2005 was a year of transition for the insurance industry. Following the various regulatory investigations, there were widespread changes in market practices, including the elimination of volume and profit-based contingents for global brokers and significant reductions in other remuneration received from the market. As a result of these changes, we also saw opportunities to quote for and win new business and to recruit talented staff enabling us to grow our franchise in the longer term. At the same time the market was highly competitive: insurance premium rates declined; new and existing competitors aggressively cut fees to retain or win new business; and there were upward pressures on the cost of hiring and retaining the best people. The combination of these factors in 2005 had an adverse impact on margins throughout the industry.
Net income in 2004 was $427 million, or $2.54 per diluted share, compared with $414 million, or $2.45 per diluted share, in 2003. Total revenues at $2,275 million were $199 million, or 10 percent higher than in 2003 of which 2 percent was attributable to the net impact of foreign currency translation and 4 percent to acquisitions and disposals. Organic revenue growth of 4 percent reflected net new business growth of 6 percent offset by a negative 2 percent impact of declining rates.
In October 2004, we announced that we were voluntarily abolishing contingent compensation arrangements. We expect the income to decline further as amounts received which are attributable to prior periods continue to run off and we continue to receive only a limited amount of market remuneration for operations outside North America for administrative and accounting services provided to insurers. In 2005, we received total market remuneration of $29 million, compared with $148 million in 2004 and $133 million in 2003.
We continue to hire new brokers, senior executives to lead practices and strengthen specific businesses, and client-facing and technical staff who we believe will help us achieve our long term growth objectives. At the same time, employees have left under the first quarter 2005 headcount reduction program. The net increase in headcount over 2005 was therefore relatively small but we believe the revised mix will be more productive. However, our experience shows that new brokers generally take 18 to 24 months or longer before they are profitable. In addition, the costs of retaining our existing and new staff have increased in a highly competitive market.
In 2006 we anticipate that revenue growth will be primarily organic based on winning new accounts, increasing business with existing clients, improving client retention rates, and hiring new revenue generating staff. It is not yet possible to assess how premium rates will impact revenue growth for the full year as there are conflicting pressures on rates in both the reinsurance and direct insurance market. For example, we saw sharp increases in January 1 renewals for energy risks in the Gulf of Mexico and catastrophe and property exposed lines with poor loss records, but elsewhere premium rates remained soft or broadly stable.
We will therefore continue to invest in talented new and existing brokers and business leaders who we believe can win new business and drive our business forward to generate improved margins in the longer term. However, in 2006 we expect recruiting opportunities to be similar to 2005 and that the competition for the best people will not abate: the related recruitment and retention spend will therefore continue to impact the ratio of remuneration costs to revenues in the shorter term. Consequently, we expect the compensation ratio (salaries and benefits as a percentage of revenues) in 2006 to be similar to the 2005 compensation ratio, excluding severance costs, of 59 percent.
In 2005, in order to diversify our funding base and to lengthen our maturity profile, we replaced the bank loan agreement we entered into in December 2003, which included a $450 million term loan facility and a $150 million revolving credit facility. On July 1, 2005 we completed a $600 million notes offering, comprising $350 million 10 year notes at 5.625 percent and $250 million 5 year notes at 5.125 percent. Proceeds from the offering were used to repay the existing $450 million bank loan on July 6, 2005 and the remainder used for general corporate purposes including additional pension fund contributions of $50 million. On October 17, 2005, we entered into a new $300 million 5 year revolving credit facility which replaced the existing $150 million facility. Our capitalization ratio (total long-term debt to total long-term debt and equity) was 32 percent at December 31, 2005 compared with 24 percent at December 31, 2004.
Further to the agreements reached with the New York Attorney General, the New York Superintendent of Insurance and the Minnesota Attorney General in first quarter 2005, we paid $51 million on July 1, 2005 into bank accounts for reimbursement funds. We continue to respond to requests for documents and information from the regulators and/or attorneys general of more than twenty other states, the District of Columbia, one US city, Canada and Australia who are conducting similar regulatory proceedings. We are co-operating fully with these investigations but at this time cannot predict how or when these investigations will be resolved.
We provide a broad range of insurance brokerage and risk management consulting services to our worldwide clients. In our capacity as an advisor and insurance broker, we act as an intermediary between our clients and insurance carriers by advising our clients on their risk management requirements, helping clients to determine the best means of managing risk, and negotiating and placing insurance risk with insurance carriers through our global distribution network.
