Europe contributed to organic growth with strong growth in Iberia, partially offset by softness in Italy. North America was flat with strong retention offset by lower new business. International organic revenue declined as a result of lower revenues in Asia and Australasia, partially offset by better performance in Latin America and Central and Eastern Europe, Middle East and Africa (‘CEEMEA’).
The Willis Towers Watson Investment, Risk and Reinsurance (‘IRR’) segment applies a sophisticated approach to risk which helps clients free up capital and manage investment complexity. The segment works closely with investors, reinsurers and insurers to manage the equation between risk and return. IRR provides investment consulting services and insurance specific services and solutions through reserves opinions, software, ratemaking, usage-based insurance, risk underwriting, and reinsurance broking.
This segment is our third largest segment and generated approximately 19% of revenues for the Company for the year ended December 31, 2016. With approximately 80% of the revenues for this segment split between North America and the U.K., this segment includes the following businesses and offerings:
Risk Consulting and Software - Risk Consulting and Software is a global business that provides advice and technology solutions to the insurance industry, as well as to corporate clients with respect to their insurance programs. Services include software and technology, risk and capital management, products and pricing, financial and regulatory reporting, financial and capital modeling, M&A, outsourcing and business management.
Capital Markets & Advisory - Capital Markets & Advisory provides investment banking services to companies involved in the insurance and reinsurance industries for a broad array of merger and acquisition transactions as well as capital markets products.
IRR total segment revenues for the year ended December 31, 2015 were $813 million, compared to $766 million for the year ended December 31, 2014, an increase of $47 million or 6%. The growth was driven by our acquisition of Miller Insurance Services, with additional organic growth in Reinsurance and Capital Markets & Advisory, partially offset by the negative impact from foreign currency translation and a $12 million settlement received in 2014.
The Willis Towers Watson Exchange Solutions (‘ES’) segment provides primary medical and ancillary benefit exchange and outsourcing services to active employees and retirees across both the group and individual markets. A significant portion of the revenues in this segment is recurring in nature, driven by either the commissions from the policies we sell, or from long-term service contracts with our clients that typically range from three to five years. Revenues across this segment may be seasonal, driven by the magnitude and timing of client transition activities, and we typically increase our membership levels significantly effective January 1, after calendar year-end benefits elections.
Retiree & Access Exchanges - This business provides solutions through a proprietary technology platform, OneExchange Retiree, which enables our employer clients to transition their retirees to individual, defined contribution health plans that provide individuals with a tax-free allowance or contribution to spend on healthcare services at an annual cost that the employer controls, as opposed to group-based, defined benefit health plans that provide groups of individuals with healthcare benefits at uncertain annual costs.
Consumer-Directed Accounts - This business uses its SaaS-based technology and related services to deliver consumer-driven healthcare and reimbursement accounts, including health savings accounts, health reimbursement arrangements and other consumer-directed accounts.
The table below presents segment commissions and fees, and segment interest and other income for ES for the year ended December 31, 2016.
ES total segment revenues for the year ended December 31, 2016 were $654 million. ES was not part of our business operations prior to the Merger. See the ‘Supplementary Pro Forma Segment Revenues Analysis’ section below for additional discussion of our 2016 results.
The pro forma financial information is only for Willis and Towers Watson and does not include Gras Savoye or other merger or acquisition activity on a pro forma basis.
Conforming reclassifications and adjustments. Certain reclassifications have been made to amounts in the Towers Watson historical statement of operations to conform to Willis’ presentation, including reclassifying certain contra revenue accounts and Towers Watson’s professional and subcontracted services, occupancy and general and administrative expenses within the relevant Willis captions.
Rent. Adjustment to eliminate $5 million of historical rent expense for the year ended December 31, 2015 offset by $1 million amortization of our favorable and unfavorable lease agreements.
Income taxes. Adjustments to record the income tax impact of the pro forma adjustments, including the removal of the tax consequences of the repatriation of foreign earnings to partially fund the pre-Merger special dividend. The income tax expense was calculated based on the U.S. and foreign statutory rates applicable to adjustments made. Where applicable, a U.S. statutory rate of 40% was used. Pro forma adjustments for income tax purposes have been determined without regard to potential tax planning strategies that may result from the Merger of Towers Watson with Willis. Tax benefits from the Merger have not been considered in our pro forma adjustments.
Total revenues for the year ended December 31, 2016 were $7.9 billion, compared to $7.5 billion pro forma revenues for the year ended December 31, 2015, an increase of $395 million, or 5%. This growth was driven by a 7% increase due to our acquisitions of Gras Savoye and Miller and 1% organic revenue growth, partially offset by adverse foreign currency exchange movements of 3%. The primary drivers of our growth were within our Corporate Risk and Broking and Exchange Solutions segments. See our segment revenues analysis for a further discussion of our segment results.
Our results can be materially impacted by changes in currency conversions, which can fluctuate significantly over the course of a calendar year. For the year ended December 31, 2016, currency translation decreased our consolidated revenues by $202 million on a constant currency basis from the pro forma year ended December 31, 2015. The primary currency driving the change was the Pound sterling which weakened against the U.S. dollar during 2016.
The organic change presented above includes the reduction to revenues for the year ended December 31, 2016 related to the fair value adjustment for deferred revenue made during purchase accounting for the Merger. If this revenue had not been reduced, the constant currency change would have been an increase of 9% and the organic change would have been an increase of 2%, respectively, for the year ended December 31, 2016.
Salaries and benefits were $4.6 billion for the year ended December 31, 2016, an increase of $215 million, or 5%, compared to $4.4 billion for the pro forma year ended December 31, 2015. The increase was primarily related to our acquisitions of Gras Savoye and Miller which contributed approximately $291 million of the increase, partially offset by increased net periodic benefit credits from the adoption of the granular approach to calculating service and interest costs of $51 million.
Other operating expenses include occupancy, legal, marketing, licenses, royalties, supplies, technology, printing and telephone costs, as well as insurance, including premiums on excess insurance and losses on professional liability claims, non-client-reimbursed travel by colleagues, publications, professional subscriptions and development, recruitment, other professional fees and irrecoverable value added and sales taxes.
Amortization includes amortization of acquired intangible assets, including acquired internally developed software. Amortization was $591 million for the year ended December 31, 2016, an increase of $56 million, or 10%, compared to $535 million for the pro forma year ended December 31, 2015. The increase in amortization in 2016 is primarily due to amortization of the intangible assets acquired in our acquisitions of Gras Savoye and Miller. We acquired approximately $231 million and $440 million in intangible assets in our acquisitions of Miller and Gras Savoye, respectively. These intangible assets are amortized over their expected lives which range from 4 to 25 years. See Note 3 - Merger and Acquisitions and Note 8 - Goodwill and Other Intangible Assets within Item 8 of this Annual Report on Form 10-K for additional information about our intangible assets.
Transaction and integration expenses were $177 million for the year ended December 31, 2016, an increase of $147 million compared to $30 million for the pro forma year ended December 31, 2015. The increase in 2016 is primarily due to integration expenses incurred subsequent to the Merger. For the year ended December 31, 2016, approximately $162 million of these expenses were related to the Merger and $15 million were related to the integration of Gras Savoye. For the pro forma year ended December 31, 2015, transaction expenses related to the Merger of $151 million have been eliminated as part of the pro forma adjustments. Of the remaining $30 million of transaction and integration expenses, approximately $15 million were related to Gras Savoye, $11 million were related to Miller, and $4 million were related to other miscellaneous M&A activity.
Please see the discussion in the ‘As Reported Consolidated Financial Information’ section above.
Other expense/(income), net, for the year ended December 31, 2016 was $27 million of net expense, which was primarily foreign currency transaction losses. Other expense/(income), net for the pro forma year ended December 31, 2015 was $112 million of net income, which was primarily due to $80 million of gains on disposals of operations and $59 million in the gain on the remeasurement of equity interests, partially offset by $30 million in foreign currency transaction losses in 2015.
For the year ended December 31, 2016, there was a $96 million benefit from income taxes, due primarily to a benefit from the release of a portion of our U.S. valuation allowances and shifts in the global mix of income as a result of the Merger. This shift creates additional deductions in jurisdictions with high statutory income tax rates, which reduces the global effective tax rate. For the pro forma year ended December 31, 2015, there was a provision for income taxes of $70 million. Legacy Willis had a benefit from income taxes due to the release of a portion of U.S. valuation allowances in 2015 which was more than offset by the provision for income taxes for Legacy Towers Watson.
The following table sets out the components of HCB revenues for the year ended December 31, 2016 and pro forma revenues for the year ended December 31, 2015, and the components of the change in commissions and fees for the year ended December 31, 2016.
HCB total segment revenues for the year ended December 31, 2016 and pro forma for the year ended December 31, 2015 were $3.2 billion; and commissions and fees for the year ended December 31, 2016 and pro forma for the year ended December 31, 2015 were $3.2 billion, representing an increase of $59 million. Pro forma and constant currency revenue growth were driven by the acquisition of Gras Savoye, which occurred on December 29, 2015. In an effort to align resources and market demand, a significant restructuring across all lines of business took place during the second half of 2016, which caused disruption in our billable hours. Across the segment, performance was mixed, resulting in flat organic growth. Retirement revenues declined slightly as a result of reduced actuarial consulting, primarily in the fourth quarter. The Health and Benefits North America consulting business continued to see demand for plan design projects and increased product revenue. The Talent and Rewards advisory business was down period-over-period as the M&A market softened. The Technology and Administration Solutions
Great Britain business had strong performance, led by increased project and administration activity along with new clients. Internationally, Global Wealth Solutions has been negatively impacted by adverse conditions in the Greater China market.
The following table sets out the components of IRR revenues for the year ended December 31, 2016 and pro forma revenues for the year ended December 31, 2015, and the components of the change in commissions and fees for the year ended December 31, 2016.
