As part of the fourth quarter restructuring plan, the Company consolidated real estate requirements at 48 offices worldwide. The real estate activities represented the closure, abandonment and downsizing of office space globally, including 34 locations in the U.S.
SELECTED FINANCIAL DATA ALEXANDER & ALEXANDER SERVICES INC. AND SUBSIDIARIES SELECTED CONSOLIDATED FINANCIAL DATA
(4) Dividends on the Series B Cumulative Convertible Preferred Stock are payable in kind (additional Series B preferred shares) until December 15, 1996 and thereafter, at the Board of Directors election, until December 15, 1999.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (MD&A)
The year 1994 marked major and significant changes for the Company as a restructuring process was undertaken by the Company's new senior management and substantially completed. In addition, the Company reduced its financial exposures to various longstanding litigation and other contingencies and sold various non-core businesses. These actions included the following:
. In July 1994, the Company began a major internal review of all of its worldwide operations to identify opportunities to reduce costs and enhance client service.
. On March 27, 1995, the Company entered into a new $200 million three-year credit facility with various banks.
. In January 1995, the Company negotiated the settlement of certain indemnification obligations relating to the 1987 sale of Shand Morahan & Company, Inc. (Shand). The settlement resulted in a fourth quarter 1994 pre-tax charge of $32.5 million. Under terms of the settlement, the Company will pay $14 million in cash, issue a five-year interest bearing note in the principal amount of $14 million and expects to pay a contingent obligation of $4.5 million.
. On March 27, 1995, the Company, Shand and the rehabilitator of Mutual Fire, Marine and Inland Insurance Company (Mutual Fire) entered into a settlement agreement, which if approved by the courts, would terminate the rehabilitator's litigation and release the Company and Shand from any further claims by the rehabilitator. In the fourth quarter of 1994, the Company increased its previously established reserves of $10 million based on an estimated settlement amount, and recorded a pre-tax charge of $37.2 million ($24.2 million after-tax or $0.55 per share).
. In February 1995, the Company settled a 1985 lawsuit by the Pine Top Insurance Company ending litigation seeking compensatory, punitive and other damages of over $87 million. The amount of the settlement was not material and was previously reserved by the Company.
. In November 1994, the Company completed the sale of its U.S.-based personal lines insurance broking business. The total proceeds from the sale were $30.2 million and a pre-tax gain of $20.2 million was reflected in the fourth quarter of 1994 results.
The Company's insurance broking revenues are generally affected by premium rates charged by insurance companies in the property and casualty markets and the overall available market capacity. Since the mid-to-late 1980s, commission and fee growth has been constrained due to soft pricing and excess capacity and the resultant intense competition among insurance carriers and brokers for market share. Lower interest rates have reduced investment income earned on fiduciary funds.
The Company's restructuring and related initiatives in part reflect management's view that insurance premium pricing will not improve significantly in the foreseeable future. Revenue growth will depend increasingly on the development of new products and services and new business generation. In addition, interest rates are expected to increase moderately in the U.S. and U.K.
Revenue growth from the Company's human resource management consulting operations was impacted by uncertainty over health care reform in the U.S. Many clients postponed or reduced planned employee benefit reviews while waiting to analyze the impact of the potential governmental health care proposals. The Company anticipates moderate revenue growth in 1995 as corporations recognize that any such proposals are not likely to affect their efforts to redesign and streamline employee benefit packages.
Overall comparable operating expenses are expected to decline in 1995 resulting from implementing the plan of restructuring and other expense reduction initiatives. The Company has estimated that approximately $100 million of expense savings will be realized from these efforts; however, approximately one-half of such savings will be offset by investments in new technology, products and personnel to support revenue growth as well as normal inflationary increases.
In 1993, net income was $26.9 million, or $0.48 per share, including after-tax gains of $2.3 million, or $0.05 per share, from the sale of three small operations and a gain relating to a cumulative effect adjustment of $3.3 million, or $0.08 per share, from a change in accounting for income taxes.
Total 1994 commissions and fees decreased from 1993 by $15.4 million, or 1.2 percent, compared to a $9.3 million, or 0.7 percent, decrease in 1993 versus 1992. The sale of non-core operations reduced revenues in the comparable periods and foreign exchange rates had a negative effect of $54.3 million in 1993. When adjusted for these items, total commissions and fees decreased by $8 million, or 0.6 percent, in 1994 after increasing $53.2 million, or 4.1 percent, in 1993.
The Company enters into interest rate swaps and forward rate agreements to limit the earnings volatility associated with changes in short-term interest rates on its existing and anticipated fiduciary investments with maturities of three months or less. In addition, as part of its interest rate management program, the Company utilizes various types of interest rate options, including caps, collars, floors and interest rate guarantees. For additional information relating to the Company's interest rate financial instruments, see Note 12 of Notes to Financial Statements.
Consolidated operating expenses increased by $117.5 million, or 9.1 percent, in 1994 compared to a $5.3 million, or 0.4 percent, increase in 1993. Excluding the restructuring charges described below, total operating expenses increased in 1994 by $48.5 million, or 3.8 percent. Expense comparisons reflect both foreign currency fluctuations and the effects of acquisitions and dispositions. In 1994, total operating expenses increased by $44 million after adjusting for these items.
In 1993 versus 1992, consolidated operating expenses were favorably impacted by $66.3 million as a result of lower foreign exchange rates and hedging gains. Operations sold in 1992 also reduced operating expenses in 1993 by $1.8 million. Excluding the effect of foreign exchange variances and sold businesses, total operating expenses increased by $73.4 million over 1992 levels.
