Risk and Insurance Brokerage Services. Brokerage segment results are principally affected by:
•conditions in insurance markets, particularly fluctuations in premiums charged by insurance companies,
As more fully discussed below in "Key Recent Events," in November 2008 we completed the merger with Benfield Group Limited ("Benfield"), a leading independent reinsurance intermediary. Combining the Benfield operations with our existing and complementary reinsurance operations will allow Aon to offer clients an integrated set of risk management products and services, including treaty and facultative reinsurance, innovative risk capital management and related advisory services.
Liquidity is derived from cash flows from our businesses, excluding funds held on behalf of clients, and from financing. We use liquidity to:
Because we are a holding company, our subsidiaries may not have available cash to pay us dividends. Our access to cash generated from operations outside the U.S. may be affected by tax considerations and by pension funding requirements in our international pension plans.
•Our revenues from continuing operations increased $272 million or 4% overall. More specifically:
•Operating expenses increased 6% in 2008 due primarily to higher restructuring costs, unfavorable foreign exchange and higher compensation costs, partially offset by the savings related to our restructuring programs.
•Income from continuing operations decreased $41 million in 2008 to $621 million, as higher costs, especially restructuring expenses, more than offset higher revenue and a lower tax rate.
•We utilized the funds received from the sales of CICA and Sterling to increase the volume of share repurchases early in the year. During 2008, we repurchased approximately 42.6 million shares at a cost of $1.9 billion. Share repurchases were halted in August in anticipation of the merger with Benfield.
In August 2008, we announced that we had entered into an agreement to merge with Benfield. In November 2008, we completed the transaction, paying Benfield shareholders £3.50 per common share and £2.80 per preferred share ($1,281 million). We also acquired cash and assumed debt in the transaction. A portion of the cash acquired is restricted as to its use for general corporate purposes. We also announced in the fourth quarter a global restructuring plan in conjunction with the merger. The restructuring plan, which will continue through the end of 2011, is intended to integrate and streamline operations across the combined Aon Benfield organization. We estimate that this plan will result in cumulative costs totaling approximately $185 million over a three-year period, and that approximately $104 million of the costs will be included in the purchase price allocation with the remainder being recorded in operations in future periods.
All of our financial information reflects the application of critical accounting policies, estimates, assumptions and judgments, as discussed below under "Critical Accounting Policies and Estimates."
In addition to Benfield, we purchased 30 companies during 2008, primarily related to our Risk and Insurance Brokerage operations, for an aggregate amount of $105 million. Among the other companies purchased, in early 2008 we agreed to buy substantially all of A. J. Gallagher's U.S. and U.K. reinsurance brokerage business for $30 million in cash, plus an additional payment based on revenue produced by the acquired businesses in the first year after the deal closed. This transaction gives us a larger presence as a reinsurance broker for accident, health and life insurance in the U.S., and for accident and specialty casualty and financial institutions insurance in the U.K.
In January 2009, we reached a definitive agreement to sell our FFG Insurance Company ("FFG"), Atlanta International Insurance Company ("AIIC") and Citadel Insurance Company ("Citadel") (together the "P&C operations") to National Indemnity Company. FFG and Citadel were property and casualty insurance operations that were in runoff and had been previously included in unallocated income and expense. Operating results for these units have been reclassified to discontinued operations for all periods presented. AIIC was a unit of Alexander & Alexander Services, Inc. ("A&A") which was placed in run-off in 1985 when A&A discontinued its property and casualty insurance underwriting operations. At the time of our acquisition of A&A in 1997, we placed the operations of AIIC, among other run-off units still operated by A&A, into discontinued operations. The sale is subject to various closing conditions and is expected to be completed in the first half of 2009. We estimate that we will
•CICA was sold to ACE Limited for cash consideration of $2,525 million, after final adjustments. We also received a one-time dividend of $325 million from CICA prior to the close of the transaction.
We have included CICA and Sterling's operating results through the date of sale in discontinued operations. We recorded a pretax gain on these sales of approximately $1.4 billion.
•Aon Warranty Group ("AWG") and its worldwide warranty and credit operations, which were previously included in the Insurance Underwriting segment, and
Results of the businesses included in discontinued operations are as follows (in millions):
business, Aon has guaranteed the collection of the principal amount of the premium finance notes sold to the buyer, estimated at closing to be approximately $745 million, if losses exceed the historical credit loss reserve for the business. Historical losses in this business have been very low since the premium finance notes are generally fully collateralized by the lender's right, in the event of non-payment, to cancel the underlying insurance contract and collect the unearned premium from the insurance carrier. In addition, we may receive up to $10 million from the buyer over the next two years based on the amount of insurance premiums and related obligations financed by the buyer over such period that are generated from certain of Cananwill's producers.
In 2007, we sold the following businesses that remained in our continuing operating results:
•25% of our Botswana subsidiary, which is included in the Risk and Insurance Brokerage Services segment. A pretax gain of $4 million was recognized on the sale.
In fourth quarter 2008, we announced a global restructuring plan ("Aon Benfield Plan") in conjunction with our merger with Benfield. The restructuring plan, which will continue through the end of 2011, is intended to integrate and streamline operations across the combined Aon Benfield organization. The Aon Benfield Plan includes an estimated 500 to 700 job eliminations. Additionally, duplicate space and assets will be abandoned. We estimate that this plan will result in cumulative costs totaling approximately $185 million over a three-year period, and that approximately $104 million of the costs will be included in the purchase price allocation with the remainder being recorded in operations in future periods.
The following is a summary of the restructuring costs related to the Aon Benfield Plan and our estimate of the amounts that will be included in the purchase price allocation and our ongoing operations (in millions):
In 2007, we announced a global restructuring plan intended to create a more streamlined organization and reduce future expense growth to better serve clients ("2007 Plan"). The three-year plan has evolved as new opportunities have been identified and existing initiatives have been finalized. We estimate that the 2007 Plan will result in cumulative pretax charges totaling approximately $550 million. Expenses will include workforce reduction and lease consolidation costs, asset impairments, as well as other expenses necessary to implement the restructuring initiative. We recorded approximately $251 million and $46 million of restructuring and related expenses in 2008 and 2007, respectively, and expect the remaining restructuring and related expenses to affect operations through the end of 2009.
The 2007 Plan includes an estimated 3,900 job eliminations beginning in the third quarter of 2007 and continuing into 2009. Through the end of 2008, 1,400 job eliminations have occurred. We also expect to close or consolidate several offices resulting in sublease losses or lease buy-outs. Costs related to the restructuring are included in compensation and benefits, other general expenses and depreciation and amortization in the accompanying consolidated statements of income.
(1)Actual costs, when incurred, will vary due to changes in the assumptions built into this plan. Significant assumptions likely to change when plans are finalized and approved include, but are not limited to, changes in severance calculations, changes in the assumptions underlying sublease loss calculations due to changing market conditions, and changes in the overall analysis that might cause the Company to add or cancel component initiatives. Workforce reductions reflect a cash expense, though we may recognize the expense before paying for the expenditure. Asset impairments are non-cash expenses. Lease consolidation accruals reflect the present value of future cash flows. Other costs are cash expenses, which are expensed in the period in which they are incurred.
•what we disclose as contingent assets and liabilities at the date of the financial statements, and
•regularly evaluate our estimates, assumptions and judgments, including those concerning restructuring, pensions, contingencies, intangible assets, share-based payments, income taxes and policy liabilities.
Restructuring costs that meet certain criteria are included in the purchase price allocation when related to an acquisition, or are expensed as incurred in accordance with FASB Statement No. 112, Employers Accounting for Postemployment Benefits and FASB Statement No. 146, Accounting for Costs Associated with Exit or Disposal Activities. Statement No. 146 applies to one-time workforce reduction benefits and requires companies to use Statement No. 112 when severance is paid under an ongoing severance policy. Lease consolidation costs, asset impairments and other costs associated with restructuring are accounted for under Statement No. 146 and FASB Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.