ES total segment revenues for the year ended December 31, 2016 were $654 million, compared to pro forma $487 million for the year ended December 31, 2015; and commissions and fees for the year ended December 31, 2016 were $652 million, compared to pro forma $484 million for the year ended December 31, 2015. Retiree and Access Exchanges commissions and fees increased by 41%, primarily as a result of the record 2016 annual enrollment season. The rest of the segment commissions and fees increased by 27%, primarily due to Technology and Administration Solutions adding new clients and experiencing higher project activity.
ES revenue growth is expected to slow to around 10% in 2017 due to the stabilization of the retiree enrollments. We continue to expect the active exchange growth to be strong.
The program began in the second quarter of 2014 and will be completed by the end of 2017. We are expecting to deliver $325 million of annual cost savings beginning in 2018. To achieve these savings, the Company expects to incur $130 million in restructuring charges in 2017, bringing the cumulative restructuring charges to approximately $440 million through the end of 2017.
Included within cash and cash equivalents at December 31, 2016 are amounts held for regulatory capital adequacy requirements, including $87 million held within our regulated U.K. entities for regulatory capital adequacy requirements.
Cash flows from operating activities were $920 million for 2016, compared to cash flows from operating activities of $243 million for 2015. The $920 million net cash from operating activities for 2016 included net income of $438 million, adjusted for $590 million of non-cash adjustments, partially offset by changes in operating assets and liabilities of $108 million. The $590 million non-cash adjustments primarily include depreciation, amortization, net defined benefit pension credits, share-based compensation, and the benefit from deferred income taxes. The $677 million increase in cash from operations in 2016 compared to 2015 was primarily due to cash from operations from Legacy Towers Watson and Gras Savoye.
Cash flows used in investing activities of $943 million for the year ended December 31, 2015 were primarily driven by $857 million used in the acquisitions of operations and $146 million for capital expenditures.
The debt issuance of $2.0 billion was primarily the issuance of $450 million of senior notes due 2021, $550 million of senior notes due 2026, €540 million ($609 million) of senior notes due 2022 and a $400 million drawdown on the 1-year term loan facility.
Net cash provided by financing activities in 2015 was $641 million, primarily due to $469 million net drawings on the revolving credit facility, a $592 million term loan draw down to fund the acquisition of Gras Savoye, the issuance of shares and excess tax benefit of $131 million, partially offset by dividends paid of $277 million and repurchase of shares of $82 million.
Net cash used in financing activities in 2014 was $323 million, primarily due to dividends paid of $210 million and repurchase of shares of $213 million, partially offset by proceeds from the issuance of shares and excess tax benefit of $139 million.
On March 22, 2016, we issued $450 million of 3.500% senior notes due 2021 and $550 million of 4.400% senior notes due 2026. We used the net proceeds from this offering to: repay $300 million under our $800 million revolving credit facility (which was drawn to repay our 4.125% senior notes on March 15, 2016); repay the $400 million Tranche B under our 1-year term loan facility; pay down further amounts outstanding under our $800 million revolving credit facility; and pay related accrued interest.
On May 26, 2016, we issued €540 million ($609 million) of 2.125% senior notes due 2022. These 2022 senior notes will mature on May 26, 2022. We used the net proceeds of this offering to repay Tranche A of the 1-year term loan and related accrued interest.
On April 20, 2016, the Willis Towers Watson Board reconfirmed, reapproved and reauthorized the remaining portion of the Legacy Willis program to repurchase the Company’s ordinary shares on the open market or by way of redemption or otherwise.
There are no expiration dates for these repurchase plans or programs. The following table presents specified information about the Company’s repurchases of ordinary shares for the year ended December 31, 2016.
Apart from commitments, guarantees and contingencies, as disclosed herein and Note 13 - Commitments and Contingencies located within Item 8 in this Annual Report on Form 10-K and incorporated herein by reference, as of December 31, 2016, the Company had no off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on the Company’s financial condition, results of operations or liquidity.
Guarantees, Acquisition Liabilities and Other Contractual Obligations - Information regarding guarantees and other contractual obligations and their impact on the financial statements is set forth in Item 8, Note 13 - Commitments and Contingencies to the Consolidated Financial Statements in this Annual Report on Form 10-K and is incorporated herein by reference.
Effective from January 1, 2016, we have made changes to the non-GAAP financial measures that we use to provide additional meaningful methods of evaluating the Company’s financial performance and have replaced our underlying and organic measures with those described below.
These changes have been made both as a direct consequence of the Merger and to simplify and better align these measures with how we internally assess core performance and benchmark our operating results versus competitors.
Fair value adjustment to deferred revenue - Adjustment to normalize for the deferred revenue written down as part of the purchase accounting for the Merger.
Provision for Stanford litigation - The provision for the Stanford litigation matter, which we consider to be a non-ordinary course litigation matter.
Gain on remeasurement of equity interests - The Company recognized a gain as a result of remeasuring its prior equity interest in Gras Savoye held before the business combination.
The pro forma financial information is only for Willis and Towers Watson and does not include Gras Savoye or other M&A activity on a pro forma basis.
We have included the reconciliation of Total revenues to Adjusted Revenues in the table below, together with our reconciliation of the pro forma revenues change to the constant currency and organic changes.
Organic Change - The organic presentation excludes both the impact of fluctuations in foreign currency exchange rates, as described above, as well as the period-over-period impact of acquisitions and divestitures. We believe that excluding transaction-related items from our GAAP financial measures provides useful supplemental information to our investors, and it is important in illustrating what our core operating results would have been had we not incurred these transaction-related items, since the nature, size and number of these transaction-related items can vary from period to period.
A reconciliation of Total revenues to Adjusted Revenues for the year ended December 31, 2016 and pro forma 2015, and a reconciliation of the pro forma change to the constant currency and organic change for the year ended December 31, 2016 is as follows:
Adjusted Operating Income is defined as Income from Operations adjusted for amortization, restructuring costs, transaction and integration expenses, the fair value adjustment for deferred revenue and non-recurring items that, in management’s judgment, significantly affect the period-over-period assessment of operating results.
A reconciliation of Income from Operations to Adjusted Operating Income for the year ended December 31, 2016 and pro forma year ended December 31, 2015 is as follows:
Adjusted Operating Income for the year ended December 31, 2016 was $1.6 billion, compared to pro forma $1.5 billion for the year ended December 31, 2015, an increase of $109 million. The increase in Adjusted Operating Income for the year ended December 31, 2016 was primarily driven by our acquisition of Gras Savoye, the settlement with JLT of £28 million ($41 million) related to the Fine Art, Jewellery and Specie team, and the performance of our Exchange Solutions segment.
We consider Adjusted EBITDA to be an important financial measure, which is used to internally evaluate and assess our core operations, to benchmark our operating results against our competitors, and to evaluate and measure our performance-based compensation plans.
A reconciliation of net income to Adjusted EBITDA for the year ended December 31, 2016 and pro forma year ended December 31, 2015 is as follows:
Adjusted EBITDA for the year ended December 31, 2016 was $1.8 billion, compared to pro forma $1.7 billion for the year ended December 31, 2015, an increase of $89 million. The increase in Adjusted EBITDA for the year ended December 31, 2016 was primarily driven by our acquisition of Gras Savoye, the settlement with JLT of £28 million ($41 million) related to the Fine Art, Jewellery and Specie team, and the performance of our Exchange Solutions segment.
Adjusted Net Income is defined as Net Income Attributable to Willis Towers Watson adjusted for amortization, restructuring costs, transaction and integration expenses, the fair value adjustment of deferred revenue, gain on disposal of operations and non-recurring items that, in management’s judgment, significantly affect the period-over-period assessment of operating results and the related tax effect of those adjustments. This measure is used solely for the purpose of calculating adjusted diluted earnings per share.
Adjusted Diluted Earnings Per Share is used to internally evaluate and assess our core operations and to benchmark our operating results against our competitors. Adjusted Diluted Earnings Per Share is defined as Adjusted Net Income divided by the weighted average number of shares of common stock, diluted.
A reconciliation of net income attributable to Willis Towers Watson to adjusted diluted earnings per share for the year ended December 31, 2016 and 2015 is as follows:
We have not presented this measure on a comparative pro forma basis because it is not practical to present the 2015 adjusted income tax effects on a pro forma basis, as making tax-effected non-GAAP adjustments on a proforma basis would be highly speculative in nature.
operations and non-recurring items that, in management’s judgment, significantly affect the period-over-period assessment of operating results, divided by Adjusted Income Before Taxes. Adjusted income taxes is used solely for the purpose of calculating the Adjusted Income Tax Rate.
Management believes the Adjusted Income Tax Rate presents a rate that is more closely aligned to the rate we would incur if not for the reduction of pre-tax income of the adjusted items, which are not core to our current and future operations.
The tax effect and effective tax rate were calculated using the statutory tax rate applicable to the item being adjusted for in the jurisdiction from which each adjustment arises.
We have not presented this measure on a comparative basis because it is not practical to present the 2015 adjusted income tax rate on a pro forma basis, as making tax-effected non-GAAP adjustments on a proforma basis would be highly speculative in nature.
Free Cash Flow is used to evaluate our liquidity, and is defined as cash flows from operating activities less cash used to purchase fixed assets and software for internal use.
A summary of our cash flows from operating, investing and financing activities, along with a reconciliation of cash flows from operating activities to Free Cash Flow is as follows:
Free cash flow for the year ended December 31, 2016 was $702 million, compared to free cash flow of $97 million for the year ended December 31, 2015. The $677 million increase in cash from operations in the year ended December 31, 2016 compared to the year ended December 31, 2015 was the primary driver for the increase in free cash flow period-over-period, and was primarily due to cash from operations from Legacy Towers Watson and Gras Savoye.
