The fixed assets owned by us represented approximately 3% of total assets as of December 31, 2018 and consisted primarily of furniture and equipment, leasehold improvements, computer software, internally developed software and land and buildings.
Typically, our business benefits from regulatory change, political risk or economic uncertainty. Insurance broking generally tracks the economy, but demand for both insurance broking and consulting services usually remains steady during times of uncertainty. We have some businesses, such as our health and benefits and administration businesses, which can be counter cyclical during the early period of a significant economic change.
The tables below set forth our summarized consolidated statements of comprehensive income and data as a percentage of revenue for the periods indicated. In accordance with the modified retrospective adoption requirements of ASC 606 (see Note 4 - Revenue within Item 8 of this Annual Report on Form 10-K), we have also provided our results for the year ended December 31, 2018 without the adoption of ASC 606 to show comparability to the years ended December 31, 2017 and 2016.
We derive the majority of our revenue from commissions from our brokerage businesses and fees for consulting and administration services. No single client represented a significant concentration of our consolidated revenue for any of our three most recent fiscal years.
The table below details the percentage of our revenue and expenses by transactional currency for the year ended December 31, 2018.
The following table sets forth the total revenue for the years ended December 31, 2018 and 2017 and the components of the change in total revenue for the year ended December 31, 2018, as compared to the prior year:
Our revenue can be materially impacted by changes in currency conversions, which can fluctuate significantly over the course of a calendar year. For the year ended December 31, 2018, currency translation increased our consolidated revenue by $89 million. The primary currencies driving this change were the Euro and Pound sterling.
Revenue for the year ended December 31, 2017 was $8.2 billion, compared to $7.9 billion for the year ended December 31, 2016, an increase of $315 million or 4%. This growth in revenue was driven by strong performances in all segments.
The impact of acquisitions and divestitures did not have a significant impact on the change in total revenue for the year ended December 31, 2017 since most of these transactions happened in the latter part of the year.
We manage our business across four integrated reportable operating segments: Human Capital and Benefits; Corporate Risk and Broking; Investment, Risk and Reinsurance; and Benefits Delivery and Administration.
In 2018, we made certain changes that affect our segment results that are not material. These changes include the realignment of certain businesses within our segments, as well as changes to certain allocation methodologies to better reflect the ongoing nature of our businesses. The prior period comparatives included in the tables below have been retrospectively adjusted to reflect our current segment presentation. See Note 5 - Segment Information within Item 8 in this Annual Report on Form 10-K for a further discussion of these changes.
The Company experiences seasonal fluctuations in its revenue. Revenue is typically higher during the Company’s first and fourth quarters due primarily to the timing of broking-related activities. Although the mix of quarterly income changed as a result of the adoption of ASC 606, we expect our revenue to remain highest in our first and fourth quarters.
HCB is the largest segment of the Company, generating approximately 38% of our segment revenue for the year ended December 31, 2018. HCB is focused on addressing our clients’ people and risk needs to help them take on the challenges of operating in a global marketplace. HCB is further strengthened with teams of international consultants that provide support through each of our business units to the global headquarters of multinational clients and their foreign subsidiaries.
HCB segment revenue for both years ended December 31, 2018 and 2017 was $3.2 billion. On an organic basis, HCB experienced growth globally across all businesses. Health and Benefits led the segment with growth in North America related to increased consulting work and product revenue growth, while outside of North America revenue was positively impacted by global benefits management appointments. Talent and Rewards also generated strong revenue growth, primarily from increased demand for advisory projects in Western Europe and International, as well as compensation surveys on a global basis. Retirement revenue increased, driven by higher consulting and project work across all geographies. The Technology and Administration Solutions business experienced growth in Great Britain and Western Europe as a result of new administration clients and project activity.
The following table sets forth HCB segment revenue for the years ended December 31, 2017 and 2016, and the components of the change in revenue for the year ended December 31, 2017 from the year ended December 31, 2016.
CRB generated approximately 34% of Willis Towers Watson segment revenue for the year ended December 31, 2018, and places more than $20 billion of premiums into the insurance markets, annually.