When employees are receiving incentives to stay beyond the legally required notification period, we record the cost of their severance over the remaining service period.
We have developed a restructuring plan related to our acquisition of Benfield ("Aon Benfield Plan"). The Aon Benfield Plan is accounted for in accordance with Emerging Issues Task Force (EITF) Issue No. 95-3, Recognition of Liabilities in Connection with a Purchase Business Combination, and includes reductions in staffing levels and the abandonment of excess facilities. In connection with these restructuring activities and as part of the cost of the acquisition, we established liabilities, primarily for severance and excess facilities. As required by EITF Issue No. 95-3, we will finalize our restructuring plans no later than one year from the date of the acquisition. Upon finalization of the restructuring plans or settlement of obligations for less than the expected amount, any excess liabilities will be reversed with a corresponding decrease in goodwill.
Our U.S. pension plans were closed to new entrants in 2004. In 2007, we began determining future pension benefits using a "career average pay" formula rather than the prior "final average pay" formula. Effective April 1, 2009, the Company will cease crediting future benefits relating to salary and service. As a result, we will recognize a curtailment gain of approximately $83 million in 2009. Our U.K. pension plans are also closed to new entrants. In 2007, future benefit accruals relating to salary and service ceased in the U.K. plans.
•we reported a fair value of pension assets of $1,087 million, while market-related value of assets is $1,304 million.
In accordance with FASB Statement No. 87 Employers' Accounting for Pensions, we defer recognition of gains and losses that arise from events such as changes in the discount rate and actuarial assumptions, actual demographic experience and asset performance.
losses for the U.S. plan based on the average future service of active employees. After the adoption of this amendment, unrecognized gains and losses for the U.S. plan will be based on the average life expectancy of plan members. We amortize prior service costs or credits which arise as a result of plan changes over a period based on the average expected future service of active employees in the plans at the time the prior service costs or credits were established.
The following table discloses our combined experience loss, prior service costs or credits, the number of years that we are amortizing the experience loss over, and the estimated 2009 amortization by each plan (amounts in millions):
The U.S. amount includes the impact of ceasing benefits relating to salary and service to U.S. participants, effective April 1, 2009.
In determining the expected rate of return for the U.K., Netherlands and Canadian plans, we analyzed investment community forecasts and current market conditions to develop expected returns for each of the asset classes used by the plans. We:
Generally, the U.K. plans' trustees determine the investment policy for each plan. Because there are several pension plans maintained in the U.K., our target allocation represents a weighted average of the target allocation of each plan. Further, target allocations are subject to change.
In total, at the end of the 2008 valuation year, the U.K. plans were invested 50% in equities and 50% in fixed income securities. The Netherlands's plan was invested 29% in equities and 71% in fixed income securities. The Canadian plans were invested 64% in equities and 36% in fixed income securities.
Holding all other assumptions constant, the following table reflects what a one hundred basis point increase and decrease in our estimated liability discount rate would have on our estimated 2009 pension expense (in millions):
Holding other assumptions constant, the following table reflects what a one hundred basis point increase and decrease in our estimated long-term rate of return on plan assets would have on our estimated 2009 pension expense (in millions):
We estimate contributions of approximately $400 million in 2009, and we are continuing to pursue strategic alternatives to control volatility in the pension plans.
We are required to assess the likelihood of material adverse judgments or outcomes as well as potential ranges or probability of losses. We determine the amount of reserves required, if any, for contingencies after carefully analyzing each individual issue. The required reserves may change due to new developments in each issue, or changes in approach, such as changing our settlement strategy.
Intangible assets represent the excess of cost over the value of net tangible assets of acquired businesses. We classify our intangible assets as either goodwill, trademarks, client lists, non-compete agreements, or other purchased intangibles. Our goodwill and other intangible balances at December 31, 2008 were $5,637 million and $779 million, respectively, compared to $4,915 million and $204 million, respectively, at December 31, 2007. The acquisition of Benfield in 2008 resulted in goodwill of $1,064 million and intangible assets of $583 million.
We review intangible assets that are being amortized for impairment whenever events or changes in circumstance indicate that its carrying amount may not be recoverable.
Stock-based compensation expense is based on the value of the portion of share-based payment awards that we ultimately expect to vest during that period. Thus, we have reduced expense for estimated forfeitures. We estimate forfeitures at the time of grant and revise our estimates, if necessary, in subsequent periods if actual forfeitures differ from those estimates. When the terms of an award require no additional service, the award is fully expensed at the grant date. When awards are modified, we account for the incremental shares at the fair market value at the date of modification. Expense recognition begins on the date the service period begins, which can precede or be after the grant date, depending on the provisions of the award.
•use a range of assumptions over the expected term of the options and
Beginning in 2006, executives and key employees may receive performance-based awards, which ultimately result in the receipt of RSUs, if the employee achieves his or her objectives. Such objectives may be made on a personal, group or company level. The RSUs may be immediately vested or have a future additional service period. Generally, our performance awards are fixed, which means we determine the fair value of the award at the grant date, estimate the number of shares to be delivered at the end of the performance period, and recognize the expense over the performance or vesting period, whichever is longer.
In 2007, we adopted FASB Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109. FIN 48 clarifies the accounting for uncertainty in income taxes which are recognized in a company's financial statements in accordance with Statement No. 109, and prescribes a recognition threshold and measurement of a tax position taken, or expected to be taken, in a company's tax return. As a result of our adoption of FIN 48, we did not record any adjustments to the liability for unrecognized tax benefits.
as of the end of each accounting period. After the sale is closed, we will no longer have any obligation related to these claims and claims adjustment expenses. If these liabilities prove inadequate prior to the completion of the sale, we would be required to increase the reserves, which could hurt our results and financial condition.
Many of these factors are not quantifiable in advance, and both internal and external events, such as changes in claims handling procedures, inflation, judicial and legal developments, and legislative changes, can cause our estimates to vary. The inherent uncertainty of estimating reserves is greater for certain types of liabilities, where the variables affecting the claims are subject to change and long periods of time may elapse before we can definitively determine liability. We periodically refine our reserve estimates as further losses are reported and settled and we continue to adjust the reserves as necessary when we change our estimates.
We estimate loss reserves for all property and casualty lines of business by accident year using several standard actuarial techniques, which include, but are not limited to incurred and paid loss development methods, the Bornhuetter-Ferguson method, and frequency/severity methods. We project ultimate losses on a direct, assumed, ceded and net basis, and deduct paid losses from the selected ultimate losses to arrive at the total indicated reserve. The total indicated reserve includes case reserves and incurred but not reported reserves. Our loss reserve estimates are influenced by factors such as the consistency of the results from actuarial techniques and our knowledge of emerging loss trends and rate or benefit changes.
•the impact from acquisitions, divestitures, transfer of business units, reimbursable expenses, and unusual items, which represent the most significant reconciling items.
•lower non-liquidating distributions from our Private Equity Partnership Structure I, LLC ("PEPS I") investment of $29 million,
•Asia Pacific revenue increased $34 million to $660 million, driven by organic revenue growth in most countries in Asia, along with favorable foreign exchange, which more than offset the impact of certain regulatory changes in Japan.
•$240 million or 6% increase in compensation and benefits, reflecting the impact of higher restructuring charges, acquisitions, unfavorable foreign exchange, as well as higher salary and incentive costs, which more than offset significant restructuring savings.
Other (income) expense was an expense of $39 million in 2008 versus income of $35 million in 2007. The higher expense was driven by costs associated with acquiring Benfield and lower net gains on sale of businesses.
The effective tax rate on income from continuing operations was 28.0% in 2008 and 34.5% in 2007.
•2008 and 2007, our effective tax rate also reflects the favorable resolution of tax examination issues, adjustments, and tax credits.
•2008, our rate was reduced by changes in corporate tax rates in certain foreign countries, most notably in the U.K., which reduced the enacted corporate tax rate from 30% to 28%.