The majority of our revenue is commission based and varies based upon the premiums on the policies we place on behalf of our clients. As such, when premium rates in the insurance market rise we tend to benefit and, when premium rates decline, we tend to experience pressure on our revenues,
2005 revenues at $2,267 million were broadly in line with 2004 with the benefit of an increase attributable to net acquisitions and disposals offset by a reduction in organic revenues, where net new business growth was more than offset by the reduction in market remuneration.
The following table analyzes 2005 organic growth in commissions and fees by business:
(i)Total market remuneration includes volume and profit-based contingent commissions together with compensation for product and market research carried out on behalf of insurers and income related to administration and other services provided to the market. Global: Global revenues were adversely impacted by a $91 million reduction in market remuneration in 2005 compared with 2004. Commissions and fees, excluding market remuneration, were 5 percent higher in 2005 compared with 2004. Rates were soft in virtually all the sectors we operate in and in the reinsurance market we are seeing a trend towards more centralized buying and higher retentions. Despite the highly competitive market, net new business growth improved and we saw some benefit in the London market from market remuneration migrating to fees. Our Financial and Professional Services in Global Markets and Aerospace and Niche businesses in Global Specialties all performed well.
International: International revenues were 4 percent higher than in 2004 as net new business growth and improved client retention in most regions more than offset the impact of a further softening of rates in many areas and a 1 percent reduction attributable to reduced market remuneration. South Africa, Russia, Latin America and Asia all performed well.
There was a modest negative impact from premium rates on average, although the effect varied by country and by line of business.
General and administrative expenses at $1,761 million in 2005 were $188 million, or 12 percent, higher than in 2004 of which 3 percent was attributable to acquisitions net of disposals and foreign currency translation.
Other expenses at $405 million were 4 percent higher than 2004 of which 5 percent was attributable to acquisitions net of disposals and foreign currency translation. There was an underlying decrease of 1 percent despite an additional $20 million provision for legal claims following the March 31, 2005 review of legal cases and increased legal costs mainly relating to regulatory proceedings. This decrease reflected strong controls on discretionary spending throughout 2005.
The non-cash compensation charge for performance-based stock options in 2004 was $11 million. As of December 31, 2004, we had recognized 100 percent of the $270 million non-cash compensation charge for performance-based stock options granted to management as part of the 1998 leveraged buy-out arrangement for meeting or exceeding 2001 and 2002 targets.
Salaries and benefits, excluding non-cash compensation charges for performance-based stock options, were 52 percent of revenues in 2004 compared to 50 percent of revenues in 2003, reflecting increased expenditure on recruitment and retention of staff. We recruited steadily over the preceding two years as the Company grew and we built the sales culture. The pace of this recruitment accelerated in fourth quarter 2004 and at December 31, 2004 the number of revenue earning staff was 5 percent higher than at December 31, 2003.
•a $20 million increase in severance costs primarily as a result of the first quarter 2005 headcount reduction program;
•an additional $20 million increase in the provision for claims following the March 31, 2005 review of legal proceedings; and
We earn revenue in an uneven fashion during the year, primarily due to the timing of insurance policy renewals. As many policies incept and renew as of December 31 or January 1, we generate the majority of our revenues in the first and fourth calendar quarters. General and administrative expenses, however, are incurred on a relatively even basis throughout the year. As a result, we have historically earned the majority of our operating income in the first and fourth quarters. However, significant charges in first quarter 2005 and a $78 million gain on disposal in second quarter 2005 distorted this trend in 2005. Operating income in 2005 was $94 million, $206 million, $72 million and $107 million for the first, second, third and fourth quarters, respectively.
Operating margin was 29 percent in 2004 compared with 30 percent in 2003. The decrease reflected increased recruitment and retention costs and higher legal, regulatory and compliance expenses.
In February 2004, we paid a call premium of $17 million on the early redemption of all $370 million of our 9% senior subordinated notes.
Interest expense in 2005 was $30 million compared with $22 million in 2004 with the increase mainly due to higher average levels of debt at higher interest rates following the replacement of the $450 million term loan with $600 million of senior notes in July 2005 as part of our long term capital structure planning.