Consolidated salaries and related benefits increased by $29 million, or 3.7 percent, in 1994 compared to a decrease of $19.2 million, or 2.4 percent, in 1993. The 1994 increase reflects $10.1 million of additional incentive and benefit expenses in 1994 representing a combination of amendments
Also contributing to the 1994 change were an additional $9.1 million of salaries and benefits resulting from the 1993 Mexico acquisition and from the November 1993 pooling of interests acquisition of Clay & Partners (Clay). Prior to the acquisition, Clay operated as a partnership and its operations did not reflect partner draws as salary expense. Excluding the effects of these items and a decrease due to the effect of operations sold in 1993, salaries and benefits increased $13.6 million over 1993 levels.
The 1993 decline was primarily attributable to lower foreign exchange rates, offset by slightly higher staff costs in local currency terms.
Insurance costs reflect higher third-party insurance premiums and self-insurance reserves for the Company's professional indemnity programs. The Company believes its insurance-related reserves are sufficient to cover potential claims and liabilities; however, there is no assurance that escalating litigation costs and awards, as well as insurance company insolvencies, will not have an adverse impact on the future overall costs of insurance coverages.
Effective January 1, 1993, the Company adopted SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other than Pensions" for its U.S. plans. In 1991, the Company adopted the provisions of SFAS No. 106 relating to deferred compensation plans. This statement requires the Company to accrue the estimated cost of future retiree benefit payments during the years the employee provides services. The Company previously expensed the cost of these benefits, which are principally health care and life insurance, as premiums or claims were paid. The Company has elected to amortize the initial postretirement benefit obligation of $14 million over a period of twenty years. The Company's cash flows were not affected by the implementation of this statement, and the impact to the results of operations have not been significant.
Litigation costs are associated primarily with the Mutual Fire lawsuit described in Note 14 of Notes to Financial Statements as well as a 1993 settlement of certain other litigation matters.
In the fourth quarter of 1994, the Company recorded pre-tax special charges of $69.7 million ($45.3 million after-tax, or $1.03 per share). These charges, which are reflected in non-operating results, include a $32.5 million settlement in January 1995 which resolved certain indemnification obligations relating to the 1987 sale of Shand and a $37.2 million increase to the Company's pre- existing reserves, based on settlement discussions which led to a March 1995 settlement agreement, which is subject to court approval, relating to lawsuits and other disputes brought against the Company and others by the rehabilitator of Mutual Fire. For further information relating to these matters, see Note 14 of Notes to Financial Statements.
At December 31, 1994, the Company has a net deferred tax asset balance of $136.7 million which is comprised of net deferred tax assets in the U.S. of $152.7 million offset by net deferred tax liabilities of $16 million outside the U.S. The deferred tax asset is net of a $36.7 million valuation allowance primarily relating to foreign and U.S. state net operating loss and capital loss carryforwards. The valuation allowance represents approximately 90 percent of these carryforwards. At this time the Company believes that it is more likely than not that this portion of these deferred tax assets will not be realized. The valuation allowance increased in 1994 by a net amount of $13.6 million, principally due to increases in U.S. state net operating losses and foreign capital losses.
As discussed in Note 5 of Notes to Financial Statements, the Company is currently under examination by the IRS for years 1990 and 1991. It is not expected that the examination will have any effect on realization of the 1994 carryforward.
The Company's effective tax (benefit) rates were (29) percent, 20 percent, and 42.8 percent in 1994, 1993 and 1992, respectively. These rates compare to the U.S. statutory rate of 35 percent in 1994 and 1993 and 34 percent in 1992. The effective tax rates were negatively impacted by certain expenses which were not deductible in the jurisdictions in which the Company conducts business. These expenses include amortization of goodwill and entertainment expenses. Offsetting these factors are state and local tax benefits on losses generated in the U.S. operations as well as foreign tax rates lower than the U.S. statutory rate in 1994 and 1993.
The recognition of a $3.5 million tax benefit associated with a prior year capital loss decreased the Company's 1993 effective tax rate as a result of capital gains generated in 1993. The effective tax rates in 1993 and 1992 were also favorably impacted by the results of Clay & Partners, a U.K. based actuarial consulting operation acquired in 1993 in a pooling of interests transaction. Prior to the merger, Clay operated as a partnership and accordingly, its results did not reflect corporate income taxes of approximately $1.9 million and $2.1 million in 1993 and 1992, respectively.
quarter of 1994 representing the amount of the payment that exceeded the recoverable portion of existing reserves.
In December 1994, the Company entered into an agreement to resolve certain indemnity obligations to Sphere Drake. Under terms of the Sphere Drake agreement, the Company received a cash payment of $5 million in settlement of the zero coupon notes receivable and related indemnities as well as certain income tax liabilities. The Company recorded a $20.9 million loss from discontinued operations in the third quarter in connection with this agreement.
Effective January 1, 1993, the Company adopted SFAS No. 109, "Accounting for Income Taxes." The cumulative effect of adopting this standard increased net income in the first quarter of 1993 by $3.3 million or $0.08 per share. Tax benefits of $3.2 million were also allocated to paid-in capital representing the difference in the tax bases over the book bases of the net assets of taxable business combinations accounted for as pooling of interests. These benefits would have been recognized at the respective dates of combination if SFAS No. 109 had been applied at that time.
Operating results for the Insurance Services segment of the Company's operations are summarized below:
Total 1994 broking commissions and fees increased $3.1 million, or 1.3 percent, versus 1993 levels. This compares to an increase of $12.8 million, or 5.6 percent, in 1993. Changes in foreign exchange rates increased 1994 broking revenues by $0.9 million and decreased 1993 broking revenues by $15.6 million.
Selected premium rate increases and new business in the Company's international operations, particularly in Canada, France, Asia-Pacific and Latin America were substantially offset by a decline in the U.S. The increase in 1993 broking revenues over 1992 levels was fueled by strong new business production and premium rate increases in most non-U.S. markets, especially in the U.K. and Asia-Pacific operations.
