Marsh & McLennan Companies and certain of its subsidiaries own, directly and indirectly through special purpose subsidiaries, a 58% condominium interest covering approximately 900,000 square feet in a 44-story building in New York City. This real estate serves as the Company's headquarters and is occupied primarily by the Company and its affiliates for general corporate use. The remaining 42% condominium interest in this property is owned by an unaffiliated third party. The Company’s owned interest is financed by a 30-year loan that is non-recourse to the Company (except in the event of certain prohibited actions) and secured by a first mortgage lien on the condominium interest and a first priority assignment of leases and rents. In the event (1) the Company is downgraded below B/B2 (Stable) by any of S&P, Fitch and Moody’s or (2) an event of default under the loan has occurred and is continuing, the Company would be obligated to pre-fund certain reserve accounts relating to the mortgaged property, including a rent reserve account in an amount equal to three months’ rent for the entire occupancy of the mortgaged property.
Consulting includes Health, Retirement, Talent and Investments consulting and services and products, and specialized management and economic consulting services. We conduct business in this segment through Mercer and Oliver Wyman Group.
This Management's Discussion & Analysis ("MD&A") contains forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995. See “Information Concerning Forward-Looking Statements” at the outset of this report.
Consolidated operating income increased 14% to $2.1 billion in 2013 compared with $1.8 billion in 2012 driven by a 3% increase in revenue on both a reported and underlying basis, with growth in each operating company. Expenses increased 1% on both a reported and underlying basis as the Company continues its efforts to manage expenses and improve operating efficiency.
Consolidated operating income in 2012 was $1.8 billion compared with $1.6 billion in 2011.
Discontinued operations in 2011 includes a net credit resulting from the resolution of certain legal matters and related insurance recoveries as well as the settlement of certain tax audits and the expiration of the statute of limitations related to certain indemnified matters in connection with the disposals of Putnam and Kroll. These credits are partly offset by the write-off, net of tax, of capitalized software related to the disposal of the Marsh Business Processing Outsourcing ("BPO") business.
Consolidated net income attributable to the Company was $1.4 billion in 2013, compared with $1.2 billion in 2012 and $993 million in 2011.
Underlying revenue measures the change in revenue using consistent currency exchange rates, excluding the impact of certain items such as: acquisitions, dispositions and transfers among businesses.
Consolidated revenue for 2012 increased 3% to $11.9 billion compared with $11.5 billion in 2011, reflecting a 4% increase in underlying revenue, a 1% increase due to acquisitions and a 2% negative impact of foreign currency translation. Revenue in the Risk and Insurance Services segment increased 4% in 2012 compared with 2011 or 5% on an underlying basis, reflecting increases of 5% in Marsh and 6% in Guy Carpenter. Consulting segment revenue increased 2%, resulting from a 4% increase in Mercer partly offset by a 1% decrease in the Oliver Wyman Group. On an underlying basis, Consulting segment revenue increased 4%, reflecting a 4% increase in Mercer and a 3% increase in the Oliver Wyman Group.
Consolidated operating expenses increased 2% in 2012 compared with the same period in 2011. The increase reflects a 3% increase in underlying expenses, a 1% increase due to the impact of acquisitions, offset by a 2% decrease due to the impact of foreign currency exchange translation. The increase in underlying expenses primarily reflects higher incentive compensation and benefits costs as well as restructuring costs at Mercer, which include exit costs related to a portion of Mercer's Canadian outsourcing business. These increases were partly offset by credits related to the adjustment of acquisition related contingent consideration liabilities.
In 2013, the Company implemented restructuring actions which resulted in costs totaling $22 million. The restructuring costs consist primarily of severance and benefits, costs for future rent and other real estate costs. These costs were incurred as follows: Risk and Insurance Services-$7 million; Consulting-$2 million; and Corporate-$13 million.
In Marsh, revenue grew to $5.4 billion in 2013, an increase of 4% from the prior year, reflecting 3% growth in underlying revenue and a 2% increase from acquisitions, partly offset by a 1% decrease resulting from the impact of foreign currency translation. The underlying revenue increase of 3% reflects growth in all major geographies which was driven by increased new business. International operations had underlying revenue growth of 4% reflecting increases of 13% in Latin America, 5% in Asia Pacific and 3% in EMEA, while U.S. / Canada increased 2%.
September - Marsh purchased an additional stake in Insia a.s., an insurance broker operating in the Czech Republic and Slovakia which, when combined with its prior holdings, gave Marsh a controlling interest. Insia a.s. was previously accounted for under the equity method.
Guy Carpenter’s revenue increased 5% to $1.1 billion in 2013 compared with 2012, or 5% on an underlying basis, reflecting growth across North America, International, Global Specialites and U.K. Facultative.
In July 2013, Guy Carpenter acquired Smith Group, a specialist disability reinsurance risk manager and consultant based in Maine.
Revenue in Risk and Insurance Services increased 4% in 2012 compared with 2011, reflecting a 5% increase on an underlying basis and a 2% increase from acquisitions, partly offset by a 2% decrease from the impact of foreign currency exchange translation.
Expenses in the Risk and Insurance Services segment increased 3% on both a reported and underlying basis in 2013 compared with 2012. The increase in expenses on an underlying basis is primarily due to higher base salaries, pension costs and adjustments to acquisition-related contingent consideration liabilities, partly offset by lower costs related to professional indemnity claims.