The effective tax rate in 2005 was 34 percent. The net impact of the effect of tax on net disposals, the amortization of intangibles, and the $60 million of regulatory settlement and related costs was 2 percent, of which approximately 3 percent was attributable to the $78 million profit on disposal of Stewart Smith and a negative 1 percent to the tax effect of the regulatory settlements and related costs. Excluding the effect of tax on net disposals of operations, the amortization of intangible assets, and regulatory settlements and related costs, the underlying tax rate was 32 percent compared with 33 percent in 2004 which contributed approximately $0.04 to diluted earnings per share in 2005.
equivalent to $0.08 per diluted share; and the $41 million post-tax net gain on disposal of operations primarily relating to the second quarter 2005 sale of Stewart Smith, equivalent to $0.25 per diluted share. The decrease excluding these significant items was mainly attributable to the reduction in market remuneration; increased retention, recruitment and pension costs; the impact of foreign currency translation; and the effect of Stewart Smith which was sold in April 2005; partly offset by the lower tax rate.
The Company's accounting policies are described in Note 2 to the Consolidated Financial Statements. Management considers that the following accounting estimates or assumptions are the most important to the presentation of the Company's financial condition or operating performance. Management has discussed its critical accounting estimates and associated disclosures with our Audit Committee.
expense was mainly attributable to the impact of lower discount rates and higher amortization charges for losses arising in previous years, together with a smaller increase due to increased longevity assumptions.
Based on December 31, 2005 assumptions, we expect our net pension expense in 2006 to increase by approximately $20 million over 2005 mainly reflecting the lower UK discount rate at December 31, 2005 and higher amortization charges for losses arising in prior years, as well as further increases in longevity assumptions in the United States.
We make a number of assumptions when determining our pension liabilities and pension expense which are reviewed annually by senior management and changed where 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. Other material assumptions include rates of participant mortality, the expected long-term rate of compensation and pension increases and rates of employee termination.
(2)Assumes all plan participants are one year younger. Expected long-term rates of return on plan assets are developed from the expected future returns of the various asset classes using the target asset allocations. The expected long-term rate of return used for determining the net UK pension expense in 2005 was 7.25 percent, unchanged from 2004, and equivalent to an expected return in 2005 of $112 million. The actual return in 2005 was $282 million with all asset classes performing well, especially equities.
Rates used to discount pension plan liabilities at December 31, 2005 were based on yields prevailing at that date of high quality corporate bonds of appropriate maturity. The selected rate used to discount UK plan liabilities was 4.9 percent compared with 5.3 percent at December 31, 2004 with the decrease reflecting a decline in long term bond rates in the United Kingdom during 2005. The lower discount rate at December 31, 2005 was the main contributor to the $204 million actuarial loss in 2005. Changes to the rates at which retiring members can exchange part of their future pension entitlements for a cash payment also contributed to actuarial losses in 2005.
(2)Assumes all plan participants are one year younger. The expected long-term rate of return used for determining the net US pension expense in 2005 was 8.0 percent, compared with an actual return of 9.0 percent. The rate used to discount US plan liabilities at December 31, 2005 was 5.75 percent, determined based on expected plan cash flows discounted using a corporate bond yield curve, in line with the rate used at December 31, 2004.
We purchase professional indemnity insurance for errors and insurance claims. The terms of this insurance vary by policy year and self-insured risks have increased significantly over recent years. We have established provisions against various actual and potential claims, lawsuits and other proceedings relating principally to alleged errors and omissions in connection with the placement of insurance and reinsurance in the ordinary course of business. Such provisions cover claims that have been reported but not paid and also claims that have been incurred but not reported. These provisions are established based on actuarial estimates together with individual case reviews and are believed to be adequate in the light of current information and legal advice.
In December 2004, the Financial Accounting Standards Board issued SFAS No. 123 (revised 2004), Share-Based Payment ("SFAS 123R"). SFAS 123R replaces SFAS 123 and supersedes APB 25. SFAS 123R requires that the cost resulting from all share-based payment transactions be recognized in the financial statements at fair value and that excess tax benefits be reported as a financing cash inflow rather than as a reduction of taxes paid. SFAS 123R is effective for the Company from January 1, 2006.
SFAS 123R requires public companies to account for share-based payments using the modified-prospective method. Under the modified-prospective method, from the effective date, compensation cost is recognized based on the requirements of SFAS 123R for all new share-based awards and based on the requirements of SFAS 123 for all awards granted prior to the effective date of SFAS 123R that remain unvested on the effective date.
The Company expects to apply the modified-retrospective method when adopting SFAS 123R.
In 2005, in order to diversify our funding base and to lengthen our maturity profile, we replaced the bank loan agreement we entered into in December 2003, which included a $450 million term loan facility and a $150 million revolving credit facility.
