We own and lease a number of properties for use as offices throughout the world and believe that our properties are generally suitable and adequate for the purposes for which they are used. The principal properties are located in the United Kingdom and the United States. Our principal office at Ten Trinity Square in London is a landmark building which we own. In November 2004 we entered into an Agreement for Lease with long-time client British Land plc relating to our new UK headquarters in
London. Construction is scheduled to commence in early 2005 and Willis occupancy is targeted for late 2007.
Company, which have been prepared in accordance with accounting principles generally accepted in the United States of America ("US GAAP").
•restructuring charges relating to the exit from certain US business lines for the year ended December 31, 2000 of $7 million. These consisted of $4 million of employee termination
benefits, $1 million relating to excess operating lease obligations and $2 million relating to other costs.
2004 was a challenging year for the insurance industry: rates declined as the market softened and regulatory investigations, in particular by the New York Attorney General, led to a reassessment of market practices.
Against this background, we reported a 10 percent increase in revenues of which 2 percent was attributable to the net impact of foreign currency translation and 4 percent to acquisitions and disposals. Organic revenue growth of 4 percent reflected net new business growth of 6 percent offset by a negative 2 percent impact from declining insurance premium rates.
Net income at $427 million in 2004 was $13 million or 3 percent higher than 2003 and net income per diluted share increased by 4 percent to $2.54 from $2.45 in 2003.
The Board has approved a 15 percent increase in the quarterly cash dividend to $0.86 per share annually with effect from April 2005.
Cash generated from operations was $490 million which, together with an $80 million increase in our long-term borrowings and other smaller cash inflows, was used to support our share buyback program, $339 million, dividends, $115 million, and acquisitions, $147 million.
During the year we completed several acquisitions with annualized revenues of approximately $155 million at a total cost of $195 million, including shares issued. Acquisitions included Coyle Hamilton, the Republic of Ireland's largest privately owned insurance broker; CH Jeffries and Opus in the United Kingdom which strengthened our middle market and large account capabilities; and a controlling interest in Willis A/S Denmark.
In October 2004, we announced that we were abolishing volume and profit-based contingent commissions. In North America, we discontinued these commissions as of October 21, 2004 and in other markets where we operate we unwound these commission arrangements by December 31, 2004. Globally, we earned $71 million from volume and profit-based contingent commissions in 2004 and $70 million in 2003. We do not expect to earn any of these contingent commissions in 2005 and future years although immaterial amounts may be received in relation to the winding-up of contracts from prior years.
income related to administration and other services we provide to the market. We are working with the market to restructure these contracts, which may impact the level of fees earned.
However, in the rapidly changing industry environment, we see new opportunities to enhance our global market share, especially with middle market and large accounts. Our efforts to grow market share will include increased marketing, aggressive targeting of new accounts, an emphasis on retaining existing accounts, cross-selling and continued hiring of new business producers and other staff. In addition, we continue to look for acquisition opportunities globally and we expect the pace of acquisitions will continue at the rate we experienced in 2004.
On February 15, 2005, we announced an agreement in principle to sell our wholesale unit, Stewart Smith. This disposal is part of our overall strategy of focusing on our core broking operations and divesting non-core business interests. Stewart Smith contributed $77 million of revenues in 2004.
The rates used to discount pension plan liabilities at December 31, 2004 were based on the yields prevailing at that date of high quality corporate bonds of appropriate maturity. The selected discount rates were 5.3 percent, a reduction of 0.2 percent from 2003, for the UK plan liabilities and 5.75 percent, a reduction of 0.25 percent from 2003, for the US plan liabilities. A 0.25 percent change in the discount rate for both plans would, in the absence of any other factors, impact 2005 net pension expense by approximately $10 million.
Net pension expense for our defined benefit pension plans in 2004 was $28 million, an increase of $10 million compared with 2003 arising mainly from lower discount rates and increased longevity. We expect our net pension expense in 2005 will increase by approximately $25 million over 2004 reflecting a further fall in discount rates and a further increase in longevity as well as higher amortization charges for losses arising in prior years.