For a summary of these effects, please see the rate reconciliation provided in Note 11 to the consolidated financial statements.
•Income from continuing operations declined to $621 million ($2.06 diluted net income per share) from $662 million ($2.07 diluted net income per share). Currency fluctuations positively impacted our income from continuing operations in 2008 by $0.16 per diluted share when we translate last year's statement of income at this year's foreign exchange rates. 2007's income from continuing operations was positively impacted by $0.06 per diluted share.
•$841 million in 2008 ($2.94 and $2.80 per basic and diluted net income per share, respectively). These results include the gain on the sale of our CICA and Sterling subsidiaries, the operations of CICA and Sterling for the first quarter of 2008, and the full year operations of AIS. These gains were offset in part by the estimated loss on sale of our remaining P&C operations.
- non-liquidating distributions from our PEPS I investment of $61 million,
- $14 million of realized losses on our Endurance warrants in 2006,
These increases were partially offset by a $35 million gain recognized in 2006 in connection with the contribution of our preferred stock investment in Scandent, received from the sale of our Cambridge operation, to one of our U.K. pension plans.
•U.S. revenue increased $65 million or 2%, reflecting growth in our retail business and affinity operations, partially offset by a soft reinsurance market and lower investment gains attributable to the gain recognized in 2006 on the contribution of our Scandent preferred stock.
•$166 million or 11% increase in other general expenses, reflecting unfavorable foreign exchange, the impact of acquisitions and the settlement of litigation in early 2007 for acquired employees in our U.K. reinsurance business.
•$29 million decrease in depreciation and amortization due to lower write-offs and a lower depreciable base than the prior year.
Interest expense rose $9 million as a result of higher interest rates and foreign exchange translation.
•$202 million in 2007 ($0.67 and $0.62 per basic and diluted net income per share, respectively). These results include a full year of operations for CICA and Sterling, AIS, our remaining P&C operations, as well as residual settlement activity relating to our 2006 AWG and CPG disposals.
•$230 million in 2006 ($0.73 and $0.68 per basic and diluted income per share, respectively). Results in 2006 include a full year of operations for CICA, AIS and our remaining P&C operations, and eleven months of operations and the gain on sale of AWG and CPG.
(1)Intersegment revenues of $25 million, $29 million and $59 million were included in 2008, 2007 and 2006, respectively. See Note 18 to the consolidated financial statements for further information. Risk and Insurance Brokerage Services
In 2007, we experienced a soft market in many business lines/segments and in many geographic areas. In a "soft market," premium rates flatten or decrease, along with commission revenues, due to increased competition for market share among insurance carriers or increased underwriting capacity. Prices fell throughout the year, with the greatest declines seen in large and middle-market accounts. Prices continued to decline during 2008, although the rate of decline slowed toward the end of the year. Changes in premiums have a direct and potentially material impact on the insurance brokerage industry, as commission revenues are generally based on a percentage of the premiums paid by insureds.
•provides affinity products for professional liability, life, disability income, and personal lines for individuals, associations, and businesses;
•provides investment banking products and services, including mergers and acquisitions and other financial advisory services, capital raising, contingent capital financing, insurance-linked securitizations and derivative applications;
This table details Risk and Insurance Brokerage Services commissions, fees and other by subsegment (in millions):
This table reconciles organic revenue growth to reported commissions, fees and other growth for 2008 versus 2007:
Europe, Middle East & Africa revenue increased 13%, driven by favorable foreign exchange rates, acquisitions, and 4% organic revenue growth with strong growth in Italy, Spain, the Middle East and Africa.
Asia Pacific commissions, fees and other increased 2%, due to the positive impact of foreign currency translation and strong organic growth in Asia and New Zealand, partially offset by the impact of certain regulatory changes in Japan.
U.S. revenue increased 1% over 2007 reflecting growth in our Affinity and reinsurance operations. The increase was partially offset by declines in our U.S. retail and premium finance operations, reflecting soft market conditions.
Pretax income decreased $136 million or 13% from 2007 to $874 million. In 2008, pretax margins in this segment were 14.0%, down 300 basis points from 17.0% in 2007. Contributing to decreased margins and pretax income were:
•lower gains on the sale of businesses compared to last year, and
The recent disruption in the global credit markets and the deterioration of the financial markets has created significant uncertainty in the marketplace. A severe and/or prolonged economic downturn could hurt our clients' financial condition and the levels of business activities in the industries and geographies where we operate. While we believe that the majority of our practices are well positioned to manage through this time, these challenges may reduce demand for some of our services or depress pricing of those services and have an adverse effect on our new business and results of operations.
1.Health and Benefits advises clients about how to structure, fund, and administer employee benefit programs that attract, retain, and motivate employees. Benefits consulting includes health and welfare, executive benefits, workforce strategies and productivity, absence management, benefits administration, data-driven health, compliance, employee commitment, investment advisory and elective benefits services.
2.Retirement professionals specialize in global actuarial services, defined contribution consulting, investment consulting, tax and ERISA consulting, and pension administration.
4.Strategic Human Capital delivers advice to complex global organizations on talent, change and organizational effectiveness issues, including talent strategy and acquisition, executive on-boarding, performance management, leadership assessment and development, communication strategy, workforce training and change management.
This table shows Consulting revenue by geographic area and pretax income (in millions):
•United Kingdom revenue declined 6%, driven by unfavorable foreign exchange translation despite strong organic revenue growth.
•Europe, Middle East & Africa and Asia Pacific revenue increased 13% and 27%, respectively, driven by favorable foreign currency translation and organic revenue growth.
Unallocated income consists primarily of investment income, including income or loss on investment disposals and other-than-temporary impairment losses, which is not otherwise reflected in the operating segments. We include invested assets and related investment income not directly required to support the risk and insurance brokerage services and consulting businesses.
Private equities are principally carried at cost; however, where we have significant influence, they are reported using the equity method of accounting. These investments usually do not pay dividends. Limited partnerships ("LPs") are accounted for using the equity method and changes in the value of the underlying LP investments flow through unallocated investment income.
Unallocated investment income was $68 million in 2008, a decrease of $11 million over 2007 and was driven by:
Unallocated expenses include corporate governance and other costs not attributable to the operating segments. These expenses increased to $166 million in 2008 from $130 million in 2007, driven by:
Our operating subsidiaries obtain liquidity through selling their products and services and collecting their receivables. These subsidiaries use the funds collected to pay creditors and employees and to fund acquisitions. They segregate funds that Aon is holding on behalf of clients to satisfy policyholder liabilities, so they are not available for other uses. We believe that our operating subsidiaries will have adequate liquidity to meet their needs in the foreseeable future and to provide funds to the parent company.
•received $2.8 billion, net of taxes, from the sales of our CICA and Sterling subsidiaries
•paid $1.3 billion to acquire all the common and preferred shares of Benfield, and
Cash flows provided by operating activities for the twelve months ended December 31, 2008 and 2007 are as follows (in millions):
The insurance underwriting subsidiaries used revenues generated from premiums, investments and other miscellaneous income to pay claims and other cash benefits, commissions, general expenses and taxes. Claims and other cash benefits paid were $373 million in 2008 versus $1,321 million in 2007. Commissions and general expenses paid were $232 million for 2008, compared to $793 million in 2007. Tax payments for 2008 were $63 million compared to $73 million last year.
Investing activities generated cash of $1.4 billion. We received $2.8 billion in cash from the sale of our CICA and Sterling subsidiaries. Cash flows used by investing activities included purchases, net of sales of investments, of $217 million. Cash of $103 million was used for capital expenditures, net of disposals. Acquisitions during 2008 included the merger with Benfield for $991 million, net of cash acquired, and various other acquisitions of $105 million.
•Working capital, excluding assets and liabilities held-for-sale, decreased $435 million to $1.6 billion, reflecting lower short-term investments as a result of repurchasing shares and the purchase of Benfield.
