In general, no difficulty is anticipated in negotiating renewals as leases expire or in finding other satisfactory space if the premises become unavailable. We believe that the facilities we currently occupy are adequate for the purposes for which they are being used and are well maintained. In certain circumstances, we may have unused space and may seek to sublet such space to third parties, depending upon the demands for office space in the locations involved. See Note 10 "Lease Commitments" of the Notes to Consolidated Financial Statements in Part II, Item 8 of this report for information with respect to our lease commitments as of December 31, 2010.
(1)On October 1, 2010, we completed the acquisition of Hewitt. In connection with the acquisition, we recorded intangible assets of $5.6 billion, based on the preliminary purchase accounting.
(2)In 2008, we completed the acquisition of Benfield. In connection with the acquisition, we recorded intangible assets of $1.7 billion.
(4)Effective January 1, 2009, we adopted a new accounting standard requiring non-controlling interests to be separately presented as a component of total equity. Prior years have been adjusted to conform to the new standard.
(7)Effective January 1, 2009, we adopted additional guidance regarding participating securities and computing net income per share using the two-class method. Prior years' basic and diluted net income per share have been adjusted to conform to the new guidance.
•sector specific weakness, including financial services, construction, private equity, and mergers and acquisitions, all of which have been particularly impacted by the current economic downturn.
Our revenue for 2010 increased as a result of acquisitions, including Hewitt's results from the date of the acquisition, new products and services, such as GRIP Solutions, and from improvement and stabilization in the market. We also continue to demonstrate expense discipline, while we invest in our businesses.
We have committed to our stockholders that we will focus on three key metrics: grow organically, expand margins, and increase earnings per share. The following is our measure of performance against these three metrics for 2010:
•Organic revenue growth, as defined under the caption "Review of Consolidated Results - General" below, was flat in 2010, however, this was an improvement compared to the prior year's organic revenue decline, as global economic conditions begin to stabilize following the economic slowdown that has impacted the global markets since 2008.
•Adjusted diluted earnings per share from continuing operations attributable to Aon's stockholders, as defined under the caption "Review of Consolidated Results - General" below, was $3.12 per share in 2010, similar to 2009, demonstrating solid operational performance and effective capital management despite a difficult business environment.
Additionally, the following is a summary of our 2010 financial results:
•Revenue increased $917 million, or 12%, to $8.5 billion due primarily to an increase from acquisitions, primarily Hewitt, net of dispositions and a 1% favorable impact from foreign currency translation, which was partially offset by lower fiduciary investment income of $19 million due to the decline in global interest rates. Organic revenue growth was flat in the Risk Solutions segment and 1% in the HR Solutions segment.
•Operating expenses increased $712 million from the prior year to $7.3 billion, primarily as a result of the inclusion of expenses from Hewitt and our smaller acquisitions, a $49 million non-cash U.S. defined benefit pension plan expense resulting from an adjustment to the market-related value of plan assets, $40 million of Hewitt related acquisition and integration costs,
•Net income from continuing operations attributable to Aon stockholders increased $97 million, or 15%, from 2009 to $733 million.
In our discussion of operating results, we sometimes refer to supplemental information derived from consolidated financial information specifically related to organic revenue growth, adjusted pretax margin, adjusted diluted earnings per share, and the impact of foreign exchange rate fluctuations on operating results.
We use supplemental information related to organic revenue to help us and our investors evaluate business growth from existing operations. Organic revenue excludes the impact of foreign exchange rate changes, acquisitions, divestitures, transfers between business units, fiduciary investment income, reimbursable expenses, and unusual items. Supplemental information related to organic growth represents a measure not in accordance with U.S. generally accepted accounting principles ("GAAP"), and should be viewed in addition to, not instead of, our Consolidated Statements of Income. Industry peers provide similar supplemental information about their revenue performance, although they may not make identical adjustments. Reconciliation of this non-GAAP measure, organic revenue growth percentages to the reported Commissions, fees and other revenue growth percentages, has been provided in the "Review by Segment" caption, below.
We use adjusted operating margin as a measure of core operating performance of our Risk Solutions and HR Solutions businesses. Adjusted operating margin excludes the impact of noteworthy items, including restructuring charges, the pension adjustment, Hewitt related costs, and costs for anti-bribery and compliance initiatives. This supplemental information related to adjusted operating margin represents a measure not in accordance with U.S. GAAP, and should be viewed in addition to,
We also use adjusted diluted earnings per share from continuing operations as a measure of Aon's core operating performance. Adjusted diluted earnings per share excludes the impact of restructuring charges, the pension adjustment, Hewitt related costs, and costs for anti-bribery and compliance initiatives, along with related income taxes. Reconciliations of this non-GAAP measure to the reported diluted earnings per share is as follows (in millions except per share data):
Compensation and benefits increased $500 million, or 11%, over 2009. The increase reflects a $562 million, or 75%, increase in the HR Solutions segment and a $51 million increase in unallocated expenses, which was partially offset by a $113 million, or 3%, decrease in the Risk Solutions segment.
Interest income represents income earned on operating cash balances and other income-producing investments. It does not include interest earned on funds held on behalf of clients. Interest income decreased $1 million, or 6%, from 2009, due to lower global interest rates.
Income from continuing operations before income taxes was $1.1 billion, a 12% increase from $949 million in 2009. The increase in income was driven by the inclusion of Hewitt's operating results from the date of the acquisition, lower costs and increased benefits from restructuring initiatives, favorable foreign currency translation and operational improvement, which was partially offset by the pension curtailment gain recognized last year, Hewitt related transaction and integration costs, the 2010 pension adjustment related to the U.S. defined benefit pension plan, and costs related to the Manchester United sponsorship.
In 2010, an after-tax loss from discontinued operations of $27 million ($0.09 diluted net loss per share) was recorded compared to after-tax income from discontinued operations of $111 million ($0.38 diluted net income per share) in 2009. The loss in 2010 was driven by the settlement of legacy litigation related to the Buckner vs. Resource Life case. The 2009 results include the recognition of a $55 million foreign tax carryback related to the sale of CICA, a $43 million after-tax gain on the sale of AIS and a curtailment gain on the post-retirement benefit plan related to the CICA disposal.
The effective tax rate on income from continuing operations was 28.2% and 27.5% for 2009 and 2008, respectively. The increase reflects changes in the mix between our U.S. and international pretax income.
Income from continuing operations increased to $681 million ($2.19 diluted net income per share) from $637 million ($2.04 diluted net income per share) in 2008. Currency fluctuations negatively impacted income from continuing operations in 2009 by $0.02 per diluted share when the 2008 Consolidated Statement of Income is translated using 2009 foreign exchange rates.
On October 14, 2010, we announced a global restructuring plan (the "Aon Hewitt Plan") in connection with our acquisition of Hewitt. The Aon Hewitt Plan, which will continue into 2013, is intended to streamline operations across the combined Aon Hewitt organization. The restructuring plan is expected to result in cumulative costs of approximately $325 million through the end of the plan, consisting of approximately $180 million in employee termination costs and approximately $145 million in real estate lease rationalization costs. An estimated 1,500 to 1,800 positions globally, predominately non-client facing, are expected to be eliminated as part of the plan.
As of December 31, 2010, approximately 360 jobs have been eliminated under the Aon Hewitt Plan and total expenses of $52 million have been incurred. All costs associated with the Aon Hewitt Plan are included in the HR Solutions segment. Charges related to the restructuring are included in Compensation and benefits and Other general expenses in the accompanying Consolidated Statements of Income.
The restructuring plan, before any potential reinvestment of savings, is expected to deliver approximately $280 million of annual savings in 2013. We expect to achieve approximately $355 million in annual cost savings across Aon Hewitt in 2013, including approximately $280 million of annual savings related to the restructuring plan, and additional savings in areas such as information technology, procurement and public company costs. All of the components of the restructuring and integration plan are not finalized and actual total savings, costs and timing may vary from those estimated due to changes in the scope or assumptions underlying the plan.
We announced a global restructuring plan ("Aon Benfield Plan") in conjunction with our 2008 merger with Benfield. The restructuring plan is intended to integrate and streamline operations across the combined Aon Benfield organization. The Aon Benfield Plan includes an estimated 700 job eliminations. Additionally, duplicate space and assets will be abandoned. We originally estimated that this plan would result in cumulative costs totaling approximately $185 million over a three-year period, of which $104 million was recorded as part of the Benfield purchase price allocation and $81 million of which was expected to result in future charges to earnings. During 2009, we reduced the Benfield purchase price allocation by $49 million to reflect actual severance costs being lower than originally estimated. We currently estimate the Aon Benfield Plan will result in cumulative costs totaling approximately $155 million, of which $55 million was recorded as part of the purchase price allocation, $26 million and $55 million has been recorded in earnings during 2010 and 2009, respectively, and an estimated additional $19 million will be recorded in future earnings.