The following table sets forth CRB segment revenue for the years ended December 31, 2017 and 2016, and the components of the change in revenue for the year ended December 31, 2017 from the year ended December 31, 2016.
CRB segment revenue for the years ended December 31, 2017 and 2016 was $2.7 billion and $2.6 billion, respectively. All regions contributed to the strong revenue growth led by International followed by Western Europe, North America and Great Britain. International’s growth was fueled by excellent client retention and strong new business. Western Europe, North America and Great Britain experienced good client retention and solid new business growth.
The IRR segment uses a sophisticated approach to risk, which helps clients free up capital and manage investment complexity. The segment works closely with investors, reinsurers and insurers to manage the equation between risk and return. Blending advanced analytics with deep institutional knowledge, IRR identifies new opportunities to maximize performance. IRR provides investment consulting and discretionary management services and insurance specific services and solutions through reserves opinions, software, ratemaking, risk underwriting and reinsurance broking.
Insurance Consulting and Technology - Insurance Consulting and Technology is a global business that provides advice and technology solutions to the insurance industry. Services include software and technology, risk and capital management, products and pricing, financial and regulatory reporting, financial and capital modeling, M&A, outsourcing and business management.
The following table sets forth IRR segment revenue for the years ended December 31, 2017 and 2016, and the components of the change in revenue for the year ended December 31, 2017 from the year ended December 31, 2016.
IRR segment revenue for both years ended December 31, 2017 and 2016, was $1.5 billion. Total segment revenue for the year ended December 31, 2016 included £28 million ($41 million) received for a settlement related to the Fine Arts, Jewellery and Specie Team. Wholesale Insurance Broking, Investments, Insurance Consulting and Technology, Max Matthiessen and Willis Re all posted revenue growth, primarily as a result of strong sales and increased performance fees. Willis Towers Watson Securities’ growth was flat. The reduction in Underwriting and Capital Management revenue was driven by a loss of profit commissions following the Atlantic hurricanes, the cancellation of a key contract and the divestiture of small programs in the portfolio.
The BDA segment provides primary medical and ancillary benefit exchange and outsourcing services to active employees and retirees across both the group and individual markets. A significant portion of the revenue in this segment is recurring in
Benefits Outsourcing - Through our proprietary BenefitConnect technology, this business provides a broad suite of health and welfare outsourcing services as well as decision support and modeling tools for pension users within the U.S.
BDA segment revenue for the years ended December 31, 2018 and 2017 was $758 million and $734 million, respectively. Anchored by a solid client base, increased membership and enrollments across all businesses helped to drive the segment forward on an organic basis.
Salaries and benefits, as a percentage of revenue, represented 60%, 61% and 61% for the years ended December 31, 2018, 2017 and 2016, respectively.
Depreciation represents the expense incurred over the useful lives of our tangible fixed assets and internally developed software. Depreciation for the year ended December 31, 2018 was $208 million, compared to $203 million for the year ended December 31, 2017, an increase of $5 million. Depreciation for the year ended December 31, 2017 was $203 million, compared to $178 million for the year ended December 31, 2016, an increase of $25 million. These year-over-year increases were due primarily to higher depreciable assets bases resulting from additional assets placed in service in the previous years.
These costs were incurred during the prior years and were related to the Operational Improvement Program (‘OIP’) and Business Restructuring Program, which were completed, and for which costs were fully accrued, by the end of 2017. We spent a cumulative amount of $441 million on restructuring charges for the OIP since it began in the second quarter of 2014.
Income from operations for the year ended December 31, 2018 was $809 million, compared to $516 million for the year ended December 31, 2017, an increase of $293 million. Adjusting for the impact of ASC 606, which reduced operating income in 2018 by $98 million, income from operations would have increased by $391 million. This increase was due to continued organic revenue growth across all segments. Income from operations for the year ended December 31, 2017 was $516 million, compared to $348 million for the year ended December 31, 2016, an increase of $168 million, or 48%. This increase resulted primarily from additional revenue of $315 million driven by growth across all segments, partially offset by additional costs resulting primarily from our integration activities and additional salary and benefits costs.