We recognize deferred tax assets and liabilities for the estimated future tax consequences of events attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating and capital loss and tax credit carryforwards. We
At December 31, 2004, the Company had gross deferred tax assets of $377 million (2003: $308 million) against which a valuation allowance of $123 million (2003: $114 million) had been recognized. To the extent that the actual future taxable income in the periods during which the temporary differences are expected to reverse differs from current projections, or assumed prudent and feasible tax planning strategies fail to materialize, or new tax planning strategies are developed, or material changes occur in actual tax rates or loss carry forward time limits, the Company may adjust the deferred tax asset considered realizable in future periods. Such adjustments could result in a significant increase or decrease in the effective tax rate and have a material impact on our net income, although management does not believe that this is likely.
As a consequence of the increasing cost of purchasing professional indemnity insurance for errors and omissions claims, we raised our self-insured retentions in 2004 and reduced the amount of coverage purchased from our insurers. Accordingly, our provisions for claims at December 31, 2004, including provisions for claims incurred but not reported, reflect the higher level of risk being retained.
There was no significant impact on our operating results in 2004 when compared to 2003 from all expenses associated with these issues (insurance premiums payable, claims paid and insurance recoveries received, together with adjustments to provisions held).
SFAS 123R permits public companies to account for share-based payments using one of two methods: modified-prospective method or modified-retrospective method. Under the modified-prospective method, from the effective date, compensation cost is recognized based on the requirements of SFAS 123R for all new share-based awards and based on the requirements of SFAS 123 for all awards granted prior to the effective date of SFAS 123R that remain unvested on the effective date.
The SFAS 123 pro forma disclosures given in Note 2 of Notes to the Consolidated Financial Statements show the impact of the Company adopting SFAS 123R in prior periods. The Company has not yet determined which transition method to use.
We provide a broad range of insurance brokerage and risk management consulting services to our worldwide clients. In our capacity as an advisor and insurance broker, we act as an intermediary between our clients and insurance carriers by advising our clients on their risk management requirements, assisting clients to determine the best means of managing risk, and negotiating and placing insurance risk with insurance carriers through our global distribution network.
During 2004, all our businesses reported growth in their 2004 revenues compared with 2003 despite the declining rate environment.
Organic revenue growth in 2004 was 4 percent comprised of approximately 6 percent net new business growth partly offset by a 2 percent reduction due to declining insurance premium rates. The following table sets out revenue growth by business.
North America: Organic revenue growth in our North America business was 3 percent in 2004 despite the elimination of volume and profit-based contingent commissions in the fourth quarter and a softening insurance market place. As we moved through 2004, declining premium rates had an increasingly negative effect.
In 2004, revenues included $27 million of volume and profit-based contingent commissions. Due to the abolition of these commissions in October 2004, there were no volume and profit-based contingent commissions in the fourth quarter 2004. In 2003, revenues included $30 million of volume and profit-based contingent commissions of which $10 million was recognized in the fourth quarter.
International: Organic revenue growth in our International business of 9 percent in 2004 was driven by good performances in Europe, notably the Netherlands and Iberia, Asia and Latin America. There was a modest negative impact from premium rates on average, although the effect varied by country and by line of business.
Net acquisitions and disposals, mainly reflecting the disposal of third-party administration units in North America in 2002, had a small negative impact on revenue growth.
We estimate that organic revenue growth of 15 percent in 2003 comprised approximately 12 percent due to net new business growth and approximately 3 percent from the impact of higher premium rates.
(i)Organic revenue growth excludes the impact of foreign currency translation and acquisitions and disposals from reported revenues. We use organic growth as a measure of business growth generated by operations that were part of the Group at the end of the period.
General and administrative expenses, including non-cash compensation charges, at $1,573 million in 2004 were $145 million or 10 percent higher than in 2003.
Excluding non-cash compensation charges for performance-based stock options, there was an underlying increase of $154 million, or 11 percent, of which 2 percent was attributable to foreign currency translation and 4 percent to acquisitions and disposals.
quarters, respectively. Volume and profit-based contingent commissions contributed $21 million, $15 million, $10 million and $25 million respectively to operating income by quarter.