•Short-term debt decreased by $147 million as a result of paying down our short-term borrowings under our Euro facility, partially offset by debt assumed from Benfield.
•Goodwill increased $722 million, due primarily to the Benfield merger ($1,064 million), partially offset by a decrease due to the impact of foreign exchange rates.
•Other intangible assets increased $575 million, mainly due to the Benfield merger, partially offset by current year amortization.
•Pensions, post employment and post retirement liabilities increased by $443 million as a result of adverse pension asset performance, mortality changes and lower discount rates in the U.S. This increase more than offset the impact of contributions made to our pension plans, higher discount rates in the international plans and the impact of foreign currency translation.
•Other non-current liabilities increased by $265 million due primarily to the merger with Benfield in 2008.
Total debt at December 31, 2008, was $2.0 billion, a decrease of $168 million from December 31, 2007, reflecting lower overall borrowings under our Euro Credit facility and the impact of foreign currency translation, offset in part by an increase due to including debt related to a variable interest entity for which Benfield is the primary beneficiary.
Our total debt as a percentage of total capital was 27.1% and 25.6% at December 31, 2008 and 2007, respectively.
We have disclosed future payments of our long-term debt and operating lease commitments with initial or remaining non-cancelable lease terms in excess of one year in Note 10 to the consolidated financial statements.
At December 31, 2008, we had a $600 million U.S. committed bank credit facility, which expires in February 2010, to support commercial paper and other short-term borrowings. This facility allows us to issue up to $150 million in letters of credit.
We also have foreign credit facilities available. At December 31, 2008, we had available to us:
•a five-year €650 million ($912 million) multi-currency facility, of which $605 million was outstanding at December 31, 2008. See Note 10 to the consolidated financial statements for further discussion on both our U.S. and Euro facilities, and
This table shows the major rating agencies' ratings of our debt at February 24, 2009:
During 2008, Moody's Investor Service changed our rating outlook to stable from positive, reflecting the integration risk associated with the recently completed Benfield merger and the decline in our cash position.
Accumulated other comprehensive loss increased $736 million since December 31, 2007. Compared to year-end 2007:
•net foreign exchange translation decreased by $182 million because of the strengthening of the U.S. dollar against foreign currencies, especially in the fourth quarter,
•our net post-retirement benefit obligation increased by $497 million, reflecting adverse pension asset performance and lower discount rates.
Juniperus Insurance Opportunity Fund Limited ("Juniperus"), a VIE, is an investment vehicle that invests in an actively managed and diversified portfolio of insurance risks. In 2008, a subsidiary of Aon Benfield acquired a 76% equity interest in the Juniperus' Class A shares. Also in 2008, Juniperus Capital Holdings Limited ("JCHL") was formed to provide investment management and related services to Juniperus. Aon Benfield has 55% of the economic interest and 66% of the voting interest of JCHL. Based on Aon Benfield's equity interest in Juniperus, it is subject to a majority of the expected residual returns and losses. Similarly, Aon Benfield's equity interest and loan to JCHL would deem it to absorb a majority of the expected losses in JCHL. Therefore, Aon Benfield is considered the primary beneficiary of both companies. Aon is required to consolidate both Juniperus and JCHL under the provisions of FIN 46(R). At December 31, 2008, Juniperus and JCHL together had assets of $121 million and liabilities of $68 million. For Juniperus, if a disaster such as wind, earthquakes or other named catastrophe occurs, we could lose some or all of our equity investment of approximately $55 million.
Some of our U.S., U.K., Canadian, and Australian subsidiaries originate short-term loans (generally with terms of 12 months or less) to businesses to finance their insurance premium obligations, and then sell these premium finance agreements in securitization transactions that meet the criteria for sale accounting under Statement No. 140.
The sale agreements limit the total amount advanced by the Bank SPEs on premium finance agreements sold to them at any one time, which were $1.2 billion and $1.8 billion at December 31, 2008 and 2007, respectively. After the sale of the U.S. operations, the amount that can be advanced by the Bank SPEs is approximately $240 million.
•various other unaffiliated companies sell receivables to the Bank SPEs, and
•unaffiliated third parties have either made substantial equity investments in the Bank SPEs, hold voting control of the Bank SPEs, or generally have the risks and rewards of ownership of the assets of the Bank SPEs through liquidity support agreements or other arrangements involving significant variable interests.
We record gains on the sale of premium finance agreements. When we calculate the gain, we include all costs we expect to incur for the relevant Bank SPEs. The gains, which are included in commissions, fees and other revenue in the consolidated statements of income, were $54 million, $64 million and $63 million for the years ended December 31, 2008, 2007 and 2006, respectively. In addition, we:
•record our retained interest in the sold premium finance agreements at fair value, and report it in receivables in the consolidated statements of financial position,
•estimate fair value by discounting estimated future cash flows using discount rates that are commensurate with the underlying risk, expected future prepayment rates, and credit loss estimates, and
•remain contingently liable should the funding costs of the U.S. Bank SPEs exceed the interest and late fees accrued or collected on the sold U.S. portfolio and
•continually review our retained interest in the sold portfolio, taking into consideration credit loss trends in the sold portfolio, conditions in the credit markets and other factors, and adjust its carrying value accordingly.
For those operations we continue to own, we intend to renew the conduit facilities, which have 364-day terms, as they expire. The current environment in the credit markets has influenced the renewal process and the renewed U.S., Canadian and U.K. terms are more restrictive. In more detail:
•based upon our estimated needs for the coming year, we reduced the level of committed availability by $479 million at the renewal dates, have further reduced the committed availability to its current level, and had scheduled additional decreases of $160 million by March 31, 2009.
•the securitization program costs added on the pass-through funding costs from the U.S. Bank SPEs.
We also face the risk the Bank SPEs will be unable to provide the liquidity or will become an unreliable source of the liquidity necessary to fund new premium finance agreements. If this occurs, we will consider alternate sources of funding, including other forms of off-balance sheet as well as on-balance sheet financing, or discontinue the origination of premium finance agreements. Furthermore, if there were adverse bank, regulatory, tax, or accounting rule changes, our access to the conduit facilities and special purpose vehicles could be affected.
•sold approximately $171 million of investment grade fixed-maturity securities to unaffiliated third parties and
As part of this transaction, we are required to purchase additional fixed-maturity securities from PEPS I in an amount equal to the unfunded LP commitments as they are requested. These fixed-maturity securities are rated below investment grade. As of December 31, 2008, the unfunded commitments amounted to $42 million. These commitments have specific expiration dates, and the general partners may decide not to draw on these commitments.
•during 2008, $32 million, which is included in investment income, a decrease of $29 million from 2007.
•Beginning in 2007, PEPS I had redeemed or collateralized all of its debt, and as a result, began to pay preferred income distributions.
•summarizes our significant contractual obligations at December 31, 2008, and the future periods during which we expect to settle these obligations in cash, and
We have provided additional details about some of these obligations in our notes to the financial statements (in millions):
(1)Included in purchase obligations are contracts for various information technology contracts. As of December 31, 2008, we can exit these obligations for termination payments of $86 million. However, given the nature of these contracts, we have included them in our contractual obligations table.
(2)Also included in purchase obligations is a $309 million contract for claims outsourcing in the U.K. We can exit this obligation after 2013 for approximately $29 million.
(3)Pension and other postretirement benefit plan obligations include estimates of our minimum funding requirements, pursuant to ERISA and other regulations and minimum funding requirements agreed with the trustees of our U.K. pension plans. Additional amounts may be agreed to with the U.K. pension plan trustees. Nonqualified pension and other postretirement benefit obligations are based on estimated future benefit payments. We may make additional discretionary contributions.
(4)Excludes $69 million of liabilities for unrecognized tax benefits due to our inability to reasonably estimate the period(s) when cash settlements will be made.
Management of Aon Corporation and its subsidiaries is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. The Company's internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles.