Investment income earned on fiduciary funds decreased by $2.2 million in 1994 primarily due to lower average investment levels, particularly in the U.S., and decreased by $18.7 million in 1993 primarily due to lower worldwide interest rates, particularly in the U.S. and U.K.
Operating results for the Human Resource Management Consulting segment of the Company's operations are summarized below:
Operating expenses, excluding $8.3 million of restructuring charges, increased by $1 million, or 0.5 percent, in 1994 compared to an increase of $10.8 million, or 5.2 percent in 1993. The impact of changes in foreign exchange rates on total operating expenses was an increase of $0.2 million and a decrease of $9.5 million for 1994 and 1993, respectively. Contributing to the 1994 increase were higher salary costs in the U.K. from the Clay acquisition, which operated as a partnership in 1993, partially offset by decreases in the total operating expenses of the U.S. operations due primarily to one-time expenses reflected in the 1993 results. In comparison to 1992, total operating expenses in 1993 were also reduced by $1.8 million as a result of an operation sold in 1992.
At December 31, 1994, the Company' operating cash and cash equivalents totaled $248.7 million, a $97.2 million increase over the 1993 year-end balance. In addition, the Company had $83.3 million of operating funds invested in short and long-term investments at December 31, 1994.
In 1994, the Company's operating activities used $16.6 million of operating funds, primarily due to an $80 million payment to a reinsurance company for the finite risk contract previously discussed. The Company subsequently borrowed $50 million relating to this payment; however, the proceeds from this borrowing are reflected in the net cash provided from financing activities.
The $69.7 million of special charges recorded in 1994 did not require a cash funding. The terms of the settlement relating to Shand will result in cash requirements of approximately $14 million in 1995 and a $18.5 million increase in long-term debt. The Company anticipates that the 1995 net cash requirements relating to Mutual Fire will approximate $9 million with the remainder represented by additional long-term debt.
The Company's net capital expenditures for property and equipment and acquisitions were $26.2 million and $47 million during 1994 and 1993, respectively. Capital expenditures for property and equipment remained stable as the Company continued with its investment in redesigning work processes and enhancing systems technology. The 1993 expenditures included $16.4 million for an acquisition in Mexico. As a result of the devaluation of the Mexican peso in late 1994, the Company's accumulated translation adjustment balance for its Mexican operation reflected an unrealized loss of $6.2 million at December 31, 1994. The Company expects to maintain its strategic investment in Mexico for the long-
term and further anticipates that its Mexican operation will remain profitable. Accordingly, the Company does not currently consider its investment in Mexico to be permanently impaired.
Supplementing the credit agreement, the Company has unsecured lines of credit available for general corporate purposes totaling $97.7 million, of which $97 million were unused at December 31, 1994. These lines consist of uncommitted cancellable facilities in the U.S. and other countries. If drawn, the lines bear interest at market rates and carry annual commitment fees of not greater than 1/2 percent of the line.
On March 27, 1995, the Company's existing credit agreement was cancelled and replaced by a new $200 million three-year facility with various banks which expires in March 1998. See Note 8 of Notes to Financial Statements for further information regarding this credit agreement.
In 1994, the Accumulated Translation Adjustments, which represent the cumulative effect of translating the Company's international operations to U.S. dollars, positively impacted total Stockholders' Equity by $11.4 million. The increase resulted from the weakening of the U.S. dollar against most of the major currencies of the Company's overseas operations.
The Company believes that cash flow from operations, along with current operating cash balances, supplemented by the proceeds from the Series B Convertible Preferred Shares and assets sales, will be sufficient to fund working capital and other operating requirements. In the event additional funds are required, the Company believes it will have sufficient resources, including borrowing capacity, to meet such requirements.
The Company's management is responsible for the preparation and contents of the information and representations contained in the consolidated financial statements and other sections of this Annual Report on Form 10-K. Management believes that the consolidated financial statements and related information have been prepared in accordance with generally accepted accounting principles appropriate in the circumstances, including amounts that are based on management's judgment and best estimates.
Frank G. Zarb Chairman of the Board, Chief Executive Officer & President
We have audited the accompanying consolidated balance sheets of Alexander & Alexander Services Inc. and Subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of operations, cash flows and stockholders' equity for each of the three years in the period ended December 31, 1994. Our audits also included the financial statement schedule listed in the Index at Item 8. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the companies at December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
As discussed in Notes 5, 7 and 11 to the consolidated financial statements, in 1994 the Company changed its method of accounting for certain investments in debt and equity securities and postemployment benefits, and, in 1993, income taxes and postretirement benefits.
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, (IN MILLIONS)
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY--(CONTINUED) FOR THE YEARS ENDED DECEMBER 31, (IN MILLIONS)
Net foreign currency transaction gains, included in operating income, amounted to $4.8 million, $9 million and $5.6 million for the years ended December 31, 1994, 1993 and 1992, respectively.
PROPERTY AND DEPRECIATION The cost of property and equipment is depreciated generally using the straight-line method over the estimated useful lives of the related assets which range from 3 to 40 years for buildings and 10 years for equipment. Leasehold improvements are capitalized and amortized over the shorter of the life of the asset or the lease term.
The Company periodically evaluates the carrying value of its intangible assets, principally goodwill, by projecting operating results over the remaining lives of such assets on an undiscounted basis. Such projections take into account past financial performance as well as management's estimate of future operating results.
Income taxes are generally not provided on undistributed earnings of foreign subsidiaries because they are considered to be permanently invested or will not be repatriated unless any additional federal income taxes would be substantially offset by foreign tax credits.