Operating margin, or operating income as a percentage of revenues, was 29.3 percent in 2004 compared with 29.9 percent in 2003 and 24.1 percent in 2002. An $80 million non-cash compensation charge for performance-based stock options significantly impacted operating margin in 2002. Excluding non-cash compensation charges and the net impact of acquisitions and disposals from all years, operating margin was 29.3 percent in 2004, 30.3 percent in 2003 and 28.0 percent in 2002. The decrease in 2004 compared with 2003 reflects the increase in recruitment and retention costs and higher legal, regulatory and compliance expenses.
Interest expense in 2004 was $22 million, significantly lower than in 2003, $53 million, and 2002, $65 million. This decrease reflects the benefit of lower average levels of debt, together with lower interest rates on our new credit facilities.
Income tax expense for 2002 amounted to $141 million, an effective rate of 40 percent. Adjusting for the non-cash compensation charge for performance options, for which approximately 60 percent of the total charge was non-deductible, and acquisitions and disposals, the underlying tax rate for 2002 was 35 percent.
The average number of diluted shares outstanding for the year was 168 million as calculated under the treasury stock method.
On February 2, 2004, we redeemed all the $370 million then outstanding of our 9% senior subordinated notes. To finance the repayment, we drew down $300 million of bank loans under our senior credit facility with the remaining balance of $70 million and call premium of $17 million being financed using cash from operations. On June 1, 2004, we drew down the remaining $150 million of bank loans in accordance with our credit facility arrangements.
During 2004, we began a program of share buybacks. Total repurchases under the program at December 31, 2004 were 9.3 million shares of common stock at a cost of $339 million out of the Company's authorization limit of $500 million. Buyback activity in fourth quarter 2004 was modest at 0.3 million shares for $12 million.
The new regulations change the basis for the withdrawal of commissions from fiduciary funds from an earned to a receipts basis with a consequential increase in the balances held in fiduciary funds. As a
result, on January 15, 2005, the date the new regulations came into force in the United Kingdom, fiduciary funds were increased by $134 million with a corresponding decrease in own funds. On a full-year basis, we do not expect these regulations to have any further significant impact on the cash flow from operating activities.
Net cash provided by operations, which excludes fiduciary cash movements, was $490 million in 2004, having increased to $493 million in 2003 from $343 million in 2002. Net cash provided by operations was flat in 2004 compared with 2003 reflecting the impact of recruitment and retention strategies employed by the group at the end of 2004 and higher expenses related to legal, investigative and regulatory compliance. The increase in 2003 compared with 2002 was due mainly to increasing revenue and widening operating margins over that period.
Net cash in 2005 will be adversely impacted by the abolition of volume and profit-based contingent commissions. However, we expect to mitigate this impact by the steps we are taking to grow our market share and by continuing to control expenses tightly.
Cash used for acquisitions in 2003 amounted to $91 million (net of cash acquired), primarily incurred in acquiring further interests in Willis GmbH, Willis Iberia and Willis Italia as we continued our policy of acquiring controlling interests in most major associate companies and other remaining minority interests. Cash used for acquisitions in 2002 amounted to $13 million (net of cash acquired), primarily incurred in acquiring Richard N. Goldman and further interests in Willis GmbH.
Capital expenditures for 2004, 2003 and 2002 were $49 million, $57 million and $47 million, respectively. We have funded our requirements for capital expenditures by cash generated internally from operations and expect to continue to do so in the future.
Cash used in financing activities amounted to $333 million in 2004 compared with $222 million in 2003 and $218 million in 2002. In December 2003, we replaced our existing senior credit facilities with a new $600 million facility, consisting of a $450 million amortizing five-year term loan and a $150 million revolving credit facility. These new facilities are unsecured. Both the term loan and the revolving credit facility now bear interest at a rate of LIBOR plus 85 basis points (reduced from 95 basis points prior to December 4, 2004), subject to adjustment based on future changes in interest coverage, leverage and credit ratings. On June 4, 2004, the Company entered into a series of interest swap agreements in order to fix our interest payment obligations until 2006.
During 2003, debt repayments amounted to $198 million following repayments of $221 million in 2002.
As of December 31, 2004, we had cash and cash equivalents of $351 million, down from $364 million at December 31, 2003. We expect that internally generated funds will be sufficient to meet our foreseeable operating cash requirements, capital expenditures and dividend payments. In addition we have an undrawn $150 million revolving credit facility.
