This discussion includes references to non-GAAP financial measures as defined in the rules of the Securities and Exchange Commission (‘SEC’). We present such non-GAAP financial measures, specifically, adjusted, constant currency and organic non-GAAP financial measures, as we believe such information is of interest to the investment community because it provides additional meaningful methods of evaluating certain aspects of the Company’s operating performance from period to period on a basis that may not be otherwise apparent under U.S. GAAP, and these provide a measure against which our businesses may be assessed in the future.
Our methods of calculating these measures may differ from those used by other companies and therefore comparability may be limited. These financial measures should be viewed in addition to, not in lieu of, the consolidated financial statements for the year ended December 31, 2016.
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 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.
We are not an insurance company, and therefore we do not underwrite insurable risks for our own account.
Management has considered the U.K. referendum vote on June 23, 2016 to depart from the E.U. and the uncertainties about the near-term and longer-term effects of Brexit on the Company. The terms of Brexit, and its impact, are highly uncertain. For a further discussion of the risks of Brexit to the Company, see Part I, Item 1A. Risk Factors within this Annual Report on Form 10-K.
Typically, our business benefits from regulatory change, political risk or economic uncertainty. Insurance broking generally tracks the economy, but demand for both insurance broking and consulting services usually remains steady during times of uncertainty. We believe that the U.K. has good long-term growth opportunities and, given that, we believe the impact to Willis Towers Watson will be neutral to slightly positive over the next couple of years, with some periods of increase and decrease in that time frame. We have some businesses, such as our health and benefits and administration businesses, which can be counter cyclical during the early period of a significant economic change.
The market for our consulting, technology and solutions, and private exchange services is subject to change as a result of economic, regulatory and legislative changes, technological developments, and increased competition from established and new competitors. Regulatory and legislative actions, along with continuously evolving technological developments, will likely have the greatest impact on the overall market for our exchange products. We believe the primary factors in selecting a human resources or risk management consulting firm include reputation, the ability to provide measurable increases to shareholder value and return on investment, global scale, quality of service and the ability to tailor services to clients’ unique needs. With regard to the market for exchanges, we believe that clients base their decisions on a variety of factors that include the ability of the provider to deliver measurable cost savings for clients, a strong reputation for efficient execution, a provider's capability in delivering a broad number of configurations to serve various population segments and financing options, and an innovative service delivery model and platform.
Willis Towers Watson sees that a unified approach to people and risk can be a path to growth for our clients. Our integrated teams bring together our understanding of risk strategies and market analytics. This helps clients around the world to achieve their objectives.
Delivering a powerful client proposition with an integrated global platform. Our highly complementary offerings provide comprehensive advice, analytics, specialty capabilities and solutions covering benefits, exchange solutions, brokerage and advisory, risk and capital management, and talent and rewards;
continuing to modernize the way we run our business to better serve our clients, enable the skills of our staff, and lower our costs of doing business;
During the second quarter of 2016, we began managing our business and reporting our segmental results across four integrated reportable operating segments: Human Capital and Benefits; Corporate Risk and Broking; Investment, Risk and Reinsurance; and Exchange Solutions.
The table below sets forth our consolidated statements of operations and data as a percentage of revenues for the years ended December 31, 2016, 2015, and 2014.
The following table details our top five markets based on percentage of consolidated revenues from the countries where work is performed for the year ended December 31, 2016. These figures do not represent the currency of the related revenue, which is presented in the succeeding table.
Total revenues for the year ended December 31, 2015 were $3.8 billion, compared to $3.8 billion for the year ended December 31, 2014, an increase of $27 million, or 1%. This growth in revenues was driven primarily by a $115 million organic growth in commissions and fees and a net $157 million increase through acquisitions, partially offset by a $15 million organic decline in interest and other income and $230 million in adverse foreign currency movements.
In 2015, the foreign currency impact was as a result of the strengthening of the U.S. dollar against a number of currencies, most significantly the Euro and the Pound sterling.
Other operating expenses for the years ended December 31, 2016 and December 31, 2015 were $1.6 billion and $718 million, respectively, an increase of $833 million. The growth in expenses was primarily driven by the Merger and our acquisition of Gras Savoye. Other operating expenses for the years ended December 31, 2015 and December 31, 2014 were $718 million and $659 million, respectively, an increase of $59 million. This growth included a net $36 million increase from acquisitions and disposals, and a $70 million increase relating to the provision for the Stanford litigation. Growth was partially offset primarily by $42 million of favorable foreign currency movements.
Depreciation represents the expense incurred over the useful life of our tangible fixed assets and internally developed software. Depreciation for the years ended December 31, 2016 and December 31, 2015 was $178 million and $95 million, respectively, an increase of $83 million. The growth in expenses was primarily driven by the Merger and our acquisition of Gras Savoye. Depreciation expense for the years ended December 31, 2015 and December 31, 2014 was $95 million and $92 million, respectively, an increase of $3 million. The increase of $3 million included an organic increase of $4 million and a net $4 million increase from acquisitions and disposals, partially offset by $5 million of favorable foreign currency movements.
Amortization includes amortization of acquired intangible assets, including acquired internally developed software. Amortization for the years ended December 31, 2016 and December 31, 2015 was $591 million and $76 million, respectively, an increase of $515 million. The primary driver of the increase in amortization was our acquisition of approximately $4.0 billion in intangible assets in our Merger with Towers Watson and our acquisition of $231 million and $440 million of intangible assets related to our acquisitions of Miller and Gras Savoye, respectively. Amortization for the year ended December 31, 2015 was $76 million, an increase of $22 million compared to December 31, 2014. The increase primarily reflects the increased expense related to our acquisitions of Charles Monat and Max Matthiessen, partially offset by the ongoing reduction in the Hilb Rogal Hobbs Company, a wholly owned subsidiary, acquisition amortization.
Restructuring costs for the year ended December 31, 2016 were $193 million of which $145 million related to the Operational Improvement Program (‘OIP’) and $48 million relating to the Business Restructure Program. Restructuring costs for the years ended December 31, 2015 and December 31, 2014 were $126 million and $36 million, respectively, all of which was related to the OIP. See our discussion in the Operational Improvement Program and Business Restructure Program section herein and Note 5 - Restructuring Costs within Item 8 of this Annual Report on Form 10-K for additional details about these expenses.
acquisition of Miller resulted in its expenses initially exceeding the increase in revenues generated by the acquisition, due to the seasonal profile of the business.
Interest expense for the years ended December 31, 2016, 2015 and 2014 was $184 million, $142 million and $135 million, respectively. Interest expense is primarily related to interest on our senior notes and term loans. Interest expense increased by $42 million for the year ended December 31, 2016, which was primarily related to additional debt acquired in the Merger and as part of the acquisition of Gras Savoye. Interest expense increased by $7 million for the year ended December 31, 2015 as compared to the year ended December 31, 2014, which was primarily related to the $8 million increase in the unwind of the discount on contingent and deferred considerations.
Other expense/(income), net, includes other gains and losses, including gains and losses on foreign currency transactions.
(Benefit from)/provision for income taxes for the years ended December 31, 2016, 2015 and 2014 were $(96) million, $(33) million and $159 million, respectively. The benefit from income taxes in 2016 was primarily due to the release of a portion of U.S. valuation allowances and shifts in the global mix of income as a result of the Merger. This shift creates additional deductions in jurisdictions with high statutory income tax rates, which reduces the global effective tax rate. The benefit from income taxes in 2015 was primarily due to an income tax benefit from the release of a portion of U.S. valuation allowances.
All prior period segment revenues information has been recast from our historically reported filings to conform to the current reportable segment structure.
Segment revenues exclude amounts that were directly incurred on behalf of our clients and reimbursed by them (reimbursed expenses); however, these amounts are included in consolidated revenues.
The Merger affects the comparability of this data between 2016 and other periods presented. See ‘Supplementary Pro Forma Segment Revenues Analysis’ for additional analysis.
Beginning with 2017, we are realigning teams within some segments and will update our corporate expense allocation methodology to move additional costs which were formerly identified as corporate costs into the segments. We may continue to refine teams, business units and the cost allocation methodology as we continue the integration phase of the Merger.
The Willis Towers Watson Human Capital & Benefits (‘HCB’) segment provides an array of advice, broking, solutions and software for employee benefit plans, the HR organization and the management teams of our clients.
HCB total segment revenues for the year ended December 31, 2015 were $698 million, compared to $655 million for the year ended December 31, 2014, an increase of $43 million or 7%. HCB recorded mid-single-digit growth driven by organic growth and our strategic acquisition of Evolution Benefits Consulting in 2015.
Property and Casualty - Property and Casualty provides property and liability insurance brokerage services across a wide range of industries including construction, real estate, healthcare, and natural resources.
Transport - Transport provides specialist expertise to the transportation, aerospace, marine and space industries.