REVENUE RECOGNITION Commissions and fees for insurance services are generally recognized on the effective date of the policies or the billing date, whichever is later. Any subsequent commission adjustments, including policy cancellations, are generally recognized upon notification from the insurance carriers. Contingent commissions and commissions on policies billed and collected directly by insurance carriers are recognized when received.
PRESENTATION Unless otherwise indicated, all amounts are stated in millions of U.S. dollars. Certain prior period amounts have been reclassified to conform with the current year presentation.
During 1994, the Company changed its presentation of cash flows to distinguish fiduciary cash and cash equivalents and fiduciary investments from operating cash and cash equivalents and operating investments. The Company believes that this presentation of cash flows provides more useful information regarding the cash flows that are available for general corporate purposes.
On November 30, 1993, the Company issued 2.3 million shares of its Common Stock for all of the partnership interests of Clay & Partners (Clay), a U.K.-based actuarial consulting operation. This acquisition has been accounted for as a pooling of interests and, accordingly, the consolidated financial statements have been restated for all periods prior to the acquisition. In connection with the merger, the Company recorded $14.4 million as additional paid-in capital representing deferred tax benefits associated with the taxable business combination of Clay.
Effective July 1, 1993, the Company acquired an 80 percent interest in a Mexican insurance brokerage company which was accounted for as a purchase. The purchase price was $16.9 million, including a $7.4 million cash payment and notes payable of $9.5 million due in three installments from 1994 to 1995. The excess of the purchase price over the fair value of net tangible assets acquired was
approximately $16 million. As a result of the devaluation of the Mexican peso in late 1994, the Company's accumulated translation adjustment balance for its Mexican operation reflected an unrealized loss of $6.2 million at December 31, 1994. The Company expects to maintain its strategic investment in Mexico for the long-term and further anticipates that its Mexican operation will remain profitable. Accordingly, the Company does not currently consider its investment in Mexico to be permanently impaired.
During 1992, the Company sold three non-core businesses, including a U.K.-based pension fund management operation, a Netherlands-based non-broking operation and a U.S.-based administrator of workers' compensation funds. Total proceeds on these sales were $77.4 million with resulting pre-tax gains of $43.8 million ($28.5 million after-tax or $0.66 per share).
These gains are included in Other Income (Expenses) in the Consolidated Statements of Operations.
On February 28, 1995 the Company completed the sale of Alexsis, Inc., its U.S.-based third party claims administrator, for total cash proceeds of $47.1 million. The pre-tax gain on this transaction will approximate $30 million and will be reflected in the first quarter of 1995.
Total revenues and operating income (loss) from all of these operations were $120.9 million, $128.3 million and $127.1 million and $10.4 million, $2.5 million and $(1.5) million, respectively, for the years ended December 31, 1994, 1993 and 1992.
In the fourth quarter of 1994, management committed to a formal plan of restructuring the Company's operations and recorded a $69 million pre-tax charge ($45.1 million after-tax, or $1.03 per share). The restructuring charge included $25.2 million to consolidate real estate space requirements at 48 offices worldwide, and $43.8 million for voluntary early retirement programs and involuntary workforce reductions involving approximately 1,100 positions, of which 650 are in the U.S.
In the fourth quarter of 1994, the Company recorded pre-tax special charges of $69.7 million ($45.3 million after-tax, or $1.03 per share). These charges, which are reflected in non-operating results, include a $32.5 million settlement in January 1995 which resolved certain indemnification obligations relating to the 1987 sale of Shand Morahan & Company (Shand) and a $37.2 million increase to the Company's pre-existing reserves, based on settlement discussions which led to a March 1995 settlement agreement, which is subject to court approval, relating to lawsuits and other disputes brought against the Company and others by the rehabilitator of Mutual Fire, Marine & Inland Insurance Company (Mutual Fire) (See Note 14 of Notes to Financial Statements).
FOR THE YEARS ENDED DECEMBER 31, ------------------------ 1994 1993 1992 ----- ------ ----- Gains on sales of businesses (See Note 2)........... $20.2 $ 3.9 $43.8 Litigation costs.................................... (9.1) (20.2) (5.8) Other............................................... (0.2) 0.7 1.9 ----- ------ ----- $10.9 $(15.6) $39.9 ----- ------ ----- ----- ------ -----
The components of the provision (benefit) for income taxes on continuing operations are as follows:
Federal income taxes have not been provided on undistributed earnings of foreign subsidiaries which aggregated approximately $309.8 million at December 31, 1994, because such earnings are permanently invested or will not be repatriated unless any additional income taxes would be substantially offset by foreign tax credits. It is not practicable to determine the amount of unrecognized deferred income tax liabilities on these undistributed earnings.
The Company expects that sufficient taxable income will be generated in future years to realize the U.S. federal net operating loss and tax credit carryforwards and, therefore, the Company believes that a valuation allowance is not necessary for these amounts. Although future earnings cannot be predicted with certainty, management currently believes that realization of the net deferred tax asset is more likely than not. The Company will report on its 1995 U.S. federal income tax return gains totaling an estimated $50 million with respect to the sales of its personal lines business and its Alexsis subsidiary. Based on 1994 results, excluding nonrecurring items and sold subsidiaries and businesses, with an estimated 8.5% reduction in U.S. operating costs as a result of the Company's restructuring in 1994, the
During 1994, the Company was advised that the Joint Committee on Taxation had approved the agreement reached in 1993 by the Company and the Appeals Office of the Internal Revenue Service (IRS) on settlement of tax issues with respect to years 1980 through 1986. Also during 1994, the Company reached an agreement with the IRS on settlement of the examination of years 1987 through 1989. On February 28, 1995, the Company paid the amounts due for years 1980 through 1989 and charged the tax and net interest totaling $35.6 million against previously established reserves.