Willis Towers Watson considers several factors prior to the start of each fiscal year when determining the appropriate annual assumptions, including economic forecasts, relevant benchmarks, historical trends, portfolio composition and peer company comparisons. These assumptions, used to determine our pension liabilities and pension expense are reviewed annually by senior management and changed when appropriate. A discount rate will be changed annually if underlying rates have moved, whereas the expected long-term return on assets will be changed less frequently as longer term trends in asset returns emerge or long term target asset allocations are revised. To calculate the discount rate, we use the granular approach to determining service cost and interest cost. We began using this method to calculate the discount rate in 2016. This was treated as a change in accounting estimate, and resulted in a credit of $51 million included in our total net periodic benefit income. The expected rate of return assumptions for all plans are supported by an analysis of the weighted-average yield expected to be achieved with the anticipated makeup of investments. Other material assumptions include rates of participant mortality, and the expected long-term rate of compensation and pension increases.
Funding is based on actuarially determined contributions and is limited to amounts that are currently deductible for tax purposes, or as agreed to with the plan trustees for the U.K. plans. Since funding calculations are based on different measurements than those used for accounting purposes, pension contributions are not equal to net periodic benefit cost.
During fiscal year 2016, the Company performed Step 1 of the two-step impairment test for all reporting units. Each of the reporting units' estimated fair values were in excess of their carrying values. To perform the test, we used valuation techniques to estimate the fair value of a reporting unit that fall under income or market approaches. Under the discounted cash flow method, an income approach, the business enterprise value is determined by discounting to present value the terminal value which is calculated using debt-free after-tax cash flows for a finite period of years. Key estimates in this approach were internal financial projection estimates prepared by management, business risk, and expected rates of return on capital. The guideline company method, a market approach, develops valuation multiples by comparing our reporting units to similar publicly traded companies. Key estimates and selection of valuation multiples rely on the selection of similar companies, obtaining estimates of forecast revenues and EBITDA estimates for the similar companies and selection of valuation multiples as they apply to the reporting unit characteristics. Under the similar transactions method, a market approach, actual transaction prices and operating data from companies deemed reasonably similar to the reporting units is used to develop valuation multiples as an indication of how much a knowledgeable investor in the marketplace would be willing to pay for the business units.
If the Company was required to perform Step 2, we would determine the implied fair value of the reporting unit used in Step 1 to all of the assets and liabilities of that reporting unit (including any recognized or unrecognized intangible assets) as if the reporting unit had been acquired in a business combination. Then the implied fair value of goodwill would be compared to the carrying amount of goodwill to determine if goodwill is impaired. For the year ended December 31, 2016, we did not record any impairment losses of goodwill or intangibles.
We expect certain revenue streams to have accelerated revenue recognition timing. In particular, the revenue recognition for our Retiree Medicare Exchange is expected to move from monthly ratable recognition over the policy period, to the recognition upon placement of the policy during the Company’s fourth quarter of the preceding calendar year in the amount of one year of expected commissions. Therefore, upon adoption, we will reflect an adjustment to retained earnings for the revenue that would otherwise have been recognized during our 2018 calendar year since our earnings process will have been completed during the fourth quarter of 2017.
We have audited the accompanying consolidated balance sheets of Willis Towers Watson Public Limited Company and subsidiaries (the “Company”) as of December 31, 2016 and 2015, and the related consolidated statements of operations, comprehensive income/(loss), changes in equity, and cash flows for each of the three years in the period ended December 31, 2016. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Willis Towers Watson Public Limited Company and subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2016, based on the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 1, 2017 expressed an unqualified opinion on the Company’s internal control over financial reporting.
Basic and diluted earnings per share and cash dividends declared per share, for the years ended December 31, 2015 and 2014 have been retroactively adjusted to reflect the reverse stock split on January 4, 2016. See Note 3 - Merger and Acquisitions for further details.
The nominal value of the ordinary shares and the number of ordinary shares issued in the years ended December 31, 2015 and 2014 have been retroactively adjusted to reflect the reverse stock split on January 4, 2016. See Note 3 - Merger and Acquisitions for further details.
As an insurance broker, we act as an intermediary between our clients and insurance carriers by advising our clients on their risk management requirements, helping clients determine the best means of managing risk and negotiating and placing insurance with insurance carriers through our global distribution network. We operate the largest private Medicare exchange in the United States (‘U.S.’). Through this exchange and those for active employees, we help our clients move to a more sustainable economic model by capping and controlling the costs associated with healthcare benefits.
The Merger with Towers Watson that closed on January 4, 2016 affects the comparability between 2016 and other periods presented. See Note 3 - Merger and Acquisitions for additional information.
Use of Estimates - These consolidated financial statements conform to accounting principles generally accepted in the United States of America (‘U.S. GAAP’), which require management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Our estimates, judgments and assumptions are continually evaluated based on available information and experience. Because of the use of estimates inherent in the financial reporting process, actual results could differ from those estimates. Estimates are used when accounting for revenue recognition, the selection of useful lives of fixed and intangible assets, impairment testing, valuation of billed and unbilled receivables from clients, discretionary compensation, income taxes, pension assumptions, incurred but not reported claims, legal reserves and goodwill and intangible assets.
Going Concern - Management evaluates at each annual and interim period whether there are conditions or events, considered in the aggregate, that raise substantial doubt about our ability to continue as a going concern within one year after the date that the consolidated financial statements are issued. Management’s evaluation is based on relevant conditions and events that are known and reasonably knowable at the date that the consolidated financial statements are issued. Management has concluded that there are no conditions or events, considered in the aggregate, that raise substantial doubt about our ability to continue as a going concern within one year after the date of these financial statements.
Investments in Associates - Investments are accounted for using the equity method of accounting, included within other non-current assets in the consolidated balance sheets, if the Company has the ability to exercise significant influence, but not control, over the investee. Significant influence is generally deemed to exist if the Company has an equity ownership in the voting stock of the investee between 20 and 50 percent, although other factors, such as representation on the Board of Directors and the impact of commercial arrangements, are considered in determining whether the equity method of accounting is appropriate. Under the equity method of accounting, the investment is carried at the cost of acquisition, plus the Company’s equity in undistributed net income since acquisition, less any dividends received since acquisition.
Cash and Cash Equivalents - Cash and cash equivalents primarily consist of time deposits with original maturities of 90 days or less. Willis Limited, our U.K. brokerage subsidiary regulated by the Financial Conduct Authority, is currently required to maintain $140 million in unencumbered and available funds, of which at least $79 million must be in cash, for regulatory purposes. Term deposits and certificates of deposits with original maturities greater than 90 days are considered to be short-term investments. There is no restricted cash included in our cash and cash equivalents balance, as these amounts are included in fiduciary assets.
obligations on their behalf. These amounts are included in fiduciary assets and fiduciary liabilities on the consolidated balance sheets.
Accounts Receivable - Accounts receivable includes both billed and unbilled receivables and is stated at estimated net realizable values. Provision for billed receivables is recorded, when necessary, in an amount considered by management to be sufficient to meet probable future losses related to uncollectible accounts. Accrued and unbilled receivables are stated at net realizable value which includes an allowance for accrued and unbillable amounts. See Note 14 - Supplementary Information for Certain Balance Sheet Accounts for additional information about our accounts receivable.
Income Taxes - 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 consolidated statement of operations in the period in which the change is enacted. 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. The Company adjusts valuation allowances to measure deferred tax assets at the amounts considered realizable in future periods if the Company’s facts and assumptions change. In making such determination, the Company considers all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies and the results of recent financial operations. We place more reliance on evidence that is objectively verifiable.
The Company recognizes interest and penalties relating to unrecognized tax benefits within income taxes. See Note 6 - Income Taxes for additional information about our income taxes.
The Company evaluates whether its contracts include clauses or conditions which would be required to be separately accounted for at fair value as embedded derivatives. See Note 9 - Derivative Financial Instruments for additional information about our derivatives.
The Company expenses equity-based compensation, which is included in Salaries and benefits in the consolidated statements of operations, primarily on a straight-line basis over the requisite service period based upon the fair value of the award on the date of grant, the estimated achievement of any performance targets and anticipated staff retention. The awards under equity-based compensation are classified as equity and included as a component of equity on the Company’s consolidated balance sheets, as the ultimate payment of such awards will not be achieved through use of the Company’s cash or other assets. See Note 17 - Share-based Compensation for additional information about our share-based compensation.
Fixed Assets - Fixed assets are stated at cost less accumulated depreciation. Expenditures for improvements are capitalized; repairs and maintenance are charged to expenses as incurred. Depreciation is computed primarily using the straight-line method based on the estimated useful lives of assets.
Revenue Recognition - Revenues include insurance commissions, fees in lieu of commission, fees for consulting services rendered, hosted and delivered software, survey sales, interest and other income.
Revenues for fixed-fee arrangements are based upon the proportional performance method to the extent estimates can be made of the remaining work required under the arrangement. If we do not have sufficient information to estimate
proportional performance, we recognize the fees straight-line over the contract period. We typically have four types of fixed-fee arrangements: annual recurring projects, projects of a short duration, stand-ready obligations and non-recurring system projects.
Non-recurring system projects. These projects are longer in duration and subject to more changes in scope as the project progresses. Certain software or outsourced administration contracts generally provide that if the client terminates a contract, we are entitled to payment for services performed through termination.
Revenue recognition for fixed-fee engagements is affected by a number of factors that change the estimated amount of work required to complete the project such as changes in scope, the staffing on the engagement and/or the level of client participation. The periodic engagement evaluations require us to make judgments and estimates regarding the overall profitability and stage of project completion that, in turn, affect how we recognize revenue. We recognize a loss on an engagement when estimated revenues to be received for that engagement are less than the total estimated costs associated with the engagement. Losses are recognized in the period in which the loss becomes probable and the amount of the loss is reasonably estimable.
Delivered software. We deliver software under arrangements with clients who take possession of our software. The maintenance associated with the initial software fees is a fixed percentage which enables us to determine the stand-alone value of the delivered software separate from the maintenance. We recognize the initial software fees as software is delivered to the client and we recognize the maintenance ratably over the contract period based on each element’s relative fair value. For software arrangements in which initial fees are received in connection with mandatory maintenance for the initial software license to remain active, we determined that the initial maintenance period is substantive. Therefore, we recognize the fees for the initial license and maintenance bundle ratably over the initial contract term, which is generally one year. Each subsequent renewal fee is recognized ratably over the contractually stated renewal period.