Wholesale Insurance Broking - Wholesale provides wholesale and specialist broking services to retail brokers.
The table below presents segment commissions and fees, and segment interest and other income for IRR for the years ended December 31, 2016, 2015, and 2014.
IRR total segment revenues for the year ended December 31, 2016 were $1.4 billion, compared to $813 million for the year ended December 31, 2015, an increase of $628 million or 77%. This growth in revenues was driven by the Merger and a full year of revenues from Miller, following our acquisition in May 2015. See the ‘Supplementary Pro Forma Segment Revenues Analysis’ section below for additional discussion of our 2016 results.
ES generated approximately 8% of our revenues for the year ended December 31, 2016. ES provides services across four integrated or related offerings to customers primarily in the U.S. through four business units:
Technology and Administration Solutions - Through our proprietary BenefitConnect technology, this business provides a broad suite of health and welfare outsourcing services as well as decision support and modeling tools for pension users within the U.S.
Intercompany trading. Adjustments to eliminate trading between Legacy Willis and Legacy Towers Watson of $1 million for the year ended December 31, 2015.
Pension and post-retirement benefit amortization. Adjustments to remove the net periodic benefit costs of $33 million for the year ended December 31, 2015 associated with the amortization of net actuarial losses and prior service credits/costs for Towers Watson’s pension and other post-retirement benefit plans.
amortization. See Item 8, Note 3 - Merger and Acquisitions and Note 8 - Goodwill and Other Intangible Assets.
Interest Expense. Net adjustments to interest expense include additional interest and amortization of related deferred debt issuance costs. Approximately $13 million incremental interest expense was recorded for the year ended December 31, 2015 related to a borrowing under a $340 million term loan as part of the funding for the pre-Merger special dividend on December 29, 2015 and the portion of the senior notes issuance used to repay Towers Watson’s existing debt at the time of the Merger.
The following table sets out the total revenues generated for the year ended December 31, 2016, pro forma revenues generated for the year ended December 31, 2015, and the components of the change for the year ended December 31, 2016.
Net income attributable to Willis Towers Watson for the year ended December 31, 2016 was $420 million, a decrease of $220 million compared to $640 million for the pro forma year ended December 31, 2015. The decrease was primarily driven by increased transaction and integration expenses of $147 million and restructuring costs of $67 million in 2016 and gains on disposals of $80 million and remeasurement of equity interests of $59 million in 2015, partially offset by a decrease in income tax expense of $166 million.
The following table sets out the components of CRB 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.
CRB total segment and commissions and fees revenues for the year ended December 31, 2016 were $2.5 billion, compared to pro forma $2.3 billion for the year ended December 31, 2015. The growth for the year ended December 31, 2016 was 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 revenue gains in Iberia, partially offset by softness in Italy. North America was flat with strong retention offset by lower new business. Offsetting the growth in Great Britain and Western Europe, International organic revenue declined as a result of lower revenues in Asia and Australasia, partially offset by better performance in Latin America and CEEMEA.
IRR total segment revenues for the year ended December 31, 2016 and pro forma for the year ended December 31, 2015 were $1.4 billion. Included in total segment revenues for the year ended December 31, 2016 is a previously disclosed settlement with JLT of £28 million ($41 million) related to the Fine Art, Jewellery and Specie team. Commissions and fees for the year ended December 31, 2016 and pro forma for the year ended December 31, 2015 were $1.4 billion, representing a decrease of $17 million. The organic decline was primarily related to the following factors: soft market conditions and renewal factors impacting our Reinsurance and Portfolio and Underwriting Services businesses, particularly in North America; a decline in overall insurance industry M&A activity impacting our Capital Markets & Advisory business after a record year in 2015; and a decline arising from lower demand in risk consulting projects.
The following table sets out the components of ES 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.
The primary elements of the program include: moving more than 3,500 support roles from higher cost locations to facilities in lower cost locations; net workforce reductions in support positions; lease consolidation in real estate; and information technology systems simplification and rationalization.
Total spend, actual savings, and timing may vary positively or negatively from these estimates due to changes in the scope, underlying assumptions, or execution risk of the restructuring plan throughout its duration. Restructuring costs related to the OIP for the years ended December 31, 2016 and 2015 by segment are as follows:
In the second quarter of 2016, we began planning targeted staffing reductions in certain portions of the business due to a reduction in business demand or change in business focus (hereinafter referred to as the Business Restructure Program, or the ‘BRP’). The main element of the program is the workforce reduction of approximately 450 positions across all segments, resulting in annualized savings of approximately $80 million. The program was complete as of December 31, 2016.
Our principal sources of liquidity are funds generated by operating activities, available cash and cash equivalents and amounts available under revolving credit facilities.
Historically, we have not provided deferred taxes on cumulative earnings of our subsidiaries that have been reinvested indefinitely. 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 through goodwill. We continue to assert that the cumulative earnings of our other subsidiaries are reinvested indefinitely and we do not provide deferred tax liabilities on these amounts. The Company has no current plans and does not anticipate repatriating cash other than for certain foreign subsidiaries. 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. One of the potential sources of cash may be through settlement of intercompany loans or return of capital distributions in a tax efficient manner.
Events that could change the historical cash flow dynamics discussed above include significant changes in operating results, potential future acquisitions or divestitures, material changes in geographic sources of cash, unexpected adverse impacts from litigation or future pension funding during periods of severe downturn in the capital markets.
During the year ended December 31, 2016, the Company restructured some of its debt financing in March and May 2016. We issued (i) $1.0 billion of senior notes ($450 million due 2021 and $550 million due 2026) to: refinance the $300 million senior notes due 2016; refinance $400 million of debt assumed as part of the Merger; and make further repayment on the revolving credit facility, and (ii) €540 million ($609 million) of senior notes to repay Tranche A of the 1-year term loan that was used to finance the acquisition of Gras Savoye.
Our cash and cash equivalents at December 31, 2016 totaled $870 million, compared to $532 million at December 31, 2015. The increase in cash from December 31, 2015 to December 31, 2016 was primarily due to cash acquired in the Merger with Towers Watson.
Additionally, $557 million was available to draw under our $800 million revolving credit facility, compared with $333 million at December 31, 2015, and $420 million was available to draw for regulatory capital purposes related to securities underwriting.
Cash flows from operating activities for 2015 was $243 million, which included net income of $384 million, adjusted for $38 million of non-cash adjustments to reconcile net income to cash used in operating activities, offset by changes in operating assets and liabilities of $179 million.
Cash flows from operating activities for 2014 was $477 million, which included net income of $373 million, adjusted for $257 million of non-cash adjustments to reconcile net income to cash used in operating activities, offset by changes in operating assets and liabilities of $153 million.
Cash flows used in financing activities for 2016 were $762 million. The primary drivers during the period were debt issuance of $2.0 billion, debt repayments of $1.9 billion, net payments on the revolving credit facility of $237 million, dividend payments of $199 million, and share repurchases of $396 million.
The debt repayments of $1.9 billion were primarily $300 million repayment of senior notes due 2016, $400 million repayment of Legacy Towers Watson debt and repayments of $592 million and $400 million on the 1-year term loan facility.
At December 31, 2016, our material mandatory debt repayments over the next twelve months include $394 million senior notes due 2017, scheduled repayments of $85 million on our term loan maturing in 2019 and scheduled repayments of $22 million on our 7-year term loan.
At December 31, 2016 and December 31, 2015, we were in compliance with all financial covenants.
At December 31, 2016 and 2015, we had fiduciary funds of $2.5 billion and $2.3 billion, respectively.
On November 10, 2016, the Company announced the Board of Directors approved an increase to the existing share repurchase program of $1 billion. The $1 billion increase is in addition to the remaining authority on the Legacy Willis program discussed in the preceding paragraph. We anticipate this authorization to be executed in 2017 and 2018. At December 31, 2016, approximately $1.1 billion remained on the open-ended repurchase authorities granted by the Board.
The Company has no material commitments for capital expenditures. Our capital expenditures for fixed assets and software for internal use and capitalized software costs were $303 million for the year ended December 31, 2016. Expected capital expenditures for fixed assets and software for internal use are approximately $250 million for the year ended December 31, 2017. We expect cash from operations to adequately provide for these cash needs.
Total cash dividends of $199 million were paid during 2016. In February 2017, the board of directors approved a quarterly cash dividend of $0.53 per share, which will be paid on or about April 17, 2017, for an annual rate of $2.12 per share.
The Company’s material contractual obligations as of December 31, 2016 are as follows:
Debt obligations and facilities - The Company’s material debt and related interest obligations at December 31, 2016 are shown in the above table. Mandatory repayments of debt over the next 12 months include maturity of the 6.200% senior notes due 2017 and the scheduled repayment of the current portion of the Company’s 7-year and 2019 term loans. The Company also has the right, at its option, to prepay indebtedness under the credit facility without further penalty and to redeem the senior notes by paying a ‘make-whole’ premium as provided under the applicable debt instrument.