Other income, net for the year ended December 31, 2018 was $250 million, compared to $164 million for the year ended December 31, 2017, an increase of $86 million. The additional income in 2018 as compared to the prior year primarily related to increased pension benefit income of $58 million for full year 2018, in comparison with the prior year, and favorable foreign exchange activity, primarily occurring in the second quarter of 2018, of approximately $48 million. Other income, net for the year ended December 31, 2017 was $164 million, compared to $178 million for the year ended December 31, 2016. The lower income was primarily due to unfavorable foreign exchange activity of approximately $43 million.
Prior to U.S. Tax Reform, our effective tax rate was lower than the U.S. statutory tax rate of 35%, primarily due to our global mix of income and deductions in jurisdictions with high statutory income tax rates. For 2018, while the U.S. federal corporate income tax rate has decreased as a result of U.S. Tax Reform, certain deferred tax benefits realized as a result of both the Merger and deductions in jurisdictions with high statutory income tax rates have now been reduced as well. This offsets, in part, the benefit of U.S. Tax Reform, thus increasing our income tax rate.
As discussed in Note 4 - Revenue, within Item 8 in this Annual Report on Form 10-K, the Company adopted ASC 606 as of January 1, 2018. Since the Company adopted the guidance using the modified retrospective method, we have provided the impact to the affected financial statement line items within the consolidated financial statements for 2018; the 2017 and 2016 comparative financial statement line items have not been restated in accordance with the new standard. In an effort to help the readers of this Form 10-K better understand the impact that this guidance has on our reported segment results, we have included below the revenue and operating income by segment as reported, as well as without the adoption of ASC 606, and brief explanations of the changes (amounts exclude results not allocated to the operating segments):
Revenue for certain arrangements in our Health and Benefits broking business will now be recognized more evenly over the year to reflect the nature of the ongoing obligations to our customers, as well as receipt of the monthly commissions. These contracts are monthly or annual in nature and are considered complete as of the transition date for all contracts entered into for 2017 and prior years. The total change to revenue as a result of this accounting change for the year ended December 31, 2018 was a decrease of $57 million.
The majority of revenue recognition within our Medicare broking arrangements in Individual Marketplace has moved from monthly ratable recognition over the policy period, to recognition upon placement of the policy. Consequently, the Company will now recognize approximately two-thirds of one calendar year of expected commissions during the fourth quarter of the preceding calendar year. The remainder of the revenue is recognized consistently with methods used prior to the adoption of ASC 606. During the year ended December 31, 2018, the revenue timing changes from ASC 606 resulted in a reduction of revenue from ASC 605 of approximately $38 million.
Bonus Depreciation - The Company completed its determination of all capital expenditures that qualify for immediate expensing. For the year ended December 31, 2017, the Company recorded a provisional deduction of $40 million based on its current intent to fully expense all qualifying expenditures. This resulted in an increase of approximately $14 million to the Company's U.S. federal current income taxes receivable and a corresponding increase in its net deferred tax liabilities of approximately $14 million. However, as a result of further analysis on assets placed in service after September 27, 2017, the Company concluded its tax deduction to be $8 million. The tax deduction was reflected on the Company’s 2017 U.S. federal corporate income tax return filed on October 12, 2018. The effect of the measurement-period adjustment on the 2018 effective tax rate is included in the reduction of the federal corporate tax rate above.
Valuation allowances - The Company has concluded there have been no changes to valuation allowances as a result of U.S. Tax Reform.
The Company recognizes deferred tax balances 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. Beginning in 2016, as a result of our plan to restructure or distribute accumulated earnings of certain acquired Towers Watson foreign operations, we accrued deferred taxes on the historical and current year earnings of those subsidiaries. The historical cumulative earnings of our other subsidiaries had been reinvested indefinitely and therefore we had not provided deferred tax liabilities on these amounts.
During the year ended December 31, 2018, we completed an offering of $600 million of 4.500% senior notes due 2028 and $400 million of 5.050% senior notes due 2048. Net proceeds of $989 million were used to prepay in full $127 million outstanding under our term loan due December 2019, and to repay a portion of the amount outstanding under our $1.25 billion revolving credit facility.