In May 2014, the Financial Accounting Standards Board (‘FASB’) issued Accounting Standard Update (‘ASU’) No. 2014-09 ‘Revenue From Contracts With Customers’. The new standard supersedes most current revenue recognition guidance and eliminates industry-specific guidance. The ASU is based on the principle that an entity should recognize revenue to depict the transfer of 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. The ASU also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to fulfill a contract. Entities have the option of using either a full retrospective or a modified retrospective approach for the adoption of the new standard. Additional ASUs have since been issued, all of which provide additional guidance, examples and technical corrections for the implementation of ASU No. 2014-09. The guidance is effective for the Company at the beginning of its 2018 fiscal year, with early adoption permitted.
While we are still in the process of analyzing our various revenue streams to determine the full impact this standard will have on our revenue recognition, cost deferral, systems and processes, the Company has determined the following:
In August 2016, the FASB issued ASU No. 2016-15 ‘Statement of Cash Flows - Classification of Certain Cash Receipts and Cash Payments’, which amends guidance on presentation and classification of eight specific cash flow issues with the objective of reducing diversity in practice. The ASU becomes effective for the Company at the beginning of 2018. Early adoption is permitted and any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. An entity that elects early adoption must adopt all of the amendments in the same period. The Company is still assessing the impact of this ASU, but we believe the impact on our financial statements will be immaterial as we are largely in compliance with its requirements.
In January 2017, the FASB issued ASU No. 2017-04 ‘Simplifying the Test for Goodwill Impairment’, which simplifies the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. In computing the implied fair value of goodwill under Step 2, current U.S. GAAP requires the performance of procedures to determine the fair value at the impairment testing date of assets and liabilities (including unrecognized assets and liabilities) following the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. Instead, the amendments under this ASU require the goodwill impairment test to be performed by comparing the fair value of a reporting unit with its carrying amount. An impairment charge should be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. The ASU becomes effective for the Company at the beginning of 2020. The amendments in this ASU should be applied on a prospective basis. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company does not expect an immediate impact to its consolidated financial statements upon adopting this ASU since the most recent Step 1 goodwill impairment test resulted in fair values exceeding carrying values for all reporting units at October 1, 2016.
In May 2015, the FASB issued ASU No. 2015-07, ‘Fair Value Measurement - Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent)’, which simplifies reporting requirements and modifies those investments required to be classified within the fair value hierarchy. Certain investments measured at fair value using the Net Asset Value (‘NAV’) practical expedient are no longer required to be classified as a Level within the fair value hierarchy table. Entities will be required to include in their disclosure, the fair value of the investments using the NAV practical expedient so that financial statement users can reconcile amounts reported in the fair value hierarchy table to amounts reported on the balance sheet. The ASU is to be applied retrospectively in all periods presented in an entity’s financial statements. The Company adopted this standard on January 1, 2016. The adoption has been reflected in the fair value tables in Note 12 - Retirement Benefits to these financial statements.
Towers Watson was a leading global professional services firm operating throughout the world, dating back more than 100 years. The Merger will allow the combined firm to go to market with complementary strategic product and services offerings.
Immediately following the Merger, Willis effected (i) a consolidation (i.e., a reverse stock split under Irish law) of Willis ordinary shares whereby every 2.6490 Willis ordinary shares were consolidated into one Willis ordinary share $0.000304635 nominal value per share and (ii) an amendment to its Constitution and other organizational documents to change its name from Willis Group Holdings Public Limited Company to Willis Towers Watson Public Limited Company.
On December 29, 2015, the third business day immediately prior to the closing date of the Merger, Towers Watson declared and paid the Towers Watson pre-merger special dividend, in an amount of $10.00 per share of Towers Watson common stock, approximately $694 million in the aggregate based on approximately 69 million Towers Watson shares issued and outstanding at December 29, 2015.
A summary of the fair values of the identifiable assets acquired, and liabilities assumed, of Towers Watson at January 4, 2016 are summarized in the following table.
Includes acquired contingent liabilities of $242 million. See Note 13 - Commitments and Contingencies for a discussion of our material acquired contingencies related to Legacy Towers Watson.
Represents both debt due upon change of control of $400 million borrowed under Towers Watson’s term loan ($188 million) and revolving credit facility ($212 million) and a draw down under a new term loan of $340 million. The $400 million debt was repaid by Willis’ borrowings under the 1-year term loan facility on January 4, 2016. The $340 million new term loan partially funded the $694 million Towers Watson pre-merger special dividend.
The purchase price allocation as of the date of acquisition was based on a valuation of the assets acquired and liabilities assumed in the acquisition. All revisions to the purchase price allocation during the year ended December 31, 2016 are reflected in our current consolidated financial statements, and the purchase price allocation is final.
The following pro forma financial information is unaudited and is intended to reflect the impact of the Merger on Willis Towers Watson’s consolidated financial statements as if the Merger had taken place on January 1, 2015 and presents the results of operations of Willis Towers Watson based on the historical financial statements of Willis and Towers Watson after giving effect to the Merger and pro forma adjustments. Pro forma adjustments are included only to the extent they are (i) directly attributable to the Merger, (ii) factually supportable and (iii) with respect to the consolidated statement of operations, expected to have a continuing impact on the combined results. The accompanying unaudited pro forma financial information is presented for illustrative purposes only and has not been adjusted to give effect to certain expected financial benefits of the Merger, such as revenue synergies, tax savings and cost synergies, or the anticipated costs to achieve these benefits, including the cost of integration activities. The unaudited pro forma results are not indicative of what would have occurred had the Merger taken place on the indicated date.
The above pro forma financial information for the year ended December 31, 2015 does not include pro forma adjustments for the Gras Savoye or other acquisitions as their revenues and results of operations were immaterial to the consolidated financial statements.
In connection with our Merger with Towers Watson on January 4, 2016, we assumed certain stock options and restricted stock units (‘RSU’) issued under the Towers Watson & Co. 2009 Long Term Incentive Plan (‘LTIP’), the Liazon Corporation 2011 Equity Incentive Plan, and the Extend Health, Inc. 2007 Equity Incentive Plan.
The following table presents the Company’s allocation of the purchase price to the assets acquired and liabilities assumed based on their fair values:
Deferred consideration is payable at the first, second and third anniversaries of the acquisition. Contingent consideration is payable at the third anniversary of the acquisition and is contingent on meeting certain earnings before interest, taxes, depreciation and amortization (‘EBITDA’) performance targets. At December 31, 2015, the discounted fair value of the deferred and contingent considerations, based on best estimates, at acquisition were $124 million and $29 million, respectively. At December 31, 2016, the discounted fair values of the deferred consideration, related to the second and third anniversaries, and contingent consideration were $69 million and $26 million, respectively.
The purchase price allocation as of the date of acquisition was based on a valuation of the assets acquired, liabilities assumed, and contingent consideration associated with the acquisition. There have been no material revisions to the purchase price allocation during the year ended December 31, 2016 and the purchase price allocation is final.
During the second quarter of 2016, we began managing our business across four integrated reportable operating segments. As a result, the Company has changed the way it manages and reports segment revenues and segment operating income, resulting in a change in the Company’s reportable segments from eight reportable segments, formerly known as Willis International; Willis North America; Willis Capital, Wholesale & Reinsurance; Willis GB; Towers Watson Benefits; Towers Watson Exchange Solutions; Towers Watson Risk and Financial Services; and Towers Watson Talent and Rewards, into four reportable segments: Human Capital and Benefits; Corporate Risk and Broking; Investment, Risk and Reinsurance; and Exchange Solutions.
The prior period comparatives have been retroactively reclassified for our segment reorganization.
Willis Towers Watson’s chief operating decision maker is the chief executive officer. We determined that the operational data used by the chief operating decision maker is at the segment level. Management bases strategic goals and decisions on these segments and the data presented below is used to assess the adequacy of strategic decisions, the method of achieving these strategies and related financial results.
The Exchange Solutions (‘ES’) segment provides primary medical and ancillary benefit exchange and outsourcing services to active employees and retirees across both the group and individual markets. ES services individual populations via its ‘group to individual’ technology platform, which tightly integrates patented call routing technology, an efficient quoting and enrollment engine, a custom-developed Customer Relationship Management system and comprehensive insurance carrier connectivity. This segment also delivers group benefit exchanges and full outsourcing solutions serving the active employees of employers across the United States. ES uses Software as a Service (‘SaaS’)-based technology and related services to deliver consumer-driven healthcare and reimbursement accounts, including health savings accounts, health reimbursement arrangements, flexible spending accounts and other consumer-directed accounts.
Segment revenues and operating income both include revenue that was deferred by Towers Watson at the time of the Merger, and eliminated due to purchase accounting. The impact of the elimination from purchase accounting (which is the reduction to 2016 consolidated revenues and operating income) has been included in the reconciliation to our consolidated results in order to provide the actual revenues that the segments would have recognized on an unadjusted basis.
The table below presents segment commissions and fees, segment interest and other income, segment revenues, and segment operating income for our reportable segments for the years ended December 31, 2016, 2015, and 2014, respectively:
Below are our revenues and long-lived assets by legal entity for Ireland, our country of domicile, countries with significant concentrations, and all other foreign countries for each of the years ended December 31, 2016, 2015 and 2014:
The Company recognized restructuring costs of $145 million, $126 million, and $36 million for the years ended December 31, 2016, 2015 and 2014, related to its OIP. The Company expects to incur an additional $130 million of restructuring costs through the end of 2017, bringing the cumulative restructuring charges to approximately $440 million.