Company at $50 million. This proposed adjustment relates to intercompany transactions involving the stock of a U.K. subsidiary.
The Company disagrees with the IRS position on this issue. Although the ultimate outcome of the matter cannot be predicted with certainty, the Company and its independent tax counsel believe there are meritorious defenses to the proposed adjustment and substantial arguments to sustain the Company's position and that the Company should prevail in the event this issue is litigated. A similar set of transactions occurred in 1993 for which the IRS could propose an increase in taxable income which would result in an additional tax liability estimated by the Company at $25 million. The Company's 1993 tax return is not currently under examination. The Company believes it should prevail in the event this similar issue is raised by the IRS. Accordingly, no provision for any liability with respect to the 1991 and 1993 transactions has been made in the consolidated financial statements.
A summary of the net liabilities of discontinued operations is as follows:
The insurance liabilities represent estimates of future claims expected to be made under occurrence-based insurance policies and reinsurance business written through Lloyd's and the London market covering primarily asbestosis, environmental pollution, and latent disease risks in the United States which are coupled with substantial litigation expenses. These claims are expected to develop and be settled over the next twenty to thirty years.
Liabilities stemming from these claims cannot be estimated using conventional actuarial reserving techniques because the available historical experience is not adequate to support the use of such techniques and because case law, as well as scientific standards for measuring the adequacy of site cleanup (both of which have had, and will continue to have, a significant bearing on the ultimate extent of the liabilities) is still evolving. Accordingly, the Company's independent actuaries have combined available exposure information with other data and have used various projection techniques to estimate the insurance liabilities, consisting principally of incurred but not reported losses.
In 1994, Orion who has financial responsibility for sharing certain of the indemnity liabilities, was placed in provisional liquidation by order of the English Courts. Based on current facts and circumstances, the Company believes that the provisional liquidation will not have a material adverse effect on the net liabilities of discontinued operations.
The insurance liabilities set forth above represent the Company's best estimates of the probable liabilities based on independent actuarial estimates. The recoverable amounts under the finite risk contracts, which are considered probable of realization based on independent actuarial estimates of losses and pay out patterns, represent the excess of such liabilities over the Company's retention levels. The premium adjustment represents the recoverable amount considered probable of realization at the earliest date the Company can exercise its right to terminate the finite risk contract covering the insurance underwriting subsidiaries currently in run-off.
Insurance liabilities in excess of recorded liabilities could develop in the future. Based on independent actuarial estimates of the amount and timing of claim payments, it is reasonably possible
that such additional liabilities, net of estimated amounts recoverable for paid losses under the finite risk contracts, could amount to $74 million. However, management currently believes that such additional insurance liabilities are not likely to develop.
The 1994 provision for loss of $28.9 million includes a $6 million charge associated with the 1994 finite risk contract, a $20.9 million charge relating to an agreement that resolved certain indemnity obligations to Sphere Drake and a $2 million charge recorded in the fourth quarter of 1994 related to other liabilities. Under terms of the Sphere Drake agreement, the Company received a cash payment of $5 million in settlement of the zero coupon notes receivable and related indemnities as well as certain income tax liabilities. The provision for loss in 1992 relates principally to increases in estimated liabilities associated with the indemnities provided to the purchaser of Sphere Drake resulting from more complete information becoming available in the fourth quarter of 1992.
PENSION PLANS The Company has contributory and non-contributory defined benefit pension plans covering substantially all employees. The plans generally provide pension benefits that are based on the employee's years of service and compensation prior to retirement. In general, it is the Company's policy to fund these plans consistent with laws and regulations of the respective jurisdictions in which the Company operates.
THRIFT PLANS The Company maintains thrift plans for most U.S. and Canadian employees. Under the thrift plans, eligible employees may contribute amounts through payroll deduction, supplemented by Company contributions, for investments in various funds established by the plans. The cost of these plans was $11.9 million in 1994, $11.3 million in 1993 and $10.8 million in 1992.
The discount rate used in determining the accumulated postretirement benefit obligation was 8.5 percent and the compensation rate increase was 4.5 percent. The expected rate of return on plan assets was 5.75 percent. The assumed medical trend rate is 10 percent in 1995 and gradually declines to 5.5 percent in 2000 and thereafter. Increasing the trend rate by 1 percent and holding all other assumptions constant, the impact on the cost component and the accumulated benefit obligation is an increase of $0.2 million and $1.2 million, respectively.
Certain of the Company's international subsidiaries have similar plans for their employees; however, most retirees are covered primarily by government sponsored programs. As a result, the cost to the Company for retired employees is not significant for these programs.
DEFERRED COMPENSATION PLAN The Company has a deferred compensation plan which permitted certain of its key officers and employees to defer a portion of their incentive compensation during 1986 to 1989. The Company has purchased whole life insurance policies on each participant's life to assist in the funding of the deferred compensation liability. At December 31, 1994, the cash surrender value of
B. NOTE PAYABLE In July 1994, Alexander & Alexander Services Inc. borrowed $50 million from the reinsurance company that executed a finite risk contract relating to the Company's discontinued operations. The note is payable in five equal annual installments, commencing July 1, 1997 and bears
interest at a rate of 9.45 percent. If Alexander & Alexander Services Inc. defaults on the borrowing, the reinsurance company may utilize the Alexander & Alexander Services Inc. note to settle reinsurance claims under the finite risk contract.
D. NON-RECOURSE MORTGAGE NOTES Two subsidiaries of the Company had an investment in a direct financing lease of an office building and related non-recourse mortgage notes. In July 1994, a contractual option to purchase the office building was exercised by the lessee by assuming the non-recourse mortgage notes. No gain or loss was recognized on this transaction.