Expenses in the Risk and Insurance Services segment increased 3% in 2012 compared with 2011, reflecting a 2% increase from acquisitions and a 2% decrease due to the impact of foreign currency translation. Expenses on an underlying basis increased 3% primarily due to higher base salaries, incentive compensation and benefits costs partly offset by credits related to adjustments to acquisition- related contingent consideration liabilities.
Reimbursable expenses incurred by professional staff in the generation of revenue and sub-advisory fees related to investment management are included in revenue and the related expenses are included in other operating expenses.
July - Oliver Wyman acquired Corven, a U.K.-based management consultancy firm.
The following results of Corporate and Other includes the run-off of Corporate Advisory and Restructuring Group ("CARG") operations:
Corporate expenses in 2013 were $190 million compared to $203 million in 2012. The decrease is primarily due to lower amortization of equity awards and lower severance, partially offset by higher pension expense.
Corporate expenses in 2012 were $203 million compared to $188 million in 2011. The increase was primarily due to accelerated amortization of equity awards for retirement eligible senior executives and higher consulting costs associated with corporate initiatives.
The CARG amounts reflect payments received related to the CARG businesses divested in 2008.
As part of the disposal transactions for Putnam and Kroll, the Company provided certain indemnities, primarily related to pre-transaction tax uncertainties and legal contingencies. In accordance with applicable accounting guidance, liabilities were established related to these indemnities at the time of the sales and reflected as a reduction of the gain on disposal. Discontinued operations includes charges or credits resulting from the settlement or resolution of the indemnified matters, as well as adjustments to the liabilities related to such matters. Discontinued operations in 2013 includes estimated costs covered under the indemnity related to the Kroll sale as well as tax indemnities related to the Putnam sale. Discontinued operations in 2011 includes credits of $50 million from the resolution of certain legal matters
In the fourth quarter of 2011, management initiated a plan to sell the Marsh BPO business which was completed in August 2012. Marsh's BPO business, previously part of Marsh U.S. Consumer business, provided policy, claims, call center and accounting operations on an outsourced basis to life insurance carriers. Marsh invested in a technology platform that was designed to make the BPO business scalable and more efficient. During 2011, Marsh decided that it would cease investing in the technology platform and instead exit the business via a sale. The Company wrote off capitalized software of the BPO business of $17 million, net of tax, which is included in discontinued operations in 2011.
Summarized Statements of Income data for discontinued operations is as follows:
In 2012, investment income was $24 million compared with $9 million in 2011. This increase was primarily due to higher mark-to-market gains on private equity fund investments, partly offset by an impairment loss on a debt security of $8 million.
The lower effective tax rate attributed to the Company's foreign operations primarily reflects lower corporate tax rates that prevail outside of the U.S., net of the U.S. tax impact from repatriating foreign earnings. In 2013, pre-tax income in the U.K., Canada, Australia, France and Bermuda accounted for approximately 60% of the Company's total non-U.S. pre-tax income, with effective rates in those countries of 21% (excluding the non-cash deferred tax impact of U.K. tax legislation enacted in 2013), 27%, 31%, 42% and 0%, respectively. Under current U.S. tax law, the Company anticipates its non-U.S. operations will continue to incur taxes at rates below the U.S. federal tax rate of 35%.
The Company's U.S. revenue over the past three years has been approximately 45% of total revenue, while over that period the pre-tax income from U.S. locations varied from 9% to 21% of total pre-tax income.
The Company generated $1.3 billion of cash from operations in both 2013 and 2012. These amounts reflect the net income reported by the Company during those periods, excluding gains or losses from investments, cost of extinguishment of debt and the disposition of businesses, adjusted for non-cash
charges and changes in working capital which relate, primarily, to the timing of payments for accrued liabilities or receipts of assets.
During 2013, the Company contributed $26 million to its U.S. pension plans and $620 million to non-U.S. pension plans, which included contributions of $250 million to pre-fund all of the 2014 and a substantial portion of the 2015 deficit funding contributions for the U.K. plans and a discretionary contribution of $70 million to the Canadian plans. In 2012, the Company contributed $124 million to U.S. plans and $389 million to non-U.S. plans, which included $100 million of discretionary contributions to each of the U.S. and the U.K. plans.
In the U.S., contributions to the tax-qualified defined benefit plans are based on ERISA guidelines and the Company generally expects to maintain a funded status of 80% or more of the liability determined under the ERISA guidelines. The pension stabilization provisions included in the "Moving Ahead for Progress in the 21st Century Act", enacted on July 6, 2012, changed the methodology for determining the discount rate used for calculating plan liabilities under ERISA, which determines, in part, the funding requirements. After considering the impact of the pension funding stabilization provisions discussed above, the Company expects less than $1 million of contributions will be required for its U.S. tax-qualified plan through the end of 2014. The Company also expects to fund approximately $24 million to its non-qualified U.S. pension plans in 2014.