Operating Leases - We lease office space and furniture under operating lease agreements with terms typically ranging from three to twenty years. We have determined that there is not a large concentration of leases that will expire in any one fiscal year. Consequently, management anticipates that any increase in future rent expense on leases will be mainly market-driven. We also lease cars and selected computer equipment under operating lease agreements. For acquired operating leases, intangible assets or liabilities have been recognized for the difference between the contractual cash obligations and the estimated market rates at the time of acquisition. These intangibles are amortized to rent expense but do not affect our contractual cash obligations. See further discussion in Item 8, Note 13 - Commitments and Contingencies to the Consolidated Financial Statements in this Annual Report on Form 10-K.
Pension Contributions - The Company has agreed with Trustees of certain plans in the U.K. to contribute deficit funding and minimum ongoing accrual of benefits funding and presented those obligations in the table above. These obligations exclude any potential funding level contributions, which are dependent on future funding level assessments. There are no contractual obligations for our U.S. pension plans. Our total expected contributions to all qualified pension plans, including amounts presented above, for the year ending December 31, 2017 are projected to be $128 million. Additionally, the Company expects to pay $60 million in benefits directly to participants for the year ended 2017.
Uncertain Tax Positions - The table above does not include liabilities for uncertain tax positions under ASC 740, Income Taxes. The settlement period for the $56 million liability, which excludes interest and penalties, cannot be reasonably estimated since it depends on the timing and possible outcomes of tax examinations with various tax authorities.
In order to assist readers of our consolidated financial statements in understanding the core operating results that Willis Towers Watson’s management uses to evaluate the business and for financial planning, we present non-GAAP measures: (1) Adjusted Revenues, (2) Constant Currency Change, (3) Organic Change, (4) Adjusted Operating Income, (5) Adjusted EBITDA, (6) Adjusted Net Income, (7) Adjusted Diluted Earnings Per Share, (8) Adjusted Income Before Taxes, (9) Adjusted Income Taxes/Tax Rate and (10) Free Cash Flow. The Company believes that these measures are relevant and provide useful information widely used by analysts, investors and other interested parties in our industry to provide a baseline for evaluating and comparing our operating and liquidity results.
Within these measures, we have adjusted for significant items which will not be settled in cash, or which we believe to be items that are not core to our current or future operations. These items include the following:
Restructuring and Transaction and integration expenses - Management believes it is appropriate to adjust for restructuring and transaction and integration expenses when they relate to a specific significant program with a defined set of activities and costs that are not expected to continue beyond a defined period of time. We believe the adjustment is necessary to present how the Company is performing, both now and in the future when these programs will have concluded.
Gains and losses on disposals of operations - Adjustment to remove the results of disposed operations.
These measures are different than those reported in our Form 10-K for the year ended December 31, 2015 and filed with the SEC on February 29, 2016. Historical non-GAAP measures have been recalculated using management’s new metrics for 2016.
We consider Adjusted Revenues to be an important financial measure, which is used to internally evaluate and assess our core operations and to benchmark our operating results against our competitors. Adjusted Revenues presents relevant period-over-period comparisons of revenues by excluding the impact of purchase accounting rules.
Adjusted Revenues is defined as Total revenues adjusted for the fair value adjustment for deferred revenues that would otherwise have been recognized but for the purchase accounting treatment of these transactions. GAAP accounting requires the elimination of this revenue.
The constant currency and organic change results, and a reconciliation from the as reported results for consolidated revenues are included in the As Reported Consolidated Financial Information section within this Form 10-K. These measures are also reported by segment in the As Reported Segment Revenues Analysis tables in that discussion and analysis.
We consider Adjusted Operating Income to be an important financial measure, which is used to internally evaluate and assess our core operations and to benchmark our operating results against our competitors.
Adjusted EBITDA is defined as Net Income adjusted for provision for income taxes, interest expense, depreciation and amortization, restructuring costs, transaction and integration expenses, the fair value adjustment for 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.
Adjusted Income Before Taxes is defined as Income from continuing operations before income taxes and interest in earnings of associates 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. Adjusted income before taxes is used solely for the purpose of calculating the adjusted income tax rate.
Adjusted Income Tax Rate is defined as Provision for income taxes adjusted for taxes on certain items of amortization, restructuring costs, transaction and integration expenses, the fair value adjustment for deferred revenue, gain on disposal of
A reconciliation of income from continuing operations before income taxes and interest in earnings of associates to adjusted income and provision for income taxes to adjusted income taxes for the year ended December 31, 2016 is as follows:
These effective tax rates are calculated using extended values from our consolidated statement of operations for this reconciliation, and are therefore more precise tax rates than can be calculated from rounded values.
Our compensation program includes a discretionary bonus that is determined by management and has historically been paid once per fiscal year in the form of cash and/or deferred stock units after our annual operating results are finalized.
The Company recognizes deferred tax assets and liabilities for the estimated future tax consequences of events attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating and capital loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted rates in effect for the year in which the differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of changes in tax rates is recognized in the statement of operations in the period in which the 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 amount 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.
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 and consulting services 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 certain cases, where a range of loss exists, we accrue the minimum amount in the range if no amount within the range is a better estimate than any other amount.
We maintain defined benefit pension plans for employees in several countries, with the most significant defined benefit plans offered in the U.S. and U.K. Our disclosures in Note 12 - Retirement Benefits contain additional information about our other less significant but material retirement plans. Within our critical accounting policy discussion, we have excluded analysis for plans outside of those noted in the description below, as any variance of recorded information based on management’s estimates would be immaterial.
Legacy Willis - This plan covers approximately one third of the Legacy Willis employees in the United States and is now frozen with no new entrants nor future accruals.
Legacy Towers Watson - This plan covers substantially all Legacy Towers Watson U.S. employees, with the exception of certain employees of our Exchange Solutions segment. Prior to December 31, 2010, employees earned benefits under their original plan formulas, which were frozen on December 31, 2011. Beginning January 1, 2012, all Legacy Towers Watson employees, including named executive officers, accrue qualified and non-qualified benefits under a stable value pension design.
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 rates and other 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) based on the average working life expectancy of each 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.
We recorded a combined $124 million net periodic benefit income for our U.S. and U.K. plans for the year ended December 31, 2016. For the U.S. and U.K. funded plans, the following table presents our estimated net periodic benefit income for 2017 and the impact to both plans of a 0.25% increase and decrease to both the expected return on assets (‘EROA’) and the discount rate assumptions, and the projected benefit obligations as of December 31, 2016 and the impact of a 0.25% increase and decrease to the discount rates:
Goodwill is tested at the reporting unit level, and the Company had eight reporting units as of October 1, 2016.
While we are still in the process of analyzing the various Accounting Standards Updates (‘ASU’) issued by the Financial Accounting Standards Board (‘FASB’), those which we believe will have a material impact to our financial statements are listed below. See Note 2 - Basis of Presentation and Significant Accounting Policies within Item 8 of this Form 10-K for additional information.
The Company will adopt the standard using the modified retrospective approach on January 1, 2018.
We expect our accounting for deferred costs will change. First, for those portions of the business that currently defer costs (related to system implementation activities), the length of time over which we amortize those costs is expected to extend to a longer estimated contract term. Currently these costs are amortized over a typical period of 3-5 years in accordance with the initial stated terms of the customer agreement. Second, we believe there may be other types of arrangements with associated costs that do not meet the rules for cost deferral under current U.S. GAAP but do meet the rules under the new standard. We are still evaluating the types of arrangements that might now have cost deferral impacts.
Consolidated Statements of Comprehensive Income/(Loss) for each of the three years in the period ended December 31, 2016
Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 2016
(in millions of U.S. dollars and numbers of shares in thousands)
We believe our broad perspective allows us to see the critical intersections between talent, assets and ideas - the dynamic formula that drives business performance.
Conforming reclassifications - Certain reclassifications have been made to prior period amounts to conform to the current year presentation. A material reclassification within the 2015 Consolidated Statement of Operations was made to reclassify $84 million of Transaction and integration expenses from Salary and benefits and Other operating expenses of $3 million and $81 million, respectively. This reclassification was made to present information on a comparable basis.
Fair Value of Financial Instruments - The carrying values of our cash and cash equivalents, accounts receivable, accrued expenses, revolving lines of credit and term loans approximate their fair values because of the short maturity and liquidity of those instruments. We consider the difference between carrying value and fair value to be immaterial for our senior notes. The fair value of our senior notes are considered Level 2 financial instruments as they are corroborated by observable market data. See Note 11 - Fair Value Measurements for additional information about our measurements of fair value.
The Company periodically reviews its investments in associates for which fair value is less than cost to determine if the decline in value is other than temporary. If the decline in value is judged to be other than temporary, the cost basis of the investment is written down to fair value. The amount of any write-down is included in the consolidated statements of operations.