Based on our assessment, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2008.
We have audited Aon Corporation's internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Aon Corporation's management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company's assets that could have a material effect on the financial statements.
In our opinion, Aon Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on the COSO criteria.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Aon Corporation at December 31, 2008 and 2007, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2008, in conformity with U.S. generally accepted accounting principles.
(1) 2008 includes $376 of tax payments related to the sale of CICA and Sterling.
The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles ("GAAP"). The consolidated financial statements include the accounts of Aon Corporation and its majority-owned subsidiaries and variable interest entities ("VIEs") for which Aon is the primary beneficiary ("Aon" or the "Company"). The consolidated financial statements exclude special-purpose entities ("SPEs") considered VIEs for which Aon is not the primary beneficiary. All material intercompany accounts and transactions have been eliminated.
The Company's operations include collecting premiums and claims amounts from clients and insurers. Beginning in 2008, the Company began reporting unremitted amounts as fiduciary assets. Previously, these amounts were reported in short-term investments and receivables. 2007 amounts have been reclassified to conform to this presentation. In addition, certain amounts in prior years' consolidated financial statements and footnotes related to discontinued operations have been reclassified to conform to the 2008 presentation.
Cash and cash equivalents include cash balances and all highly liquid investments with initial maturities of three months or less.
Cash and cash equivalents for 2008 included restricted balances of $194 million. Restricted balances are held for the benefit of a reinsurance agreement with a third-party reinsurance company.
Short-term investments include certificates of deposit, money market funds and highly liquid debt instruments purchased with initial maturities in excess of three months and up to one year and are carried at amortized cost, which approximates fair value. Short-term investments also include fixed maturity securities that mature within a year, and are reported at fair value.
In its capacity as an insurance agent and broker, Aon collects premiums from insureds and, after deducting its commission, remits the premiums to the respective insurers. Aon also collects claims or refunds from insurers on behalf of insureds. Uncollected premiums from insureds and uncollected claims or refunds from insurers are recorded as fiduciary assets in the Company's consolidated statements of financial position. Unremitted insurance premiums and claims are held in a fiduciary capacity. The obligation to remit these funds is recorded as fiduciary liabilities on the Company's consolidated statement of financial position. The time frame that the Company holds such funds is dependent upon the date the insured remits the payment of the premium to Aon and the date Aon is required to forward those payments to the insurer.
Property and equipment is stated at cost, less accumulated depreciation. Depreciation is generally calculated using the straight-line method over estimated useful lives. Included in this category is internal use software, which is software that is acquired, internally developed or modified solely to meet internal needs, with no plan to market externally. Costs related to directly obtaining, developing or
upgrading internal use software are capitalized and amortized using the straight-line method over a range principally between 3 to 5 years. The weighted-average original life of Aon's software at December 31, 2008 is 4.4 years.
•Equity method investments - Aon accounts for limited partnership and other investments using the equity method of accounting if the investment gives Aon the ability to exercise significant influence over, but not control of, an investee. Significant influence generally represents an ownership interest between 20% and 50% of the voting stock of the investee. Under the equity method of accounting, investments are stated at initial cost and are adjusted for subsequent additional investments and the proportionate share of earnings or losses and distributions.
•Private Equity Partnership Structures I, LLC Preferred Stock ("PEPS I") - The Company's investment in PEPS I is carried at fair value, estimated primarily from valuations received from the general partners of the limited partnership interests held by PEPS I. Further information on PEPS I is included in Note 9.
Aon adopted FASB Statement No. 157, Fair Value Measurements and Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities as of January 1, 2008. Both standards address aspects of fair-value accounting. Statement No. 157 defines fair value, establishes a consistent framework for measuring fair value and expands disclosure requirements about fair-value measurements. Under Statement No. 159, the Company has the ability to elect to report most financial instruments and certain other items at fair value on an instrument-by-instrument basis with changes in fair value reported in earnings. After the initial adoption, the election is made at the acquisition of an eligible financial asset, financial liability, or firm commitment or when certain specified reconsideration events occur. The fair value election may not be revoked once an election is made. The implementation of Statement No. 157 did not have a material impact on the consolidated financial statements. When adopting Statement No. 159, the Company did not elect to report any additional financial instruments at fair value. See Note 16 for further discussion of the effect of adopting Statement No. 157 on the Company's consolidated financial statements.
In September 2008, the FASB issued Staff Position No. FAS 133-1 and FIN 45-4 ("FSP FAS 133-1 and FIN 45-4"), Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45; and Clarification of the Effective Date of FASB Statement No. 161. This FSP (1) requires disclosures by sellers of credit derivatives, including credit derivatives embedded in a hybrid instrument (2) requires an additional disclosure about the current status of the payment/performance risk of a guarantee and (3) clarifies the FASB's intent about the effective date of Statement No. 161. The provisions of the FSP that amend Statement No. 133 and Interpretation No. 45 are effective for reporting periods ending after November 15, 2008. The clarification of the effective date of Statement No. 161 is effective upon issuance of the FSP. The Company's disclosures pertaining to its reinsurance guarantee are included in Note 7.
On December 31, 2006, the Company adopted FASB Statement No. 158, Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No 87, 88, 106, and 132(R). Statement No. 158 requires plan sponsors of defined benefit pension and other postretirement benefit plans (collectively, "postretirement benefit plans") to recognize the funded status of their postretirement benefit plans in the statement of financial position, measure the fair value of plan assets and benefit obligations as of the date of the fiscal year-end statement of financial position, and provide additional disclosures. Adoption of the measurement date provisions of Statement No. 158 resulted in the Company changing the measurement date of its U.S. plans (previously November 30) and U.K. plans (previously September 30) to December 31. The impact of adopting Statement No. 158
was a decrease to stockholders' equity of $349 million and $33 million for the funded status and measurement date provisions, respectively.
Both Statements are effective for Aon as of January 1, 2009. Early adoption is prohibited. Aon is currently evaluating these Statements to determine what impact, if any, they will have on its consolidated financial statements.
In June 2008, the FASB issued Staff Position EITF 03-6-1 ("FSP EITF 03-6-1"), Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities. The staff position holds that unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents are "participating securities" as defined in EITF 03-6, Participating Securities and the Two-Class Method under FASB Statement No. 128, and therefore should be included in computing earnings per share using the two class method. Certain of Aon's restricted stock awards allow the holder to receive a nonforfeitable dividend equivalent. FSP EITF 03-6-1 is effective for Aon
Income per share is calculated as follows (in millions except per share data):
The components of net property and equipment are as follows (in millions):
In 2008, 2007 and 2006, Aon completed a number of acquisitions, primarily related to its insurance brokerage operations. The following table includes the aggregate amounts paid and intangible assets recorded as a result of the acquisitions. Amounts paid include cash paid for current year's acquisitions as well as installment payments made during the year for previous years' acquisitions. Estimated fair values of assets acquired and liabilities assumed are subject to adjustment when purchase accounting is finalized.
In January 2009, the Company reached a definitive agreement to sell FFG Insurance Company ("FFG"), Atlanta International Insurance Company ("AIIC") and Citadel Insurance Company ("Citadel") (together the "P&C operations"). FFG and Citadel are property and casualty insurance operations that were in runoff and had been previously included in unallocated income and expense in Aon's segment information. Operating results for these units have been reclassified to discontinued operations for all periods presented. AIIC is a property and casualty insurance operation that was previously reported in discontinued operations. The sale is subject to various closing conditions and is expected to be completed in the first half of 2009. At closing, the P&C operations are required to have $200 million of statutory surplus. Aon anticipates incurring a pretax loss of approximately $191 million on the sale of these operations, which has been recorded in 2008 in income from discontinued operations.