Supplementing the credit agreement, the Company has unsecured lines of credit available for general corporate purposes totaling $97.7 million of which $97 million were unused as of December 31, 1994. These lines consist of both committed and uncommitted facilities in the U.S. and certain other countries. If drawn, the lines bear interest at market rates and carry annual commitment fees of not greater than 1/2 percent of the line.
On March 27, 1995, the Company's existing credit agreement was cancelled and replaced by a new $200 million three-year facility with various banks which expires in March 1998. The new agreement provides for unsecured borrowings and contains various covenants, including minimum consolidated tangible capital funds, minimum consolidated tangible net worth, maximum leverage and minimum cash flow coverage requirements. The Company currently believes that the covenant regarding minimum cash flow coverage is the most restrictive. This covenant requires that the ratio of earnings before interest, taxes, depreciation and amortization to interest expense and cash dividends exceed 4.25 to 1. In addition, the occurrence of a "Special Event" under the AIG Agreement which is not waived would constitute an event of default under the new agreement. (See Note 10 to Notes to Financial Statements)
Under the 1988 Long-Term Incentive Compensation Plan (1988 Plan), as amended by action of the Board of Directors in September 1994, up to 5,499,000 shares of the Company's Common Stock may be awarded to officers and key employees. The 1988 Plan includes grants in the form of incentive stock options and non-qualified options, stock appreciation rights, restricted stock awards, performance share/unit awards and other stock based awards.
Stock appreciation rights may be granted alone or in conjunction with a stock option at a price not less than the fair market value of the Common Stock at date of grant. Upon exercise of a stock appreciation right, the participant will receive cash, Common Stock or a combination thereof equal to the excess of the market value over the exercise price of the stock appreciation right. Exercise of either the right or the stock option will result in the surrender of the other.
Restricted stock awards may be granted which limit the sale or transfer of the shares until the expiration of a specified time period. Such awards are subject to forfeiture if the participant does not remain in the employ of the Company throughout the restricted time period. A maximum of 1,250,000 shares may be issued under the 1988 Plan. There were 308,500, 60,000 and 92,810 shares issued in 1994, 1993 and 1992, respectively. Also in 1994, 271,307 shares of restricted stock were awarded to an executive officer to offset the loss of certain benefits from the executive's prior employer when the executive joined the Company. In addition, 140,000 shares of Common Stock were delivered to a Company trust to fund a special compensation award to a non-executive director.
Performance share/unit awards may be granted based upon certain performance criteria as determined by the Company and Benefits Committee of the Board of Directors. Upon achievement of the performance share/unit criteria, the participant will receive cash, Common Stock or a combination thereof equal to the award. There were 23,000 performance share/unit awards made in 1994. No performance share/unit awards were made in 1993 and 1992.
The Charter Amendment, which became effective on July 15, 1994, increased the total authorized capital stock of the Company to 292,000,000 shares of five classes consisting of 200,000,000 shares of Common Stock, par value $1.00 (Common Stock); 26,000,000 shares of Class A Common Stock, par value $.00001 (Class A Common Stock) 11,000,000 shares of Class C Common Stock, par value $1.00 (Class C Common Stock); 40,000,000 Class D Stock; and 15,000,000 shares of Preferred Stock, par value $1.00 (Preferred Shares). The aggregate par value of all shares of all classes of stock which the Company will, pursuant to the Charter Amendment, have authority to issue is $266,000,260. Prior to the effective date of the Charter Amendment, the Company had total authorized capital stock equal to 88,500,000 shares of four classes consisting of 60,000,000 shares of Common Stock; 13,000,000 Class A Common Stock, 5,500,000 Class C Common Stock, and 10,000,000 Preferred Shares.
COMMON STOCK AND EQUIVALENTS In addition to its Common Stock, the Company has issued two classes of voting equity securities, Class A and Class C Common Stock, with voting rights equal to the Company's Common Stock. Associated with each such share is a dividend paying share issued by a Canadian (RSC Class 1 share) or a United Kingdom (AASUK Dividend share) subsidiary which pays dividends in Canadian dollars and pounds sterling respectively, equivalent to the dividends paid on shares of Common Stock. Holders of these securities, therefore, hold the economic equivalent of shares of Common Stock. Each Class A share (together with an RSC Class 1 share) and Class C share (together with an AASUK Dividend share) may be exchanged at any time for a share of Common Stock.
No dividends may be declared or paid on the Company's Common Stock unless an equivalent amount per share is declared and paid on the RSC Class 1 and AASUK Dividend shares. Accordingly,
At December 31, 1994, the Company had 5.5 million shares of Common Stock reserved for issuance under employee stock option plans, 1.5 million shares reserved for issuance in the event of conversion of the 11 percent convertible subordinated debentures and 2.7 million shares reserved for issuance upon redemption or conversion of the Class A and Class C shares.
CLASS D STOCK Shares of the Company's Series B Convertible Preferred Shares are convertible into Class D Stock, at a conversion price of $17 per share, subject to adjustment. No shares of Class D Stock are currently outstanding. Holders of the Class D Stock have the same rights to receive dividends and distributions as the holders of the Common Stock. In the event of the voluntary or involuntary liquidation, dissolution or winding up of the Company, the holders of Class D Stock and Common Stock participate ratably in proportion to the number of shares held by each such holder in any distribution of assets of the Company to such stockholders. In addition, in the event the Company effects a subdivision or combination or consolidation of the outstanding shares of Class D Stock into a greater or lesser number of shares of Class D Stock, then in each such case the Company will effect an equivalent subdivision or combination or consolidation of the outstanding shares of Common Stock into a greater or lesser number of shares of Common Stock. The Class D Stock are non-voting, except as provided by law, in the event of a proposed amendment to the Company's Charter that would adversely affect holders of shares of Class D Stock and following the occurrence of a Specified Corporate Event. The holders of the Class D Stock have the right to exchange Class D Stock for Common Stock, at any time or from time to time, on a share-for-share basis, provided, however, that no person is entitled to acquire Common Stock upon such exchange if after giving effect thereto such person has, or will have the then contractual right to acquire through conversion, exercise of warrants or otherwise, more than 9.9 percent of the combined voting power of the Company's voting shares then outstanding, absent certain events.