The following is a summary of the restructuring and related expenses by type that have been incurred and are estimated to be incurred through the end of the restructuring initiative related to the Aon Benfield Plan (in millions):
All costs associated with the Aon Benfield Plan are included in the Risk Solutions segment. Charges related to the restructuring are included in Compensation and benefits and Other general expenses in the Consolidated Statements of Income. We expect these restructuring activities and related expenses to affect continuing operations into 2011.
We estimate that we realized cost savings, before any reinvestment of savings, of approximately $476 million and $269 million in 2010 and 2009, respectively, and expect annual cost savings of approximately $536 million in 2011.
Our balance sheet and strong cash flow provide us with financial flexibility to create long-term value for our stockholders. Our primary sources of liquidity are cash flow from operations, available cash reserves and debt capacity available under various credit facilities. Our primary uses of liquidity are operating expenses, capital expenditures, acquisitions, share repurchases, restructuring, pension obligations and stockholder dividends.
Cash and short-term investments increased $492 million to $1.1 billion in 2010, demonstrating our strong balance sheet which provides us with significant financial flexibility. During 2010, cash flow from operating activities, excluding client held funds, increased $271 million to $768 million. Uses of funds in 2010 included the acquisition of Hewitt and the repurchase of $250 million of common stock. In the fourth quarter, we acquired Hewitt for a total purchase price of $4.9 billion with 50% cash and 50%
Our investment grade rating is important to us for a number of reasons, the most important of which is preserving our financial flexibility. If our credit ratings were downgraded to below investment grade, the interest expense on any outstanding balances on our credit facilities would increase and we could incur additional requests for pension contributions. To manage unforeseen situations, we have committed credit lines of approximately $1.3 billion and we manage our business to ensure we maintain our current investment grade ratings as evidenced by the equity component of the purchase price for Hewitt.
The Consolidated Statement of Cash Flows includes Hewitt activity from the date of acquisition, October 1, 2010.
Cash used for financing activities in 2008 was $2.2 billion. This was primarily comprised of $1.9 billion of share repurchase activity, less the proceeds from the exercise of stock options of $246 million; the net repayment of debt of $386 million, almost entirely related to our Euro credit facility; and dividends of $171 million.
At December 31, 2010, our cash and cash equivalents and short-term investments were $1.1 billion, an increase of $492 million from December 31, 2009. Of the total balance recorded at December 31, 2010, approximately $60 million was restricted as to its use. At December 31, 2010, $521 million of cash and cash equivalents and short-term investments were held in the U.S. and $610 million was held by our subsidiaries in other countries. Due to differences in tax rates, the repatriation of funds from certain countries into the U.S. could have an unfavorable tax impact.
In our capacity as an insurance broker or agent, we collect premiums from insureds and, after deducting our commission, remit the premiums to the respective insurance underwriter. We also collect claims or refunds from underwriters on behalf of insureds, which are then remitted to the insureds.
As of December 31, 2010, our investments in money market funds and highly liquid debt instruments had a fair value of $2.6 billion and are reported as cash equivalents, short-term investments or fiduciary assets in the Consolidated Statements of Financial Position depending on their nature and initial maturity.
In 2007, our Board of Directors increased the authorized share repurchase program to $4.6 billion of our outstanding common stock. Shares may be repurchased through the open market or in privately negotiated transactions from time to time, based on prevailing market conditions, and will be funded from available capital. Any repurchased shares will be available for employee stock plans and for other corporate purposes. In 2010, we repurchased 6.1 million shares at a cost of $250 million. In 2009, we repurchased 15.1 million shares at a cost of $590 million. In 2008, we repurchased 42.6 million shares at a cost of $1.9 billion. Since the inception of our share repurchase program in 2005, we have repurchased a total of 111.9 million shares for an aggregate cost of $4.6 billion. As of December 31, 2010, we were authorized to purchase up to $15 million of additional shares under this share repurchase program. The timing and amount of future purchases will be based on market and other conditions.
For both our U.S. and Euro Facilities, the two most significant covenants require us to maintain a ratio of consolidated EBITDA (earnings before interest, taxes, depreciation and amortization), adjusted for Hewitt related transaction costs and up to $50 million in non-recurring cash charges ("Adjusted EBITDA") to consolidated interest expense of 4 to 1 and a ratio of consolidated debt to Adjusted EBITDA of not greater than 3 to 1. We were in compliance with these and all other covenants as of December 31, 2010.
(2)In 2007, our principal U.K subsidiary agreed with the trustees of one of the U.K. plans to contribute £9.4 million ($15 million) per year to that pension plan for the next six years, with the amount payable increasing by approximately 5% on each April 1. The trustees of the plan have certain rights to request that our U.K. subsidiary advance an amount equal to an actuarially determined winding-up deficit. As of December 31, 2010, the estimated winding-up deficit was £270 million ($421 million). The trustees of the plan have accepted in practice the agreed-upon schedule of contributions detailed above and have not requested the winding-up deficit be paid.
•Cash and short-term investments increased $492 million, resulting primarily from cash from operations including Hewitt, partially offset by cash used for our ongoing share repurchase program, funding of our various pension plans, and the acquisition of businesses.
•Goodwill and Other Intangibles increased $2.6 billion and $2.8 billion, respectively, due principally to the acquisition of Hewitt as well as other smaller acquisitions during 2010.
•Short-term debt increased $482 million, due principally to the reclassification of our 5.05% CAD 375 million ($372 million at December 31, 2010 exchange rates) debt securities from long-term, as the due date of the securities is April 2011, and the inclusion of $100 million of our $1 billion Senior Term Loan Credit Facility which is due within one year from the balance sheet date.
In December 2010, we prepaid $299 million of debt assumed in the Hewitt acquisition and used a portion of PEPS I restricted cash to repurchase $47 million of debt held by PEPS I, a consolidated VIE.
In October 2010, we replaced our five-year €650 million ($853 million at December 31, 2010 exchange rates) multi-currency foreign credit facility, which expired in October 2010, with a new five-year €650 million Euro Facility which expires in 2015.
In 2010, we reclassified our indirect wholly owned subsidiary's 5.05% CAD 375 million ($372 million at December 31, 2010 exchange rates) debt securities, which are guaranteed by Aon, to Short-term debt and current portion of long-term debt in the Consolidated Statements of Financial Position as the due date of the securities, April 2011, is less than one year from the current balance sheet date. We are exploring alternatives to refinance this obligation, and how we proceed will depend upon our liquidity profile and debt market conditions, among other considerations.
Our total debt as a percentage of total capital attributable to Aon stockholders was 35.3% and 27.2% at December 31, 2010 and December 31, 2009, respectively. The increase in the debt to capital ratio at December 31, 2010 is attributable to the $2.5 billion in debt financing issued to fund the Hewitt acquisition.
Accumulated other comprehensive loss increased $242 million since December 31, 2009, primarily reflecting the following:
•a decline in net foreign currency translation adjustments of $133 million, which was attributable to the strengthening of the U.S. dollar against foreign currencies,
•an increase of $41 million in net post-retirement benefit obligations, and
In 2001, we sold the vast majority of our limited partnership ("LP") portfolio, valued at $450 million, to PEPS I, a QSPE. In accordance with the recently issued VIE guidance, former QSPEs must now be assessed to determine if they are VIEs. We concluded that PEPS I is a VIE and that we hold a variable interest in PEPS I. We also concluded that we are the primary beneficiary of PEPS I, as we have the power to direct the activities that most significantly impact economic performance and we have the obligation or right to absorb losses or receive benefits that could potentially be significant to PEPS I. As a result of adopting this new guidance, we consolidated PEPS I effective January 1, 2010. The financial statement impact of consolidating PEPS I resulted in:
•the addition of $77 million of equity method investments in LP's; cash of $57 million, of which $52 million was restricted; long-term debt of $47 million; a decrease in accumulated other comprehensive income net of tax of $44 million; and an increase in retained earnings of $44 million.
In December 2010, the majority of PEPS I restricted cash was used to repurchase $47 million in PEPS I debt, with the remaining cash now available for general use.
considered to be the primary beneficiary of either entity and have therefore deconsolidated both entities.