In 2008, Aon reached a definitive agreement to sell AIS Management Corporation ("AIS"), which was previously included in the Risk and Insurance Brokerage Services segment, to Mercury General Corporation, for approximately $120 million in cash at closing, plus a potential earn-out of up to $35 million payable over the two years following the completion of the agreement. The disposition was completed in January 2009. The Company anticipates recognizing a pretax gain of approximately $85 million from the sale of AIS in first quarter 2009.
•AWG and its worldwide warranty and credit operations, which was previously included in the Company's former Insurance Underwriting segment.
In fourth quarter 2008, the Company announced a global restructuring plan in conjunction with its acquisition of Benfield ("Aon Benfield Plan"). The restructuring plan, which will continue through the end of 2011, is intended to integrate and streamline operations across the combined Aon Benfield organization. The Aon Benfield Plan includes an estimated 500 to 700 job eliminations. Additionally, duplicate space and assets will be abandoned. The Aon Benfield Plan is accounted for in accordance with Emerging Issues Task Force (EITF) Issue No. 95-3, Recognition of Liabilities in Connection with a Purchase Business Combination. In connection with these restructuring activities and as part of the Benfield purchase price allocation, the Company has established liabilities, primarily for severance and excess facilities. As required by EITF Issue No. 95-3, the Company will finalize its restructuring plans no later than one year from the date of the acquisition. Upon finalization of the restructuring plans or settlement of obligations for less than the expected amount, any excess liabilities will be reversed with a corresponding decrease in goodwill.
The following summarizes the estimated restructuring costs related to the merger and integration of Benfield (in millions):
All of the components of the restructuring plan are not finalized and actual savings, total costs and timing may vary from those estimated due to changes in the scope, underlying assumptions of the plan, and to foreign exchange rates.
Below is a summary of 2007 restructuring and related expenses by type incurred and estimated to be incurred through the end of the restructuring initiative (in millions):
The following is a summary of the restructuring and related expenses incurred by segment (in millions):
In 2001, Aon sold the vast majority of its limited partnership (LP) portfolio, valued at $450 million, to PEPS I, a QSPE. The common stock interest in PEPS I is held by a limited liability company which is owned by Aon (49%) and by a charitable trust, which is not controlled by Aon (51%). Aon does not include the assets and liabilities or operations of PEPS I in its consolidated financial statements. Approximately $171 million of investment grade fixed-maturity securities were sold by PEPS I to unaffiliated third parties. PEPS I then paid Aon $171 million in cash and issued to Aon an additional $279 million in fixed-maturity and preferred stock securities.
As part of this transaction, Aon is required to purchase from PEPS I additional securities equal to the unfunded limited partnership commitments, as they are requested. These securities are rated below investment grade. Aon funded $2 million of commitments in both 2008 and 2007. As of December 31, 2008, the unfunded commitments were $42 million. The commitments have specific expiration dates and the partners may decide not to draw on these commitments.
Aon created Aon Capital A, a wholly-owned statutory business trust, for the purpose of issuing mandatorily redeemable preferred capital securities ("Capital Securities"). Aon received cash and an investment in 100% of the common equity of Aon Capital A by issuing 8.205% Junior Subordinated Deferrable Interest Debentures (subordinated debt) to Aon Capital A. The Capital Securities are subject to mandatory redemption on January 1, 2027 (upon the maturity of the subordinated debt) or are redeemable in whole, but not in part, at the option of Aon (through its prepayment of the subordinated debt) upon the occurrence of certain events. Interest is payable semi-annually on the Capital Securities. Aon determined that it is not the primary beneficiary of Aon Capital A, VIE, and, in accordance with FIN 46(R), Aon recorded long-term debt for the subordinated debt of $726 million.
In 2006, an indirect wholly-owned subsidiary of Aon issued CAD 375 million of 5.05% senior unsecured debentures due in April 2011. The principal and interest on the debentures is unconditionally and irrevocably guaranteed by Aon.
Certain of Aon's European subsidiaries have a €650 million (U.S. $912 million) multi-currency revolving loan credit facility. This facility will mature in October 2010. Commitment fees of 8.75 basis points are payable on the unused portion of the facility. At December 31, 2008, Aon has borrowed €431 million ($605 million) under this facility. At December 31, 2007, €376 million and $250 million were borrowed. At December 31, 2007, $250 million of the Euro facility was classified as short-term debt in the consolidated statements of financial position. Aon has guaranteed the obligations of its subsidiaries with respect to this facility.
Aon maintains a $600 million, 5-year U.S. committed bank credit facility to support commercial paper and other short-term borrowings, which expires in February 2010. This facility permits the issuance of up to $150 million in letters of credit. At December 31, 2008 and 2007, Aon had $20 million in letters of credit outstanding. Based on Aon's current credit ratings, commitment fees of 15 basis points are payable on the unused portion of the facility.
Outstanding debt securities, including Aon Capital A's, are not redeemable by Aon prior to maturity. There are no sinking fund provisions. Interest is payable semi-annually on most debt securities.
Aon and its principal domestic subsidiaries are included in a consolidated federal income tax return. Aon's international subsidiaries file various income tax returns in their jurisdictions.
Income from continuing operations before provision for income tax and the provision for income tax consist of the following (in millions):
Deferred income taxes (assets and liabilities have been netted by jurisdiction) have been classified in the consolidated statements of financial position as follows (in millions):
Valuation allowances have been established primarily with regard to the tax benefits of certain net operating loss and tax credit carryforwards. Valuation allowances decreased by $7 million in 2008, attributable largely to the periodic reconciliation of previous provisions to filed or audited and agreed tax returns and to the assessment of the potential future utilization of certain international loss carryforwards. Although future earnings cannot be predicted with certainty, management believes that the realization of the net deferred tax asset is more likely than not.
At December 31, 2008, Aon had domestic federal operating loss carryforwards of $8 million that will expire at various dates from 2009 to 2023, state operating loss carryforwards of $555 million that will expire at various dates from 2009 to 2027, and foreign operating and capital loss carryforwards of $350 million and $79 million, respectively, nearly all of which are subject to indefinite carryforward.
As of December 31, 2008, $69 million of unrecognized tax benefits would impact the effective tax rate if recognized. Aon does not expect the unrecognized tax positions to change significantly over the next twelve months.
Aon and its subsidiaries file income tax returns in the U.S. federal jurisdiction as well as various state and international jurisdictions. Aon has substantially concluded all U.S. federal income tax matters for years through 2006. Material U.S. state and local income tax jurisdiction examinations have been concluded for years through 2002. Aon has concluded income tax examinations in its primary international jurisdictions through 2002.
In 2005, Aon's Board of Directors authorized the repurchase of up to $1 billion of Aon's common stock. In 2006, the Board increased that amount to $2 billion. In December 2007, the Board increased the authorization amount to $4.6 billion. Shares may be repurchased through the open market or in privately negotiated transactions from time to time, based on prevailing market conditions, and will be funded from available capital. Any repurchased shares will be available for employee stock plans and for other corporate purposes. In 2008, Aon repurchased 42.6 million shares at a cost of $1.9 billion. In 2007, the Company repurchased 19.1 million shares at a cost of $751 million. In 2006, the Company repurchased 28.4 million shares at a cost of $1,048 million.
In 2008, Aon issued 0.4 million new shares of common stock for employee benefit plans. In addition, Aon reissued 9.1 million shares of treasury stock for employee benefit programs and 0.3 million shares in connection with employee stock purchase plans.
In November 2007, the Company redeemed all of its remaining outstanding 31/2% Senior Convertible Debentures that were due in 2012. All of the holders of the Debentures elected to convert their debentures into Aon common stock at a conversion rate of 46.5658 shares of common stock for each $1,000 principal amount of Debentures. As a result of this redemption and earlier voluntary redemptions, approximately 14 million shares of Aon common stock were issued in 2007.
During 2008, 2007 and 2006, Aon paid dividends on its common stock of $171 million, $176 million and $189 million, respectively. Dividends paid per common share were $0.60 for the years ended December 31, 2008, 2007 and 2006.