Under the terms of the senior credit facility, $150 million of the term loans mature in each of December 2006, December 2007 and December 2008.
In November 2004, we entered into a 25 year agreement with British Land plc relating to our new UK headquarters in London. Construction is scheduled to commence in early 2005 and our occupancy is targeted for late 2007. Our contractual obligations in relation to this commitment totalling $893 million are included in the table above, but are contingent upon the successful completion of construction.
As part of our acquisition of 33 percent of Gras Savoye, we entered into a put arrangement, whereby the other shareholders in Gras Savoye (primarily two families, two insurance companies and Gras Savoye's executive management team) could put their shares to us. Until 2011, we will be
We have audited the accompanying consolidated balance sheets of Willis Group Holdings Limited and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of operations, stockholders' equity, comprehensive income and cash flows for each of the three years in the period ended December 31, 2004. Our audits also included the financial statement schedule listed in the index at Item 15. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We have also audited in accordance with the standards of the Public Company Accounting Oversight Board (United States) the effectiveness of the Company's internal control over financial reporting as of December 31, 2004, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 8, 2005 expressed an unqualified opinion on management's assessment of the effectiveness of the Company's internal control over financial reporting and an unqualified opinion on the effectiveness of the Company's internal control over financial reporting.
We have audited management's assessment, included in the accompanying Management Report on Internal Controls, that Willis Group Holdings Limited and its subsidiaries (collectively, the "Company") maintained effective internal control over financial reporting as of December 31, 2004, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the Company's internal control over financial reporting based on our audit.
In our opinion, management's assessment that the Company maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedules as of and for the year ended December 31, 2004 of the Company and our report dated March 8, 2005 expressed an unqualified opinion on those financial statements and financial statement schedule.
Business-Willis Group Holdings Limited ("Willis Group Holdings") and subsidiaries (collectively, the "Company") provide a broad range of value-added risk management consulting and insurance brokerage services, both directly and indirectly through its associates, to a diverse base of clients internationally. The Company provides specialized risk management advisory and other services on a global basis to clients in various industries, including aerospace, marine, energy and construction industries. In its capacity as an advisor and insurance broker, the Company acts as an intermediary between clients and insurance carriers by advising clients on risk management requirements, helping clients determine the best means of managing risk, and negotiating and placing insurance risk with insurance carriers through the Company's global distribution network. The Company also provides other value-added services.
Cash and Cash Equivalents-Cash and cash equivalents primarily consist of time deposits and certificates of deposit with original maturities of three months or less.
Accounts receivable are stated at estimated net realizable values. Allowances are recorded, when necessary, in an amount considered by management to be sufficient to meet probable future losses related to uncollectible accounts. The write-off of accounts receivable was $5 million, $2 million and $2 million in the years ended December 31, 2004, 2003 and 2002, respectively.
Goodwill and Other Intangible Assets-Goodwill represents the excess of the cost of businesses acquired over the fair market value of identifiable net assets at the dates of acquisition. The Company reviews goodwill for impairment annually and whenever facts or circumstances indicate that the carrying amounts may not be recoverable. As part of the evaluation the estimated future undiscounted cash flows associated with the underlying business operation are compared to the carrying amount of goodwill to determine if a write-down is required. If such an assessment indicates that the undiscounted future cash flows will not be recovered, the carrying amount is reduced to the estimated fair value. Acquired intangible assets are being amortized on a straight-line basis over their estimated useful life.
The requirements of the modified-retrospective method are as above, with the exception that companies are permitted to restate, based on the amounts previously recognized under SFAS 123 for pro forma disclosure purposes, either all prior periods presented or prior interim periods in the year of adoption.
The SFAS 123 pro forma disclosures given in Note 2 show the impact of the Company adopting SFAS 123R in prior periods. The Company has not yet determined which transition method to use.