After completion of a consultation period with affected colleagues, in January 2014, the Company amended its U.K. defined benefit pension plans, to close those plans to future benefit accruals effective August 1, 2014 and will replace those plans, along with its existing defined contribution plans, with a new, comprehensive defined contribution arrangement. As required under GAAP, the Company re-measured the defined benefit plans’ assets and liabilities at the amendment date, based on assumptions and market conditions at that date. As a result of the re-measurement, the Projected Benefit Obligation ("PBO") increased by approximately $147 million and the funded status decreased by approximately $137 million. The change in the PBO and in the funded status relates primarily to a decrease in the discount rate at the re-measurement date. The net periodic benefit costs recognized in 2014 will be the weighted average resulting from the December 31, 2013 measurement and the January 2014 re-measurement. The Company will recognize a curtailment gain of $63 million in the first quarter of 2014, primarily resulting
The year-over-year change in the funded status of the Company's pension plans is impacted by the variance between actual and assumed results, particularly with regard to return on assets and changes in the discount rate, as well as the amount of Company contributions, if any. Unrecognized actuarial losses were approximately $1.0 billion and $3.0 billion at December 31, 2013 for the U.S. plans and non-U.S. plans, respectively, compared with $1.9 billion and $3.3 billion at December 31, 2012. The decrease is primarily due to the impact of increases in the discount rates, actual returns on plan assets in 2013 that were higher than the estimated long-term rate of return on plan assets and discretionary contributions to the plans, discussed above. In the past several years, the amount of actuarial losses has been significantly impacted, both positively and negatively, by actual asset performance and changes in discount rates. The discount rate used to measure plan liabilities increased in both the U.S. and the U.K. (the Company's two largest plans) in 2013 after decreasing in each of the four years from 2009 to 2012. At the end of 2009, the weighted average discount rate for all plans was 6.0%, declining to 5.6%, 4.9% and 4.4% at the end of 2010, 2011 and 2012, respectively. In 2013 the weighted average discount rate increased to 4.8%. An increase in the discount rate decreases the measured plan liability, resulting in actuarial gains, while a decrease in the discount rate increases the measured plan liability, resulting in actuarial losses. During 2013, the Company's defined benefit pension plan assets had actual returns of 12.6% and 8.6% in the U.S. and U.K., respectively. During 2012, the Company's defined benefit pension plan assets had actual returns of 14.1%, and 9.8% in the U.S. and U.K., respectively; and in 2011, the actual returns were 5.8% in the U.S. and 4.8% in the U.K. In 2012 and 2010, actuarial losses resulting from declines in the discount rate were partly offset by actual asset returns which exceeded the assumed rates of return in each year. In 2011, both the decline in the discount rate and actual asset returns that were lower than the assumed rates of return contributed to the actuarial losses.
As a result of the plan remeasurement to reflect the amendments to the U.K. plans, described above, an incremental decrease of approximately $31 million for defined benefit pension expense is expected for 2014, primarily resulting from the elimination of the service cost component, effective August 1, 2014. However, the decrease in the defined benefit pension cost resulting from the amendment will be largely offset by increased cost for the new defined contribution plan which will replace the existing defined benefit plans in the U.K.
The Company received $322 million in cash refunds of U.S. federal income taxes during the second quarter of 2011, comprising $212 million from carrying back the net capital loss incurred in 2010 from the sale of Kroll and various other assets, and $110 million from the cash settlement of the IRS audit for the periods 2006 through 2008. The audit settlement primarily reflected the allowance of carry back claims
for net operating losses and excess foreign tax credits arising in 2008. The impact on the tax provision of these events was reflected in prior periods and did not impact income tax expense reported in 2011.
Net cash used for financing activities was $834 million in 2013 compared with $633 million of net cash used for financing activities in 2012. The Company increased outstanding debt by approximately $37 million in 2013 while outstanding debt decreased by $10 million and $100 million in 2012 and 2011, respectively.
On July 15, 2011, the Company purchased $600 million of outstanding notes comprising $330 million of its 2014 Notes and $270 million of its 2015 Notes (collectively, the "Notes"). The Company acquired the Notes at fair value plus a tender premium, which exceeded its carrying value. A cost of approximately $72 million was recorded in the Consolidated Statements of Income in the third quarter of 2011 related to the extinguishment of this debt.
During 2013, the Company paid $17 million of contingent payments related to acquisitions made in prior years. These payments are split between financing and operating cash flows in the consolidated statements of cash flows. The portion of these payments that are reflected as a financing activity is $9 million, which represents payments related to the contingent consideration liability that was recorded on the date of acquisition. Any payments made related to increases in the contingent consideration liability subsequent to the date of acquisition are reflected as operating cash flows, which in 2013 was $8 million. Remaining estimated future contingent consideration payments of $104 million for acquisitions completed in 2013 and in prior years are recorded in accounts payable and accrued liabilities or other liabilities in the consolidated balance sheet at December 31, 2013.
The Company and certain of its subsidiaries maintain a $1.0 billion multi-currency five-year unsecured revolving credit facility. The interest rate on this facility is based on LIBOR plus an agreed fixed margin which varies with the Company's credit ratings. This facility requires the Company to maintain certain coverage and leverage ratios which are tested quarterly. There were no borrowings under this facility at December 31, 2013.
In December 2012, the Company closed on a $50 million, 3-year delayed draw term loan facility. The interest rate on this facility is based on LIBOR plus an agreed fixed margin which varies with the Company's credit ratings. The facility requires the Company to maintain coverage ratios and leverage ratios consistent with the revolving credit facility discussed above. The Company had $50 million of borrowings under this facility at December 31, 2013.
The Company also maintains other credit facilities, guarantees and letters of credit with various banks, primarily related to operations located outside the United States, aggregating $282 million at December 31, 2013 and $247 million at December 31, 2012. There was $1 million outstanding borrowings under these facilities at December 31, 2013 and no outstanding borrowings under these facilities at December 31, 2012.
The Company made 15 acquisitions in 2012. Cash used for these acquisitions, net of cash acquired was $230 million. In addition, in 2012, the Company paid $59 million of deferred purchase consideration related to acquisitions made in prior years and $3 million for the purchase of other intangible assets.