The components of other comprehensive income (loss) and the related tax effects are as follows (in millions):
The following tables provide a reconciliation of the changes in the benefit obligations and fair value of assets for the years ended December 31, 2008 and 2007 and a statement of the funded status as of December 31, 2008 and 2007, for the U.S. plans and material international plans, which are located in the U.K., the Netherlands and Canada. These plans represent approximately 95% of the Company's pension obligations. The Company will retain the obligations and assets related to the participation of CICA and Sterling employees in the Company's U.S. and Canadian pension plans.
In 2008, U.S. plans with a projected benefit obligation ("PBO") and an accumulated benefit obligation ("ABO") in excess of the fair value of plan assets had a PBO of $2.1 billion, an ABO of $2.1 billion and plan assets of $1.1 billion. International plans with a PBO in excess of the fair value of plan assets had a PBO of $3.5 billion and plan assets with a fair value of $3.0 billion, and plans with an ABO in excess of the fair value of plan assets had an ABO of $3.0 billion and plan assets with a fair value of $2.5 billion.
In connection with the Company ceasing crediting future benefits relating to salary and service of the U.S. non-qualified defined benefit pension plan, a curtailment loss of $8 million was also recognized in 2008. In connection with the sale of CICA, a curtailment gain of $13 million was recognized in discontinued operations in 2008. In 2009, a curtailment gain of approximately $83 million will be recognized as a result of the Company ceasing crediting future benefits relating to salary and service of the U.S. defined benefit pension plan.
Aon's pension plan asset allocation as of December 31, 2008 and 2007 is as follows:
Estimated future benefit payments for plans are as follows at December 31, 2008 (in millions):
Other information related to the Company's other post-retirement benefit plans is as follows:
•To contribute $5 million to fund other post-retirement benefit plans during 2009.
The following table summarizes stock-based compensation expense related to all stock-based payments recognized in continuing operations in the consolidated statements of income in compensation and benefits (in millions):
Stock awards, in the form of RSUs, are granted to certain executives and key employees. Prior to 2006, RSUs granted to employees were service-based. Beginning with awards granted in 2006, awards to employees may consist of both performance-based and service-based RSUs. Service-based awards generally vest between five and ten years from the date of grant. For most employees, incentive compensation in excess of $50,000 is partially paid in RSUs, which vest ratably over three years. Stock awards are issued as they vest. With certain limited exceptions, any break in continuous employment will cause the forfeiture of all unvested awards. The compensation cost associated with stock awards is amortized over the service period using the straight-line method. Dividend equivalents are paid on certain service-based RSUs, based on the initial grant amount. At December 31, 2008, 2007 and 2006, the number of shares available for stock awards is included with options available for grant.
Beginning in 2006, performance-based RSUs have been granted to certain executives and key employees. Vesting of these awards is contingent upon meeting various individual, divisional or company-wide performance conditions, including revenue generation or growth in revenue, pretax
income or earnings per share over a one- to five-year period. The performance conditions are not considered in the determination of the grant date fair value for these awards. Compensation cost is recognized over the performance period, and in certain cases an additional vesting period, based on management's estimate of the number of units expected to vest. Compensation cost is adjusted to reflect the actual number of shares paid out at the end of the programs. The payout of shares under these performance-based plans may range from 0-200% of the number of units granted, based on the plan. Dividend equivalents are generally not paid on the performance-based RSUs.
A summary of the status of Aon's non-vested service-based stock awards is as follows (shares in thousands):
Options to purchase common stock are granted to certain executives and key employees, generally at 100% of market value on the date of grant. Generally, employees are required to complete two continuous years of service before the options begin to vest in increments until the completion of a 4-year period of continuous employment, although a number of options were granted that require five continuous years of service before all options would vest. The maximum contractual term on stock options is generally ten years from the date of grant.
Aon uses a lattice-binomial option-pricing model to value stock options. Lattice-based option valuation models utilize a range of assumptions over the expected term of the options. Expected volatilities are based on the average of the historical volatility of Aon's stock price and the implied volatility of traded options and Aon's stock. Aon uses historical data to estimate option exercise and employee terminations within the valuation model, stratifying between executives and key employees. The expected dividend yield assumption is based on the Company's historical and expected future dividend rate. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.
A summary of the status of Aon's stock options and related information are as follows (shares in thousands):
A summary of options outstanding and exercisable as of December 31, 2008 is as follows (shares in thousands):
The aggregate intrinsic value represents the total pretax intrinsic value, based on options with an exercise price less than the Company's closing stock price of $45.68 as of December 31, 2008, which would have been received by the option holders had those option holders exercised their options as of that date. At December 31, 2008, the aggregate intrinsic value of options outstanding was $284 million, of which $162 million was exercisable.
Unamortized deferred compensation expense, which includes both options and awards, amounted to $307 million as of December 31, 2008, with a remaining weighted-average amortization period of approximately 2.2 years.
Aon has an employee stock purchase plan that provides for the purchase of a maximum of 7.5 million shares of Aon's common stock by eligible U.S. employees. Under the plan, shares of Aon's common stock may be purchased at 3-month intervals at 85% of the lower of the fair market value of the common stock on the first or the last day of each 3-month period. In 2008, 2007, and 2006, 320,000 shares, 405,000 shares and 457,000 shares, respectively, were issued to employees under the plan. Compensation expense recognized was $3 million each in 2008, 2007 and 2006.
Aon also has an employee stock purchase for eligible U.K. employees that provides for the purchase of shares after a 3-year period and which is similar to the U.S. plan described above. Three-year periods began in 2008 and 2006, allowing for the purchase of a maximum of 200,000 and 525,000 shares, respectively. In 2008 and 2007, 6,000 shares and less than 1,000 shares, respectively, were issued under the plan. No shares were issued under the plan in 2006. In 2008, 2007 and 2006, compensation expense recognized was less than $1 million each year.
Aon is exposed to market risk from changes in foreign currency exchange rates, interest rates and equity security prices. To manage the risk related to these exposures, Aon enters into various derivative transactions. The derivatives have the effect of reducing Aon's market risks by creating offsetting market exposures. Aon does not enter into derivative transactions for trading purposes.
All derivative instruments are recognized in the consolidated statements of financial position at fair value. Unless otherwise noted, derivative instruments with a positive fair value are reported in receivables and derivative instruments with a negative fair value are reported in other current liabilities in the consolidated statements of financial position. Where Aon has entered into master netting agreements with counterparties, the derivative positions are netted by counterparty and are reported accordingly in receivables or other current liabilities consistent with FASB Interpretation No. 39, Offsetting of Amounts Related to Certain Contracts. Changes in the fair value of derivative instruments are recognized immediately in earnings, unless the derivative is designated as a hedge and qualifies for hedge accounting.
For a fair value hedge, the change in fair value of the hedging instrument and the change in fair value of the hedged item attributable to the risk being hedged are both recognized currently in earnings. Aon did not enter into any fair value hedges in 2008. For a cash flow hedge, the effective
Certain of Aon's foreign brokerage subsidiaries, primarily in the U.K., receive revenues in currencies (primarily in U.S. dollars and Euros) that differ from their functional currencies. The foreign subsidiary's functional currency revenue will fluctuate as the currency exchange rates change. To reduce this variability, Aon uses foreign exchange forwards and over-the-counter options to hedge the foreign exchange risk of the forecasted revenue for up to a maximum of three years in the future. Aon has designated these derivatives as cash flow hedges of its forecasted foreign currency denominated revenue. As of December 31, 2008, a $34 million pretax loss has been deferred to OCI, $10 million of which is expected to be reclassified to earnings as an adjustment to other general expenses in 2009. Deferred gains or losses will be reclassified from OCI to other general expenses when the hedged revenue is recognized. The hedge had no material ineffectiveness in 2008, 2007 or 2006. For the year ended December 31, 2008, the Company recognized immaterial losses on cash flow hedges that were discontinued due to forecast revisions. Aon also uses forward contracts, which have not been designated as hedges for accounting purposes, to hedge economic risks that arise from fluctuations in the currency exchange rates. Changes in the fair value of these derivatives are recorded in other general expenses in the consolidated statements of income.