At December 31, 2010, we held a 36% interest in Juniperus which is accounted for using the equity method of accounting. Our potential loss at December 31, 2010 is limited to our investment of $73 million in Juniperus, which is recorded in Investments in the Consolidated Statements of Financial Position. We have not provided any financing to Juniperus other than previously contractually required amounts.
Juniperus and JCHL had combined assets and liabilities of $121 million and $22 million, respectively, at December 31, 2008. For the year ended December 31, 2009, we recognized $36 million of pretax income from Juniperus and JCHL. We recognized $16 million of after-tax income, after allocating the appropriate share of net income to the non-controlling interests.
•HR Solutions (formerly Consulting) partners with organizations to solve their most complex benefits, talent and related financial challenges, and improve business performance by designing, implementing, communicating and administering a wide range of human capital, retirement, investment management, health care, compensation and talent management strategies.
The demand for property and casualty insurance generally rises as the overall level of economic activity increases and generally falls as such activity decreases, affecting both the commissions and fees generated by our brokerage business. The economic activity that impacts property and casualty insurance is described as exposure units, and is most closely correlated with employment levels, corporate revenue and asset values. During 2010 we continued to see a "soft market", which began in 2007, in our retail brokerage product line. In a soft market, premium rates flatten or decrease, along with commission revenues, due to increased competition for market share among insurance carriers or increased underwriting capacity. Changes in premiums have a direct and potentially material impact on the insurance brokerage industry, as commission revenues are generally based on a percentage of the
premiums paid by insureds. In 2010, pricing decreased in both our retail and reinsurance brokerage product lines and we expect similar pricing declines to continue into 2011.
Risk Solutions generated approximately 75% of our consolidated total revenues in 2010. Revenues are generated primarily through fees paid by clients, commissions and fees paid by insurance and reinsurance companies, and investment income on funds held on behalf of clients. Our revenues vary from quarter to quarter throughout the year as a result of the timing of our clients' policy renewals, the net effect of new and lost business, the timing of services provided to our clients, and the income we earn on investments, which is heavily influenced by short-term interest rates.
In February 2009, we completed the sale of the U.S. operations of Cananwill, our premium finance business. In June and July of 2009, we entered into agreements with third parties with respect to our international premium finance businesses, whereby these third parties began originating, financing, and servicing premium finance loans generated by referrals from our brokerage operations.
In November 2008 we expanded our product offerings through the merger with Benfield, a leading independent reinsurance intermediary. Benfield products were integrated with our existing reinsurance products in 2009.
In 2010, commissions, fees and other revenue increased $137 million or 2% from 2009 driven primarily by the increase from acquisitions, primarily Allied North America, net of dispositions and the favorable impact of foreign currency translation. Organic revenue growth was flat in 2010.
The 6% increase in Americas reflects the impact of the Allied acquisition, net of small dispositions, and favorable foreign currency translation. Organic revenue growth was flat as strong growth in Latin America and benefits related to GRIP were partially offset by declines in the US Retail and Canadian operations.
Operating income increased $294 million or 33% from 2009 to $1.2 billion in 2010. In 2010, operating income margins in this segment were 18.6%, up 430 basis points from 14.3% in 2009. Contributing to increased operating income and margins were lower restructuring costs of $267 million, savings related to the restructuring plan and other cost savings initiatives, the favorable impact of foreign currency translation, and a $15 million reduction related to the 2009 Benfield integration costs. The increase in operating income was partially offset by higher E&O expenses as a result of insurance recoveries in the prior year, the 2009 net pension curtailment gain of $54 million, and a $19 million reduction in investment income.
•Benefits Outsourcing applies our HR expertise primarily through defined benefit (pension), defined contribution (401(k)), and health and welfare administrative services. Our model replaces the resource-intensive processes once required to administer benefit plans with more efficient, effective, and less costly solutions.
•Human Resource Business Processing Outsourcing ("HR BPO") provides market-leading solutions to manage employee data; administer benefits, payroll and other human resources processes; and record and manage talent, workforce and other core HR process transactions as well as other complementary services such as absence management, flexible spending, dependent audit and participant advocacy.
Outsourcing revenue increased $540 million, or 283%, driven by the inclusion of Hewitt from the date of acquisition and favorable foreign currency translation, partially offset by a 1% decrease in organic revenue due primarily to a decline in project-related revenue and price compression in benefits administration.
Unallocated operating loss includes corporate governance costs not allocated to the operating segments. In 2009, it also included revenue and expenses from our equity ownership in insurance investments obtained as part of the Benfield acquisition. Net unallocated expenses increased $120 million to $202 million for 2010. The increase was driven mainly by the $49 million non-cash U.S. defined benefit pension plan expense resulting from an adjustment to the market-related value of plan assets, Hewitt transaction costs of $21 million and the net impact of the insurance investments in 2009.
Interest income consists primarily of income earned on our operating cash balances and other income-producing securities. It does not include interest earned on funds held on behalf of clients. Interest income was $15 million in 2010, a decrease of $1 million from 2009 reflecting the overall impact of lower interest rates.
Interest expense, which represents the cost of our worldwide debt obligations, increased $60 million primarily as a result of the $2.5 billion in debt issued in connection with the Hewitt acquisition and costs associated with the cancellation of a $1.5 billion bridge loan commitment, which was replaced by the issuance of $1.5 billion in notes prior to the acquisition being completed.
Where we have provided notice of cancellation pursuant to a lease agreement or abandoned space and have no intention of reoccupying it, we recognize a loss. The loss reflects our best estimate of the net present value of the future cash flows associated with the lease at the date we vacate the property or sign a sublease arrangement. To determine the loss, we estimate sublease income based on current market quotes for similar properties. When we finalize definitive agreements with the sublessee, we adjust our sublease losses for actual outcomes.
Accounting guidance requires that our exit and disposal accruals reflect the fair value of the liability. Where material, we discount the lease loss calculations to arrive at their net present value.
For the remaining lease term or severance payout, we decrease the liability for payments and increase the liability for accretion of the discount, if material. The discount reflects our incremental borrowing rate, which matches the lifetime of the liability. Significant changes in the discount rate selected or the estimations of sublease income in the case of leases could impact the amounts recorded.
Asset impairments may result from large-scale restructurings and we account for these impairments in the period when they become known. Furthermore, we record impairments by reducing the book value to the net present value of future cash flows (in situations where the asset had an identifiable cash flow stream) or accelerating the depreciation to reflect the revised useful life.
Our U.S., U.K. and Canadian pension plans were previously closed to new entrants. Effective January 1, 2009, our Netherlands plan was also closed to new entrants. In 2007, future benefit accruals relating to salary and service ceased in our U.K. plans. Effective April 1, 2009, we ceased crediting future benefits relating to salary and service for our two U.S. plans. As a result, we recognized a curtailment gain of $83 million in 2009. In 2010, we ceased crediting future benefits relating to service in our Canadian defined benefit pension plans. We recognized a curtailment loss of $5 million related to the Canadian pension plans in 2009.
The following table discloses our combined experience loss, the number of years over which we are amortizing the experience loss, and the estimated 2011 amortization of loss by country (amounts in millions):
The unrecognized prior service cost at December 31, 2010 was $17 million in the U.K.
Holding other assumptions constant, the following table reflects what a one hundred basis point increase and decrease in our estimated long-term rate of return on plan assets would have on our estimated 2011 pension expense (in millions):
We estimate contributions of approximately $403 million in 2011 as compared with $288 million in 2010.
Although goodwill is not amortized, we test it for impairment at least annually in the fourth quarter. In the fourth quarter, we also test acquired trademarks (which also are not amortized) for impairment. We test more frequently if there are indicators of impairment or whenever business circumstances suggest that the carrying value of goodwill or trademarks may not be recoverable. These indicators may include a sustained significant decline in our share price and market capitalization, a decline in our expected future cash flows, or a significant adverse change in legal factors or in the business climate, among others. No events occurred during 2010 or 2009 that indicate the existence of an impairment with respect to our reported goodwill or trademarks.
We perform impairment reviews at the reporting unit level. A reporting unit is an operating segment or one level below an operating segment (referred to as a "component"). A component of an operating segment is a reporting unit if the component constitutes a business for which discrete financial information is available and segment management regularly reviews the operating results of that component. An operating segment shall be deemed to be a reporting unit if all of its components are similar, if none of its components is a reporting unit, or if the segment comprises only a single component.