The Company has commitments for potential future investments of approximately $25 million in two private equity funds that invest primarily in financial services companies.
The determination of net periodic pension cost is based on a number of assumptions, including an expected long-term rate of return on plan assets, the discount rate, mortality and assumed rate of salary increase. Significant assumptions used in the calculation of net periodic pension costs and pension liabilities are disclosed in Note 8 to the consolidated financial statements. The Company believes the assumptions for each plan are reasonable and appropriate and will continue to evaluate assumptions at least annually and adjust them as appropriate. Based on its current assumptions, the Company expects pension expense in 2014 to decrease approximately $128 million compared with 2013, partly offset by compensation considerations.
The Company's tax rate reflects its income, statutory tax rates and tax planning in the various jurisdictions in which it operates. Significant judgment is required in determining the annual effective tax rate and in evaluating uncertain tax positions. The Company reports a liability for unrecognized tax benefits resulting from uncertain tax positions taken or expected to be taken in a tax return. The evaluation of a tax position is a two-step process. The first step involves recognition. The Company determines whether it is more likely than not that a tax position will be sustained upon tax examination, including resolution of any related appeals or litigation, based on only the technical merits of the position. The technical merits of a tax position derive from both statutory and judicial authority (legislation and statutes, legislative intent,
regulations, rulings, and case law) and their applicability to the facts and circumstances of the tax position. If a tax position does not meet the more likely than not recognition threshold, the benefit of that position is not recognized in the financial statements. The second step is measurement. A tax position that meets the more likely than not recognition threshold is measured to determine the amount of benefit to recognize in the financial statements. The tax position is measured as the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate resolution with a taxing authority.
The Company completed its 2013 annual review in the third quarter and concluded goodwill was not impaired, as the fair value of each reporting unit exceeded its carrying value by a substantial margin.
and awards granted thereunder to determine if awards will be treated as equity awards or liability awards, as defined by the accounting guidance.
As of December 31, 2013, there was $17 million of unrecognized compensation cost related to stock option awards. The weighted-average periods over which the costs are expected to be recognized is 1.2 years. Also as of December 31, 2013, there was $74 million of unrecognized compensation cost related to the Company’s restricted stock, restricted stock unit and deferred stock unit awards. The weighted-average period over which that cost is expected to be recognized is approximately one year.
Nature of Operations: Marsh & McLennan Companies, Inc. (the "Company”), a global professional services firm, is organized based on the different services that it offers. Under this organizational structure, the Company’s two business segments are Risk and Insurance Services and Consulting.
Acquisitions impacting the Risk and Insurance Services and Consulting segments are discussed in Note 4 below.
In certain instances, the Company advances premiums, refunds or claims to insurance underwriters or insureds prior to collection. These advances are made from corporate funds and are reflected in the accompanying consolidated balance sheets as receivables.
Revenue: Risk and Insurance Services revenue includes insurance commissions, fees for services rendered and interest income on certain fiduciary funds. Insurance commissions and fees for risk transfer services generally are recorded as of the effective date of the applicable policies or, in certain cases (primarily in the Company's reinsurance broking operations), as of the effective date or billing date, whichever is later. A reserve for policy cancellation is provided based on historic and current data on cancellations. Fees for non-risk transfer services provided to clients are recognized over the period in which the services are provided, using a proportional performance model. Fees resulting from
Cash and Cash Equivalents: Cash and cash equivalents primarily consist of certificates of deposit and time deposits, with original maturities of three months or less, and money market funds. The estimated fair value of the Company's cash and cash equivalents approximates their carrying value. The Company is required to maintain operating funds of approximately $190 million related to regulatory requirements outside the U.S. or as collateral under captive insurance arrangements.
Certain investments, primarily investments in private equity funds, are accounted for under the equity method using a consistently applied three-month lag period adjusted for any known significant changes from the lag period to the reporting date of the Company. The underlying private equity funds follow investment company accounting, where investments within the fund are carried at fair value. The Company records in earnings, investment gains/losses for its proportionate share of the change in fair value of the funds, which amounted to gains of $12 million, $33 million and $10 million in 2013, 2012 and 2011, respectively. Investments recorded using the equity method are included in other assets in the consolidated balance sheets.
As part of the sale of MMC Capital in 2005, the Company retained the right to receive certain performance fees related to the Trident II and Trident III private equity partnerships. The Company recognizes performance fee income when such fees are no longer subject to forfeiture, which may take a number of years to resolve. The Company deferred the recognition of income related to such performance fees of $38 million and $63 million at December 31, 2013 and 2012, respectively, related to Trident III. This income is based on the investment performance over the life of each investment in the private equity fund, and future declines in fund performance from current levels may result in the forfeiture of such revenue. Trident II has now fully harvested all its portfolio investments and final distributions were made to partners during the fourth quarter of 2013. Therefore, the Company no longer holds an investment in Trident II. Approximately $40 million and $15 million of performance fees were recognized in 2013 related to Trident III and Trident II, respectively, and included as part of investment income. The Company received approximately $100 million in cash proceeds related to Trident II partnership distributions in 2013.
Gains or losses recognized in earnings from the investments, including the performance fees discussed above, are included in investment income in the consolidated statements of income.
Capitalized Software Costs: The Company capitalizes certain costs to develop, purchase or modify software for the internal use of the Company. These costs are amortized on a straight-line basis over periods ranging from 3 to 10 years. Costs incurred during the preliminary project stage and post implementation stage, are expensed as incurred. Costs incurred during the application development stage are capitalized. Costs related to updates and enhancements are only capitalized if they will result in additional functionality. Capitalized computer software costs of $399 million and $278 million, net of accumulated amortization of $748 million and $691 million at December 31, 2013 and 2012, respectively, are included in other assets in the consolidated balance sheets.