On July 1, 2005, we completed a senior notes offering of $600 million enabling us to access an alternative source of finance for the Company at attractive rates and spreads. The issue also facilitates further access to the debt markets in the future, providing additional flexibility. The issue comprised $250 million 5 year notes priced at 5.125 percent and $350 million 10 year notes priced at 5.625 percent. Net proceeds after expenses totaled $593 million and were used to repay the existing shorter term $450 million bank loan on July 6, 2005. The remaining balance was used for general corporate purposes including additional pension fund contributions of $50 million.
Net cash provided by operations, which excludes fiduciary cash, was $140 million in 2005 compared with $490 million in 2004 and $493 million in 2003. The reduction in net cash provided by operations in 2005 was primarily attributable to a reclassification of approximately $155 million own funds to fiduciary funds under new Financial Services Authority ("FSA") regulations in the United Kingdom which came into force in January 2005, and the $51 million regulatory settlement.
The new FSA regulations require fiduciary funds to be held in designated trust accounts, restrict the financial instruments in which such funds may be invested and affect the timing of transferring commissions from fiduciary funds to own funds. The regulations change the basis for the withdrawal of commissions from fiduciary funds from an earned to a receipts basis with a consequential increase in the balances held in fiduciary funds.
In addition to the impact of the new FSA regulations, net cash provided by operations in 2005 compared with 2004 was also adversely impacted by the abolition of volume and profit-based contingent commissions and the reduction in other market remuneration.
Total net cash provided by investing activities was $32 million in 2005 compared with a $183 million outflow in 2004 and a $135 million outflow in 2003. Net cash proceeds from the sale of operations totaled $90 million pre-tax and were mainly attributable to the sale of Stewart Smith on April 14, 2005. Cash used for acquisitions in 2005 amounted to $35 million (net of cash acquired), primarily incurred in acquiring CGI Consulting Group, Inc., now Willis Benefits of Pennsylvania, Inc., a US employee benefits firm and Primary Worldwide Corporation in the US, now Willis Consulting Services of California, Inc., C.R. King and Partners Limited in the United Kingdom, J.H. Asesores y Corredores de Seguros S.A. a Peruvian broker, K.R. Athos Consultoria e Corretora de Seguros de Vida S/C Ltd, a Brazilian employee benefits firm and Essence, a Taiwanese broker.
We have historically funded acquisitions with cash or a combination of cash and equity. Depending on the acquisition and the economics of the transaction, we would expect this pattern to continue.
The completion of our senior notes offering of $600 million in July 2005 and the subsequent repayment of the $450 million term loan generated a net cash inflow of $143 million. There was a net inflow of $63 million from refinancing debt in 2004. During 2003, debt repayments amounted to $198 million.
As of December 31, 2005, we had cash and cash equivalents of $193 million, compared with $351 million at December 31, 2004. We expect that internally generated funds will be sufficient to meet our foreseeable operating cash requirements, capital expenditures and dividend payments. Additionally our new undrawn $300 million revolving credit facility gives us additional financial flexibility.
(1)Based on the earliest dates on which options could be exercised. In November 2004, we entered into a 25 year agreement with British Land plc relating to our new UK headquarters in London. Construction commenced in early 2005 and our occupancy is targeted for late 2007. Our contractual obligations in relation to this commitment totaling $800 million are included in the table above, but are contingent upon the successful completion of construction.
Following changes to UK pensions legislation in 2005, we are now required to agree a funding strategy for our UK defined benefit plan with the plan's trustees. In January 2006, we agreed to make additional contributions in 2006 and 2007 of $95 million and $86 million respectively.
As part of our acquisition of 33 percent of Gras Savoye, we entered into a put arrangement, whereby the other shareholders in Gras Savoye (primarily two families, two insurance companies and Gras Savoye's executive management team) could put their shares to us. Until 2011, we will be obligated to buy the shares of certain shareholders to the extent those shareholders put their shares, potentially increasing our ownership from 33 percent to 90 percent if all shareholders put their shares, at a price determined by a contractual formula based on earnings and revenue. Management shareholders of Gras Savoye (representing approximately 10 percent of shares) do not have general put rights before 2011, but have certain put rights on their death, disability or retirement from which payments, at December 31, 2005 based on the formula would not have exceeded $57 million. The shareholders may put their shares individually at any time during the put period.
We have audited the accompanying consolidated balance sheets of Willis Group Holdings Limited and subsidiaries (collectively, the "Company") as of December 31, 2005 and 2004, and the related consolidated statements of operations, stockholders' equity, comprehensive income and cash flows for each of the three years in the period ended December 31, 2005. Our audits also included the financial statement schedule listed in the index at Item 15. These financial statements and financial statement schedule are the responsibility of Willis Group Holdings Limited management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.