We review intangible assets that are being amortized for impairment whenever events or changes in circumstance indicate that their carrying amount may not be recoverable. There were no indications that the carrying values of amortizable intangible assets were impaired as of December 31, 2010 or 2009. If we are required to record impairment charges in the future, they could materially impact our results of operations.
Stock-based compensation expense is based on the value of the portion of share-based payment awards that we ultimately expect to vest during that period based on the achievement of service or performance conditions. Thus, we have reduced expense for estimated forfeitures. We estimate forfeitures at the time of grant based on our actual experience to date and revise our estimates, if necessary, in subsequent periods if actual forfeitures differ from those estimates. When the terms of an award require no additional service, the award is fully expensed at the grant date. When awards are modified, we account for the incremental shares at the fair market value at the date of modification. Expense recognition begins on the date the service period begins, which can precede or be after the grant date, depending on the provisions of the award.
We use a lattice-binomial option-pricing model to value stock options granted. Lattice-based option valuation models use a range of assumptions over the expected term of the options, and estimate expected volatilities based on the average of the historical volatility of our stock price and the implied volatility of traded options on our stock.
•use historical data to estimate option exercise and employee terminations within the valuation model. In 2008 and prior years, we stratified between executives and key employees. Beginning in 2009, after reviewing additional historical data, we changed the valuation model to stratify employees between those receiving Leadership Performance Plan ("LPP") options, Special Stock Plan options, and all other option grants. We believe that this stratification better represents prospective stock option exercise patterns.
•base the expected dividend yield assumption on our current dividend rate, and
The carrying values of deferred income tax assets and liabilities reflect the application of our income tax accounting policies, and are based on management's assumptions and estimates about
future operating results and levels of taxable income, and judgments regarding the interpretation of the provisions of current accounting principles.
We assess carryforwards and tax credits for realization as a reduction of future taxable income by using a "more likely than not" determination. We have not recognized a U.S. deferred tax liability for undistributed earnings of certain foreign subsidiaries of our continuing operations to the extent they are considered permanently reinvested. Distributions may be subject to additional U.S. income taxes if we either distribute these earnings, or we are deemed to have distributed these earnings, according to the Internal Revenue Code, and could materially affect our future effective tax rate.
Note 2 "Summary of Significant Accounting Principles and Practices" of the Notes to Consolidated Financial Statements contains a summary of our significant accounting policies, including a discussion of recently issued accounting pronouncements and their impact or future potential impact on our financial results, if determinable.
The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles ("U.S. GAAP"). The consolidated financial statements include the accounts of Aon Corporation and its majority-owned subsidiaries and variable interest entities ("VIEs") for which Aon is considered to be the primary beneficiary ("Aon" or the "Company"). The consolidated financial statements exclude special-purpose entities ("SPEs") considered VIEs for which Aon is not the primary beneficiary. All material intercompany accounts and transactions have been eliminated.
In 2010, the Company renamed its operating segments, with the Risk and Insurance Brokerage Services segment now being called Risk Solutions and the Consulting segment now being called HR Solutions.
•All Treasury stock transactions were previously combined in a single line in the 2009 and 2008 presentation. The current presentation separately discloses the purchase of treasury stock and the issuance of stock, either new shares or from treasury shares, for employee benefit plans.
HR Solutions segment revenues consist primarily of fees paid by clients for consulting advice and outsourcing contracts. Fees paid by clients for consulting services are typically charged on an hourly, project or fixed fee basis. Revenues from time-and-materials or cost-plus arrangements are recognized as services are performed, which is measured by the amount of time incurred. Revenues from fixed-fee contracts are recognized ratably over the term of the contract. Reimbursements received for out-of-pocket expenses are recorded as a component of revenues. The Company's outsourcing contracts typically have three-to-five year terms for benefits services and five-to-ten year terms for human resources business process outsourcing ("HR BPO") services. The Company recognizes revenues as services are performed. The Company also receives implementation fees from clients either up-front or over the ongoing services period as a component of the fee per participant. Lump sum implementation fees received from a client are initially deferred and then recognized as revenue evenly over the ongoing contract services period. If a client terminates an outsourcing services arrangement prior to the end of the contract, a loss on the contract may be recorded, if necessary, and any remaining deferred implementation revenues would then be recognized into earnings over the remaining service period through the termination date. Services provided outside the scope of the Company's outsourcing contracts are recognized on a time-and-material or fixed-fee basis.
The Company records annual expenses relating to its pension benefits and other post-employment benefit plans based on calculations that include various actuarial assumptions, including discount rates, assumed asset rates of return, inflation rates, mortality rates, compensation increases, and turnover rates. The Company reviews its actuarial assumptions on an annual basis and makes modifications to these assumptions based on current rates and trends. The effects of gains, losses, and prior service costs and credits are amortized over future service periods or future estimated lives if the plans are frozen. The funded status of each plan, calculated as the fair value of plan assets less the accumulated projected benefit obligation, is reflected in the Company's Consolidated Statements of Financial Position using a December 31 measurement date.
In its capacity as an insurance agent and broker, Aon collects premiums from insureds and, after deducting its commission, remits the premiums to the respective insurers. Aon also collects claims or refunds from insurers on behalf of insureds. Uncollected premiums from insureds and uncollected claims or refunds from insurers are recorded as Fiduciary assets in the Company's Consolidated Statements of Financial Position. Unremitted insurance premiums and claims are held in a fiduciary capacity. The obligation to remit these funds is recorded as Fiduciary liabilities in the Company's Consolidated Statements of Financial Position. Some of the Company's outsourcing agreements also require it to hold funds to pay certain obligations on behalf of clients. These funds are also recorded as Fiduciary assets with the related obligation recorded as a Fiduciary liability in the Company's Consolidated Statements of Financial Position.
Aon maintained premium trust balances for premiums collected from insureds but not yet remitted to insurance companies of $3.5 billion and $3.3 billion at December 31, 2010 and 2009, respectively. These funds and a corresponding liability are included in Fiduciary assets and Fiduciary liabilities, respectively, in the accompanying Consolidated Statements of Financial Position.
Aon's policy for estimating its allowances for doubtful accounts with respect to receivables is to record an allowance based on a variety of factors, including evaluation of historical write-offs, aging of balances and other qualitative and quantitative analyses. Receivables included an allowance for doubtful accounts of $102 million and $92 million at December 31, 2010 and 2009, respectively.
Property and equipment is stated at cost, less accumulated depreciation. Depreciation is generally calculated using the straight-line method over estimated useful lives. Included in this category is internal use software, which is software that is acquired, internally developed or modified solely to meet internal needs, with no plan to market externally. Costs related to directly obtaining, developing or upgrading internal use software are capitalized and amortized using the straight-line method over a range principally between 3 to 10 years.
•Fixed-maturity securities are classified as available for sale and are reported at fair value with any resulting gain or loss recorded directly to stockholders' equity as a component of Accumulated other comprehensive income or loss, net of deferred income taxes. Interest on fixed-maturity securities is recorded in Interest income when earned and is adjusted for any amortization of premium or accretion of discount.
The Company assesses any declines in the fair value of investments to determine whether such declines are other-than-temporary. This assessment is made considering all available evidence, including changes in general market conditions, specific industry and individual company data, the length of time and the extent to which the fair value has been less than cost, the financial condition and the near-term prospects of the entity issuing the security, and the Company's ability and intent to hold the investment until recovery of its cost basis. Other-than-temporary impairments of investments are recorded as part of Other income in the Company's Consolidated Statements of Income in the period in which the determination is made.
Goodwill represents the excess of acquisition cost over the fair value of the net assets acquired. Goodwill is allocated to various reporting units, which are one reporting level below the operating segment. Upon disposition of a business entity, goodwill is allocated to the disposed entity based on the fair value of that entity compared to the fair value of the reporting unit in which it was included. Goodwill is not amortized, but instead is tested for impairment at least annually. The goodwill impairment test is performed at the reporting unit level and is a two-step analysis. First, the fair value of each reporting unit is compared to its book value. If the fair value of the reporting unit is less than its book value, the Company performs a hypothetical purchase price allocation based on the reporting unit's fair value to determine the fair value of the reporting unit's goodwill. Fair value is determined using a combination of present value techniques and market prices of comparable businesses.
Intangible assets include customer related and contract based assets representing primarily client relationships and non-compete covenants, trademarks, and marketing and technology related assets. These intangible assets, with the exception of trademarks, are amortized over periods ranging from 1 to 13 years, with a weighted average original life of 10 years. Trademarks are not amortized as such assets have been determined to have indefinite useful lives. Similar to goodwill, trademarks are tested at least annually for impairments using an analysis of expected future cash flows. Interim impairment testing may be performed when events or changes in circumstances indicate that the carrying amount of the intangible asset may not be recoverable.