Legal and Other Loss Contingencies: The Company and its subsidiaries are subject to a significant number of claims, lawsuits and proceedings including claims for errors and omissions ("E&O"). GAAP requires that a liability be recorded when a loss is both probable and reasonably estimable. Significant management judgment is required to apply this guidance. The Company utilizes case level reviews by inside and outside counsel, an internal actuarial analysis and other analysis to estimate potential losses. The liability is reviewed quarterly and adjusted as developments warrant. In many cases, the Company has not recorded a liability, other than for legal fees to defend the claim, because we are unable, at the present time, to make a determination that a loss is both probable and reasonably estimable. Given the unpredictability of E&O claims and of litigation that could flow from them, it is possible that an adverse outcome in a particular matter could have a material adverse effect on the Company’s businesses, results of operations, financial condition or cash flow in a given quarterly or annual period.
The legal and other contingent liabilities described above are not discounted.
Uncertain tax positions are evaluated based upon the facts and circumstances that exist at each reporting period. Subsequent changes in judgment based upon new information may lead to changes in recognition, de-recognition, and measurement. Adjustments may result, for example, upon resolution of an issue with the taxing authorities, or expiration of a statute of limitations barring an assessment for an issue. The Company recognizes interest and penalties, if any, related to unrecognized tax benefits in income tax expense.
Diluted net income per share attributable to the Company and income from continuing operations per share are calculated by dividing the respective after-tax income attributable to common shares by the weighted average number of outstanding shares of the Company’s common stock, which have been adjusted for the dilutive effect of potentially issuable common shares. Reconciliations of the applicable income components used for diluted EPS - Continuing operations and basic weighted average common shares outstanding to diluted weighted average common shares outstanding are presented below. The reconciling items related to the calculation of diluted weighted average common shares outstanding are the same for net income attributable to the Company.
In June 2013, the FASB issued new accounting guidance which amends the criteria for an entity to qualify as an investment company. The guidance clarifies the characteristics of an investment company, provides comprehensive guidance to determine whether an entity is an investment company and sets
measurement and disclosure requirements for investment companies. The guidance is effective for interim and annual reporting periods beginning after December 15, 2013. Earlier application is prohibited. Adoption of the guidance is not expected to materially affect the Company's financial position, results of operations or cash flows.
Reclassifications: Certain reclassifications have been made to prior period amounts to conform with current year presentation, in particular with regard to the Per Share Data disclosure in Footnote 1, which is presented using the treasury stock method, since there is no difference in the earnings per share calculation between the treasury stock method and the two-class method for the three years presented.
The Company had non-cash issuances of common stock under its share-based payment plan of $150 million, $193 million and $197 million for the years ended December 31, 2013, 2012 and 2011, respectively. The Company recorded stock-based compensation expense related to equity awards of $110 million, $152 million and $165 million for the years ended December 31, 2013, 2012 and 2011, respectively.
An analysis of the allowance for doubtful accounts is as follows:
The changes in the balances of each component of Accumulated Other Comprehensive Income ("AOCI") for the year ended December 31, 2013, including amounts reclassified out of AOCI, are as follows:
The Company’s acquisitions have been accounted for as purchases. Net assets and results of operations are included in the Company’s consolidated financial statements commencing at the respective purchase dates. In connection with acquisitions, the Company records the estimated value of the net tangible assets purchased and the value of the identifiable intangible assets purchased, which typically consist of purchased customer lists, trademarks and non-compete agreements. The valuation of purchased intangible assets involves significant estimates and assumptions. Any change in assumptions could affect the carrying value of such intangible assets.
September - Marsh purchased an additional stake in Insia a.s., an insurance broker operating in the Czech Republic and Slovakia which, when combined with its prior holdings, gave MMC a controlling interest. Insia a.s. was previously accounted for under the equity method.
Total purchase consideration for acquisitions made during 2012 was $360 million, which consisted of cash paid of $252 million, deferred purchase and estimated contingent consideration of $46 million, and cash held in escrow of $62 million at December 31, 2011 that was released in the first quarter of 2012. Contingent consideration arrangements are primarily based on EBITDA and revenue targets over two to four years. The fair value of the contingent consideration was based on projected revenue and earnings of the acquired entities. Estimated fair values of assets acquired and liabilities assumed are subject to adjustment when purchase accounting is finalized. During 2012, the Company also paid $59 million of deferred purchase consideration and $30 million of contingent consideration related to acquisitions made in prior years. In addition, the Company paid $3 million to purchase other intangible assets during 2012.
Net of valuation allowances of $70 million in 2013 and $65 million in 2012.
The Company’s consolidated tax rate was 30.1%, 29.0% and 30.1% in 2013, 2012 and 2011, respectively. The tax rate in each year reflects foreign operations, which are generally taxed at rates lower than the U.S. statutory tax rate.
Valuation allowances had net increases of $10 million and $23 million in 2013 and 2012, respectively, and a decrease of $1 million in 2011. During the respective years, adjustments of the beginning of the year balances of valuation allowances decreased income tax expense by $3 million in 2013 and increased income tax expense by $16 million in 2012. None of the cumulative valuation allowances relate to amounts which if realized would increase contributed capital in the future. Approximately 66% of the Company’s net operating loss carryforwards expire from 2014 through 2033, and others are unlimited. The potential tax benefit from net operating loss carryforwards at the end of 2013 comprised state and local, and non-U.S. tax benefits of $60 million and $90 million, respectively, before reduction for valuation allowances. Foreign tax credit carryforwards expire from 2019 through 2022.