We have also audited in accordance with the standards of the Public Company Accounting Oversight Board (United States) the effectiveness of the Company's internal control over financial reporting as of December 31, 2005, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 2, 2006 expressed an unqualified opinion on management's assessment of the effectiveness of the Company's internal control over financial reporting and an unqualified opinion on the effectiveness of the Company's internal control over financial reporting.
Principles of Consolidation-The accompanying consolidated financial statements include the accounts of Willis Group Holdings and its subsidiaries, all of which are controlled through the ownership of a majority voting interest. Intercompany balances and transactions have been eliminated on consolidation.
be kept in certain regulated bank accounts subject to guidelines which emphasize capital preservation and liquidity; such funds are not available to service the Company's debt or for other corporate purposes. Notwithstanding the legal relationships with clients and insurers, the Company is entitled to retain investment income earned on fiduciary funds in accordance with industry custom and practice and, in some cases, as supported by agreements with insureds.
Accounts Receivable and Accounts Payable-In its capacity as an insurance agent or broker, the Company collects premiums from insureds and, after deducting its commissions, remits the premiums to the respective insurers; the Company also collects claims or refunds from insurers on behalf of insureds. Uncollected premiums from insureds and uncollected claims or refunds from insurers are recorded as accounts receivable on the Company's consolidated balance sheets. Unremitted insurance premiums and claims are held in a fiduciary capacity. The obligation to remit these funds is recorded as accounts payable on the Company's consolidated balance sheets. The period for which the Company holds such funds is dependent upon the date the insured remits the payment of the premium to the Company and the date the Company is required to forward such payment to the insurer. Balances arising from insurance brokerage transactions are reported as separate assets or liabilities unless such balances are due to or from the same party and a right of offset exists, in which case the balances are recorded net.
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 using the straight-line method based on the estimated useful lives of assets.
value. On inception of an option agreement, the Company records the puts and calls at fair value. The put and call options are subsequently marked to market at each reporting period with changes in value being recognized in the statements of operations.
Income Taxes-The Company accounts for income taxes under the provisions of SFAS No. 109, Accounting for Income Taxes ("SFAS 109"). The Company is subject to the income tax laws of the various tax jurisdictions in which the Company operates, principally the United States and United Kingdom. These tax laws are complex and subject to different interpretations by taxpayers and the tax authorities. When establishing income tax provisions, the Company therefore makes a number of judgments and interpretations about the application and interaction of these tax laws. The Company has estimated tax reserves that management believe are adequate in relation to the potential for future assessments. Once established, the Company only adjusts tax reserves when more information is available or when an event occurs necessitating a change to tax reserves. Changes in these tax laws or our interpretations of these laws and the resolution of current and future tax audits could significantly impact the Company's effective tax rate and results of operations in a given period.
SFAS 109 requires recognition of 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 carryforwards. Deferred tax assets and liabilities are measured using enacted rates in effect for the year in which the differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of changes in tax rates is recognized in the statement of operations in the period in which the enactment date changes. Deferred tax assets and liabilities 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.
Pensions-The Company accounts for pension expense in accordance with SFAS No. 87, Employers' Accounting for Pensions. Pension information is presented in accordance with SFAS No. 132 (Revised 2003), Employers' Disclosures About Pensions and Other Post Retirement Benefits.
Had compensation expense for such plans been determined consistent with the fair value method prescribed by SFAS 123, Accounting for Stock-Based Compensation ("SFAS 123") using the Black-
Scholes option-pricing model, the Company's pro forma net income and net income per share would have been:
(1)Arising from certain changes in UK tax legislation (see Note 4). Revenue Recognition-Revenue includes insurance commissions, fees for services rendered, certain commissions receivable from insurance carriers and investment income earned on fiduciary balances.
The Company takes credit for commissions (or fees negotiated in lieu of commission) in respect of insurance placements at the date when the insured is billed or at the inception date of the policy, whichever is later. Commissions on additional premiums and adjustments are recognized as and when advised. Fees for risk management and other services are recognized as the services are provided. Negotiated fee arrangements for an agreed period covering multiple insurance placements, the provision of risk management and/or other services are determined, contract by contract, on the basis of the relative fair value of the services completed and the services yet to be rendered. The Company establishes contract cancellation reserves where appropriate; at December 31, 2005, 2004 and 2003, such amounts were not material.