An analysis of the total cumulative restructuring costs recognized for the OIP from commencement to December 31, 2016 by segment, and costs attributable to corporate functions, are as follows:
An analysis of the total cumulative restructuring costs recognized for the BRP from commencement to December 31, 2016 by segment, and those costs attributable to corporate functions, are as follows:
An analysis of income/(loss) before income taxes by taxing jurisdiction is shown below:
The components of the income tax provision for continuing operations include:
Willis Towers Watson plc is a non-trading holding company tax resident in Ireland where it is taxed at the statutory rate of 25%. The provision for income tax on continuing operations has been reconciled above to the U.S. federal statutory tax rate of 35% due to significant operations in the U.S.
Deferred income tax assets and liabilities included in the consolidated balance sheets at December 31, 2016 and 2015 are comprised of the following:
The net deferred income tax assets are included in other non-current assets and the net deferred tax liabilities are included in deferred tax liabilities in our balance sheets.
At December 31, 2016 and 2015, the Company had valuation allowances of $134 million and $187 million, respectively, to reduce its deferred tax assets to estimated realizable value. The valuation allowance at December 31, 2016 relates to deferred tax assets for U.K. capital loss carryforwards of $28 million, which have an unlimited carryforward period. The valuation allowances on U.S. and non-U.S. net operating losses are $78 million and $28 million, respectively. The valuation allowance at December 31, 2015 relates to deferred tax assets for U.K. capital loss carryforwards of $33 million and accrued interest not currently deductible of $69 million, which have an unlimited carryforward period. The valuation allowances on U.S. and non-U.S. net operating losses are $79 million and $6 million, respectively.
The amount charged to tax expense in the table above for 2016 differs from the effect of $74 million disclosed in the rate reconciliation primarily because the movement in this table includes the effects of acquisition accounting, which does not impact tax expense.
As a result of the Merger, and our plan to restructure certain foreign operations or distribute accumulated earnings of certain acquired Towers Watson subsidiaries’, we recorded a deferred tax liability of $77 million on outside basis differences and cumulative earnings through goodwill. We continue to assert that the historical cumulative earnings of our other subsidiaries are reinvested indefinitely and we do not provide deferred tax liabilities on these amounts. The cumulative earnings related to amounts reinvested indefinitely as of December 31, 2016 were approximately $5.9 billion. It is not practicable to estimate the tax liability that might be payable if such earnings are not reinvested indefinitely. If future events, including material changes in estimates of cash, working capital, long-term investment requirements or U.S. tax reform necessitate that these earnings be distributed, an additional provision for income and foreign withholding taxes, net of credits, may be necessary.
At December 31, 2016, the amount of unrecognized tax benefits associated with uncertain tax positions, determined in accordance with ASC 740-10, excluding interest and penalties, was $56 million. This liability can be reduced by $4 million of offsetting deferred tax benefits associated with timing differences, foreign tax credits and the federal tax benefit of state income taxes. If recognized, $52 million of this difference would impact our effective tax rate.
A reconciliation of the beginning and ending balances of the liability for unrecognized tax benefits is as follows:
Tax expense for the years ended December 31, 2016 and 2015 include interest benefits of $1 million, and nil, respectively.
The Company and its subsidiaries file income tax returns in various tax jurisdictions in which it operates. During calendar year 2016 the Company recognized approximately $3 million of income tax benefits, including interest and penalties due to U.S. Federal lapses in statutes of limitations and effective settlements related to fiscal year 2015.
Willis North America Inc. is not currently under examination by the U.S. Internal Revenue Service (‘IRS’). Although tax years 2008 through 2012 are closed, the IRS could make adjustments (but not assess additional tax) up to the amount of net operating losses carried forward from those years and utilized in open years. Towers Watson & Co. is currently being audited by the IRS under the Compliance Assurance Process (‘CAP’) for the short tax period July 1, 2015 to January 4, 2016. Under CAP, the IRS works with large business taxpayers to identify and resolve issues prior to the filing of a tax return. This is Towers Watson & Co.’s last year in the CAP program. As of December 31, 2016, the Company has not been advised of any significant adjustments. We also have ongoing state income tax examinations in certain states for tax years ranging from fiscal year ended June 30, 2012 through fiscal year ended June 30, 2014. The statute of limitations in certain states extends back to 2002 as a result of changes to taxable income resulting from prior year federal tax examinations.
The following table reflects changes in the net carrying amount of the components of fixed assets for the year ended December 31, 2016 and 2015:
Included within land and buildings are the following assets held under capital leases:
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. Goodwill is allocated to our reporting units primarily based on the original purchase price allocation for acquisitions within the reporting units, or relative fair value when an acquisition covers multiple reporting units. When a business entity is sold, goodwill is allocated to the entity disposed of based on the relative fair value of that entity compared with the fair value of the reporting unit in which it is included.
During the second quarter of 2016, the Company changed the way it manages and reports operating results, resulting in a change in the Company’s operating and reportable segments from the Legacy Company platforms into four integrated reportable operating segments: Human Capital and Benefits; Corporate Risk and Broking; Investment, Risk and Reinsurance; and Exchange Solutions. See Note 4 - Segment Information for a description of our segments.
The components of goodwill are outlined below for the years ended December 31, 2016 and 2015:
The following table reflects the carrying value of finite-lived intangible assets and liabilities as of December 31, 2016 and December 31, 2015:
We are exposed to certain interest rate and foreign currency risks. Where possible, we identify exposures in our business that can be offset internally. Where no natural offset is identified, we may choose to enter into various derivative transactions. For the years ended December 31, 2016 and 2015, all of our derivative instruments qualifying for hedge accounting are considered cash flow hedges. These instruments have the effect of reducing our exposure to unfavorable changes in interest and foreign currency rates. The Company’s Board of Directors reviews and approves policies for managing each of these risks as summarized below.
As a result of the Company’s operating activities, the Company holds fiduciary funds. The Company earns interest on these funds, which is included in the Company’s consolidated financial statements as interest and other income. These funds are regulated in terms of access as are the instruments in which they may be invested, most of which are short-term in nature.
Some of our non-U.S. subsidiaries receive revenues and incur expenses in currencies other than their functional currency and as a result, the foreign subsidiary’s functional currency revenues will fluctuate as the currency rates change. Additionally, the forecast Pounds sterling expenses of our London brokerage market operations may exceed their Pounds sterling revenues, and they may also hold a significant net Pounds sterling asset or liability position in the balance sheet. To reduce the variability, we use foreign exchange forward contracts to hedge this foreign exchange risk.
These derivatives were designated as hedging instruments and as of December 31, 2016 and December 31, 2015 had a total notional amount of $945 million and $1.2 billion, respectively, and net fair value liabilities of $110 million and $28 million, respectively.
The material effects of derivative instruments that are designated as hedging instruments on the consolidated statements of operations for the years ended December 31, 2016, 2015 and 2014 are as follows:
We also enter into foreign currency transactions, primarily to hedge certain intercompany loans. These derivatives are not generally designated as hedging instruments and at December 31, 2016 and December 31, 2015 we had notional amounts of $630 million and $574 million, and net fair value liabilities of $8 million, and $3 million, respectively, for each of the years then ended. The effects of derivatives that have not been designated as hedging instruments on the consolidated statements of operations for the three years ended December 31, 2016 are immaterial.
All direct obligations under the 4.125% (repaid during 2016) and 5.750% senior notes are issued by the Company and guaranteed by Trinity Acquisition plc, Willis Netherlands Holdings B.V., Willis Investment U.K. Holdings Limited, TA I Limited, Willis North America Inc., Willis Group Limited, Willis Towers Watson Sub Holdings Unlimited Company and WTW Bermuda Holdings Ltd. See Note 22 - Financial Information for Parent Issuer, Guarantor Subsidiaries and Non-Guarantor Subsidiaries.
Drawings under the $800 million revolving credit facility (‘RCF’) bear interest at LIBOR plus a margin of 1.25% to 2.00%, or alternatively the base rate plus a margin of 0.25% to 1.00% based upon the Company’s guaranteed senior unsecured long-term debt rating; a 1.375% margin applies while the Company’s debt rating remains BBB/Baa3. As of December 31, 2016 and December 31, 2015, $238 million and $467 million was outstanding under this revolving credit facility, respectively.
The 7-year term loan facility expiring 2018 bears interest at the same rate applicable to the $800 million revolving credit facility and is repayable in quarterly installments of $6 million with a final repayment of $186 million due in the third quarter of 2018.
As of December 31, 2016 and 2015, there were no borrowings outstanding under the WSI revolving credit facility. On April 27, 2016, the end date of the credit period was extended to April 28, 2017 and the repayment date was extended to April 28, 2018. There were no other significant changes in the terms of this credit facility.
The agreements relating to the $800 million revolving credit facility, the 7-year term loan facility, and the 1-year term loan contain requirements that we are not to exceed certain levels of consolidated funded indebtedness in relation to consolidated EBITDA and we are to maintain at least a minimum level of consolidated EBITDA to consolidated cash interest expense, subject to certain adjustments. In addition, the agreements relating to our facilities and senior notes include, in the aggregate, covenants relating to the delivery of financial statements, reports and notices, limitations on liens, limitations on sales and other disposals of assets, limitations on indebtedness and other liabilities, limitations on sale and leaseback transactions, limitations on mergers and other fundamental changes, maintenance of property, maintenance of insurance, nature of business, compliance with applicable laws, maintenance of corporate existence and rights, payment of taxes and access to information and properties. At December 31, 2016 and December 31, 2015, we were in compliance with all financial covenants.
There were no significant transfers between Levels 1, 2 or 3 in the fiscal years ended December 31, 2016 and 2015.
The following presents our liabilities not measured at fair value on a recurring basis at December 31, 2016 and 2015:
Willis Towers Watson sponsors both qualified and non-qualified defined benefit pension plans and other post-retirement welfare plans (‘PRW’) plans throughout the world. The majority of our plan assets and obligations are in the United States and the United Kingdom. We have also included disclosures related to defined benefit plans in certain other countries, which includes Canada, Germany, Ireland and the Netherlands. Together, these disclosed funded and unfunded plans represented 99% of Willis Towers Watson’s pension and PRW obligations and plan assets and are disclosed herein for the 2016 disclosures.