Acquisitions-During 2004, the Company acquired the following 9 entities for $192 million, which includes the cost of issuing 1.1 million shares with a fair value at the date of issuance of $40 million:
•Ital Re S.p.A, based in Rome and Milan, Italy, a major reinsurance broker;
•Kirecon A/S, based in Copenhagen, Denmark, a leading Danish reinsurance broker;
•Herzfeld & Levy S.A., an insurance broker, headquartered in Buenos Aires, Argentina;
•Coyle Hamilton Holdings Limited, the Republic of Ireland's largest privately owned insurance broker;
•Maisterenna Asesores, a general insurance broker based in Monterrey, Mexico; and
•Opus Holdings Limited, a regional insurance broking business in the United Kingdom.
The Company also acquired additional interests in several of its existing subsidiaries for $12 million, including $5 million for the issuance of 0.2 million shares.
The Company recognizes a deferred tax liability related to the undistributed earnings of subsidiaries when the Company expects that it will recover those undistributed earnings in a taxable manner, such as through receipt of dividends or sale of the investments. The Company does not, however, provide for income taxes on the unremitted earnings of certain other subsidiaries where, in management's opinion, such earnings have been indefinitely reinvested in those operations, or will be remitted either in a tax free liquidation or as dividends with taxes substantially offset by foreign tax credits. It is not practical to determine the amount of unrecognized deferred tax liabilities for temporary differences related to these investments.
The Company holds a number of investments which it accounts for using the equity method. The Company's interest in the outstanding stock of the more significant associates is as follows:
During the third quarter of 2002, the reported results for the nine months ended September 30, 2002 exceeded the performance criteria (based on the twelve months' results ending December 31, 2002) necessary to trigger the vesting of the performance options. In accordance with SFAS No. 128, Earnings per Share, such potentially issuable shares have been included in the calculation of the average number of diluted shares from the beginning of the third quarter of 2002.
Options to purchase 5.0 million shares for the year ended December 31, 2004 were not included in the computation of the dilutive effect of stock options because the effect was antidilutive (2003 and 2002: nil).
The debt securities are classified as available-for-sale. Accordingly, they are recorded at fair market value with unrealized holding gains and losses reported, net of tax, as a component of other comprehensive income. As of December 31, 2004 and 2003, the amortized cost of such securities approximated fair value.
Senior Credit Facility (entered into December 4, 2003)-On December 4, 2003 ("the effective date"), the Company entered into a new credit agreement providing up to $450 million in term loans and $150 million in revolving credit facilities.
On February 2, 2004, the Company redeemed all the outstanding 9% senior subordinated notes (see below). On the same day, the Company drew down $300 million of term loans under the Senior Credit Facility. The remaining $150 million under the Senior Credit Facility was drawn down on June 1, 2004.
The credit agreement contains numerous operating and financial covenants, including requirements to maintain minimum ratios of consolidated EBITDA to consolidated net interest expense and maximum levels of net indebtedness in relation to consolidated EBITDA, in each case subject to certain adjustments. In addition, the credit agreement includes covenants relating to the delivery of financial statements, reports and notices, limitations on liens, limitations on sales and other disposals of assets, limitations on indebtedness and other liabilities, limitations on sale and leaseback transactions, limitations on mergers and other fundamental changes, maintenance of property, maintenance of insurance, nature of business, compliance with applicable laws, maintenance of corporate existence and rights, use of proceeds, payment of taxes and access to information and properties. At December 31, 2004, the Company was in compliance with all covenants.
9% Senior Subordinated Notes-In February 1999, Willis North America refinanced a short-term loan by issuing 9% senior subordinated notes due 2009 (the "Notes") in the aggregate principal amount of $550 million. The interest on the Notes was payable semi-annually on February 1 and August 1. During 2003, Willis North America bought back and canceled Notes totaling $40 million. The difference between the market price paid and the book value was not material.
On February 2, 2004, Willis North America redeemed the Notes, in whole, at a redemption price of 104.5 percent of the aggregate principal amount of the Notes being redeemed, resulting in a premium of $17 million, plus accrued and unpaid interest.
The indenture for the Notes contained covenants that, among other things, limited the ability of Willis North America, Willis Group Limited and some of their subsidiaries to incur additional indebtedness and issue preferred stock; pay dividends or make other distributions; repurchase capital stock or subordinated indebtedness; create liens; enter into some transactions with associates; sell assets and assets of subsidiaries; issue or sell capital stock of some subsidiaries; and enter into some mergers and acquisitions.