Assets and liabilities associated with non-U.S. entities have been translated into U.S. dollars as of December 31, 2018 at U.S. dollar rates that fluctuate compared to historical periods. As a result, cash flows derived from changes in the consolidated balance sheets include the impact of the change in foreign exchange translation rates.
Cash flows from operating activities were $1.3 billion for 2018, compared to cash flows from operating activities of $862 million for 2017. The $1.3 billion net cash from operating activities for 2018 included net income of $715 million, adjusted for $570 million of non-cash adjustments, and changes in operating assets and liabilities of $3 million. The $570 million non-cash adjustments primarily include depreciation, amortization, and the benefit from deferred income taxes. The $426 million increase in cash from operations in 2018 compared to 2017 primarily resulted from increased cash collections from customers and other working capital improvements.
Cash flows from operating activities were $862 million for 2017, compared to cash flows from operating activities of $933 million for 2016. The $862 million net cash from operating activities for 2017 included net income of $592 million, adjusted for $548 million of non-cash adjustments, partially offset by changes in operating assets and liabilities of $278 million. The $548 million of non-cash adjustments primarily include depreciation, amortization, and the benefit from deferred income taxes. The $71 million decrease in cash from operations in 2017 compared to 2016 primarily resulted from changes in working capital and higher discretionary compensation payments made in 2017 for the 2016 compensation cycle. These discretionary compensation payments were lower in 2016 because they included only a partial payment to Legacy Towers Watson colleagues due to the timing of the Merger.
Cash flows used in investing activities for 2018 and 2017 were $341 million and $335 million, respectively, primarily driven by capital expenditures and capitalized software additions.
Cash flows used in financing activities for 2018 were $903 million. The significant financing activities included share repurchases of $602 million and dividend payments of $306 million, which were partially offset by net borrowings of $66 million.
Total debt, total equity, and the capitalization ratio at December 31, 2018 and December 31, 2017 were as follows:
As an intermediary, we hold funds, generally in a fiduciary capacity, for the account of third parties, typically as the result of premiums received from clients that are in transit to insurers and claims due to clients that are in transit from insurers. We report premiums, which are held on account of, or due from, clients as assets with a corresponding liability due to the insurers. Claims held by, or due to, us which are due to clients are also shown as both Fiduciary assets and Fiduciary liabilities on our balance sheets.
The Company is authorized to repurchase shares, by way of redemption, and will consider whether to do so from time to time, based on many factors, including market conditions.
On February 23, 2018, the board of directors approved an increase to the existing share repurchase program of $400 million.
Apart from commitments, guarantees and contingencies, as disclosed herein and Note 14 - Commitments and Contingencies located within Item 8 of this Annual Report on Form 10-K and incorporated herein by reference, as of December 31, 2018, the Company had no off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on the Company’s financial condition, results of operations or liquidity.
Debt obligations and facilities - The Company’s material debt and related interest obligations at December 31, 2018 are shown in the above table. The Company’s mandatory debt repayment over the next 12 months is a scheduled repayment of its outstanding 7.000% senior notes due in 2019. The Company also has the right, at its option, to prepay indebtedness under the credit facility without further penalty and to redeem the senior notes by paying a ‘make-whole’ premium as provided under the applicable debt instrument.
Operating Leases - We lease office space and furniture under operating lease agreements with terms typically ranging from three to ten years. We have determined that there is not a large concentration of leases that will expire in any one fiscal year. Consequently, management anticipates that any increase in future rent expense on leases will be mainly market-driven. We also lease cars and selected computer equipment under operating lease agreements, although this activity is relatively insignificant. For acquired operating leases, intangible assets or liabilities have been recognized for the difference between the contractual cash obligations and the estimated market rates at the time of acquisition. These intangibles are amortized to rent expense but do not affect our contractual cash obligations. See further discussion in Item 8, Note 14 - Commitments and Contingencies in this Annual Report on Form 10-K.
Pension Contributions - The Company has agreed with Trustees of certain plans in the U.K. to contribute deficit funding and minimum ongoing accrual of benefits funding and presented those obligations in the table above. These obligations exclude employee contributions and any potential funding level contributions, which are dependent on future funding level assessments. There are no contractual obligations for our U.S. pension plans. Our total expected contributions to all qualified pension plans, including amounts presented above, for the year ending December 31, 2019 are projected to be $162 million. Additionally, the Company expects to pay $60 million in benefits directly to participants for the year ended 2019.