All derivative instruments are recognized in the Consolidated Statements of Financial Position at fair value. Where the Company has entered into master netting agreements with counterparties, the derivative positions are netted by counterparty and are reported accordingly in other assets or other liabilities. Changes in the fair value of derivative instruments are recognized immediately in earnings, unless the derivative is designated as a hedge and qualifies for hedge accounting.
exchange for nonmonetary assets. Gains and losses from the remeasurement of monetary assets and liabilities are included in Other general expenses within the Consolidated Statements of Income. The effect of foreign exchange gains and losses on the Consolidated Statements of Income was a loss of $18 million and $26 million in 2010 and 2009, respectively, and a gain of $18 million in 2008. Included in these amounts were derivative hedging losses of $11 million, $15 million and $36 million in 2010, 2009 and 2008, respectively.
The Company recognizes the effect of income tax positions only if sustaining those positions is more likely than not. Changes in recognition or measurement are reflected in the period in which a change in judgment occurs. The Company records penalties and interest related to unrecognized tax benefits in Income taxes in the Company's Consolidated Statements of Income.
"Fair Value and Financial Instruments" for these disclosures. The guidance also requires entities to disclose information in the Level 3 rollforward about purchases, sales, issuances and settlements on a gross basis. Aon will make the required disclosures beginning with its report covering the first quarter of 2011 when this part of the guidance becomes effective.
The revised principle also requires that net income be adjusted to include the net income attributable to the noncontrolling interests and a new separate caption for net income attributable to Aon stockholders be presented in the Consolidated Statements of Income. The adoption of this new
guidance increased net income by $16 million for 2008. Net income attributable to Aon stockholders equals net income as previously reported prior to the adoption of the guidance.
Effective January 1, 2009, the Company adopted guidance which states that unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents, whether paid or unpaid, are participating securities, as defined, and therefore should be included in computing basic and diluted earnings per share using the two class method. Certain of Aon's restricted stock awards allow the holder to receive a non-forfeitable dividend equivalent.
Certain common stock equivalents primarily related to options were not included in the computation of diluted net income per share because their inclusion would have been antidilutive. The number of shares excluded from the calculation was 5 million in 2010 and 2009, and 3 million in 2008.
In April 2008, the Company sold its Combined Insurance Company of America ("CICA") subsidiary to ACE Limited and its Sterling Life Insurance Company ("Sterling") subsidiary to Munich Re Group. After final adjustments, Aon received $2.525 billion in cash for CICA and $341 million in cash for Sterling. Additionally, CICA paid a $325 million dividend to Aon before the sale transaction was completed. A pretax gain of $1.4 billion was recognized on the sale of these businesses, which included the reversal of the cumulative translation adjustment account (related to selling CICA's foreign entities) of $134 million. In 2009, the Company recognized a $55 million foreign tax carryback related to the sale of CICA.
The operating results of all these businesses are classified as discontinued operations as follows (in millions):
In 2009, the Company completed the acquisitions of Allied North America, FCC Global Insurance Services and Carpenter Moore Insurance Services which are included in the Risk Solutions segment.
The results of operations of these acquisitions are included in the Consolidated Statements of Financial Position from the dates they were acquired. These acquisitions, excluding Hewitt, would not produce a materially different result if they had been reported from the beginning of the period in which they were acquired.
On October 1, 2010, the Company completed its acquisition of Hewitt (the "Acquisition"), one of the world's leading human resource consulting and outsourcing companies. Aon purchased all of the outstanding shares of Hewitt common stock in a cash-and-stock transaction valued at $4.9 billion, of which the total amount of cash paid and the total number of shares of stock issued by Aon each represented approximately 50% of the aggregate consideration.
Hewitt provides leading organizations around the world with expert human resources consulting and outsourcing solutions to help them anticipate and solve their most complex benefits, talent, and related financial challenges. Hewitt works with companies to design, implement, communicate, and administer a wide range of human resources, retirement, investment management, health care, compensation, and talent management strategies. Hewitt now operates globally together with Aon's existing consulting and outsourcing operations under the newly created Aon Hewitt brand.
Under the terms of the merger agreement, each share of Class A common stock, par value $0.01 per share, of Hewitt ("Hewitt Common Stock") outstanding immediately prior to the acquisition date was converted into the right to receive, at the election of each of the holders of Hewitt Common Stock, (i) 0.6362 of a share of common stock, par value $1.00 per share, of Aon ("Aon Common Stock") and $25.61 in cash (the "Mixed Consideration"), (ii) 0.7494 shares of Aon Common Stock and $21.19 in cash (the "Stock Electing Consideration"), or (iii) $50.46 in cash (the "Cash Electing Consideration"). Pursuant to the terms of the merger agreement, the Cash Electing Consideration and the Stock Electing Consideration payable in the Acquisition were calculated based on the closing volume-weighted average price of Aon Common Stock on the New York Stock Exchange for the period of ten consecutive trading days ended on September 30, 2010, which was $39.0545, and the Stock Electing Consideration was subject to automatic proration and adjustment to ensure that the total amount of cash paid and the total number of shares of Aon Common Stock issued by Aon in the Acquisition each represented approximately 50% of the consideration, taking into account the rollover of the Hewitt stock options as described in the merger agreement.
The transaction has been accounted for using the acquisition method of accounting which requires, among other things, that most assets acquired and liabilities assumed be recognized at their fair values as of the acquisition date. The following table summarizes the preliminary amounts recognized for assets acquired and liabilities assumed as of the acquisition date. Certain estimated values are not yet finalized (see below) and are subject to change, which could be significant. The Company will finalize the amounts recognized as information necessary to complete the analyses is obtained. The Company expects to finalize these amounts as soon as possible but no later than one year from the acquisition date.
(4)Included in Other current assets ($31 million), Deferred tax assets ($62 million), Other current liabilities ($32 million) and Deferred tax liabilities ($1.1 billion) in the Company's Consolidated Statements of Financial Position.
Goodwill is calculated as the excess of the consideration transferred over the net assets acquired and represents the synergies and other benefits that are expected to arise from combining the operations of Hewitt with the operations of Aon, and the future economic benefits arising from other
The recorded amounts are preliminary and subject to change. The following items are still subject to change:
•Amounts for income tax assets, receivables and liabilities pending the filing of Hewitt's pre-acquisition tax returns and the receipt of information from taxing authorities which may change certain estimates and assumptions used.
•Amounts for deferred tax assets and liabilities pending the finalization of the valuations of assets acquired, liabilities assumed and resulting goodwill.
The following unaudited pro forma consolidated results of operations for 2010 and 2009 assume that the acquisition of Hewitt was completed as of January 1, 2009 (in millions, except per share amounts):
acquisition on January 1, 2009. In addition, the unaudited pro forma consolidated results do not purport to project the future results of operations of the combined company nor do they reflect the expected realization of any cost savings associated with the acquisition. The unaudited pro forma consolidated results reflect primarily the following pro forma pre-tax adjustments:
•Deferred costs which did meet the definition of an asset were eliminated at the acquisition date, and, as such, the recognition of deferred costs by Hewitt in 2010 and 2009 is not reflected in the unaudited pro forma operating results. This resulted in $16 million in 2010 and $22 million in 2009 of deferred costs recorded by Hewitt being eliminated;
•Additional expense of $15 million incurred in 2010 and 2009 related to the recognition of the fair value of adjustments associated with the assumption of unfavorable lease obligations;
In connection with the acquisition, the Company recorded net tangible assets, goodwill and other intangibles which are reported within the Risk Solutions segment. None of the goodwill is deductible for tax purposes. Of the acquired intangible assets, $128 million was assigned to registered trademarks, which were determined to have indefinite useful lives. Of the remaining balance of intangible assets acquired, $449 million was assigned to customer relationships, and $2 million was assigned to non-competition agreements, which are being amortized over weighted average useful lives of 12 years and 1 year, respectively.
In 2010, the Company completed the disposition of eight entities. The following table includes the gains or losses recorded as a result of these and other disposals made in 2010, 2009 and 2008 (in millions):
In December 2008, Aon signed a definitive agreement to sell the U.S. Cananwill operations. This disposition was completed in February 2009. A net pretax loss of $4 million was recorded, of which a gain of $3 million was recorded in 2010, and losses of $2 million and $5 million were recorded in 2009 and 2008, respectively, and is included in Other income in the Consolidated Statements of Income. As part of the agreement, Aon was entitled to receive up to $10 million from the buyer over the two years following the sale, based on the amount of insurance premiums and related obligations financed and collected by the buyer over this period that are generated from certain of Cananwill's producers. As of December 31, 2010, Aon had received all amounts owed from the buyer and satisfied all guarantees.