SERIES A CONVERTIBLE PREFERRED SHARES In March 1993, the Company completed a private placement of 2.3 million shares of $3.625 Series A Convertible Preferred Shares (Series A Convertible Preferred Shares). Gross proceeds of the offering were $115 million with net proceeds to the Company of $110.9 million. Holders of the Series A Convertible Preferred Shares are entitled to receive cumulative cash dividends at an annual rate of $3.625 per share, payable quarterly in arrears. The Series A Convertible Preferred Shares have priority as to dividends over the Common Stock. The shares are convertible into Common Stock at a conversion price of $31.875 per share of Common Stock, subject to adjustments. Common Stock issued upon conversion will include Rights, as described below,
NOTES TO FINANCIAL STATEMENTS (CONTINUED) (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
provided the conversion occurs prior to the distribution, redemption or expiration of such Rights. The Series A Convertible Preferred Shares may be redeemed by the Company on and after March 22, 1997, in whole or in part, at $52.18 per share until March 14, 1998, and declining ratably annually to $50 per share on or after March 15, 2003, plus accrued and unpaid dividends. The Series A Convertible Preferred Shares are non-voting, except as provided by law and except that, among other things, holders will be entitled to vote as a separate class with any other series of outstanding Preferred Stock to elect a maximum of two directors if the equivalent of six or more quarterly dividends on the Series A Convertible Preferred Shares are in arrears. The Series A Convertible Preferred Shares have a liquidation preference of $50 per share.
SERIES B CONVERTIBLE PREFERRED SHARES The Series B Convertible Preferred Shares were issued on July 15, 1994. After giving effect to estimated transaction expenses, a $10 million indemnification provision and the cost of an option for an insurance-based financing arrangement, the sale of the Series B Convertible Preferred Shares increased the Company's capital by approximately $186 million. The shares are convertible into Class D Stock at a conversion price of $17 per share of Class D Stock, subject to adjustment. The holders of the Class D Stock have the right to exchange Class D Stock for Common Stock, at any time or from time to time, on a share-for-share basis, subject to certain limitations discussed below as to the amount of shares which may be converted. Dividends on the Series B Convertible Preferred Shares will reduce the amount of earnings otherwise available for common stockholders by approximately $16 million in the first year after issuance, and by approximately $23 million by the fifth year after issuance, assuming dividends on the Series B Convertible Preferred Shares were to be paid in kind throughout the first five years after issuance.
The Series B Convertible Preferred Shares may be redeemed in whole or in part by the Company after December 15,1999, so long as after that date the Common Stock has traded 30 consecutive trading days on the New York Stock Exchange at a price in excess of 150 percent of the then effective conversion price. The redemption price will be $54 per share until December 14, 2000, declining ratably annually to $50 per share on or after December 14, 2006, plus accrued and unpaid dividends. All redemptions are to be made pro-rata.
If the Company is subsequently acquired, each Right will entitle the holder to purchase at the then-current exercise price, stock of the surviving company having a market value of twice the exercise price of each Right. In addition, if a person or group acquires more than 15 percent, but less than 50 percent, of the Company's voting shares, the Board of Directors may exchange each Right for one one-hundredth of a Participating Preferred Share. The Rights are redeemable by the Board until the time of
On April 21, 1992, the Board of Directors of the Company approved an Amendment to the Rights Agreement (the Rights Agreement), dated as of June 11, 1987, between the Company and First Chicago Trust Company of New York, as amended and restated as of March 22, 1990. The Amendment provides for certain technical revisions in the Rights Agreement including definition of Shares Acquisition Date to mean the first date of public announcement by the Company that an Acquiring Person has become such. The Amendment also provides that if the Rights become exercisable, the Company, acting by resolution of the Board of Directors, may (and if a sufficient number of Participating Preferred Shares is not available for issuance upon exercise of the Right, shall), issue equity securities, debt securities, cash and/or other property in lieu of Participating Preferred Shares.
In connection with the AIG Investment, the Board of Directors amended the Rights Agreement. Pursuant to Amendment No. 2 to the Rights Agreement, effective as of June 6, 1994, the acquisition of Series B Convertible Preferred Shares upon closing of the AIG Agreement, the acquisition of Class D Stock upon conversion of Series B Convertible Preferred Shares, the acquisition of Common Stock upon exchange for Class D Stock or the acquisition by AIG or its affiliates or any transferee thereof of any securities of the Company (if such acquisition is permitted by the Purchase Agreement) will not (i) cause any person to become an Acquiring Person, (ii) cause the Distribution Date or the Shares Acquisition Date to occur, or (iii) give rise to a Section 11(a)(ii) Event (as such capitalized terms are defined in the Rights Agreement).
In addition, on July 15, 1994, the Board of Directors approved Amendment No. 3 to the Rights Agreement, which provides for, among other things, modifications of the definitions of Acquiring Person and Distribution Date to raise from 10 percent to 15 percent the percentage of stock ownership needed to cause a person to become an Acquiring Person or to cause a Distribution Date to occur (as such capitalized terms are defined in the Rights Agreement).