Lines of Credit-The Company also has available $5 million (2003: $2 million) in lines of credit, of which $nil (2003: $nil) was drawn as of December 31, 2004 (excluding the $150 million revolving credit facility).
The Company's investment policy includes a mandate to diversify assets and the Company invests in a variety of asset classes to achieve that goal. The UK Plan's assets are divided into 8 separate portfolios according to asset class and managed by 7 investment managers. The broad target allocations are UK and foreign equities (75 percent), debt securities (20 percent) and real estate (5 percent). The US Plan's assets are currently invested in 16 funds representing most standard equity and debt security classes. The broad target allocations are US and foreign equities (64 percent) and debt securities (36 percent).
Willis North America has a 401(k) plan covering all eligible employees of Willis North America and its subsidiaries. The plan allows participants to make pre-tax contributions and the Company provides a matching contribution of 3 percent of employees' annual eligible compensation. All investment assets of the plan are held in a trust account administered by independent trustees. The Company's 401(k) mandatory matching contributions for 2004, 2003 and 2002 were approximately $1 million, $5 million and $5 million, respectively.
The Company has adopted the plans described below providing for the grant of time-based options and performance-based options and various other share-based grants to employees. The objectives of these plans include attracting and retaining the best personnel, motivating management personnel by means of growth-related incentives to achieve long-range goals and providing employees with the opportunity to increase their share ownership in the Company.
Amended and Restated 1998 Share Purchase and Option Plan-This plan, which was established on December 18, 1998, provides for the granting of time-based and performance-based options to employees of the Company. There are 30,000,000 shares available for grant under this plan provided, however, that in no event the total number of shares subject to options and other equity for current and future participants exceed 25 percent of the equity of Willis Group Holdings on a fully diluted basis. All options granted under this plan are exercisable at £2 per share ($3.84 using the year-end exchange rate of £1 = $1.92) except for 111,111 time-based options which are exercisable at $13.50. No further grants are to be made under this plan.
Willis Award Plan-This plan, which was established on July 13, 2000, provides for the granting of time-based options to selected employees who have been identified as superior performers. There are 5,000,000 shares available for grant under this plan provided, however, that in no event the total number of shares subject to options and other equity for current and future participants exceed 25 percent of the equity of Willis Group Holdings on a fully diluted basis. All options granted under this plan are exercisable at £2 per share ($3.84 using the year-end exchange rate of £1 = $1.92). The options vest immediately on the grant date and are exercisable any time up to July 13, 2010.
2001 Share Purchase and Option Plan-This plan, which was established on May 3, 2001, provides for the granting of time-based options and various other share-based grants at fair market value to employees of the Company. There are 15,000,000 shares available for grant under this plan. Options are exercisable on a variety of dates, including from the first, third, sixth or eighth anniversary of grant, although for certain options the exercisable date may accelerate depending on the achievement of certain performance goals. Unless terminated sooner by the Board of Directors, the 2001 Plan will expire 10 years after its adoption. That termination will not affect the validity of any grant outstanding at that date.
Compensation Expense-Willis Group Holdings applies the intrinsic value method allowed by APB 25 in accounting for its stock option plans. Under APB 25, compensation expense resulting from awards under fixed plans (time-based options, options granted pursuant to the Willis Award Plan and various other share-based grants to employees) are measured as the difference between the quoted (or best estimate of) market price, and the exercise price on the measurement date. All fixed plan options have been granted by Willis Group Holdings at an exercise price equal to the quoted market price at the measurement date, or management's best estimate of market price prior to the initial public
offering. Accordingly, pursuant to APB 25 no compensation expense has been recognized for fixed option plans in the statements of operations.
Management determined in the third quarter of 2001 that it was probable that the maximum performance condition would be attained. The measurement date under APB 25 was December 31, 2002. Accordingly, compensation expense for the year ended December 31, 2004 of $11 million ($8 million, net of tax) (2003: $20 million ($16 million, net of tax)) (2002: $80 million ($67 million, net of tax)); was recognized based on the 10.9 million (2003: 10.9 million; 2002: 11.1 million) unforfeited performance options outstanding at that date, a quoted market price of $28.67 (2003: $28.67, 2002: $28.67) and an average elapsed performance period of 100 percent (2003: 95 percent; 2002: 85 percent).