Following is a reconciliation of the Company’s total gross unrecognized tax benefits for the years ended December 31, 2013, 2012 and 2011:
Of the total unrecognized tax benefits at December 31, 2013, 2012 and 2011, $71 million, $96 million and $102 million, respectively, represent the amount that, if recognized, would favorably affect the effective tax rate in any future periods. The total gross amount of accrued interest and penalties at December 31, 2013, 2012 and 2011, before any applicable federal benefit, was $10 million, $13 million and $17 million, respectively.
As discussed in Note 5, the Company has provided certain indemnities related to contingent tax liabilities as part of the disposals of Putnam and Kroll. At December 31, 2013, 2012 and 2011, $2 million, $6 million and $14 million, respectively, included in the table above, relates to Putnam and Kroll positions included in consolidated Company tax returns. Since the Company remains primarily liable to the taxing authorities for resolution of uncertain tax positions related to consolidated returns, these balances will remain as part of the Company’s consolidated liability for uncertain tax positions. Any future charges or credits that are directly related to the disposal of Putnam and Kroll and the indemnified contingent tax issues, including interest accrued, will be recorded in discontinued operations as incurred.
The Company is routinely examined by the jurisdictions in which it has significant operations. During 2013, the Company settled federal tax audits with the Internal Revenue Service (IRS) for years 2007 and 2009 through 2011. The tax year 2008 was settled in a prior period. During 2011, the Company was accepted to participate in the IRS Compliance Assurance Process (CAP) which is structured to conduct real-time compliance reviews. The IRS is currently examining 2012 and performing a pre-filing review of the Company's 2013 U.S. operations. New York State and New York City have examinations underway for various entities covering the years 2007 through 2011. During 2013, the State of Illinois commenced an audit of the Company for years 2009 through 2012. During 2013, the Company filed appeals in the Massachusetts Appellate Tax Board for various entities for assessments received at the end of 2012, and the Company is currently appealing those assessments. During 2013, the United Kingdom commenced an examination of tax years 2011 and 2012 for various subsidiaries. There are no ongoing tax audits in the jurisdictions outside the U.S. in which the Company has significant operations. The Company regularly considers the likelihood of assessments in each of the taxing jurisdictions resulting from examinations. The Company has established appropriate liabilities for uncertain tax positions in relation to the potential assessments. The Company believes the resolution of tax matters will not have a material effect on the consolidated financial position of the Company, although a resolution of tax matters could
have a material impact on the Company's net income or cash flows and on its effective tax rate in a particular future period. It is reasonably possible that the total amount of unrecognized tax benefits will decrease between zero and approximately $21 million within the next twelve months due to settlement of audits and expiration of statutes of limitation.
The Company uses actuaries from Mercer, a subsidiary of the Company, to perform valuations of its pension plans. The long-term rate of return on plan assets assumption is determined for each plan based on the facts and circumstances that exist as of the measurement date, and the specific portfolio mix of each plan’s assets. The Company utilizes a model developed by the Mercer actuaries to assist in the determination of this assumption. The model takes into account several factors, including: actual and target portfolio allocation; investment, administrative and trading expenses incurred directly by the plan trust; historical portfolio performance; relevant forward-looking economic analysis; and expected returns, variances and correlations for different asset classes. These measures are used to determine probabilities using standard statistical techniques to calculate a range of expected returns on the portfolio. The Company generally does not adjust the rate of return assumption from year to year if, at the measurement date, it is within the best estimate range, defined as between the 25th and 75th percentile of the expected long-term annual returns in accordance with the “American Academy of Actuaries Pension Practice Council Note May 2001 Selecting and Documenting Investment Return Assumptions” and consistent with Actuarial Standards of Practice No. 27. Historical long-term average asset returns of each plan are also reviewed to determine whether they are consistent and reasonable compared with the best estimate range. The expected return on plan assets is determined by applying the assumed long-term rate of return to the market-related value of plan assets. This market-related value recognizes investment gains or losses over a five-year period from the year in which they occur. Investment gains or losses for this purpose are the difference between the expected return calculated using the market-related value of assets and the actual return based on the market value of assets. Since the market-related value of assets recognizes gains or losses over a five-year period, the future market-related value of the assets will be impacted as previously deferred gains or losses are reflected.
within acceptable risk parameters. The Company uses threshold-based portfolio rebalancing to ensure the actual portfolio remains consistent with target asset allocation ranges.
The projected benefit obligation and fair value of plan assets for U.S. pension plans with projected benefit obligations in excess of plan assets was $4.8 billion and $4.3 billion, respectively, as of December 31, 2013 and $5.2 billion and $3.9 billion, respectively, as of December 31, 2012.
As of December 31, 2013, the U.S. qualified plan holds 5.4 million shares of the Company’s common stock which were contributed to the Plan by the Company in 2005. This represented approximately 6% of that plan’s assets as of December 31, 2013. In addition, plan assets may be invested in funds managed by Mercer Investments, a subsidiary of the Company.
The Company expects to fund approximately $24 million for its U.S. non-qualified plans in 2014. The Company’s policy for funding its tax-qualified defined benefit retirement plans is to contribute amounts at least sufficient to meet the funding requirements set forth in the U.S. and applicable foreign law. The
Company expects less than $1 million of contributions will be required for its U.S. tax-qualified plan through the end of 2014.