Certain prior year amounts have been reclassified between the presentation groupings of ‘U.S.’, ‘U.K.’ and ‘Other’ to conform to current year presentation. The significant plans within each grouping are described below:
2017 Changes - The Legacy Towers Watson plan’s current non-contributory stable value formula is not available to employees hired or rehired on or after January 1, 2017. Beginning July 1, 2017, Legacy Towers Watson employees participating in the Plan will accrue benefits under a new non-contributory stable value pension formula. Also beginning July 1, 2017, the Plan will cover newly eligible employees, including employees hired on or after January 1, 2017, and employees from Legacy Willis and the Exchange Solutions segment, who elect to participate (who do not ‘opt out’) under a new contributory stable value pension formula.
Canada (Legacy Towers Watson) - Participants accrue qualified and non-qualified benefits based on a career average benefit formula. Additionally, participants can choose to make voluntary contributions to purchase enhancements to their pension.
Germany (Legacy Willis) -The defined benefit plan population consists of retirees receiving annuities and two participants with deferred vested benefits. Other employees and former employees participate in defined contribution arrangements.
The following table presents the projected benefit obligation, accumulated benefit obligation and fair value of plan assets for our plans that have an accumulated benefit obligation in excess of plan assets as of December 31, 2016 and 2015.
During fiscal year 2016, WTW adopted the granular approach to calculating service and interest cost. This was treated as a change in accounting estimate, and resulted in a credit of $51 million included in our total net periodic benefit income reflected above.
On March 6, 2015, Legacy Willis announced to members of the U.K. defined benefit pension plan that with effect from June 30, 2015, future salary increases would not be pensionable (the ‘salary freeze’). Legacy Willis recognized the salary freeze as a plan amendment at the announcement date. The impact of the salary freeze reduced the plan’s projected benefit obligation by approximately $215 million and created a prior service credit which is recognized in other comprehensive income and then amortized to the consolidated statement of operations over the remaining expected service life of active employees.
The estimated net actuarial loss and prior service cost for the defined benefit plans that will be amortized from accumulated other comprehensive loss into net periodic benefit cost over the next fiscal year are:
The determination of the Company’s obligations and annual expense under the plans is based on a number of assumptions that, given the longevity of the plans, are long-term in focus. A change in one or a combination of these assumptions could have a material impact on our projected benefit obligation. However, certain of these changes, such as changes in the discount rate and actuarial assumptions, are not recognized immediately in net income, but are instead recorded in other comprehensive income. The accumulated gains and losses not yet recognized in net income are amortized into net income as a component of the net periodic benefit cost/(credit) generally based on the average working life expectancy of the plan’s active participants to the extent that the net gains or losses as of the beginning of the year exceed 10% of the greater of the market-related value of plan assets or the projected benefit obligation. The average remaining service period of participants for the PRW plan is approximately 9.5 years.
The Company considers several factors prior to the start of each fiscal year when determining the appropriate annual assumptions, including economic forecasts, relevant benchmarks, historical trends, portfolio composition and peer company comparisons. These assumptions, used to determine our pension liabilities and pension expense, are reviewed annually by senior management and changed when appropriate. The discount rate will be changed annually if underlying rates have moved, whereas the expected long-term return on assets will be changed less frequently as longer term trends in asset returns emerge or long-term target asset allocations are revised. To calculate the discount rate, we use the granular approach to determining service and interest costs. The expected rate of return assumptions for all plans are supported by an analysis of the weighted-average yield expected to be achieved based upon the anticipated makeup of the plans’ investments. Other material assumptions include rates of participant mortality, and the expected long-term rate of compensation and pension increases.
The following assumptions were used in the valuations of Willis Towers Watson’s defined benefit pension plans and PRW plan. The assumptions presented for the U.S. plans represent the weighted-average of rates for all U.S. plans. The assumptions presented for the U.K. plans represent the weighted-average of rates for the U.K. plans. The assumptions presented for the Other plans represent the weighted-average of rates for the Canada, France, Germany, Ireland, and Netherlands plans.
The following table presents the assumptions used in the valuation to determine the projected benefit obligation for the fiscal years ended December 31, 2016 and 2015:
A one percentage point change in the assumed healthcare cost trend rates would have an immaterial effect on the post-retirement benefit cost and obligation as of December 31, 2016.
The Legacy Willis plan in Germany and the Legacy Towers Watson plan in the Netherlands are invested in insurance contracts. Consequently, the asset allocations of the plans are managed by the insurer. The Legacy Gras Savoye plan in France is unfunded.
The fair values of our U.S. plan assets by asset category at December 31, 2016 and 2015 are as follows:
The fair values of our Other plan assets by asset category at December 31, 2016 and 2015 are as follows:
In accordance with Subtopic 820-10, Fair Value Measurement and Disclosures, certain investments that are measured at fair value using the net asset value per share practical expedient have not been classified in the fair value hierarchy. The fair value amounts presented in these tables are intended to permit reconciliation of the fair value hierarchy to the amounts presented in the statements of net assets. See the description of ASU 2015-07 in Note 2 - Basis of Presentation and Significant Accounting Policies, which notes the adoption of this practical expedient for the presentation of our pension plan investments in the fair value hierarchy tables included above, and the retrospective application to comparative periods.
As a result of the inherent limitations related to the valuations of the Level 3 investments, due to the unobservable inputs of the underlying funds, the estimated fair value may differ significantly from the values that would have been used had a market for those investments existed.
Legacy Willis has a 401(k) plan covering all eligible employees of Legacy Willis U.S. and its subsidiaries. The plan allows participants to make pre-tax contributions which the Company, at its discretion, may match. All investment assets of the plan are held in a trust account administered by independent trustees.
The Legacy Towers Watson U.S. Defined Contribution Plan allows eligible Towers Watson U.S. employees to participate in a savings plan design that provides for 100% match on the first 2% of employee contributions and 50% match on the next 4% of employee contributions. Employees vest in the employer match upon two years of service.
The Company leases certain land, building and equipment under various operating lease commitments. The total amount of the minimum rent is expensed on a straight-line basis over the term of the lease. Rental expenses and sub-lease rental income for operating leases are recorded as part of other operating expenses in the consolidated statements of operations. Rental expense, exclusive of sublease income, was $302 million, $142 million, and $134 million for the years ended December 31, 2016, 2015 and 2014, respectively. We have entered into sublease agreements for some of our excess leased space. Sublease income was $17 million, $17 million, and $13 million for the years ended December 31, 2016, 2015 and 2014, respectively.
Certain of Willis Towers Watson’s subsidiaries have given the landlords of some leasehold properties occupied by the Company in the United Kingdom and the United States guarantees in respect of the performance of the lease obligations of the subsidiary holding the lease. The operating lease obligations subject to such guarantees amounted to $558 million and $676 million at December 31, 2016 and 2015, respectively. The capital lease obligations subject to such guarantees amounted to $9 million and $10 million as of December 31, 2016 and 2015, respectively.
The Company has deferred and contingent consideration due to be paid on existing acquisitions until 2019 totaling $142 million at December 31, 2016. Most notably, our liability for the acquisition of Miller Insurance Services LLP in May 2015, for which deferred and contingent consideration, including interest, was $95 million at December 31, 2016. Total deferred and contingent consideration paid during the year ended December 31, 2016 was $67 million.
In July 2010, the Company made a capital commitment of $25 million to Trident V Parallel Fund, LP, an investment fund managed by Stone Point Capital. This replaced a capital commitment of $25 million that had been made to Trident V, LP in December 2009. As of December 31, 2016 there have been approximately $23 million of capital contributions.
In May 2011, the Company made a capital commitment of $10 million to Dowling Capital Partners I, LP. As of December 31, 2016 there had been approximately $8 million of capital contributions.
Other contractual obligations at December 31, 2016 and 2015, include certain capital lease obligations totaling $54 million and $59 million, respectively, primarily in respect of the Company’s Nashville property.
On the basis of current information, the Company does not expect that the actual claims, lawsuits and other proceedings to which the Company is subject, or potential claims, lawsuits, and other proceedings relating to matters of which it is aware, will ultimately have a material adverse effect on the Company’s financial condition, results of operations or liquidity. Nonetheless, given the large or indeterminate amounts sought in certain of these actions, and the inherent unpredictability of litigation and disputes with insurance companies, it is possible that an adverse outcome or settlement in certain matters could, from time to time, have a material adverse effect on the Company’s results of operations or cash flows in any particular quarterly or annual periods.
The Company provides for contingent liabilities based on ASC 450, Contingencies, when it is determined that a liability, inclusive of defense costs, is probable and reasonably estimable. Unasserted claims reserves are primarily developed actuarially. Litigation is subject to many factors which are difficult to predict so there can be no assurance that in the event of a material unfavorable result in one or more claims, we will not incur material costs.