The pro forma disclosures required by SFAS 123R in Note 2 were estimated using the Black-Scholes option pricing model with the following weighted-average assumptions:
The Black-Scholes model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions. Because Willis Group Holdings employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
(1)Certain options are exercisable at £2 per share. Year-end exchange rates of £1 = $1.92, £1 = $1.79 and £1 = $1.61 have been used as of December 31, 2004, 2003 and 2002, respectively. A summary of time-based options outstanding and exercisable at December 31, 2004 is as follows:
The main risks arising from the Company's financial instruments are interest rate risk, liquidity risk, foreign currency risk and credit risk. The Company's board of directors reviews and agrees policies for managing each of these risks as summarized below. The Company has applied SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended by SFAS No. 149, in accounting for these financial instruments.
Interest Rate Risk-In 2004, the Company's operations were financed principally through the Senior Credit Facility (Note 8). As of December 31, 2004, $450 million was drawn down under the new Senior Credit Facility. Interest rate swaps were used to generate the desired interest rate profile and to manage the Company's exposure to interest rate fluctuations. Willis North America entered into a series of interest rate swap agreements on June 4, 2004 under which the LIBOR-based variable rate interest payment obligations on the full amount of the term loans were swapped for fixed rate interest payment obligations until 2006.
Liquidity Risk-The Company's objective is to ensure that it has the ability to generate sufficient cash either from internal or external sources, in a timely and cost-effective manner, to meet its commitments as they fall due. The Company's management of liquidity risk is embedded within its overall risk management framework. Scenario analysis is continually undertaken to ensure that the Company's resources can meet its liquidity requirements. These resources are supplemented by a $150 million revolving credit facility which expires on December 4, 2008, of which no amount is currently drawn.
The fair value of these contracts is recorded in other assets and other liabilities. For contracts that are qualifying cash flow hedges as defined by SFAS 133, changes in fair value are recorded as a component of other comprehensive income. Amounts are reclassified from other comprehensive income into earnings when the hedged exposure affects earnings. For contracts that do not qualify for hedge accounting as defined by SFAS 133, changes in fair value are recorded in general and administrative expenses (see table above on previous page).
(1)Forward exchange contracts range in maturity from 2005 to 2007. Credit Risk and Concentrations of Credit Risk-Credit risk represents the accounting loss that would be recognized at the reporting date if counterparties failed to perform as contracted and from movements in interest rates and foreign exchange rates. The Company does not anticipate non-performance by counterparties. The Company generally does not require collateral or other security to support financial instruments with credit risk; however, it is the Company's policy to enter into master netting arrangements with counterparties as practical.
Operating Leases-The Company leases certain land, buildings and equipment under various operating lease arrangements. Original non-cancellable lease terms typically are between 10 and 20 years and may contain escalation clauses, along with options that permit early withdrawal. The total amount of the minimum rent is expensed on a straight-line basis over the term of the lease.
Certain of Willis Group Holdings' subsidiaries have given the landlords of some leasehold properties occupied by the Company in the United Kingdom and the United States guarantees in respect of the performance of the lease obligations of the subsidiary holding the lease. The operating lease obligations subject to such guarantees amounted to $1,050 million and $158 million at December 31, 2004 and 2003, respectively.
Put and Call Options Relating to Subsidiaries and Associates-For certain subsidiaries and associates, the Company has the right to purchase shares (a call option) from co-shareholders at various dates in the future. In addition, the co-shareholders of certain subsidiaries and associates have the right to sell (a put option) their shares to the Company at various dates in the future. Generally, the exercise price of such puts and calls is formula-based (using revenues and earnings) and is designed to reflect fair value. Based on current projections of profitability and exchange rates, the potential amount payable in 2005 from these options is not expected to exceed $376 million. Of this balance, $368 million relates to Gras Savoye, as disclosed in Note 5.