Common Shares Split - On January 4, 2016, the Company effected a 1 to 2.6490 reverse share split to shareholders of record as of January 4, 2016. All share and per share information has been retroactively adjusted to reflect the reverse share split and show the new number of shares. See Note 3 - Merger and Acquisitions for additional information about our Merger and reverse share split.
Fiduciary Assets and Liabilities - Fiduciary funds represent unremitted premiums received from insureds and unremitted claims or refunds received from insurers. Fiduciary funds are generally required to 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 insureds 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. 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, or the date the Company receives refunds from the insurers, and the date the Company is required to forward such payment to the insurer, or insured, respectively. In certain instances, the Company advances premiums, refunds or claims to insurance underwriters or insureds prior to collection. Such advances are made from fiduciary funds and are reflected in the consolidated balance sheets as fiduciary assets. Fiduciary liabilities represent the obligations to remit fiduciary funds and fiduciary receivables to insurers or insureds. Certain of our health and welfare benefits administration outsourcing agreements require us to hold funds on behalf of clients to pay
Foreign Currency - Transactions in currencies other than the functional currency of the entity are recorded at the rates of exchange prevailing at the date of the transaction. Monetary assets and liabilities in currencies other than the functional currency are translated at the rates of exchange prevailing at the balance sheet date and the related transaction gains and losses are reported in the consolidated statements of operations. Certain intercompany loans are determined to be of a long-term investment nature. The Company records transaction gains and losses from remeasuring such loans in the consolidated statements of comprehensive income/(loss).
Derivatives - The Company uses derivative financial instruments for other than trading purposes to alter the risk profile of an existing underlying exposure. Interest rate swaps have been used to manage interest risk exposures. Forward foreign currency exchange contracts are used to manage currency exposures arising from future income and expenses. The fair values of derivative contracts are recorded in other assets and other liabilities. The effective portions of changes in the fair value of derivatives that qualify for hedge accounting as cash flow hedges are recorded in other comprehensive income. Amounts are reclassified from other comprehensive income into earnings when the hedged exposure affects earnings. If the derivative is designated as, and qualifies as, an effective fair value hedge, the changes in the fair value of the derivative and of the hedged item attributable to the hedged risk are both recognized in earnings. The amount of hedge ineffectiveness recognized in earnings is based on the extent to which an offset between the fair value of the derivative and hedged item is not achieved. Changes in fair value of derivatives that do not qualify for hedge accounting, together with any hedge ineffectiveness on those that do qualify, are recorded in other operating expenses or interest expense as appropriate.
Share-Based Compensation - The Company has equity-based compensation plans that provide for grants of restricted stock units and stock options to employees and non-employee directors of the Company who perform services for the Company.
Operating Leases -Rentals payable on operating leases are charged straight line to Other operating expenses in the consolidated statements of operations over the lease term. See Note 13 - Commitments and Contingencies for additional information about our operating leases.
Goodwill and Other Intangible Assets - In applying the acquisition method of accounting for business combinations, amounts assigned to identifiable assets and liabilities acquired were based on estimated fair values as of the date of acquisition, with the remainder recorded as goodwill. Intangible assets are initially valued at fair value using generally accepted valuation methods appropriate for the type of intangible asset. Intangible assets with definite lives are amortized over their estimated useful lives and are reviewed for impairment if indicators of impairment arise. Intangible assets with indefinite lives (currently only acquired software that is in the in-process research and development stage) are tested for impairment annually as of October 1, and whenever indicators of impairment exist. The fair values of intangible assets are compared with their carrying values, and an impairment loss would be recognized for the amount by which a carrying amount exceeds its fair value.
Goodwill is tested for impairment annually as of October 1, and whenever indicators of impairment exist. Goodwill is tested at the reporting unit level, and the Company had eight reporting units as of October 1, 2016. In the first step of the impairment test, the fair value of each reporting unit is compared with its carrying value, including goodwill. If the carrying value of a reporting unit exceeds its fair value, the amount of an impairment loss, if any, is calculated in the second step of the impairment test by comparing the implied fair value of reporting unit goodwill with the carrying amount of that goodwill. The Company’s goodwill impairment tests for the years ended December 31, 2016 and 2015 have not resulted in any impairment charges. See Note 8 - Goodwill and Other Intangible Assets for additional information about our goodwill and other intangible assets.
Revenue recognized in excess of billings is recorded as unbilled accounts receivable. Cash collections in excess of revenue recognized are recorded as deferred revenue until the revenue recognition criteria are met. Client reimbursable expenses, including those relating to travel, other out-of-pocket expenses and any third-party costs, are included in revenue, and an equivalent amount of reimbursable expenses is included in other operating expenses as a cost of revenue.
Commissions revenue. Brokerage commissions and fees negotiated in lieu of commissions are recognized at the later of the policy inception date or when the policy placement is complete. In situations in which our fees are not fixed and determinable due to the uncertainty of the commission fee per policy, we recognize revenue as the fees are determined. Commissions on additional premiums and adjustments are recognized when approved by or agreed between the parties and collectability is reasonably assured.
Hosted software. We have developed various software programs and technologies that we provide to clients in connection with consulting services. In most instances, such software is hosted and maintained by us and ownership of the technology and rights to the related code remain with us. We defer costs for software developed to be utilized in providing services to a client, but for which the client does not have the contractual right to take possession, during the implementation stage. We recognize these deferred costs from the go live date, signaling the end of the implementation stage, until the end of the initial term of the contract with the client. We determined that the system implementation and customized ongoing administrative services are one combined service. Revenue is recognized over the service period, after the go live date, in proportion to the services performed. As a result, we do not recognize revenue during the implementation phase of an engagement.
The Company continues to update its assessment of the impacts of the accounting standard, and related updates, to the consolidated financial statements, and will note material impacts when known.
In February 2016, the FASB issued ASU No. 2016-02 ‘Leases’, which requires a lessee to recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. The ASU becomes effective for the Company at the beginning of the 2019 fiscal year and early adoption is permitted. In transition, the Company is required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach, which includes a number of optional practical expedients. While the Company continues to assess the impact of the ASU to the consolidated financial statements, the majority of our leases are currently considered operating leases and will be capitalized as a lease asset on our balance sheet with a related lease liability for the obligated lease payments.
In March 2016, the FASB issued ASU No. 2016-09 ‘Compensation - Stock Compensation’, which simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The ASU becomes effective for the Company at the beginning of the 2017 fiscal year and early adoption is permitted. Certain applications of the ASU are to be applied prospectively or retrospectively with a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The Company is currently assessing the impact that this standard will have on its consolidated financial statements.
In October 2016, the FASB issued ASU No. 2016-16 ‘Income Taxes’, which amends guidance regarding the recognition of current and deferred income taxes for intra-entity asset transfers. Current U.S. GAAP prohibits the recognition of current and deferred income taxes for an intra-entity asset transfer until the asset has been sold to an outside party. The ASU states that an entity should recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. The amendments in this ASU should be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. The Company intends to early adopt this standard on January 1, 2017. The cumulative-effect adjustment will be immaterial to the consolidated financial statements.
In January 2017, the FASB issued ASU No. 2017-01 ‘Business Combinations - Clarifying the Definition of a Business’, which clarifies the definition of a business, to assist with the evaluation of whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The amendments in this ASU include the provision of a screen to determine when an integrated set of assets and activities is not a business; that is, when substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset (or a group of similar identifiable assets), the set is not a business. This screen reduces the number of transactions that need to be further evaluated. The ASU becomes effective for the Company at the beginning of 2018. The amendments in this ASU should be applied prospectively. Early adoption is permitted for acquisitions (or disposals) that have not already been reported in the financial statements. The Company is currently assessing the impact that this ASU will have on its consolidated financial statements.
In September 2015, the FASB issued ASU No. 2015-16 ‘Simplifying the Accounting for Measurement-Period Adjustments’ in relation to business combinations, which requires that an acquirer recognize adjustments to provisional amounts that are identified in the measurement period in the reporting period in which the adjustment amounts are determined. The Company adopted this standard on January 1, 2016. Adjustments made to provisional amounts related to business combinations are reflected in the consolidated financial statements and disclosed in Note 8 - Goodwill and Other Intangible Assets and Note 3 - Merger and Acquisitions to these consolidated financial statements.
Includes $348 million in accounts payable, accrued liabilities and deferred revenue, $308 million in employee-related liabilities and $11 million in other current liabilities.
Represents software not yet placed in service. As of the date of the Merger, $39 million was not yet placed in service. Once placed into service, each in-process research and development (‘IPR&D’) software component will be reclassified into finite-lived software intangible assets and amortized in line with underlying cash flows or on a straight line basis.