Transition Tax - The table above excludes a $4 million transition tax payable resulting from U.S. Tax Reform. The Company elects to pay this one-time tax liability over an eight-year period without interest. Future guidance may be released which could also impact this estimate.
Additionally in 2018, we adopted ASC 606, which has a material impact on the amount, timing and classification of certain revenue and costs included in our consolidated financial statements. Since the Company adopted the guidance using the modified retrospective method, the 2018 financial information is presented on the basis of the ASC 606 adoption, however, the 2017 and prior comparative financial data has not been restated in accordance with the new standard. In an effort to help the readers of this Form 10-K better understand the impact that this guidance had on our non-GAAP measures, we have presented these measures as reported, as well as without the adoption of ASC 606, and a brief explanation of the changes.
Furthermore, the compensation for senior executives under certain long-term incentive programs is determined based on the results of our non-GAAP measures for the period 2016 through 2018 calculated without the adoption of ASC 606. Therefore, to ensure transparency, we consider it necessary to also provide the non-GAAP measures without the adoption of ASC 606. This will enable financial statement users the ability to evaluate management’s performance based on the same elements utilized for performance-based remuneration.
Fair value adjustment to deferred revenue - Adjustment in 2016 to normalize for the deferred revenue written down as part of the purchase accounting for the Merger.
Venezuelan currency devaluation - Foreign exchange losses incurred as a consequence of the Venezuelan government’s enforced changes to exchange rate mechanisms.
We consider adjusted revenue to be an important financial measure, which is used to internally evaluate and assess our core operations and to benchmark our operating results against our competitors.
Adjusted revenue is defined as total revenue adjusted for the fair value adjustment for deferred revenue that would otherwise have been recognized but for the purchase accounting treatment of these transactions. U.S. GAAP accounting requires the elimination of this revenue.
We have included the reconciliation of total revenue to adjusted revenue in the table below, together with our reconciliation of the resulting revenue change to the constant currency and organic changes.
Constant Currency Change - Represents the year-over-year change in revenue excluding the impact of foreign currency fluctuations. To calculate this impact, the prior year local currency results are first translated using the current year monthly average exchange rates. The change is calculated by comparing the prior year revenue, translated at the current year monthly average exchange rates, to the current year as reported revenue, for the same period. We believe constant currency measures provide useful information to investors because they provide transparency to performance by excluding the effects that foreign currency exchange rate fluctuations have on period-over-period comparability given volatility in foreign currency exchange markets.
A reconciliation of the reported changes to the constant currency and organic changes for the years ended December 31, 2018 and 2017 is as follows:
Reconciliations of income from operations to adjusted operating income for the years ended December 31, 2018, 2017 and 2016 are as follows:
Adjusted operating income for the year ended December 31, 2017 increased to $1.5 billion, from $1.4 billion for the year ended December 31, 2016, an increase of $92 million, or 6%. Income from operations increased by $168 million, primarily due to revenue growth across all segments, partially offset by higher salaries and benefits costs. The year ended December 31, 2016 also included settlement income of £28 million ($41 million) related to the Fine Arts, Jewellery and Specie team.
Adjusted EBITDA for the year ended December 31, 2017 was $1.9 billion, compared to $1.8 billion for the year ended December 31, 2016. The increase in Adjusted EBITDA for the year ended December 31, 2017 was primarily due to revenue growth across all segments, partially offset by higher salary and benefits costs. The year ended December 31, 2016 also included settlement income of £28 million ($41 million) related to the Fine Arts, Jewellery and Specie team.
Adjusted net income is defined as net income attributable to Willis Towers Watson adjusted for amortization, restructuring costs, transaction and integration expenses, (gain)/loss on disposal of operations and non-recurring items that, in management’s judgment, significantly affect the period-over-period assessment of operating results, the related tax effect of those adjustments and the tax effects of internal reorganizations and U.S. Tax Reform. This measure is used solely for the purpose of calculating adjusted diluted earnings per share.