Five putative class action complaints challenging the Merger were filed in the Court of Chancery for the State of Delaware, captioned New Jersey Building Laborers’ Statewide Annuity Fund v. Towers Watson & Co., et al., C.A. No. 11270-CB (filed on July 9, 2015), Stein v. Towers Watson & Co., et al., C.A. No. 11271-CB (filed on July 9, 2015), City of Atlanta Firefighters’ Pension Fund v. Ganzi, et al., C.A. No. 11275-CB (filed on July 10, 2015), Cordell v. Haley, et al., C.A. No. 11358-CB (filed on July 31, 2015), and Mills v. Towers Watson & Co., et al., C.A. No. 11423-CB (filed on August 24, 2015). The Stein action was voluntarily dismissed on July 28, 2015. These complaints were filed by purported stockholders of Towers Watson on behalf of a putative class comprised of all Towers Watson stockholders. The complaints sought, among other things, to enjoin the Merger, and generally alleged that Towers Watson’s directors breached their fiduciary duties to Towers Watson stockholders by agreeing to merge Towers Watson with Willis through an inadequate and unfair process, which led to inadequate and unfair consideration, and by agreeing to unfair deal protection devices. The complaints also alleged that Willis and the Merger Sub formed for purposes of consummating the Merger aided and abetted the alleged breaches of fiduciary duties by Towers Watson directors. On August 17, 2015, the court consolidated the New Jersey Building Laborers’ Statewide Annuity Fund, City of Atlanta Firefighters’ Pension Fund, and Cordell actions (the Mills action had not yet been filed) and any other actions then pending or thereafter filed arising out of the same issues of fact under the caption In re Towers Watson & Co. Stockholders Litigation, Consolidated C.A. No. 11270-CB. On September 9, 2015, the plaintiffs in the consolidated action and in Mills filed a consolidated amended complaint, which, among other things, added claims for alleged misstatements and omissions from a
preliminary proxy statement and prospectus for the Merger dated August 27, 2015. On September 17, 2015, plaintiffs filed a motion for expedited proceedings and a motion for a preliminary injunction, which motions plaintiffs voluntarily withdrew on October 19, 2015. On December 14, 2015, the defendants filed motions to dismiss the consolidated amended complaint. On April 1, 2016, the court consolidated the Mills action into the consolidated action. On April 18, 2016, the court dismissed the consolidated action as moot, set a briefing schedule for plaintiffs’ application for an award of attorneys’ fees and reimbursement of expenses, and scheduled a hearing on plaintiffs’ fee and expense application for June 28, 2016. On April 27, 2016, plaintiffs filed a petition for an award of attorneys’ fees and expenses, requesting an aggregate fee and expense award of at least $1.7 million. On June 8, 2016, defendants filed their opposition to the petition. After negotiations, the parties agreed in principle to resolve the petition for a payment of $250,000 to plaintiffs’ counsel by the Company. On July 29, 2016, the court entered a proposed order submitted by the parties closing the consolidated action for all purposes.
Rupert, et al. v. Winter, et al., Case No. 2009C115137, was filed on September 14, 2009 on behalf of 97 Stanford investors against Willis Group Holdings plc, Willis of Colorado, Inc. and the same Willis associate, among others, in Texas state court (Bexar County). The complaint alleges claims under the Securities Act of 1933, Texas and Colorado
Florida suits: On February 14, 2013, five lawsuits were filed against Willis Group Holdings plc, Willis Limited and Willis of Colorado, Inc. in Florida state court (Miami-Dade County) alleging violations of Florida common law. The
five suits are: (1) Barbar, et al. v. Willis Group Holdings Public Limited Company, et al., Case No. 13-05666CA27, filed on behalf of 35 Stanford investors seeking compensatory damages in excess of $30 million; (2) de Gadala-Maria, et al. v. Willis Group Holdings Public Limited Company, et al., Case No. 13-05669CA30, filed on behalf of 64 Stanford investors seeking compensatory damages in excess of $83.5 million; (3) Ranni, et ano. v. Willis Group Holdings Public Limited Company, et al., Case No. 13-05673CA06, filed on behalf of two Stanford investors seeking compensatory damages in excess of $3 million; (4) Tisminesky, et al. v. Willis Group Holdings Public Limited Company, et al., Case No. 13-05676CA09, filed on behalf of 11 Stanford investors seeking compensatory damages in excess of $6.5 million; and (5) Zacarias, et al. v. Willis Group Holdings Public Limited Company, et al., Case No. 13-05678CA11, filed on behalf of 10 Stanford investors seeking compensatory damages in excess of $12.5 million. On June 3, 2013, Willis of Colorado, Inc. removed all five cases to the Southern District of Florida and, on June 4, 2013, notified the JPML of the pendency of these related actions. On June 10, 2013, the court in Tisminesky issued an order sua sponte staying and administratively closing that action pending a determination by the JPML as to whether it should be transferred to the Northern District of Texas for consolidation and coordination with the other Stanford-related actions. On June 11, 2013, Willis of Colorado, Inc. moved to stay the other four actions pending the JPML’s transfer decision. On June 20, 2013, the JPML issued a conditional transfer order for the transfer of the five actions to the Northern District of Texas, the transmittal of which was stayed for seven days to allow for any opposition to be filed. On June 28, 2013, with no opposition having been filed, the JPML lifted the stay, enabling the transfer to go forward.
On April 1, 2015, the defendants except Willis Group Holdings plc filed motions to dismiss the complaints in Zacarias, Tisminesky and de Gadala-Maria. On June 19, 2015, Willis Group Holdings plc filed motions to dismiss the complaints in Zacarias, Tisminesky and de Gadala-Maria for lack of personal jurisdiction. On July 15, 2015, the court dismissed the complaint in Zacarias in its entirety with leave to replead within 21 days. On July 21, 2015, the court dismissed the complaints in Tisminesky and de Gadala-Maria in their entirety with leave to replead within 21 days. On August 6, 2015, the plaintiffs in Zacarias, Tisminesky and de Gadala-Maria filed amended complaints (in which, among other things, Willis Group Holdings plc was no longer named as a defendant). On September 11, 2015, the defendants filed motions to dismiss the amended complaints. The motions await disposition by the court.
Janvey, et al. v. Willis of Colorado, Inc., et al., Case No. 3:13-CV-03980-D, was filed on October 1, 2013 also in the Northern District of Texas against Willis Group Holdings plc, Willis Limited, Willis North America Inc., Willis of Colorado, Inc. and the same Willis associate. The complaint was filed (i) by Ralph S. Janvey, in his capacity as Court-Appointed Receiver for the Stanford Receivership Estate, and the Official Stanford Investors Committee (the ‘OSIC’) against all defendants and (ii) on behalf of a putative, worldwide class of Stanford investors against Willis North America Inc. Plaintiffs Janvey and the OSIC allege claims under Texas common law and the court’s Amended Order Appointing Receiver, and the putative class plaintiffs allege claims under Texas statutory and common law. Plaintiffs seek actual damages in excess of $1 billion, punitive damages and costs. As alleged by the Stanford Receiver, the total amount of collective losses allegedly sustained by all investors in Stanford certificates of deposit is approximately $4.6 billion.
On January 26, 2015, the court entered an order setting a schedule for briefing and discovery regarding the plaintiffs’ motion for class certification, which schedule, among other things, provided for the submission of the plaintiffs’ motion for class certification (following the completion of briefing and discovery) on July 20, 2015. By letter dated March 4, 2015, the parties requested that the court consolidate the scheduling orders entered in Troice and Janvey to provide for a class certification submission date of April 20, 2015 in both cases. On March 6, 2015, the court entered an order consolidating the scheduling orders in Troice and Janvey, providing for a class certification submission date of April 20, 2015 in both cases, and vacating the July 20, 2015 class certification submission date in the original Janvey scheduling order.
On November 17, 2015, Willis Group Holdings plc withdrew its motion to dismiss for lack of personal jurisdiction.
Settlement. On March 31, 2016, the Company entered into a settlement in principle, as reflected in a Settlement Term Sheet, relating to the Stanford litigation matter. The Company agreed to the Settlement Term Sheet to eliminate the distraction, burden, expense and uncertainty of further litigation. In particular, if the settlement and the related bar orders described below are approved by the Court and become effective, the Company (a newly-combined firm) would be able to conduct itself with the bar orders’ protection from the continued overhang of matters alleged to have occurred approximately a decade ago. Further, the Settlement Term Sheet provided that the parties understood and agreed that there is no admission of liability or wrongdoing by the Company. The Company expressly denies any liability or wrongdoing with respect to the matters alleged in the Stanford litigation. Specifically, the parties to the Settlement Term Sheet are Ralph S. Janvey (in his capacity as the Court-appointed receiver (the ‘Receiver’) for The Stanford Financial Group and its affiliated entities in receivership (collectively, ‘Stanford’)), the Official Stanford Investors Committee, Samuel Troice, Martha Diaz, Paula Gilly-Flores, Punga Punga Financial, Ltd., Manuel Canabal, Daniel Gomez Ferreiro and Promotora Villa Marina, C.A. (collectively, ‘Plaintiffs’), on the one hand, and Willis Towers Watson Public Limited Company (formerly Willis Group Holdings Public Limited Company), Willis Limited, Willis North America Inc. and Willis of Colorado, Inc. (collectively, ‘Defendants’), on the other hand.
In the amended complaint, plaintiff alleges various deficiencies in pension actuarial work-product and advice stated to have been provided by Legacy Towers Watson’s predecessor firm, Towers Perrin, in its capacity as principal actuary to the Houston Firefighters’ Relief and Retirement Fund (the ‘Fund’). Towers Perrin is stated to have acted in this capacity between “the early 1980s until 2003”.
In particular, the amended complaint alleges “misrepresentations and miscalculations” in valuation reports allegedly issued by Towers Perrin from 2000 through 2002 upon which plaintiff claims to have relied. Plaintiff asserts that Towers Perrin assigned a new team of actuaries to the Fund in 2002 “to correct Towers’ own earlier mistakes” and that the new team “altered” certain calculations which “increased the actuarial accrued liability by $163 million.” Plaintiff claims that the reports indicated that the City’s minimum contribution percentages to the Fund would remain in place through at least 2019; and that existing benefits under the Fund could be increased, and new benefits could be added, without increasing plaintiff’s financial burden, and without increasing plaintiff’s rate of annual contributions to the Fund. The amended complaint alleges that plaintiff relied on these reports when supporting a new benefit package for the Fund. These reports, and other advice, are alleged, among other things, to have been negligent, to have misrepresented the present and future financial condition of the Fund and the contributions required to be made by plaintiff to support those benefits. Plaintiff asserts that, but for Towers Perrin’s alleged negligence and misrepresentations, plaintiff would not have supported the benefit increase, and that such increased benefits would not and could not have been approved or enacted. It is further asserted that Towers Perrin’s alleged “negligence and misrepresentations damaged the City to the tune of tens of millions of dollars in annual contributions.”