Stock Options. The outstanding unvested employee stock options were converted into 592,486 Willis Towers Watson stock options using the conversion ratios stated in the Merger agreement for the number of options. The fair value of the stock options was calculated using the Black-Scholes model with a volatility and risk-free interest rate over the expected term of each
group of options and the Willis Towers Watson’s closing share price on the date of acquisition. We determined the fair value of the portion of the outstanding options related to pre-acquisition employee service using the straight-line expense methodology from the date of grant to the acquisition date to be $7 million, which was added to the transaction consideration. The fair value of the remaining portion of options related to the post-acquisition employee services was $13 million, and will be recorded over the future vesting periods.
Restricted Stock Units. The outstanding unvested restricted stock units were converted into 597,307 Willis Towers Watson restricted stock units using the conversion ratios stated in the Merger agreement. The fair value of these restricted stock units was calculated using Willis Towers Watson’s closing share price on the date of acquisition. We determined the fair value of the portion of the outstanding RSUs related to pre-acquisition employee service using the straight-line expense methodology from the date of grant to the acquisition date to be $30 million which was added to the transaction consideration. The fair value of the remaining portion of RSUs related to the post-acquisition employee services was $32 million, and will be recorded over the future vesting periods.
On December 29, 2015, Legacy Willis completed the transaction to acquire substantially all of the remaining 70% of the outstanding share capital of Gras Savoye, the leading insurance broker in France, for total consideration of €544 million ($592 million) of which $582 million in cash was paid at closing. Additionally, the previously held equity interest in Gras Savoye was remeasured to a fair value of €221 million ($241 million) giving a total fair value on a 100% basis of €765 million ($833 million).
On May 31, 2015, Legacy Willis completed the transaction to acquire an 85 percent interest in Miller, a leading London wholesale specialist insurance broking firm, for total consideration of $401 million including cash consideration of $232 million.
Management evaluates the performance of its segments and allocates resources to them based on net operating income on a pre-bonus, pre-tax basis. Consolidated U.S. GAAP revenues include amounts that were directly incurred on behalf of our clients and reimbursed by them (reimbursable expenses).
See Item 1 within this Annual Report on Form 10-K for complete descriptions of our segments. A brief description of our new segments are as follows:
The Human Capital & Benefits (‘HCB’) segment provides an array of advice, broking, solutions and software for our clients. HCB is the largest segment of the Company. The segment is focused on addressing our clients’ employee and risk needs so that they can deliver sustainable employee experiences. This segment also delivers full outsourcing solutions to employers outside of the United States.
The Corporate Risk and Broking (‘CRB’) segment provides a broad range of risk advice, insurance broking and consulting services to clients worldwide ranging from small businesses to multinational corporations. The segment delivers innovative, integrated global solutions tailored to client needs and underpinned by data and analytics. CRB operates as an integrated global team comprising both functional and geographic leadership. In these operations, we have extensive specialized experience handling diverse lines of coverage, including complex insurance programs. A key objective is to assist clients in reducing their overall cost of risk.
The Investment, Risk and Reinsurance (‘IRR’) segment uses 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. Blending advanced analytics with deep institutional knowledge, IRR identifies new opportunities to maximize performance. IRR provides investment consulting services and insurance specific services and solutions through reserves opinions, software, ratemaking, usage-based insurance, risk underwriting, and reinsurance broking.
Under the new segment structure and for internal and segment reporting, Willis Towers Watson segment revenues include commissions and fees, interest and other income. U.S. GAAP revenues include amounts that were directly incurred on behalf of our clients and reimbursed by them (reimbursable expenses), which are removed from segment revenues. Segment commissions and fees excludes interest and other income. Segment operating income excludes certain costs, including (i) amortization of intangibles; (ii) restructuring costs; (iii) certain transaction and integration expenses; (iv) certain litigation provisions; and (v) to the extent that the actual expense based upon which allocations are made differs from the forecast/budget amount, a reconciling item will be created between internally allocated expenses and the actual expense that we report for U.S. GAAP purposes.
The table below presents a reconciliation of the information reported by segment to the consolidated amounts reported for the years ended December 31, 2016, 2015, and 2014, respectively:
None of the Company’s customers represented a significant amount of the Company’s consolidated commissions and fees for the years ended December 31, 2016, 2015 and 2014.
The Company had two restructuring programs during the year ended December 31, 2016. The Legacy Willis Operational Improvement Program (‘OIP’) and the Willis Towers Watson Business Restructuring Program (‘BRP’). Expenses related to these plans are recorded in restructuring costs on the consolidated statements of operations.
An analysis of our total restructuring costs recorded in the statements of operations, and the costs by segment, and costs attributable to corporate functions, for the years ended December 31, 2016, 2015, and 2014 are as follows:
The prior period comparatives have been retroactively reclassified for our segment reorganization. See Note 4 - Segment Information for further details.
Operational Improvement Program - In April 2014, Legacy Willis announced a multi-year operational improvement program designed to strengthen its client service capabilities and to deliver future cost savings. The main elements of the program, which will be completed by the end of 2017, include: moving more than 3,500 support roles from higher cost locations to facilities in lower cost locations; net workforce reductions in support positions; lease consolidation in real estate; and information technology systems simplification and rationalization.
At December 31, 2016, the Company’s liability under the OIP is as follows:
At December 31, 2016, the Company’s liability under the BRP is as follows:
The reported income tax provision for continuing operations differs from the amounts that would have resulted had the reported income before income taxes been taxed at the U.S. federal statutory rate. The principal reasons for the differences between the amounts provided and those that would have resulted from the application of the U.S. federal statutory tax rate are as follows:
At December 31, 2016, the Company had deferred tax assets of $894 million, net of the valuation allowance. Management believes, based on the evaluation of positive and negative evidence, including the future reversal of existing taxable temporary differences, it is more likely than not that the Company will realize the benefits of these deductible differences, net of the valuation allowance. During calendar year 2016 the Company released a valuation allowance of $69 million relating to accrued interest not deductible as a result of deferred tax liabilities recorded for the Merger. The future reversal of the deferred tax liabilities serve as a source of income to recognize the deferred tax asset for accrued interest not deductible.
At December 31, 2016, we had U.S. federal and non-U.S. tax loss carryforwards amounting to $246 million of which $197 million can be indefinitely carried forward under local statutes. The remaining $49 million of net operating loss carryforwards will expire, if unused, in varying amounts from 2017 through 2036. In addition, we had U.S. state net operating loss carryforwards of $1.2 billion, which will expire in varying amounts from 2017 to 2036.
The Company recognizes 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. Historically, we have not provided deferred taxes on the cumulative earnings of our subsidiaries that have been reinvested indefinitely.
The liability for the years ended December 31, 2015 and 2014, respectively, had nil and $2 million of deferred tax benefits that, if recognized, would have a favorable impact on our effective tax rate. In addition, there are no material balances that would result in adjustments to other tax accounts.
Interest and penalties related to unrecognized tax benefits are included as a component of income tax expense. At December 31, 2016, we had cumulative accrued interest of $4 million. At December 31, 2015, the cumulative accrued interest was immaterial. Penalties accrued in 2016 and 2015, respectively, were immaterial.
All U.K. tax returns have been filed timely and are in the normal process of being reviewed by HM Revenue & Customs. The Company is not currently subject to any material examinations in other jurisdictions. A summary of the tax years that remain open to tax examination in our major tax jurisdictions are as follows:
Depreciation related to capital leases was $2 million for each of the years ended December 31, 2016, 2015 and 2014.
In-process research and development intangible assets acquired as part of the Merger on January 4, 2016 of $39 million ($36 million at December 31, 2016) have not yet been placed in service and are not included in this presentation.
The following table reflects changes in the net carrying amount of the components of finite-lived intangible assets for the year ended December 31, 2015:
We recorded amortization related to our finite-lived intangible assets, exclusive of the amortization of our favorable lease agreements, of $591 million, $76 million, and $54 million for the years ended December 31, 2016, 2015 and 2014, respectively.
Our acquired unfavorable lease liabilities were $29 million and $23 million as of December 31, 2016 and December 31, 2015, respectively, and are recorded in the other non-current liabilities in the consolidated balance sheet.
The table below reflects the future estimated amortization expense for amortizable intangible assets and the rent offset resulting from amortization of the net lease intangible assets and liabilities for the next five years are as follows:
During 2015, in order to manage interest rate risk arising from these financial assets, the Company entered into interest rate swaps to receive a fixed rate of interest and pay a variable rate of interest. These derivatives were designated as hedging instruments at December 31, 2016 and December 31, 2015 and had total notional amounts of $300 million and fair values of nil for each period, respectively.
At December 31, 2016, the Company estimates, based on current interest and exchange rates, there will be $64 million of net derivative losses on forward exchange rates, interest rate swaps, and treasury locks reclassified from accumulated comprehensive income into earnings within the next 12 months as the forecast transactions affect earnings. At December 31, 2016, our longest outstanding maturity was 2.5 years.