In 2010, Aon completed the sale of seven smaller operations in the Risk Solutions segment and one in the HR Solutions segment. Total pretax losses of $7 million were recognized on these sales, which are included in Other income in the Consolidated Statements of Income.
In 2008, Aon sold four small operations. Total pretax gains of $13 million were recognized on these sales, which are included in Other income in the Consolidated Statements of Income.
In 2009, the Company finalized the Benfield purchase price allocation, adjusting goodwill principally for the completion of third party valuation reports, the impact of changes in actual employee severance costs compared to original estimates and the resolution of certain tax matters.
Amortization expense on finite lived intangible assets was $154 million, $93 million, and $65 million for the years ended December 31, 2010, 2009 and 2008, respectively. The estimated future amortization for intangible assets as of December 31, 2010 is as follows (in millions):
On October 14, 2010, Aon announced a global restructuring plan ("Aon Hewitt Plan") in connection with the acquisition of Hewitt. The Aon Hewitt Plan is intended to streamline operations across the combined Aon Hewitt organization and includes an estimated 1,500 to 1,800 job eliminations. The Company expects these restructuring activities and related expenses to affect continuing operations into 2013. The Aon Hewitt Plan is expected to result in cumulative costs of approximately $325 million through the end of the plan, consisting of approximately $180 million in employee termination costs and approximately $145 million in real estate lease rationalization costs.
As of December 31, 2010, the Company's liabilities for its restructuring plans are as follows (in millions):
The Company's interest-bearing assets and other investments are included in the following categories in the Consolidated Statements of Financial Position (in millions):
On August 13, 2010, in connection with the acquisition of Hewitt, Aon entered into an unsecured three-year Term Credit Agreement (the "Term Loan Credit Facility") which provided unsecured term loan financing of up to $1.0 billion. This Term Loan Credit Facility has an interest rate of LIBOR + 2.5%, which was approximately 2.75% at December 31, 2010. The Company borrowed $1.0 billion under this facility on October 1, 2010 to finance a portion of the Hewitt purchase price. The Company incurred $26 million of deferred finance costs associated with the Term Loan Credit Facility that will be amortized over the term of the loan. Concurrent with entering into the Term Loan Credit Facility, the Company also entered into a Senior Bridge Term Loan Credit Agreement which provided unsecured bridge financing of up to $1.5 billion (the "Bridge Loan Facility") to finance a portion of the Hewitt purchase price.
In lieu of drawing under the Bridge Loan Facility, on September 7, 2010, Aon entered into an Underwriting Agreement (the "Underwriting Agreement") with several underwriters with respect to the offering and sale by the Company of $600 million aggregate principal amount of its 3.50% Senior Notes due 2015 (the "2015 Notes"), $600 million aggregate principal amount of its 5.00% Senior Notes due 2020 (the "2020 Notes") and $300 million aggregate principal amount of its 6.25% Senior Notes due 2040 (the "2040 Notes" and, together with the 2015 Notes and 2020 Notes, the "Notes") under the Company's Registration Statement on Form S-3. All of these Notes are unsecured. Deferred financing costs associated with the Notes of $12 million were capitalized and are included in Other non-current assets, and will be amortized over the respective term of each note. In 2010, the Company recorded $3 million of deferred financing cost amortization for both the Term Loan Credit Facility and the Notes, which is included in Interest expense in the Consolidated Statements of Income. Following the issuance of these Notes, on September 15, 2010, the Bridge Loan Facility was terminated and the Company recorded $14 million of related deferred financing costs in the Consolidated Statements of Income.
As part of the Hewitt acquisition, the Company assumed $346 million of long-term debt including $299 million of privately placed senior unsecured notes with varying maturity dates. As of December 31, 2010, all of these notes had matured or have been early extinguished. Also, in 2010, $47 million in long-term debt held by PEPS I, a consolidated VIE, was repurchased with a majority of the PEPS I restricted cash (See Note 16 "Variable Interest Entities").
In 2010, Aon reclassified its indirect wholly owned subsidiary's 5.05% CAD 375 million ($372 million at December 31, 2010 exchange rates) debt securities, which are guaranteed by Aon, to Short-term debt and current portion of long-term debt in the Condensed Consolidated Statements of Financial Position as the due date of the securities, April 2011, is less than one year from the balance sheet date.
In December 2009, Aon cancelled its $600 million, 5-year U.S. committed bank credit facility that was to expire in February 2010 and entered into a new $400 million, 3-year facility to support commercial paper and other short-term borrowings. Based on Aon's current credit ratings, commitment fees of 35 basis points are payable on the unused portion of the facility. At December 31, 2010, Aon had no borrowings under this facility.
On July 1, 2009, an indirect wholly-owned subsidiary of Aon issued €500 million ($656 million at December 31, 2010 exchange rates) of 6.25% senior unsecured debentures due on July 1, 2014. The carrying value of the debt includes $11 million related to hedging activities. The payment of the principal and interest on the debentures is unconditionally and irrevocably guaranteed by Aon. Proceeds from the offering were used to repay the Company's $677 million outstanding indebtedness under its 2005 Facility.
In 1997, Aon created Aon Capital A, a wholly-owned statutory business trust ("Trust"), for the purpose of issuing mandatorily redeemable preferred capital securities ("Capital Securities"). Aon received cash and an investment in 100% of the common equity of Aon Capital A by issuing 8.205% Junior Subordinated Deferrable Interest Debentures (the "Debentures") to Aon Capital A. These transactions were structured such that the net cash flows from Aon to Aon Capital A matched the cash flows from Aon Capital A to the third party investors. Aon determined that it was not the primary beneficiary of Aon Capital A, a VIE, and, thus reflected the Debentures as long-term debt. During the first half of 2009, Aon repurchased $15 million face value of the Capital Securities for approximately $10 million, resulting in a $5 million gain, which was reported in Other income in the Consolidated Statements of Income. To facilitate the legal release of the obligation created through the Debentures associated with this repurchase and future repurchases, Aon dissolved the Trust effective June 25, 2009. This dissolution resulted in the exchange of the Capital Securities held by third parties for the Debentures. Also in connection with the dissolution of the Trust, the $24 million of common equity of Aon Capital A held by Aon was exchanged for $24 million of Debentures, which were then cancelled. Following these actions, $687 million of Debentures remain outstanding. The Debentures are subject to mandatory redemption on January 1, 2027 or are redeemable in whole, but not in part, at the option of Aon upon the occurrence of certain events.
Aon leases office facilities, equipment and automobiles under non-cancellable operating leases. These leases expire at various dates and may contain renewal and expansion options. In addition to base rental costs, occupancy lease agreements generally provide for rent escalations resulting from increased assessments for real estate taxes and other charges. Approximately 88% of Aon's lease obligations are for the use of office space.
At December 31, 2010, future minimum rental payments required under operating leases for continuing operations that have initial or remaining non-cancellable lease terms in excess of one year, net of sublease rental income, most of which pertain to real estate leases, are as follows (in millions):
The components of Aon's deferred tax assets and liabilities are as follows (in millions):
The increase in deferred tax liabilities is primarily due to the identifiable intangible assets recorded as a result of the Hewitt acquisition.
Valuation allowances have been established primarily with regard to the tax benefits of certain net operating loss and tax credit carryforwards. Valuation allowances increased by $71 million in 2010, primarily attributable to the recognition of the following items: acquired valuation allowances of $58 million due to the Hewitt acquisition, an increase of $7 million in the valuation allowances for U.S. foreign tax credit carryforwards, and an increase of $8 million in the valuation allowances for an interest expense carryforward for Germany. Although future earnings cannot be predicted with certainty, management believes that the realization of the net deferred tax asset is more likely than not.
Aon recognized, as an adjustment to additional paid-in-capital, income tax benefits attributable to employee stock compensation as follows: 2010 - $20 million; 2009 - $25 million; and 2008 - $45 million.
As of December 31, 2010, $85 million of unrecognized tax benefits would impact the effective tax rate if recognized. Aon does not expect the unrecognized tax positions to change significantly over the next twelve months, except for a potential reduction of unrecognized tax benefits in the range of $10-$15 million relating to anticipated audit settlements.