In October 2004, the Company announced that it was voluntarily abolishing volume and profit-based contingent commissions. Such commissions were recognized at the earlier of the date when cash was received, or when formal, written notification of the actual amount due was received from the insurance carrier. If some of the commissions received were potentially subject to full or partial repayment to the carrier, then recognition was deferred until the conditions for repayment had passed.
Accounting Changes and Recent Accounting Pronouncements-In December 2004, the Financial Accounting Standards Board issued SFAS No. 123 (revised 2004), Share-Based Payment ("SFAS 123R"). SFAS 123R replaces SFAS 123 and supersedes APB 25. SFAS 123R requires that the cost resulting from all share-based payment transactions be recognized in the financial statements at fair value and that excess tax benefits be reported as a financing cash inflow rather than as a reduction of taxes paid. SFAS 123R is effective for the Company from January 1, 2006.
Total proceeds relating to 2005 dispositions of subsidiaries and associates amounted to $97 million, inclusive of deferred proceeds amounting to $1 million. A net gain of $78 million is recorded in the consolidated statement of operations which relates primarily to the gain arising on the sale of the Company's US wholesale unit Stewart Smith on April 14, 2005. The carrying amounts of the Stewart Smith assets and liabilities disposed of are as follows:
The components of income before income taxes, equity in net income of associates and minority interest are as follows:
Non-cashcompensation amounting to $116 million in respect of UK performance options was expensed in periods prior to January 1, 2003 without any income tax benefit being recognized. Accordingly, following the change in UK tax legislation, an income tax benefit of $35 million, and a corresponding deferred asset, was recognized in 2003.
Under current Bermuda law, the Company is not required to pay any taxes in Bermuda on its income, profits or capital gains. The following table reconciles the income tax expense in these financial statements to that which would be expected at the US federal statutory income tax rate:
(1)The year ended December 31, 2003 includes the income tax benefit of $35 million arising from the changes in UK tax legislation referred to above.
At December 31, 2005, the Company had a valuation allowance of $110 million (2004: $123 million) to reduce its deferred tax assets to estimated realizable value. The valuation allowance relates to the deferred tax assets arising from UK tax operating loss carryforwards and UK capital loss carryforwards, both of which have no expiration date. UK tax operating loss carryforwards can only be used against income arising in certain UK subsidiaries. In addition, the capital loss carryforwards can only be offset against future UK capital gains. US tax operating loss carryforwards will largely expire in 2023 and 2024 unless otherwise utilized. Management expects to fully utilize these loss carryforwards prior to expiration.
The Company recognizes current and deferred tax balances related to the undistributed earnings of subsidiaries when the Company expects that it will recover those undistributed earnings in a taxable manner, such as through receipt of dividends or sale of the investments. The Company does not, however, provide for income taxes on the unremitted earnings of certain other subsidiaries where, in management's opinion, such earnings have been indefinitely reinvested in those operations, or will be remitted either in a tax free liquidation or as dividends with taxes substantially offset by foreign tax credits. It is not practical to determine the amount of unrecognized deferred tax liabilities for temporary differences related to these investments.
Fiduciary funds-restricted, consisting primarily of time deposits and certificates of deposit with original maturities of three months or less, were $1,563 million as of December 31, 2005 (2004: $1,505 million).
On February 2, 2004, the Company redeemed all the then outstanding 9% senior subordinated notes at a redemption price of 104.5% of the aggregate principal amount of the notes being redeemed, resulting in a premium of $17 million, plus accrued and unpaid interest. On the same day, the Company drew down $300 million of term loans under the $450 million senior credit facility. The remaining $150 million of term loans under the senior credit facility was drawn down on June 1, 2004.
In 2006, the Company expects to contribute $129 million to the UK defined benefit pension plan. The Company contributed $31 million to the US plan in 2005 and expects to match or exceed this contribution level in 2006.
Company's 401(k) matching contributions for 2005, 2004 and 2003 were approximately $5 million, $1 million and $5 million, respectively.
Amended and Restated 1998 Share Purchase and Option Plan-This plan, which was established on December 18, 1998, provides for the granting of time-based and performance-based options to employees of the Company. There are 30,000,000 shares available for grant under this plan provided, however, that in no event the total number of shares subject to options and other equity for current and future participants exceed 25 percent of the equity of Willis Group Holdings on a fully diluted basis. All options granted under this plan are exercisable at £2 per share ($3.44 using the year-end exchange rate of £1 = $1.72) except for 111,111 time-based options which are exercisable at $13.50. No further grants are to be made under this plan.