All direct obligations under the 6.200% and 7.000% senior notes are issued by Willis North America Inc. and guaranteed by Willis Towers Watson, Willis Netherlands Holdings B.V., Willis Investment U.K. Holdings Limited, TA I Limited, Trinity Acquisition plc, Willis Group Limited, Willis Towers Watson Sub Holdings Unlimited Company and WTW Bermuda Holdings Ltd. See Note 21 - Financial Information for Parent Guarantor, Other Guarantor Subsidiaries and Non-Guarantor Subsidiaries .
On May 26, 2016, Trinity Acquisition plc issued €540 million ($609 million) of 2.125% senior notes due 2022 (‘2022 senior notes’). The 2022 senior notes are fully and unconditionally guaranteed by Willis Towers Watson. The effective interest rate of these senior notes is 2.154%, which includes the impact of the discount upon issuance. The 2022 senior notes will mature on
May 26, 2022. Interest accrues on the notes from May 26, 2016 and will be paid in cash on May 26 of each year. The net proceeds from this offering, after deducting underwriter discounts and commissions and estimated offering expenses, were €535 million ($600 million). We used the net proceeds of this offering to repay Tranche A of the 1-year term loan and related accrued interest.
On March 22, 2016, Trinity Acquisition plc issued $450 million of 3.500% senior notes due 2021 (‘2021 senior notes’) and $550 million of 4.400% senior notes due 2026 (‘2026 senior notes’). The 2021 senior notes and the 2026 senior notes are fully and unconditionally guaranteed by the Company. The effective interest rates of these senior notes are 3.707% and 4.572%, respectively, which includes the impact of the discount upon issuance. The 2021 senior notes and the 2026 senior notes will mature on September 15, 2021 and March 15, 2026, respectively. Interest accrues on the notes from March 22, 2016 and will be paid in cash on March 15 and September 15 of each year. The net proceeds from this offering, after deducting underwriter discounts and commissions and estimated offering expenses, were $988 million. We used the net proceeds of this offering as follows: to repay $300 million principal under our $800 million revolving credit facility and related accrued interest, which was drawn to repay our 4.125% senior notes on March 15, 2016; to repay $400 million principal on Tranche B under our 1-year term loan facility and related accrued interest; and to pay down a portion of the remaining principal amount outstanding under our $800 million revolving credit facility and related accrued interest.
On August 15, 2013, the Company issued $250 million of 4.625% senior notes due 2023 and $275 million of 6.125% senior notes due 2043. The effective interest rates of these senior notes are 4.696% and 6.154%, respectively, which include the impact of the discount upon issuance. The proceeds were used to repurchase other previously issued senior notes.
In March 2011, the Company issued $300 million of 4.125% senior notes due 2016 and $500 million of 5.750% senior notes due 2021. The effective interest rates of these senior notes are 4.240% and 5.871%, respectively, which include the impact of the discount upon issuance. The proceeds were used to repurchase and redeem other previously issued senior notes. As noted above, the 4.125% senior notes were repaid in March 2016.
Willis Securities Inc. (‘WSI’) is permitted to incur up to $400 million in indebtedness under the $800 million revolving credit facility held by Trinity Acquisition plc and has the ability to borrow in Euro, Japanese yen and other approved currencies subject to a reserve for foreign currency fluctuation.
Proceeds under the credit facility may be used for regulatory capital purposes related to securities underwriting only, which allows WSI to meet or exceed capital requirements of regulatory agencies, self-regulatory agencies and their clearing houses, including the Financial Industry Regulatory Authority. Advances under the WSI revolving credit facility bear interest at a rate equal to 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 margin of 1.50% applies while the Company’s debt rating remains BBB/Baa3.
The interest rate on the term loan is based on the Company’s choice of one, two, three or six-month LIBOR plus a spread of 1.25% to 1.75%, or alternatively the bank base rate plus 0.25% to 0.75%. The spread to each index is dependent on the Company’s consolidated leverage ratio. The weighted-average interest rate on this term loan for the year ended December 31, 2016 was 1.83%. The term loan amortizes at a rate of $21 million per quarter, beginning in March 2016, with a final maturity date of December 2019. The Company has the right to prepay a portion or all of the outstanding term loan balance on any interest payment date without penalty. At December 31, 2016, the balance outstanding on the term loan was $255 million, before reduction of $1 million in debt issuance fees.
The terms of our current financings also include certain limitations. For example, the agreements relating to the debt arrangements and credit facilities generally contain numerous operating and financial covenants, including requirements to maintain minimum ratios of consolidated EBITDA to consolidated cash interest expense and maximum levels of consolidated funded indebtedness in relation to consolidated EBITDA, in each case subject to certain adjustments. The operating restrictions and financial covenants in our credit facilities do, and any future financing agreements may, limit our ability to finance future operations or capital needs or to engage in other business activities.
Market values for our derivative instruments have been used to determine the fair value of interest rate swaps and forward foreign exchange contracts based on estimated amounts the Company would receive or have to pay to terminate the agreements, taking into account the current interest rate environment or current foreign currency forward rates. Such financial instruments are classified as Level 2 in the fair value hierarchy.
Contingent consideration payable is classified as Level 3 and we estimate fair value based on the likelihood and timing of achieving the relevant milestones of each arrangement, applying a probability assessment to each of the potential outcomes, and discounting the probability-weighted payout. Typically, milestones are based on revenue or EBITDA growth for the acquired business.
The following presents our assets and liabilities measured at fair value on a recurring basis at December 31, 2016 and December 31, 2015:
Probability weightings are based on our knowledge of the past and planned performance of the acquired entity to which the contingent consideration applies. The weighted average discount rate used on our material contingent consideration calculations was 10.76%. Using different probability weightings and discount rates could result in an increase or decrease of the contingent consideration payable.
On January 4, 2016, in connection with the Merger, we acquired additional defined benefit pension, PRW, and defined contribution plans. Total plan assets of approximately $3.7 billion and projected benefit obligations of approximately $4.6 billion were acquired. The funded status for each of the acquired plans has been included in the values of identifiable assets acquired, and liabilities assumed in Note 3 - Merger and Acquisitions and are recorded as $67 million in pension benefits assets and $923 million in liability for pension benefits.
Legacy Towers Watson - Benefit accruals earned under the Legacy Watson Wyatt defined benefit plan (predominantly pension benefits) ceased on February 28, 2015, although benefits earned prior to January 1, 2008 retain a link to salary until the employee leaves the Company. Benefit accruals earned under the legacy Towers Perrin defined benefit plan (predominantly lump sum benefits) were frozen on March 31, 2008. All participants now accrue defined contribution benefits.
2017 Canada Changes - Effective January 1, 2017, the Legacy Towers Watson Canada plan was amended with respect to future benefit accruals. The ancillary benefits were reduced for all members and the benefit formula was reduced for members joining on or after January 1, 2017. Additionally on January 1, 2017, the Legacy Willis employees in Canada joined the plan and will accrue qualified and non-qualified benefits based on a career average benefit formula.
Germany (Legacy Towers Watson) - Effective January 1, 2011, all new participants participate in a defined contribution plan. Participants hired prior to this date continue to participate in various defined contribution and defined benefit arrangements according to legacy plan formulas. The legacy defined benefit plans are primarily account-based, with some long-service participants continuing to accrue benefits according to grandfathered final-average-pay formulas.
The following schedules provide information concerning the defined benefit pension plans and PRW plan as of and for the years ended December 31 2016 and 2015:
The following table presents the projected benefit obligation and fair value of plan assets for our plans that have a projected benefit obligation in excess of plan assets as of December 31, 2016 and 2015:
The components of the net periodic benefit income and other amounts recognized in other comprehensive (income)/loss for the years ended December 31, 2016, 2015 and 2014 for the defined benefit plans and PRW plan are as follows:
This discount rate represents the assumption to determine net periodic benefit cost prior to the Company’s use of the granular approach to calculating service and interest cost which began for the 2016 fiscal year.
As part of the salary freeze negotiations with the Scheme Trustee, Legacy Willis agreed to the U.K. plan Trustee’s de-risking strategy which will lead to a strategic target asset allocation with a greater weighting to fixed income assets. Consequently, with effect from March 6, 2015, the expected return on assets assumption was reduced by 50 basis points from 7.00% to 6.50%.
The expected return on plan assets was determined on the basis of the weighted-average of the expected future returns of the various asset classes, using the target allocations shown below. The Company’s pension plan asset target allocations as of December 31, 2016 were as follows:
Our investment strategy is designed to generate returns that will reduce the interest rate risk inherent in each of the plan’s benefit obligations and enable the plans to meet their future obligations. The precise amount for which these obligations will be settled depends on future events, including the life expectancy of the plan participants and salary inflation. The obligations are estimated using actuarial assumptions, based on the current economic environment.