The Company recognizes penalties and interest related to unrecognized income tax benefits in its provision for income taxes. Aon accrued potential penalties of less than $1 million during each of 2010, 2009 and 2008. Aon accrued interest of less than $1 million in 2010, $2 million during 2009 and less than $1 million in 2008. Aon has recorded a liability for penalties of $5 million and for interest of $18 million for both December 31, 2010 and 2009.
On October 1, 2010, the Company issued 61 million shares of common stock as consideration for part of the purchase price of Hewitt (See Note 5 "Acquisitions and Dispositions"). In addition, as part of the consideration, each outstanding unvested Hewitt stock option became fully vested and was converted into an option to purchase Aon common stock with the same terms and conditions as the Hewitt stock option. As of the acquisition date, there were approximately 4.5 million options to purchase Aon common stock issued to former holders of Hewitt stock options, of which 2.3 million remain outstanding and exercisable.
In 2007, Aon's Board of Directors increased the Company's authorized share repurchase program to $4.6 billion. Shares may be repurchased through the open market or in privately negotiated transactions from time to time, based on prevailing market conditions, and will be funded from available capital. Any repurchased shares will be available for employee stock plans and for other corporate purposes. In 2010, Aon repurchased 6.1 million shares at a cost of $250 million. In 2009, Aon repurchased 15.1 million shares at a cost of $590 million. In 2008, Aon repurchased 42.6 million shares at a cost of $1.9 billion. Since the inception of its share repurchase program in 2005, the Company has repurchased a total of 111.9 million shares for an aggregate cost of $4.6 billion. As of December 31, 2010, the Company was authorized to purchase up to $15 million of additional shares under this stock repurchase program.
During 2010, 2009, and 2008, Aon paid dividends on its common stock of $175 million, $165 million and $171 million, respectively. Dividends paid per common share were $0.60 for each of the years ended December 31, 2010, 2009, and 2008.
The majority of the Company's plans are closed to new entrants. Effective January 1, 2009, the Company's Netherlands plan was also closed to new entrants. Effective April 1, 2009, the Company ceased crediting future benefits relating to salary and service in its U.S. defined benefit pension plan. This change affected approximately 6,000 active employees covered by the U.S. plan. For those employees, the Company increased its contribution to the defined contribution savings plan. In 2010, the Company ceased crediting future benefits relating to service in its Canadian defined benefit pension plans. This change affects approximately 950 active employees.
located in the U.K., the Netherlands, and Canada. These plans represent approximately 94% of the Company's pension obligations.
In 2010, U.S. plans with a projected benefit obligation ("PBO") and an accumulated benefit obligation ("ABO") in excess of the fair value of plan assets had a PBO of $2.4 billion, an ABO of $2.4 billion, and plan assets of $1.2 billion. International plans with a PBO in excess of the fair value of plan assets had a PBO of $2.7 billion and plan assets with a fair value of $2.3 billion, and plans with an ABO in excess of the fair value of plan assets had an ABO of $2.1 billion and plan assets with a fair value of $1.6 billion.
In 2009, U.S. plans with a PBO and an ABO in excess of the fair value of plan assets had a PBO of $2.1 billion, an ABO of $2.1 billion, and plan assets of $1.2 billion. International plans with a PBO in excess of the fair value of plan assets had a PBO of $4.4 billion and plan assets with a fair value of $3.6 billion, and plans with an ABO in excess of the fair value of plan assets had an ABO of $3.9 billion and plan assets with a fair value of $3.2 billion.
The amounts in Accumulated other comprehensive loss expected to be recognized as components of net periodic benefit cost during 2011 are as follows (in millions):
To determine the expected long-term rate of return on plan assets, the historical performance, investment community forecasts and current market conditions are analyzed to develop expected returns for each asset class used by the plans. The expected returns for each asset class are weighted by the target allocations of the plans.
No plan assets are expected to be returned to the Company during 2011.
The fair values of Aon's U.S. pension plan assets at December 31, 2010 and December 31, 2009, by asset category, are as follows (in millions):
The fair values of Aon's major international pension plan assets at December 31, 2010 and December 31, 2009, by asset category, are as follows (in millions):
(4)Valued using a discounted cash flow model utilizing assumptions such as discount rate, mortality, and inflation.
(4)Valued using a discounted cash flow model utilizing assumptions such as discount rate, mortality and inflation.
(5)Consists of direct real estate investment and pooled funds. The Level 3 values are based on the proportionate share ownership of the investment as determined by the investment manager.
The following table presents the changes in the Level 3 fair-value category for the years ended December 31, 2010 and December 31, 2009 (in millions):
The U.S. investment policy, as established by the Aon Retirement Plan Governance and Investment Committee ("RPGIC"), seeks reasonable asset growth at prudent risk levels within target allocations, which are 42% equity investments, 37% fixed income investments, and 21% other investments. Aon believes that plan assets are well-diversified and are of appropriate quality. The investment portfolio asset allocation is reviewed quarterly and re-balanced to be within policy target allocations. The investment policy is reviewed at least annually and revised, as deemed appropriate by the RPGIC. The investment policies for international plans are established by the local pension plan trustees and seek to maintain the plans' ability to meet liabilities and to comply with local minimum funding requirements. Plan assets are invested in diversified portfolios that provide adequate levels of return at an acceptable level of risk. The investment policies are reviewed at least annually and revised, as deemed appropriate to ensure that the objectives are being met. At December 31, 2010, the weighted average targeted allocation for the international plans was 48% for equity investments and 52% for fixed income investments.
Based on current assumptions, Aon expects to contribute approximately $121 million and $282 million, respectively, to its U.S. and international pension plans during 2011.
The following table provides an overview of the accumulated projected benefit obligation, fair value of plan assets, funded status and net amount recognized as of December 31, 2010 and 2009 for the Company's material other post-retirement benefit plans located in the U.S. and Canada (in millions):
Amounts recognized in accumulated other comprehensive income that have not yet been recognized as components of net periodic benefit cost at December 31, 2010 are $9 million and $11 million of net loss and prior service credit, respectively. The amount in accumulated other comprehensive income expected to be recognized as a component of net periodic benefit cost during 2011 is $1 million and $3 million of net loss and prior service credit, respectively.
•To contribute $8 million to fund material other post-retirement benefit plans during 2011.
material impact on the service cost and interest cost components of net periodic benefit costs for a 1% change in the assumed health care trend rate.
For most of the participants in the U.S. plan, Aon's liability for future plan cost increases for pre-65 and Medical Supplement plan coverage is limited to 5% per annum. Because of this cap, net employer trend rates for these plans are effectively limited to 5% per year in the future. During 2007, Aon recognized a plan amendment which phases out post-65 retiree coverage in its U.S. plan over the next three years. The impact of this amendment on net periodic benefit cost is being recognized over the average remaining service life of the employees.
The following table summarizes stock-based compensation expense recognized in continuing operations in the Consolidated Statements of Income in Compensation and benefits (in millions):
Aon uses a lattice-binomial option-pricing model to value stock options. Lattice-based option valuation models utilize a range of assumptions over the expected term of the options. Expected volatilities are based on the average of the historical volatility of Aon's stock price and the implied volatility of traded options and Aon's stock. In 2008 and prior years, Aon used historical data to estimate option exercise and employee attrition within the lattice-binomial option-pricing model, stratified between executives and key employees. Beginning in 2009, the valuation model stratifies employees between those receiving LPP options, Special Stock Plan ("SSP") options, and all other option grants. The Company believes that this stratification better represents prospective stock option exercise patterns. The expected dividend yield assumption is based on the Company's historical and expected future dividend rate. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. The expected life of employee stock options represents the weighted-average period stock options are expected to remain outstanding and is a derived output of the lattice-binomial model.
In connection with the LPP Plan, the Company granted the following number of stock options at the noted exercise price: 2010 - none, 2009 - 1 million shares at $39 per share, and 2008 - 820,000 shares at $41 per share. In connection with its incentive compensation plans, the Company granted the following number of stock options at the noted exercise price: 2010 - 143,000 shares at $38 per share, 2009 - 550,000 shares at $37 per share, and 2008 - 710,000 shares at $46 per share. In 2010, the Company acquired Hewitt Associates and immediately vested all outstanding options issued under Hewitt's Global Stock and Incentive Compensation Plan.