After completion of a consultation period with affected colleagues, in January 2014, the Company amended its U.K. defined benefit pension plans, to close those plans to future benefit accruals effective August 1, 2014 and will replace those plans, along with its existing defined contribution plans, with a new, comprehensive defined contribution arrangement. As required under GAAP, the Company re-measured the defined benefit plans’ assets and liabilities at the amendment date, based on assumptions and market conditions at that date. As a result of the re-measurement, the projected benefit obligation increased by approximately $147 million and the funded status decreased by approximately $137 million. The change in the PBO and in the funded status relates primarily to a decrease in the discount rate at the re-measurement date. The net periodic benefit costs recognized in 2014 will be the weighted average resulting from the December 31, 2013 measurement and the January 2014 re-measurement. The Company will recognize a curtailment gain of $63 million in the first quarter of 2014, primarily resulting from the recognition of the remaining prior service credit related to a plan amendment made in December 2012.This will be mostly offset by a transition benefit to certain employees most impacted by the amendment.
The Company expects to fund approximately $160 million to its non-U.S. pension plans in 2014. Funding requirements for non-U.S. plans vary by country. Contribution rates are generally based on local funding practices and requirements, which may differ significantly from measurements under U.S. GAAP. Funding amounts may be influenced by future asset performance, the level of discount rates and other variables impacting the assets and/or liabilities of the plan. Discretionary contributions may also be affected by alternative uses of the Company’s cash flows, including dividends, investments and share repurchases.
Private equity and real estate partnerships: Investments in private equity and real estate partnerships are valued based on the fair value reported by the manager of the corresponding partnership. The managers provide unaudited quarterly financial statements and audited annual financial statements which set forth the value of the fund. The valuations obtained from the managers are based on various analyses on the underlying holdings in each partnership, including financial valuation models and projections, comparable valuations from the public markets, and precedent private market transactions. Investments are valued in the accompanying financial statements based on the Plan’s beneficial interest in the underlying net assets of the partnership as determined by the partnership agreement.
Swap assets and liabilities: Fair values for interest rate swaps, equity index swaps and inflation swaps are estimated using a discounted cash flow pricing model. These models use observable market data such as contractual fixed rate, broker quotes, spot equity price or index value and dividend data. The fair values of credit default swaps are estimated using an income approach model which determines expected cash flows based on default probabilities from the issuer-specific credit spread curve and credit loss recovery rates, both of which are dependent on market quotes.
A summary of the status of the Company’s stock option awards as of December 31, 2013 and changes during the year then ended is presented below:
As of December 31, 2013, there was $17 million of unrecognized compensation cost related to the Company's option awards. The weighted-average period over which that cost is expected to be recognized is approximately 1.2 years. Cash received from the exercise of stock options for the years ended December 31, 2013, 2012 and 2011 was $281.1 million, $179.3 million and $111.7 million, respectively.
The weighted-average grant-date fair value of the Company's restricted stock units granted during the years ended December 31, 2012 and 2011 was $31.96 and $30.46, respectively. The weighted average grant date fair value of the Company's performance stock units granted during the years ended December 31, 2012 and 2011 was $31.89 and $30.60, respectively. The total fair value of the shares distributed during the years ended December 31, 2013, 2012 and 2011 in connection with the Company's restricted stock units and performance stock units was $205.5 million, $262.6 million and $249.0 million, respectively.
Restricted Stock: Restricted shares of the Company's common stock may be awarded under the 2011 Plan and are subject to restrictions on transferability and other restrictions, if any, as the Compensation Committee may impose. The Compensation Committee may also determine when and under what circumstances the restrictions may lapse and whether the participant receives the rights of a stockholder, including, without limitation, the right to vote and receive dividends. Unless the Compensation Committee determines otherwise, restricted stock that is still subject to restrictions is forfeited upon termination of
employment. Shares granted, generally become unrestricted at the earlier of: (1) January 1 of the year following the vesting grant date anniversary or (2) the later of the recipient's normal or actual retirement date. For shares granted prior to 2004, the vesting grant date anniversary is ten years. For shares granted during 2004 and 2005, the vesting grant date anniversary is 7 years and 5 years, respectively. However, certain restricted shares granted in 2005 vested on the third anniversary of the grant date. There have been no restricted shares granted since 2005.
As of December 31, 2013, there was $73.6 million of unrecognized compensation cost related to the Company's restricted stock, restricted stock units and performance stock unit awards. The weighted-average period over which that cost is expected to be recognized is approximately one year.
Level 1.Assets and liabilities whose values are based on unadjusted quoted prices for identical assets or liabilities in an active market (examples include active exchange-traded equity securities and money market mutual funds).
Level 2.Assets and liabilities whose values are based on the following:
Liabilities utilizing Level 3 inputs include liabilities for contingent purchase consideration.
Investments for which market quotations are readily available are valued at the sale price on their principal exchange, or official closing bid price for certain markets.
The investments listed in the caption above are valued on the basis of valuations furnished by an independent pricing service approved by the trustees or dealers. Such services or dealers determine valuations for normal institutional-size trading units of such securities using methods based on market transactions for comparable securities and various relationships, generally recognized by institutional traders, between securities.
Purchase consideration for some acquisitions made by the Company includes contingent consideration arrangements. Contingent consideration arrangements are primarily based on meeting EBITDA and revenue targets over periods from two to four years. The fair value of contingent consideration is estimated as the present value of future cash flows that would result from the projected revenue and earnings of the acquired entities.