Willis Award Plan-This plan, which was established on July 13, 2000, provides for the granting of time-based options to selected employees who have been identified as superior performers. There are 5,000,000 shares available for grant under this plan provided, however, that in no event the total number of shares subject to options and other equity for current and future participants exceed 25 percent of the equity of Willis Group Holdings on a fully diluted basis. All options granted under this plan are exercisable at £2 per share ($3.44 using the year-end exchange rate of £1 = $1.72). The options vest immediately on the grant date and are exercisable any time up to July 13, 2010.
Compensation Expense-Willis Group Holdings applies the intrinsic value method allowed by APB 25 in accounting for its stock option plans. Under APB 25, compensation expense resulting from awards under fixed plans (time-based options, options granted pursuant to the Willis Award Plan and
various other share-based grants to employees) are measured as the difference between the quoted (or best estimate of) market price, and the exercise price on the measurement date. All fixed plan options have been granted by Willis Group Holdings at an exercise price equal to the quoted market price at the measurement date, or management's best estimate of market price prior to the initial public offering. Accordingly, pursuant to APB 25 no compensation expense has been recognized for fixed option plans in the statements of operations.
(1)Certain options are exercisable at £2 per share. Year-end exchange rates of £1 = $1.72, £1 = $1.92 and £1 = $1.79 have been used as of December 31, 2005, 2004 and 2003, respectively. A summary of time-based options outstanding and exercisable at December 31, 2005 is as follows:
The Company's principal financial instruments, other than derivatives, comprise the fixed rate Senior Notes, an undrawn revolving credit facility, cash deposits and short-term investments. The Company also enters into derivative transactions (principally interest rate swaps and forward foreign currency contracts) in order to manage interest rate and currency risks arising from the Company's operations and its sources of finance. The Company does not hold financial instruments for trading purposes.
The main risks arising from the Company's financial instruments are interest rate risk, liquidity risk, foreign currency risk and credit risk. The Company's board of directors reviews and agrees policies for managing each of these risks as summarized below. The Company has applied SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended, in accounting for these financial instruments.
Amounts are reclassified from other comprehensive income into earnings when the hedged exposure affects earnings. For contracts that do not qualify for hedge accounting as defined by SFAS 133, changes in fair value are recorded in other operating expenses.
The fair value of these contracts is recorded in other assets and other liabilities. For contracts that are qualifying cash flow hedges as defined by SFAS 133, changes in fair value are recorded as a component of other comprehensive income. Amounts are reclassified from other comprehensive income into earnings when the hedged exposure affects earnings. For contracts that do not qualify for hedge accounting as defined by SFAS 133, changes in fair value are recorded in general and administrative expenses (see table on previous page).
(1)Forward exchange contracts range in maturity from 2006 to 2008. Credit Risk and Concentrations of Credit Risk-Credit risk represents the loss that would be recognized at the reporting date if counterparties failed to perform as contracted and from movements in interest rates and foreign exchange rates. The Company does not anticipate non-performance by counterparties. The Company generally does not require collateral or other security to support financial instruments with credit risk; however, it is the Company's policy to enter into master netting arrangements with counterparties as practical.
Concentrations of credit risk that arise from financial instruments exist for groups of customers or counterparties when they have similar economic characteristics that would cause their ability to meet contractual obligations to be similarly affected by changes in economic or other conditions. Financial instruments on the balance sheet that potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents, accounts receivable, and derivatives which are recorded at fair value. The Company maintains a policy providing for the diversification of cash and cash equivalent investments and places such investments in an extensive number of high quality financial institutions to limit the amount of credit risk exposure. Concentrations of credit risk with respect to receivables are limited due to the large number of clients and markets in which the Company does business, as well as the dispersion across many geographic areas. Management does not believe significant risk exists in connection with the Company's concentrations of credit as of December 31, 2005.
The components of accumulated other comprehensive loss, net of tax are as follows:
It is estimated that $5 million of net derivative losses included in other comprehensive loss will be reclassified into earnings within the next twelve months.
Certain of Willis Group Holdings' subsidiaries have given the landlords of some leasehold properties occupied by the Company in the United Kingdom and the United States guarantees in respect of the performance of the lease obligations of the subsidiary holding the lease. The operating lease obligations subject to such guarantees amounted to $935 million and $1,050 million at December 31, 2005 and 2004, respectively.
In addition, the Company has given guarantees to bankers and other third parties relating principally to letters of credit amounting to $2 million and $9 million at December 31, 2005 and 2004, respectively.