In 2005, Aon subsidiaries entered into cross-currency swaps to hedge the foreign currency risks associated with foreign denominated fixed-rate term intercompany borrowings. These swaps have been designated as cash flow hedges. As of December 31, 2008, a $5 million pretax gain had been deferred to OCI, of which a $1 million pretax loss is expected to be reclassified to earnings in 2009 as an adjustment to interest expense. The reclassification from OCI will offset the related transaction gain or loss arising from the remeasurement of the borrowing due to changes in spot exchange rates. This hedge had no material ineffectiveness in 2008, 2007 or 2006.
In 2008, Aon subsidiaries entered into cross-currency swaps to hedge the foreign currency risks associated with foreign denominated fixed-rate term intercompany receivables. These swaps have been designated as cash flow hedges. As of December 31, 2008, a $13 million pretax loss had been deferred to OCI, of which a $6 million pretax loss is expected to be reclassified to earnings in 2009 as an adjustment to interest expense. The reclassification from OCI will offset the related transaction gain or loss arising from the remeasurement of the receivable due to changes in spot exchange rates. This hedge had no material ineffectiveness in 2008.
For the Canadian and Australian sales, the Company determined that non-consolidation of the Bank SPEs is appropriate in accordance with FIN 46R because Aon is not their primary beneficiary. The Company has reached this determination by analyzing qualitative and quantitative factors related to the transactions with the Bank SPEs. Specific factors considered include the fact that Aon is not the sponsor of any of the Bank SPEs, various other unaffiliated companies sell receivables to the Bank SPEs, and unaffiliated third parties have either made substantial equity investments in the Bank SPEs, hold voting control of the Bank SPEs, or generally have the risks and rewards of ownership of the assets of the Bank SPEs through liquidity support agreements or other arrangements involving significant variable interests.
Aon records its retained interest in the sold premium finance agreements at fair value, and reports it in receivables in the consolidated statements of financial position. Aon estimates fair value by discounting estimated future cash flows using discount rates that are commensurate with the underlying risk, expected future prepayment rates, and credit loss estimates.
With the exception of the Australian sales agreements, all the other sales agreements require Aon to meet the following covenants:
Aon intends to renew these sales agreements, which have 364-day terms, as they expire. The Company renewed the U.S., Canadian and U.K. sales agreement in the fourth quarter 2008. The current environment in the credit market influenced the renewal process and the renewed terms are more restrictive: the over-collateralization requirements increased significantly (a total of $50 million on the renewal date), and, based upon the Company's estimated needs for the coming year, Aon reduced the level of committed availability by a total of $479 million at the renewal dates, has further reduced committed availability to its current level, and scheduled additional decreases of $160 million by March 31, 2009. In addition, the securitization program costs added on the pass-through funding costs from the U.S. Bank SPEs. The Australian facility expires in June 2009, and the Company expects similarly restrictive terms and pricing upon renewal of that facility. Moreover, as Aon's ability to originate and fund new premium finance agreements is dependent on the pass-through funding costs of the Bank SPEs, disruptions in the markets through which the Bank SPEs obtain funds could further diminish Aon's premium finance results of operations and cash flows. The Company also faces the risk that the Bank SPEs will be unable to provide the liquidity or will become an unreliable source of the liquidity necessary to fund new premium finance agreements. Such an occurrence would require the Company to consider alternate sources of funding, including other forms of off-balance sheet as well as on-balance sheet financing, or discontinue the origination of premium finance agreements. Additionally, if there were adverse bank, regulatory, tax, or accounting rule changes, Aon's access to the conduit facilities and special purpose vehicles could be affected.
•Globe Re Limited ("Globe Re"), which provides reinsurance coverage for a defined portfolio of property catastrophe reinsurance contracts underwritten by a third party;
These entities meet the definition of a VIE and have been consolidated in accordance with FASB Interpretation No. 46(R), Consolidation of Variable Interest Entities ("FIN 46(R)"). Under FIN 46(R), an enterprise that absorbs a majority of the VIE's expected losses, receives a majority of the VIE's expected residual returns, or both, is considered to be the prime beneficiary of the VIE and must consolidate the entity in its financial statements. At December 31, 2008, Globe Re and Juniperus/JCHL had assets of $187 million and $121 million, respectively, and liabilities of $105 million and $68 million, respectively. Aon's potential loss is limited to its equity investment in the VIEs, which is $20 million for Globe Re and $55 million for Juniperus.
Guarantees associated with Aon's limited partnership securitization are disclosed in Note 9. Guarantees with respect to reinsurance balances associated with the sale of AWG are disclosed in Note 7.
•Level 3 - Valuations derived from valuation techniques in which one or more significant inputs are unobservable.
The following methods and assumptions are used to estimate fair values of financial instruments:
Fixed-maturity securities: Fair value is based on quoted market prices, or on estimated values if they are not actively traded. In some cases where a market price is available, the Company will make use of acceptable expedients (such as matrix pricing) to estimate fair value.
Debt: Fair value is based on quoted market prices or estimates using discounted cash flow analyses based on current borrowing rates for similar types of borrowing arrangements.
The following table presents the changes in the Level 3 fair-value category for the year ended December 31, 2008 (in millions):
At the time of the 2004-05 investigation of the insurance industry by the Attorney General of New York ("NYAG") and other regulators, purported classes of clients filed civil litigation against Aon and other companies under a variety of legal theories, including state tort, contract, fiduciary duty, antitrust and statutory theories and federal antitrust and Racketeer Influenced and Corrupt Organizations Act ("RICO") theories. The federal actions were consolidated in the U.S. District Court for the District of New Jersey, and a state court collective action was filed in California. In the New Jersey actions, the Court dismissed plaintiffs' federal antitrust and RICO claims in separate orders in August and October 2007, respectively. Plaintiffs have appealed these dismissals. Aon believes it has meritorious defenses in all of these cases and intends to vigorously defend itself against these claims. The outcome of these lawsuits, and any losses or other payments that may occur as a result, cannot be predicted at this time.
Also at the time of the NYAG investigation, putative classes filed actions against Aon in the U.S. District Court for the Northern District of Illinois under the federal securities laws and ERISA. Plaintiffs in the federal securities class action have recently submitted purported expert reports estimating a range of alleged damages of $353 million to $490 million, and plaintiffs in the ERISA class actions have recently submitted purported expert reports estimating a range of alleged damages of $59 million to $349 million. In January 2009, Aon submitted its own expert reports, which concluded that plaintiffs' theories of liability and causation are meritless and that, in any event, plaintiffs incurred no damages. Aon believes it has meritorious defenses in all of these cases and intends to vigorously defend itself against these claims. The outcome of these lawsuits, and any losses or other payments that may occur as a result, cannot be predicted at this time.
A financial institution in the U.K. called Standard Life Assurance Ltd. brought an action in London Commercial Court against Aon seeking more than £50 million ($73 million a December 31, 2008 exchange rates) for alleged errors or omissions in the placement of a professional indemnity policy with certain underwriters. In a preliminary decision issued on February 13, 2008, the court construed the relevant policy language to excuse the underwriters from paying Standard Life and concluded that Aon was negligent in not seeking changes to the language. Aon filed an interlocutory
The Consulting segment provides a broad range of consulting services. These services are delivered predominantly to corporate clientele utilizing two subsegments (Consulting Services and Outsourcing) that operate in the following practice areas: Consulting Services - health and benefits, retirement, compensation, and strategic human capital and Outsourcing - human resource outsourcing.
Selected information for Aon's operating segments is as follows (in millions):
(1)Excludes the elimination of intersegment revenues and expenses of $25 million, $29 million and $59 million for 2008, 2007 and 2006, respectively.