The following fair value hierarchy table presents information about the Company’s assets and liabilities measured at fair value on a recurring basis as of December 31, 2013 and 2012.
During the year ended December 31, 2013, there were no assets or liabilities that transferred between Level 1 and Level 2 or between Level 2 and Level 3.
The table below sets forth a summary of the changes in fair value of the Company’s Level 3 liabilities for the years ended December 31, 2013 and December 31, 2012 that represent contingent purchase consideration related to acquisitions:
The Company has certain long-term investments, primarily related to investments in non-publicly traded private equity funds of $14 million and $16 million at December 31, 2013 and December 31, 2012, respectively, carried on the cost basis for which there are no readily available market prices. The carrying values of these investments approximates fair value. Management's estimate of the fair value of these non-publicly traded investments is based on valuation methodologies including estimates from private equity managers of the fair value of underlying investments in private equity funds. The ability to accurately predict future cash flows, revenue or earnings may impact the determination of fair value. The Company monitors these investments for impairment and makes appropriate reductions in carrying values when necessary. These investments would be classified as Level 3 in the fair value hierarchy and are included in Other assets in the consolidated balance sheets.
In September 2013, the Company issued $250 million of 2.55% five-year senior notes and $250 million of 4.05% ten-year senior notes. The net proceeds of this offering were used for general corporate purposes, which included a partial redemption of $250 million of the outstanding principal amount of the existing 5.75% senior notes due 2015. The redemption settled in October 2013 with a total cash outflow of approximately $275 million including a $24 million cost for early redemption.
In December 2012, the Company closed on a $50 million, three-year term loan facility. The interest rate on this facility at December 31, 2013 was 1.29%, which is based on LIBOR plus a fixed margin which varies with the Company's credit ratings. The facility requires the Company to maintain coverage ratios and leverage ratios consistent with the revolving credit facility discussed above. The Company had $50 million of borrowings under this facility at December 31, 2013.
Under the terms of the swaps, the counter-parties will pay the Company a fixed rate of 5.375% and the Company will pay interest at a floating rate of three-month LIBOR plus a fixed spread of 3.726%. The maturity date of the senior notes and the swaps match exactly. The floating rate resets quarterly, with every second reset occurring on the interest payment date of the senior notes. The swaps net settle every six months on the senior note coupon payment dates. The swaps are designated as fair value hedging instruments and are deemed to be perfectly effective in accordance with applicable accounting guidance. The fair value of the swaps at inception was zero and subsequent changes in the fair value of the interest rate swaps are reflected in the carrying value of the interest rate swaps and in the consolidated balance sheet. The carrying value of the debt on the balance sheet was adjusted by an equal amount. The gain or loss on the hedged item (fixed rate debt) and the offsetting gain or (loss) on the interest rate swaps for the periods ended December 31, 2013 and 2012 is as follows:
Additional credit facilities, guarantees and letters of credit are maintained with various banks, primarily related to operations located outside the United States, aggregating $282 million at December 31, 2013 and $247 million at December 31, 2012. There was $1 million outstanding borrowings under these facilities at December 31, 2013 and no outstanding borrowings under these facilities at December 31, 2012.
Scheduled repayments of long-term debt in 2014 and in the four succeeding years are $331 million, $241 million, $61 million, $262 million and $262 million, respectively.
In 2013, the Company implemented restructuring actions which resulted in costs totaling $22 million. Restructuring costs consist primarily of severance and benefits, costs for future rent and other real estate costs. These costs were incurred as follows: Risk and Insurance Services-$7 million; Consulting-$2 million; and Corporate-$13 million.
Details of the restructuring liability activity from January 1, 2012 through December 31, 2013, including actions taken prior to 2013 are as follows:
As of January 1, 2011, the liability balance related to restructuring activity was $211 million. In 2011, the Company accrued $51 million and had cash payments of $82 million related to restructuring activities that resulted in the liability balance at January 1, 2012 reported above.
Numerous private party lawsuits based on similar allegations to those made in the NYAG complaint were commenced against the Company, one or more of its subsidiaries, and their current and former directors and officers. The vast majority of these matters have been resolved. Two actions instituted by policyholders against the Company, Marsh and certain Marsh subsidiaries remain pending.
In connection with its acquisition of U.K.-based Sedgwick Group in 1998, the Company acquired several insurance underwriting businesses that were already in run-off, including River Thames Insurance Company Limited (“River Thames”), which the Company sold in 2001. Sedgwick guaranteed payment of claims on certain policies underwritten through the Institute of London Underwriters (the “ILU”) by River Thames. The policies covered by this guarantee are reinsured up to £40 million by a related party of River Thames. Payment of claims under the reinsurance agreement is collateralized by segregated assets held in a trust. As of December 31, 2013, the reinsurance coverage exceeded the best estimate of the projected liability of the policies covered by the guarantee. To the extent River Thames or the reinsurer is unable to meet its obligations under those policies, a claimant may seek to recover from us under the guarantee.
We have audited the accompanying consolidated balance sheets of Marsh & McLennan Companies, Inc. and subsidiaries (the “Company”) as of December 31, 2013 and 2012, and the related consolidated statements of income, comprehensive income, cash flows and equity for each of the three years in the period ended December 31, 2013. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Marsh & McLennan Companies, Inc. and subsidiaries as of December 31, 2013 and 2012, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2013, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2013, based on the criteria established in Internal Control-Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 27, 2014 expressed an unqualified opinion on the Company’s internal control over financial reporting.