Effective January 1, 1994, the Company adopted SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities." In accordance with the Statement, the Company has classified all debt and equity securities as available for sale. At December 31, 1994, net unrealized holding gains totaled $1.5 million, net of deferred income taxes of $0.2 million, and are reported as a separate component of Stockholders' Equity. During 1994, the net unrealized holding gains decreased by approximately $2 million and proceeds from sales of securities totaled $157.4 million with gross realized gains totaling $0.5 million.
The amortized cost and estimated fair value of the Company's debt and equity securities and financial instruments used to hedge the existing and anticipated fiduciary portion of such investments as of December 31, 1994 are summarized below:
Certain of the above investments with maturities greater than one year are classified as short-term and included in current assets as they represent fiduciary investments that will be utilized during the normal operating cycle of the business to pay premiums payable to insurance companies that are included in current liabilities.
broking operations. The exposures arise because a significant portion of the revenues of these operations are denominated in U.S. dollars, while their expenses are primarily denominated in U.K. pounds sterling.
The Company generally enters into interest rate swap agreements with a final maturity of three years or less. The floating rate on these agreements is generally based upon the six-month LIBOR rate on the relevant six-month reset dates. The Company also generally uses six-month LIBOR as the floating rate index for its forward rate agreements. Forward rate agreements generally have a final maturity date that is less than two years.
In addition, as part of its interest rate management program, the Company utilizes various types of interest rate options, including caps, collars, floors and interest rate guarantees. The Company generally writes covered interest rate options under which the Company receives a fixed interest rate.
The following methods and assumptions were used in estimating the fair value of each class of financial instrument. The fair values of short-term and long-term investments were estimated based upon quoted market prices for the same or similar instruments. The fair value of long-term debt, including the current portion, was estimated on the basis of market prices for similar issues at current interest rates for the applicable period. The fair value of interest rate swaps and forward rate agreements was estimated by discounting the future cash flows using rates currently available for agreements of similar terms and maturities. The fair value of foreign exchange forward contracts and foreign exchange option agreements was estimated based upon year-end exchange rates. The fair value of interest rate options was estimated based upon market quotes of the cost to settle these agreements. The carrying amounts of the Company's other financial instruments approximate fair value due to their short-term maturities.
The following table presents the carrying amounts and the estimated fair value of the Company's financial instruments that are not carried at fair value.
Future minimum annual rentals under noncancelable operating leases, excluding $11.3 million of future sublease rental income, which have been translated at December 31, 1994 closing foreign exchange rates, are as follows:
OTHER COMMITMENTS At December 31, 1994, the Company had $32.7 million of letters of credit outstanding which are required under certain agreements in the ordinary course of business.
Certain claims asserted against the Company and certain of its subsidiaries alleging, among other things, that certain Alexander Howden subsidiaries accepted, on behalf of certain insurance companies, insurance or reinsurance at premium levels not commensurate with the level of underwriting risks assumed and retroceded or reinsured those risks with financially unsound reinsurance companies.
In 1987, the Company sold Shand, its domestic underwriting management subsidiary. Prior to the sale, Shand and its subsidiaries had provided underwriting management services for and placed insurance and reinsurance with and on behalf of Mutual Fire. Mutual Fire was placed in rehabilitation by the Courts of the Commonwealth of Pennsylvania in December 1986. In February 1991, the rehabilitator filed a complaint in the Commonwealth court against Shand and the Company. The case was subsequently removed to the U.S. District Court for the Eastern District of Pennsylvania and is captioned Foster v. Alexander & Alexander Services Inc., 91 Civ. 1179. The complaint, which seeks compensatory and punitive damages, alleges that Shand and, in certain respects, the Company breached duties to and agreements with, Mutual Fire. The rehabilitator, through an expert's report, indicated that the alleged damages are approximately $234 million, a conclusion with which the Company, based on substantial arguments, strongly disagreed.
Under the 1987 agreement with the purchaser of Shand, the Company agreed to indemnify the purchaser against certain contingencies, including, among others, (i) losses arising out of pre-sale transactions between Shand or Shand's subsidiaries, on the one hand, and Mutual Fire, on the other, and (ii) losses arising out of pre-sale errors or omissions by Shand or Shand's subsidiaries. The Company's obligations under the indemnification provisions in the 1987 sales agreement were not limited as to amount or duration.
that the reasonably possible loss that might result, if any, would not be material to the Company's financial position or results of operations.
These contingent liabilities involve significant amounts. While it is not possible to predict with certainty the outcome of such contingent liabilities, the applicability or availability of coverage for such matters under the Company's professional indemnity insurance program, or their financial impact on the Company, management currently believes that such impact will not be material to the Company's financial position. However, it is possible that future developments with respect to these matters could have a material effect on future interim or annual results of operations.
Insurance Services operations include risk management and insurance services, specialist insurance and reinsurance broking.
Human Resource Management Consulting includes a variety of human resource management consulting services, including actuarial and benefit plan consulting services, flexible compensation consulting, communications and management consulting services and executive planning services, as well as human resource organizational analysis and planning.
The following tables present information about the Company's operations by business segment and geographical areas for each of the three years in the period ended December 31, 1994:
(a) The restructuring charge referred to in Note 3 of Notes to Financial Statement includes $56.3 million for insurance services, $8.3 million for human resource management consulting and $4.4 million for general corporate.
(a) The restructuring charges referred to in Note 3 of Notes to Financial Statements have been allocated to their respective geographical areas in 1994, including $31.8 million in the U.S., $21.9 million in the U.K., $4 million in Canada, $6.9 million in Other Countries and $4.4 million in general corporate.
(a) Includes a charge of $6 million, or $.14 per share, relating to the Company's discontinued operations (see Note 6 of Notes to Financial Statements).
(c) Includes charges of $163.6 million ($106.6 million after-tax or $2.43 per share) for restructuring, contingency settlements and other reserves.