On October 10, 2014, Legacy Towers Watson filed a motion to dismiss plaintiff’s entire complaint on the basis that the complaint fails to state a claim upon which relief can be granted. On November 21, 2014, the City filed its response in opposition to Legacy Towers Watson’s motion to dismiss. On September 23, 2015, Legacy Towers Watson’s motion to dismiss was denied by the United States District Court for the Southern District of Texas, Houston Division. The court entered a scheduling order setting trial for May 30, 2017. On June 20, 2016, the Court entered an amended scheduling order setting trial for October 31, 2017.
On September 4, 2014, Towers Watson Limited (‘TWL’), a wholly-owned subsidiary of Legacy Towers Watson, received a Letter of Claim (the ‘Demand Letter’) on behalf of Coal Staff Superannuation Scheme Trustees Limited (the ‘Trustee’), trustee of the British Coal Staff Superannuation Scheme (the ‘Scheme’). The Demand Letter was sent under the Professional Negligence Pre-Action Protocol, a pre-action dispute resolution procedure which applies in England and Wales.
In the Demand Letter, it is asserted that the Trustee has a claim against TWL in respect of allegedly negligent investment consulting advice provided to it by Watson Wyatt Limited, in the United Kingdom, in particular with regard to a currency hedge that was implemented in connection with the Scheme’s investment of £250 million in a Bluebay local currency emerging market debt fund in August 2008 (the ‘Investment’). It is alleged that the currency hedge has caused a substantial loss to the Scheme, compensatory damages for which losses are quantified at £47.5 million, for the period August 2008 to October 2012.
On November 11, 2015, the Trustee issued a claim form in the English High Court of Justice, Queen’s Bench Division, Commercial Court, in which TWL is named defendant. The Trustee asserts that, in breach of retainer, or of a duty of care alleged to have been owed under contract or at common law, TWL acted negligently and/or provided negligent advice in connection with the Investment and/or in relation to the monitoring of the performance of the Investment. The Trustee asserts that, but for the alleged breaches, the Scheme would have achieved a return on the Investment that was approximately £47.5 million greater than the return on the Investment which it ultimately achieved, in the period between August 2008 and 28 September 2012. The claim form was not served on TWL within the validity period.
In the Third Amended Complaint, served on April 12, 2016, Meriter alleges that Towers, Perrin, Forster & Crosby, Inc. (‘TPFC’) and Davis, Conder, Enderle & Sloan, Inc. (‘DCES’), and other entities and individuals, including Meriter’s former lawyers, acted negligently concerning the benefits consulting advice provided to Meriter, including TPFC and the lawyers’ involvement in the Plan design and drafting of the Plan document in 1987 by TPFC, and DCES and the lawyers’ Plan review, Plan redesign, Plan amendment, and drafting of ERISA section 204(h) notices in the early 2000s. Additionally, Meriter asserts that TPFC, DCES, and the individual actuary defendants breached alleged fiduciary duties to advise Meriter regarding the competency of Meriter’s then ERISA counsel. Meriter also has asserted causes of action for contribution, indemnity, and equitable subrogation related to amounts paid to settle a class action lawsuit related to the Plan that was filed by Plan participants against Meriter in 2010, alleging a number of ERISA violations and related claims. Meriter settled that lawsuit in 2015 for $82 million. Meriter seeks damages in the amount of approximately $190 million, which includes amounts it claims to have paid to settle and defend the class action litigation, and amounts it claims to have incurred as a result of improper plan design. Meriter seeks to recover these alleged damages from TWDE and the other defendants.
On January 12, 2016, TWDE and the other defendants filed a motion for partial summary judgment seeking dismissal of Meriter’s negligence and breach of fiduciary duty claims. On April 18, 2016, TWDE and the other defendants filed a motion to dismiss the contribution, indemnification, and equitable subrogation claims. On May 4, 2016, the parties appeared for oral argument on the motion for partial summary judgment, which the court granted in part and denied in part. The court dismissed the fiduciary duty claims, but not the negligence claims. Meriter subsequently moved for reconsideration of the dismissal of its breach of fiduciary duty claims, which motion was denied as to TWDE on August 16, 2016. On June 22, 2016, the court granted in part TWDE’s motion to dismiss, and dismissed the contribution and equitable subrogation claims, but denied the motion as to Meriter’s indemnification claim without prejudice to the right of any defendant to raise the issue again by later motion. On December 1, 2016, TWDE and other defendants filed a motion for summary judgment, which will be heard on March 9, 2017. Based on all of the information to date, and given the stage of the matter, TWDE is currently unable to provide an estimate of the reasonably possible loss or range of loss. TWDE disputes the allegations, and intends to defend the matter vigorously.
and 2016 an 85 percent increase in the premium rates of certain of the long term care policies it issued between 1995 and 2004 (the ‘85% Increase’).
In May 2014, the court denied the motions to dismiss filed by CalPERS and Towers Perrin addressed to the sufficiency of the complaint. On January 28, 2016, the court granted plaintiffs’ motion for class certification. The certified class as currently defined includes those long term care policy holders whose policies were “subject to” the 85% Increase. The court thereafter set an October 2, 2017 trial date.
On December 31, 2016, the Company had a number of open share-based compensation plans, which provide for the grant of time-based and performance-based options, time-based and performance-based restricted stock units, and various other share-based grants to employees. All of the Company’s share-based compensation plans under which any options, restricted stock units or other share-based grants are outstanding as of December 31, 2016 are described below. The compensation cost that has been recognized for those plans for the years ended December 31, 2016, 2015 and 2014 was $123 million, $64 million and $52 million, respectively. The total income tax benefit recognized in the consolidated statement of operations for share-based compensation arrangements for the years ended December 31, 2016, 2015, and 2014 was $35 million, $15 million and $12 million, respectively.
There were approximately 9 million shares remaining available for grant under this plan as of December 31, 2016. Options are exercisable on a variety of dates, including from the second, third, fourth or fifth anniversary of grant. Unless terminated sooner by the Board of Directors, the 2012 Plan will expire 10 years after the date of its adoption. That termination will not affect the validity of any grants outstanding at that date.
Certain options are exercisable in Pounds sterling and are converted to dollars using the exchange rate at December 31, 2016.
The number of options outstanding and other per share data have been retroactively adjusted to reflect the reverse stock split on January 4, 2016. See Note 3 - Merger and Acquisitions for further details.
The weighted average grant-date fair value of time-based options granted during the years ended December 31, 2016, 2015, and 2014 were $16.88, $14.77, and $14.12, respectively. The total intrinsic value of options exercised during the years ended December 31, 2016, 2015, and 2014 was $25 million, $17 million, and $22 million, respectively. At December 31, 2016 there was $4 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.
There were no performance-based options granted during the three years ended December 31, 2016, 2015 or 2014. However, 520,295 performance-based options were acquired during the year ended December 31, 2016, at which time the performance conditions were met. The total intrinsic value of options exercised during the years ended December 31, 2016, 2015, and 2014 was $9 million, $25 million, and $15 million, respectively. At December 31, 2016 there was $1 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements under performance-based stock option plans; that cost is expected to be recognized over a weighted-average period of 1 year.
The fair value of each time-based restricted stock unit is based on the grant date fair value, or the fair value on the acquisition date in the case of acquired awards. The fair value of each performance-based restricted stock unit is estimated on the grant date using a Monte-Carlo simulation that uses the assumptions noted in the following table. Expected volatility is based on the historical volatility of the Company’s shares. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of the grant. The assumptions noted in the table below represent the weighted-average of each assumption for each grant during the year.
A summary of time-based and performance-based restricted stock unit activity under the Plans at December 31, 2016, and changes during the year then ended, is presented below:
Cash received from option exercises under all share-based payment arrangements for the years ended December 31, 2016, 2015, and 2014 was $63 million, $124 million, and $134 million, respectively. The actual tax benefit recognized for the tax deductions from option exercises of the share-based payment arrangements totaled $30 million for the year ended December 31, 2016. The actual tax benefit recognized for the tax deductions from option exercises of the share-based payment arrangements totaled $25 million and $20 million for the years ended December 31, 2015 and December 31, 2014, respectively.
Shares outstanding, potentially issuable shares, basic and diluted earnings per share, and the dilutive effect of potentially issuable shares, for the year ended December 31, 2014 and 2015 have been retroactively adjusted to reflect the reverse stock split effected on January 4, 2016. See Note 3 - Merger and Acquisitions for further details.
During the fourth quarter of 2016, management corrected an error by recording a $103 million benefit from income taxes related to the release of a portion of our U.S. deferred tax valuation allowance. A portion of the correction should have been recorded in each of the three fiscal year 2016 Quarterly Reports on Forms 10-Q. Management has determined that the error is immaterial to the previously filed 2016 quarterly financial statements and has no impact on prior year financial statements.
Willis North America Inc. (‘Willis North America’) had $148 million senior notes outstanding that were issued on July 1, 2005 that were subsequently repaid on July 1, 2015 and has $394 million of senior notes issued on March 28, 2007 and $187 million of senior notes issued on September 29, 2009.
Note 22 - Financial Information for Parent Issuer, Guarantor Subsidiaries and Non-Guarantor Subsidiaries
The guarantor structure described above differs from the guarantor structure associated with the senior notes issued by Willis North America (the ‘Willis North America Debt Securities’) (and for which condensed consolidating financial information is presented in Note 21) in that Willis Towers Watson is the Parent Issuer and Willis North America is a subsidiary guarantor.
All direct obligations under the senior notes are jointly and severally, irrevocably and fully and unconditionally guaranteed by Willis Netherlands Holdings B.V., Willis Investment U.K. Holdings Limited, TA I Limited, Willis Group Limited, Willis North America Inc., Willis Towers Watson Sub Holdings Unlimited Company and WTW Bermuda Holdings Ltd., collectively the ‘Other Guarantors’, and with Willis Towers Watson, the ‘Guarantor Companies’.