Each pension plan seeks to achieve total returns sufficient to meet expected future obligations when considered in conjunction with expected future contributions and prudent levels of investment risk and diversification. Each plan’s targeted asset allocation is generally determined through a plan-specific Asset-Liability Modeling study. These comprehensive studies provide an evaluation of the projected status of asset and benefit obligation measures for each plan under a range of both positive and negative environments. The studies include a number of different asset mixes, spanning a range of diversification and potential equity exposures.
In evaluating the strategic asset allocation choices, an emphasis is placed on the long-term characteristics of each individual asset class, such as expected return, volatility of returns and correlations with other asset classes within the portfolios. Consideration is also given to the proper long-term level of risk for each plan, the impact of the volatility and magnitude of plan contributions and costs, and the impact that certain actuarial techniques may have on the plan’s recognition of investment experience.
We monitor investment performance and portfolio characteristics on a quarterly basis to ensure that managers are meeting expectations with respect to their investment approach. There are also various restrictions and controls placed on managers, including prohibition from investing in our stock.
The fair values of our U.K. plan assets by asset category at December 31, 2016 and 2015 are as follows:
We evaluate the need to transfer between levels based upon the nature of the financial instrument and size of the transfer relative to the total net assets of the plans. There were no significant transfers between Levels 1, 2 or 3 in the fiscal years ended December 31, 2016 and 2015.
Equity securities and Mutual Funds: Valued at the closing price reported on the active market on which the individual securities are traded. Exchange traded mutual funds are included as level 1 above.
Government bonds: Valued at the closing price reported in the active market in which the bond is traded.
Corporate bonds: Valued using pricing models maximizing the use of observable inputs for similar securities. This includes basing value on yields currently available on comparable securities of issuers with similar credit ratings.
The following table sets forth a summary of changes in the fair value of the plans’ Level 3 assets for the fiscal year ended December 31, 2016:
Funding is based on actuarially determined contributions and is limited to amounts that are currently deductible for tax purposes. Since funding calculations are based on different measurements than those used for accounting purposes, pension contributions are not equal to net periodic pension costs.
The following table sets forth our projected pension contributions to our qualified plans for fiscal year 2017, as well as the pension contributions to our qualified plans in fiscal years 2016 and 2015:
The Legacy Towers Watson U.K. pension plan has a money purchase feature to which we make core contributions plus additional contributions matching those of the participants up to a maximum rate. Contribution rates depend on the age of the participant and whether or not they arise from salary sacrifice arrangements through which the participant has elected to receive a pension contribution in lieu of additional salary.
The Company’s expenses related to its defined contribution plans for the years ended December 31, 2016, 2015 and 2014 amounted to $152 million, $77 million and $70 million.
As of December 31, 2016, the aggregate future minimum rental commitments under all non-cancellable operating lease agreements are as follows:
For certain subsidiaries and associates, the Company has the right to purchase shares (a call option) from co-shareholders at various dates in the future. In addition, the co-shareholders of certain subsidiaries and associates have the right to sell their shares (a put option) to the Company at various dates in the future. Generally, the exercise price of such put options and call options is formula-based (using revenues and earnings) and is designed to reflect fair value. Based on current projections of profitability and exchange rates, and assuming the put options are exercised, the potential amount payable from these options is not expected to exceed $73 million.
On October 1, 2015, Legacy Towers Watson made a capital commitment of $40 million to Longitude Holdings Limited in exchange for 48,322 common shares outstanding representing 24.2% of outstanding equity ownership. As of December 31, 2016, approximately $5 million of capital contributions had been made towards this commitment.
Between November 12, 2015 and December 10, 2015, in connection with the then-proposed Merger, Towers Watson received demands for appraisal under Section 262 of the Delaware General Corporation Law on behalf of ten purported beneficial owners of an aggregate of approximately 2.4% of the shares of Towers Watson common stock outstanding at the time of the Merger. Between March 3, 2016 and March 23, 2016, three appraisal petitions were filed in the Court of Chancery for the State of Delaware on behalf of three purported beneficial owners of an aggregate of 1,354,338 shares of Towers Watson common stock, captioned Rangeley Capital LLC v. Towers Watson & Co., C.A. No. 12063-CB, Merion Capital L.P. v. Towers Watson & Co., C.A. No. 12064-CB, and College Retirement Equities Fund v. Towers Watson & Co., C.A. No. 12126-CB. The appraisal petitions seek, among other things, a determination of the fair value of the appraisal petitioners’ shares at the time of the Merger; an order that Towers Watson pay that value to the appraisal petitioners, together with interest at the statutory rate; and an award of costs, attorneys’ fees, and other expenses. Towers Watson answered the appraisal petitions between March 24, 2016 and April 18, 2016. On May 9, 2016, the court consolidated the three pending appraisal proceedings under the caption In re Appraisal of Towers Watson & Co., Consolidated C.A. No. 12064-CB. Based on all of the information to date, the Company is currently unable to estimate what the court would determine, following trial, to be the fair value of the appraisal petitioners; shares. It is possible that the court could determine that fair value was the same as, less than or greater than the value received by shareholders in the Merger. Therefore we are unable to provide an estimate of the reasonably possible loss or range of loss as to such value. The Company intends to vigorously defend against the appraisal proceedings.
The Company has been named as a defendant in 15 similar lawsuits relating to the collapse of The Stanford Financial Group (‘Stanford’), for which Willis of Colorado, Inc. acted as broker of record on certain lines of insurance. The complaints in these actions generally allege that the defendants actively and materially aided Stanford’s alleged fraud by providing Stanford with certain letters regarding coverage that they knew would be used to help retain or attract actual or prospective Stanford client investors. The complaints further allege that these letters, which contain statements about Stanford and the insurance policies that the defendants placed for Stanford, contained untruths and omitted material facts and were drafted in this manner to help Stanford promote and sell its allegedly fraudulent certificates of deposit.
On March 25, 2014, the parties in Troice and the Janvey, et al. v. Willis of Colorado, Inc., et al. action discussed below stipulated to the consolidation of the two actions for pre-trial purposes under Rule 42(a) of the Federal Rules of Civil Procedure. On March 28, 2014, the Court ‘so ordered’ that stipulation and, thus, consolidated Troice and Janvey for pre-trial purposes under Rule 42(a).
On April 20, 2015, the plaintiffs filed their motion for class certification, the defendants filed their opposition to plaintiffs’ motion, and the plaintiffs filed their reply in further support of the motion. Pursuant to an agreed stipulation also filed with the court on April 20, 2015, the defendants on June 4, 2015 filed sur-replies in further opposition to the motion. The Court has not yet scheduled a hearing on the motion.
statutory law and Texas common law and seeks special, consequential and treble damages of more than $300 million, attorneys’ fees and costs. On October 20, 2009, certain defendants, including Willis of Colorado, Inc., (i) removed Rupert to the U.S. District Court for the Western District of Texas, (ii) notified the JPML of the pendency of this related action and (iii) moved to stay the action pending a determination by the JPML as to whether it should be transferred to the Northern District of Texas for consolidation or coordination with the other Stanford-related actions. On April 1, 2010, the JPML issued a final transfer order for the transfer of Rupert to the Northern District of Texas. On January 24, 2012, the court remanded Rupert to Texas state court (Bexar County), but stayed the action until further order of the court. On August 13, 2012, the plaintiffs filed a motion to lift the stay, which motion was denied by the court on September 16, 2014. On October 10, 2014, the plaintiffs appealed the court’s denial of their motion to lift the stay to the U.S. Court of Appeals for the Fifth Circuit. On January 5, 2015, the Fifth Circuit consolidated the appeal with the appeal in the Rishmague, et ano. v. Winter, et al. action discussed below, and the consolidated appeal, was fully briefed as of March 24, 2015. Oral argument on the consolidated appeal was held on September 2, 2015. On September 16, 2015, the Fifth Circuit affirmed. The defendants have not yet responded to the complaint in Rupert.
On March 31, 2016, the Company entered into a settlement in principle for $120 million relating to this litigation, and we have therefore increased our provisions by $50 million. Further details on this settlement in principle are given below.
one-time cash payment of $120 million to the Receiver to be distributed to all Stanford investors who have claims recognized by the Receiver pursuant to the distribution plan in place at the time the payment is made.
The Settlement Term Sheet also provided the parties’ agreement to seek the Court’s entry of bar orders prohibiting any continued or future litigation against the Defendants and their related parties of claims relating to Stanford, whether asserted to date or not. The terms of the bar orders therefore would prohibit all Stanford-related litigation described above, and not just the Actions, including any pending matters and any actions that may be brought in the future. Final Court approval of these bar orders is a condition of the settlement.