Most of these claims, lawsuits and other proceedings arising in the ordinary course of business are covered by professional indemnity or other appropriate insurance. In respect of self-insured deductibles, the Company has established provisions against these items which are believed to be adequate in the light of current information and legal advice, and the Company adjusts such provisions from time to time according to developments. On the basis of current information, the Company does not expect that the actual claims, lawsuits and other proceedings, including the proceedings relating to contingent compensation arrangements referred to below, to which the Company is subject or of which it is aware will ultimately have a material adverse effect on the Company's financial condition, results of operations or cash flow. Nonetheless, given the large or indeterminate amounts sought in certain of these actions, and the inherent unpredictability of litigation, it is possible that an adverse outcome in certain matters could, from time to time, have a material adverse effect on the Company's results of operations or cash flows in particular quarterly or annual periods.
Proceedings Relating to Contingent Compensation Arrangements-Beginning in April 2004, the New York Attorney General issued subpoenas to a number of insurance carriers and insurance brokerage firms, including the Company. These subpoenas requested information regarding, among other things, arrangements pursuant to which insurers compensated insurance brokers for distribution and other services provided to insurers. The New York Department of Insurance also requested information concerning these compensation arrangements. In October 2004, the New York Attorney General filed
suit against one of the insurance brokers, accusing that broker of steering clients to insurers with which it has these compensation agreements and of soliciting false or fictitious quotes from insurers (the "NY AG Complaint"). The New York Attorney General has stated publicly that he has broadened his investigation of the insurance industry to cover other practices and other possible violations of law, including violations of fiduciary duty, securities laws, and antitrust laws. The New York Attorney General has also publicly stated that civil and criminal charges may be filed against both individuals and other industry participants. After the New York Attorney General commenced his investigation, insurance commissioners and attorneys general of other states announced that they are conducting similar investigations and have issued subpoenas to a number of insurance carriers and insurance brokerage firms, including the Company. The Company has received requests for documents and information from eighteen other states and the District of Columbia. The Company is co-operating fully with these investigations and is producing documents and other information in response to these subpoenas. The Company has engaged in discussions with representatives of the New York Attorney General's Office and of other states' insurance commissioners and attorneys general about their investigations. The Company cannot predict at this time how or when those investigations will be resolved.
The compensation arrangements, which were initially the subject of the investigation by the New York Attorney General, are a longstanding and common practice within the insurance industry and have been disclosed by the Company for many years. On October 21, 2004, the Company announced that it was voluntarily abolishing these compensation arrangements immediately in North America and by December 31, 2004 outside North America. It is not possible at this time to predict or reasonably estimate what the outcome or the timing of any resolution of these proceedings or any possible future proceedings may be.
an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision-maker in deciding how to allocate resources and in assessing performance.
(1)Commissions and fees are attributed to countries based upon the location of the subsidiary generating the revenue.
The Company has an Employee Stock Ownership Plan (the "ESOP") which holds Willis Group Holdings' shares. The trustee of the ESOP transferred 608,521 and 85,467 shares during the years ended December 31, 2004 and 2003, respectively. At December 31, 2004 and 2003, the ESOP shares outstanding were 87,606 and 696,127, respectively. No dividends have been distributed on the shares held by the ESOP.
Kohlberg Kravis Roberts & Co. L.P. ("KKR"), with which Messrs. P. Golkin and S.C. Nuttall, both Directors of the Company, are affiliated, and Fisher Capital Corp. L.L.C. ("Fisher"), with which Mr. J.R. Fisher, also a Director of the Company, is affiliated, rendered in 2002 and 2003 management, consulting and certain other services to the Company for annual fees of $1,000,000 and $350,000, respectively, payable quarterly in arrears. These arrangements were terminated as of December 31, 2003. Messrs. Golkin and Nuttall disclaim any beneficial interest in these fees.
17. FINANCIAL INFORMATION FOR PARENT GUARANTOR, OTHER GUARANTOR SUBSIDIARIES AND NON-GUARANTOR SUBSIDIARIES
The Willis North America Inc. ("Willis North America") debt securities registered in April 2003 will be, if issued, jointly and severally, irrevocably and fully and unconditionally guaranteed by Willis Group Holdings, Willis Group Limited, Trinity Acquisition Limited, TA I Limited, TA II Limited, TA III Limited and TA IV Limited.
On February 15, 2005, the Company announced the disposal of its US Wholesale division, Stewart Smith Group. It is expected that the transaction will be completed at the end of the first quarter of 2005.