Proceedings Relating to Contingent Compensation Arrangements-In April 2005, the Company entered into an Assurance of Discontinuance ("NY AOD") with the New York Attorney General and the New York Superintendent of Insurance resolving the investigation commenced by the New York Attorney General in April 2004 which concerned, among other things, arrangements pursuant to which insurers compensated insurance brokers for distribution and other services provided to insurers and, as the investigation of brokers and insurers continued, broadened into an investigation of other possible violations of law, including violations of fiduciary duty, securities laws, and antitrust laws. Pursuant to the NY AOD, the Company has paid $50 million into a fund that will be distributed to eligible
In August 2004, a proceeding was commenced in the Superior Court of the State of California, County of San Diego against the Company by United Policyholders, an organization purporting to act in a representative capacity on behalf of the California general public. The complaint alleges that the compensation arrangements between the Company and insurance carriers constitute deceptive trade practices, and it seeks both injunctive and equitable relief, including restitution. This action was dismissed in December 2004, but United Policyholders has filed an appeal. The dismissal of the complaint was based on the retroactive application of newly passed legislation. The Supreme Court of California is presently considering whether this newly passed legislation should have retroactive application. The court's decision will determine whether this case will be able to proceed. Since August 2004, various plaintiffs have filed purported class actions, in New York, Illinois, California, New Jersey, Massachusetts, and Florida, under a variety of legal theories, including state tort, contract, fiduciary duty and statutory theories, and federal antitrust and RICO theories, and the Company expects that further suits may be filed. Other than a federal suit in Illinois that was voluntarily dismissed by the plaintiff in May 2005, all of the federal actions have been consolidated into two actions in federal court in New Jersey. One of the consolidated actions addresses employee benefits, while the other consolidated action addresses all other lines of insurance. In addition to the two federal actions, the Company has also been named as a defendant in purported class actions in state courts in Florida and Massachusetts. Both the consolidated federal actions and the state actions name various insurance carriers and insurance brokerage firms, including the Company, as defendants. The complaints seek monetary damages and equitable relief and make allegations regarding the practices and conduct that has been the subject of the investigation of state attorneys general and insurance commissioners, including allegations that the brokers have breached their duties to their clients by entering into contingent compensation agreements with either no disclosure or limited disclosure to clients and entered into other improper activities. The complaints also allege the existence of a conspiracy among the insurance carriers and brokers and the federal court complaints allege violations of the federal RICO statute. The Company disputes these allegations and intends to defend itself
Kohlberg Kravis Roberts & Co. L.P. ("KKR"), with which Messrs. P. Golkin and S.C. Nuttall, both Directors of the Company, are affiliated, and Fisher Capital Corp. L.L.C. ("Fisher"), with which Mr. J.R. Fisher, also a Director of the Company, is affiliated, rendered in 2003 management, consulting and certain other services to the Company for annual fees of $1,000,000 and $350,000, respectively, payable quarterly in arrears. These arrangements were terminated as of December 31, 2003. Messrs. Golkin and Nuttall disclaim any beneficial interest in these fees.
Concurrently with the secondary public offering by certain of its shareholders of 6,100,000 Shares in November 2005 (2004: 20,000,000), the Company purchased 1,488,810 (2004: 3,974,154) of its Shares from Profit Sharing (Overseas), Limited Partnership, an affiliate of KKR, and 11,190 (2004: 25,846) of its Shares from Fisher Capital Corp. L.L.C. at a price of $36.00 per Share (2004: $37.026), the net public offering price in the secondary offering, in a private non-underwritten transaction under our $500 million share repurchase program.
On July 1, 2005, Willis North America Inc. ("Willis North America") issued debt securities totaling $600 million under its April 2003 registration statement. The debt securities are jointly and severally, irrevocably and fully and unconditionally guaranteed by Willis Group Holdings, Willis Group Limited, Trinity Acquisition Limited, TA 1 Limited, TA II Limited, TA III Limited and TA IV Limited.
Presented below is condensed consolidating financial information for: i) Willis Group Holdings, which is a guarantor, on a parent company only basis; ii) the Other Guarantors which are all 100 percent owned subsidiaries of the parent; iii) the Issuer, Willis North America; iv) Other, which are the non-guarantor subsidiaries, on a combined basis; v) Eliminations; and vi) Consolidated Company and subsidiaries. The equity method has been used for all investments in subsidiaries.
The entities included in the Other Guarantors column are Willis Group Limited, Trinity Acquisition Limited, TA I Limited, TA II Limited, TA III Limited and TA IV Limited.