On or about August 31, 2016, the parties to the settlement signed a formal Settlement Agreement memorializing the terms of the settlement as originally set forth in the Settlement Term Sheet. On September 7, 2016, the plaintiffs in the Troice and Janvey actions filed with the Court a motion to approve the settlement. On October 19, 2016, the Court preliminarily approved the settlement. Several of the plaintiffs in the other actions above have objected to the settlement. A hearing to consider final approval of the settlement was held on January 20, 2017 and the Court reserved decision. The Actions are stayed pending final approval of the settlement. The timing of any final decision is subject to the discretion of the Court and any appeal, and the Court may decide not to approve the settlement.
Plaintiff seeks the award of punitive damages, actual damages, exemplary damages, special damages, attorney’s fees and expenses, costs of suit, pre- and post- judgment interest at the maximum legal rate, and other unspecified legal and equitable relief. Plaintiff has not yet quantified fully its asserted damages.
Given the stage of the proceedings, the Company is currently unable to provide an estimate of the reasonably possible loss or range of loss. The Company disputes the allegations, and intends to defend the lawsuit vigorously.
Based on current information, the Company does not anticipate any further developments, and considers the matter to be closed.
On January 6, 2015, Meriter Health Services, Inc. (‘Meriter’), plan sponsor of the Meriter Health Services Employee Retirement Plan (the ‘Plan’) filed a complaint in Wisconsin state court against Towers Watson Delaware Inc. (‘TWDE’), a wholly-owned subsidiary of the Company, and against its former lawyers, individual actuaries, and insurers.
Plaintiffs’ claims all relate to a self-funded, non-profit Long Term Care Program that CalPERS established in 1995 (the ‘LTC Program’). Plaintiffs’ claims seek unspecified damages allegedly resulting from CalPERS’ 2012 decision to implement in 2015
In May 2016, the case was reassigned to a different judge. The court agreed that Towers Perrin may file a motion for summary judgment which was initially scheduled to be heard on February 3, 2017. The hearing date was thereafter moved to March 8, 2017, and the motion at this time has been fully briefed. In the event summary judgment is denied, the court has also agreed to consider potential motions by Towers Perrin and CalPERS to decertify or modify the class.
Accounts receivable are stated at estimated net realizable values. The provisions shown below as of the end of each period, are recorded as the amounts considered by management to be sufficient to meet probable future losses related to uncollectible accounts.
On December 31, 2015 the Company began using the SIMADI rate for the Venezuelan Bolivar (approximately Venezuelan bolivars 198.7 = U.S. dollar 1) instead of the SICAD I auction rate (approximately Venezuelan bolivars 13.5 = U.S. dollar 1) to translate on Venezuelan retail operations. In March 2016, the DICOM mechanism replaced the SIMADI mechanism. At December 31, 2016, the DICOM rate was approximately Venezuelan bolivars 673 = U.S. dollar 1.
Reclassification adjustments from accumulated other comprehensive income are included in Other expense/(income), net of foreign currency translation and gains and losses on cash flow hedges. See Note 9 - Derivative Financial Instruments for additional details regarding the reclassification adjustments for the hedge settlements.
Reclassification adjustments from accumulated other comprehensive income are included in the computation of net periodic pension cost (see Note 12 - Retirement Benefits) which is included in Salaries and benefits in the accompanying consolidated statements of operations.
This plan, which was established on April 25, 2012, provides for the granting of incentive stock options, time-based or performance-based non-statutory stock options, share appreciation rights, restricted shares, time-based or performance-based restricted share units (‘RSUs’), performance-based awards and other share-based grants or any combination thereof (collectively referred to as ‘Awards’) to employees, officers, non-employee directors and consultants (‘Eligible Individuals’) of the Company. The Board of Directors also adopted a sub-plan under the 2012 plan to provide an employee sharesave scheme in the United Kingdom.
In January 2016, in connection with the Merger, we assumed the Towers Watson & Co. 2009 Long-Term Incentive Plan (‘LTIP’) and converted the outstanding unvested restricted stock units and options into Willis Towers Watson restricted stock units (‘RSUs’) and options using a conversion ratio stated in the Merger Agreement. We determined the fair value of the portion of the outstanding RSUs and options related to pre-acquisition employee service using the straight-line methodology
from date of grant to the acquisition date to be $37 million, which was added to the transaction consideration. The fair value of the remaining portion of RSUs and options related to the post-acquisition employee services was $45 million, and will be recorded over the future vesting periods. For the year ended December 31, 2016, we recorded $31 million of non-cash stock based compensation.
The acquired awards include performance-vested restricted stock units. Under the RSU agreement, participants become vested in a number of RSUs based on the achievement of specified levels of financial performance during the performance period set forth in the Merger Agreement, provided that the participant remains in continuous service with us through the end of the performance period. Dividend equivalents will accrue on these RSUs and vest to the same extent as the underlying shares. The Compensation Committee of the Board of Directors may provide for continuation of vesting of restricted stock units upon an employee’s termination under certain circumstances such as qualified retirement. The definition of qualified retirement is age 55 with 15 years of service with the Company and a minimum of one year of service in the performance period. Due to the terms of the RSU agreement, the achievement of the level of financial performance is determined at the higher of 100% or the level attained at the time of the Merger.
Classification of options as time-based or performance-based is dependent on the original terms of the award. Performance conditions on the majority of options have been met. A summary of option activity under the plans at December 31, 2016, and changes during the year then ended is presented below:
The number of nonvested shares 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 total number of time-based restricted stock units vested during the year ended December 31, 2016 was 459,838 shares at an average share price of $120.42. The total number of time-based restricted stock units vested during the year ended December 31, 2015 was 408,032 shares at an average share price of $117.72.The total number of restricted stock units vested during the year ended December 31, 2014 was 261,530 shares at an average share price of $116.97. At December 31, 2016 there was $43 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements under the plan; that cost is expected to be recognized over a weighted average period of 1 year.
The total number of performance-based restricted stock units vested during the year ended December 31, 2016 was 258,536 shares at an average share price of $119.75. The total number of performance-based restricted stock units vested during the year ended December 31, 2015 was 63,180 shares at an average share price of $117.88. The total number of performance-based restricted stock units vested during the year ended December 31, 2014 was 62,216 shares at an average share price of $116.00. At December 31, 2016 there was $54 million of total unrecognized compensation cost related to nonvested performance-based share-based compensation arrangements under the plan; that cost is expected to be recognized over a weighted average period of 2 years.
At December 31, 2016 and 2015, there were 1.2 million and 1.6 million time-based share options; 0.9 million and 0.6 million performance based options; 0.4 million and 0.7 million restricted time-based share units; and 1.2 million and 0.7 million restricted performance-based share units outstanding, respectively.
Options to purchase 0.5 million, 0.6 million and 0.9 million shares were not included in the computation of the dilutive effect of share options for the years ended December 31, 2016, 2015 and 2014, respectively, because their effect was anti-dilutive. Options to purchase nil, 0.5 million, and 0.6 million restricted stock units were not included in the computation of the dilutive effect of share options for the years ended December 31, 2016, 2015 and 2014, respectively, because their effect was anti-dilutive. The number of options for 2015 and 2014 has been retroactively adjusted to reflect the reverse stock split on January 4, 2016. See Note 3 - Merger and Acquisitions for further details.
The Merger affects the comparability of this data between 2016 and other periods presented. See Note 3 - Merger and Acquisitions for additional information.
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, Trinity Acquisition plc, Willis Group Limited, Willis Towers Watson Sub Holdings Unlimited Company and WTW Bermuda Holdings Ltd., collectively the ‘Other Guarantors’, and with Willis Towers Watson, the ‘Guarantor Companies’.
On March 17, 2011, the Company issued senior notes totaling $800 million in a registered public offering. On March 15, 2016, $300 million of these senior notes was repaid leaving $500 million outstanding. These debt securities were issued by Willis Towers Watson (‘WTW Debt Securities’) and are guaranteed by certain of the Company’s subsidiaries. Therefore, the Company is providing the condensed consolidating financial information below. The following wholly owned subsidiaries (directly or indirectly) fully and unconditionally guarantee the WTW Debt Securities on a joint and several basis: Willis Netherlands Holdings B.V., Willis Investment U.K. Holdings Limited, TA I Limited, Trinity Acquisition plc, Willis Group Limited, Willis North America Inc., Willis Towers Watson Sub Holdings Unlimited Company and WTW Bermuda Holdings Ltd. (the ‘Guarantors’).
The equity method has been used for investments in subsidiaries in the condensed consolidating balance sheets of Willis Towers Watson and the Guarantors.
Trinity Acquisition plc has $2.1 billion of senior notes outstanding, of which $525 million were issued on August 15, 2013, $1.0 billion were issued on March 22, 2016 and €540 million ($609 million) were issued on May 26, 2016.
The guarantor structure described above differs from the guarantor structure associated with the senior notes issued by the Company and Willis North America (the ‘Willis North America Debt Securities’) in that Trinity Acquisition plc is the issuer and not a subsidiary guarantor, and Willis North America Inc. is a subsidiary guarantor.