A summary of options outstanding and exercisable as of December 31, 2010 is as follows (shares in thousands):
Other information related to the Company's stock options is as follows (in millions):
Aon has an employee stock purchase plan that provides for the purchase of a maximum of 7.5 million shares of Aon's common stock by eligible U.S. employees. Under the plan, shares of Aon's common stock were purchased at 3-month intervals at 85% of the lower of the fair market value of the common stock on the first or the last day of each 3-month period. In 2010, 2009, and 2008, 357,000 shares, 323,000 shares and 320,000 shares, respectively, were issued to employees under the plan. Compensation expense recognized was $3 million each in 2010, 2009 and 2008.
Aon is exposed to market risk primarily from changes in foreign currency exchange rates and interest rates. To manage the risk related to these exposures, Aon enters into various derivative transactions that reduce Aon's market risks by creating offsetting market exposures. Aon does not enter into derivative transactions for trading purposes.
Aon and its subsidiaries are exposed to foreign exchange risk when they receive revenues, pay expenses, or enter into intercompany loans denominated in a currency that differs from their functional currency. Aon uses foreign exchange derivatives, typically forward contracts, options and cross currency swaps, to reduce its overall exposure to the effects of currency fluctuations on cash flows. Aon has hedged these exposures up to five years in the future. Aon has designated foreign exchange derivatives with a notional amount of $1.2 billion at December 31, 2010 as cash flow hedges of these exposures. As of December 31, 2010, $25 million of pretax losses have been deferred in OCI related to these hedges, of which a $24 million loss is expected to be reclassified to earnings in 2011. These hedges had no material ineffectiveness in 2010, 2009, or 2008. In addition, as of December 31, 2010, Aon has $176 million notional amount of foreign exchange derivatives not designated or qualifying as cash flow hedges offsetting these exposures.
Aon also uses foreign exchange derivatives, typically forward contracts and options, to hedge its net investments in foreign operations for up to three years in the future. As of December 31, 2010, the notional amount outstanding was $322 million and $111 million of gains have been deferred in OCI related to this hedge. This hedge had no ineffectiveness in 2010, 2009, or 2008.
Aon holds variable-rate short-term brokerage and other operating deposits. Aon uses interest rate derivatives, typically swaps, to reduce its exposure to the effects of interest rate fluctuations on the forecasted interest receipts from these deposits for up to three years in the future. Aon has designated interest rate derivatives with a notional amount of $498 million at December 31, 2010 as cash flow hedges of this exposure. As of December 31, 2010, $1 million of pretax gains have been deferred in
In August 2010, Aon entered into forward starting swaps with a total notional of $500 million to reduce its exposure to the effects of interest rate fluctuations on the forecasted interest expense cash flows related to the anticipated issuance of fixed rate debt in September 2010. Aon designated the forward starting swaps as a cash flow hedge of this exposure and terminated the positions when the debt was issued. As of December 31, 2010, $13 million of pretax losses have been deferred in OCI related to these hedges, of which $1 million is expected to be reclassified to earnings during the next twelve months. These hedges had no material ineffectiveness.
As of December 31, 2009, the fair values of derivative instruments are as follows:
The amounts of derivative gains (losses) recognized in the consolidated financial statements for the year ended December 31, 2010, are as follows (in millions):
Aon recorded a gain of $10 million and a loss of $11 million in Other general expenses for foreign exchange derivatives not designated or qualifying as hedges for 2010 and 2009, respectively.
•the removal of the $87 million PEPS I preferred stock, previously reported in investments, and
Prior to December 18, 2009, based on the Company's percentage equity interest in the Juniperus Class A shares, Aon bore a majority of the expected residual return and losses. Similarly, the Company's voting and economic interest percentage in JCHL required Aon to absorb a majority of JCHL's expected residual returns and losses. Aon was considered the primary beneficiary of both
At December 31, 2010, Aon held a 36% interest in Juniperus which is accounted for using the equity method of accounting. The Company's potential loss at December 31, 2010 is limited to its investment in Juniperus of $73 million, which is recorded in Investments in the Consolidated Statements of Financial Position. Aon has not provided any financing to Juniperus other than previously contractually required amounts.
Aon previously owned an 85% economic equity interest in Globe Re Limited ("Globe Re"), a VIE which provided reinsurance coverage for a defined portfolio of property catastrophe reinsurance contracts underwritten by a third party for a limited period which ended June 1, 2009. Aon consolidated Globe Re as it was deemed to be the primary beneficiary. In connection with the winding up of its operations, during 2009 Globe Re repaid its $100 million of short-term debt from available cash. Also in 2009, Aon's equity investment in Globe Re was repaid. Aon recognized $2 million of after-tax income from Globe Re in 2009, taking into account the share of net income attributable to non-controlling interests. Globe Re was fully liquidated in 2009.
Equity security investments are carried at fair value. Prior to 2010, this consisted of the Company's investment in PEPS I. Fair value was based on valuations received from the general partners of the limited partnership interests held by PEPS I (See Note 16 "Variable Interest Entities").
Fixed maturity investments are carried at fair value, which is based on quoted market prices or on estimated values if they are not actively traded. In some cases where a market price is not available, the Company will make use of acceptable expedients (such as matrix pricing) to estimate fair value.
Gains (losses), both realized and unrealized, included in income in 2010 and 2009 are as follows (in millions):
The majority of the Company's financial instruments is either carried at fair value or has a carrying amount that approximates fair value.
At the time of the 2004-05 investigation of the insurance industry by the Attorney General of New York ("NYAG") and other regulators, purported classes of clients filed civil litigation against Aon and other companies under a variety of legal theories, including state tort, contract, fiduciary duty, antitrust and statutory theories and federal antitrust and Racketeer Influenced and Corrupt Organizations Act ("RICO") theories. The federal actions were consolidated in the U.S. District Court for the District of New Jersey, and a state court collective action was filed in California. In the New Jersey actions, the Court dismissed plaintiffs' federal antitrust and RICO claims in separate orders in August and October 2007, respectively. In August 2010, the U.S. Court of Appeals for the Third Circuit affirmed the dismissals of most, but not all, of the claims. Aon believes it has meritorious defenses and intends to vigorously defend itself against the remaining claims. The outcome of these lawsuits, and any losses or other payments that may occur as a result, cannot be predicted at this time.
Following inquiries from regulators, the Company commenced an internal review of its compliance with certain U.S. and non-U.S. anti-corruption laws, including the U.S. Foreign Corrupt Practices Act ("FCPA"). In January 2009, Aon Limited, Aon's principal U.K. brokerage subsidiary, entered into a settlement agreement with the Financial Services Authority ("FSA") to pay a £5.25 million fine arising from its failure to exercise reasonable care to establish and maintain effective systems and controls to counter the risks of bribery arising from the use of overseas firms and individuals who helped it win business. The U.S. Securities and Exchange Commission ("SEC") and the U.S. Department of Justice ("DOJ") continue to investigate these matters. Aon is fully cooperating with these investigations and has agreed with the U.S. agencies to toll any applicable statute of limitations pending completion of the investigations. Based on current information, the Company is unable to predict at this time when the SEC and DOJ matters will be concluded, or what regulatory or other outcomes may result.
expense of $38 million was reflected in Income (loss) from discontinued operations before income taxes in the 2010 Consolidated Statements of Income. A portion of this payment may be returned to Aon if checks are undeliverable or some class members do not cash their settlement payments. Subject to certain limitations, the return payment, if any, would be divided 50% to Aon and 50% to a fund to be used for charitable purposes. Additionally, the settlement agreement with Resource Life provides potential future benefits from Resource Life. At this time, the amount of future payments, if any, cannot be determined and Aon will record any such amounts when they are determinable. The Georgia court has granted final approval of the settlement, and no appeals were taken from that order.
Aon has certain contractual contingent guarantees for premium payments owed by clients to certain insurance companies. Costs associated with these guarantees, to the extent estimable and probable, are provided in Aon's allowance for doubtful accounts. The maximum exposure with respect to such contractual contingent guarantees was approximately $7 million at December 31, 2010.
Aon classifies its businesses into two operating segments: Risk Solutions (formerly Risk and Insurance Brokerage Services) and HR Solutions (formerly Consulting). Unallocated income and expenses, when combined with the operating segments and after the elimination of intersegment revenues and expenses, total to the amounts in the Consolidated Financial Statements.
HR Solutions partners with organizations to solve their most complex benefits, talent and related financial challenges, and improve business performance by designing, implementing, communicating and administering a wide range of human capital, retirement, investment management, health care, compensation and talent management strategies.
Other income primarily consists of equity earnings and realized gains (losses) on the sale of investments, disposal of businesses and extinguishment of debt. It also includes hedging losses related to the Benfield acquisition in 2008.