Our adjusted diluted earnings per share without the adoption of ASC 606 increased for the year ended December 31, 2018 as compared to the year ended December 31, 2017 primarily due to organic revenue growth across all segments, increased pension credits and lower foreign exchange losses on a year-to-date basis.
Reconciliations of income from operations before income taxes to adjusted income before taxes and provision for/(benefit from) income taxes to adjusted income taxes for the years ended December 31, 2018, 2017 and 2016 are as follows:
Reconciliations of cash flows from operating activities to free cash flow for the years ended December 31, 2018, 2017 and 2016 are as follows:
The increase in free cash flows in 2018 as compared to 2017 primarily resulted from increased cash from operations and cash collections from our customers as compared to the prior year.
Estimation of transaction prices - This process occurs most frequently in certain broking transactions. In situations in which our fees are not fixed but are variable, we must estimate the likely commission per policy, taking into account the likelihood of cancellation before the end of the policy. For Medicare broking, Affinity arrangements and proportional treaty reinsurance broking, the commissions to which we will be entitled can vary based on the underlying individual insurance policies that are placed. For Medicare broking and proportional treaty reinsurance in particular, we base the estimates of transaction prices on supportable evidence from an analysis of past transactions, and only include amounts that are probable of being received or not refunded (referred to as applying ‘constraint’ under ASC 606). This results in us estimating a transaction price that may be significantly lower than the ultimate amount of commissions we may collect. The transaction price is then adjusted over time as we receive confirmation of our remuneration through receipt of treaty statements, or as other information becomes available.
Proportional performance basis over time recognition - Where we recognize revenue on a proportional performance basis, primarily in our consulting and outsourced administration arrangements, the amount we recognize is affected by a number of factors that can change the estimated amount of work required to complete the project, such as the staffing on the engagement and/or the level of client participation. Our periodic engagement evaluations require us to make judgments and estimates regarding the overall profitability and stages of project completion that, in turn, affect how we recognize revenue. We recognize a loss on an engagement when estimated revenue to be received for that engagement is less than the total estimated costs associated with the engagement. Losses are recognized in the period in which the loss becomes probable and the amount of the loss is reasonably estimable.
An estimated annual bonus amount is initially developed at the beginning of each fiscal year in conjunction with our budgeting process. Estimated annual operating performance is reviewed quarterly and the discretionary annual bonus amount is then adjusted, if necessary, by management to reflect changes in the forecast of pre-bonus profitability for the year.
The Company recognizes 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 carry forwards. Deferred tax assets and liabilities are measured using enacted rates in effect for the year in which the differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of changes in tax rates is recognized in the statement of comprehensive income in the period in which the change is enacted. Deferred tax assets are reduced through the establishment of a valuation allowance at such time as, based
on available evidence, it is more likely than not that the deferred tax assets will not be realized. The Company adjusts valuation allowances to measure deferred tax assets at the amount considered realizable in future periods if the Company’s facts and assumptions change. In making such determinations, the Company considers all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies and the results of recent financial operations. We place more reliance on evidence that is objectively verifiable.
Willis Towers Watson Plan - Substantially all U.S. employees are eligible to participate in this plan. Benefits are provided under a stable value pension plan design. The original stable value design came into effect on January 1, 2012. Existing plan participants as of July 1, 2017 earn benefits without having to make employee contributions, and all newly eligible employees after that date are required to contribute 2% of pay to participate in the plan.
We recorded a combined $173 million net periodic benefit income for our U.S. and U.K. plans for the year ended December 31, 2018. For the U.S. and U.K. plans, the following table presents our estimated net periodic benefit income for 2019 and the impact to both plans of a 0.25% increase and decrease to both the expected return on assets (‘EROA’) and the discount rate assumptions, and the projected benefit obligations as of December 31, 2018 and the impact of a 0.25% increase and decrease to the discount rates:
During fiscal year 2018, the Company performed Step 1 of the two-step impairment test for all reporting units. Each of the reporting units' estimated fair values were in excess of their carrying values. To perform the test, we used valuation
If the Company was required to perform Step 2, we would determine the implied fair value of the reporting unit used in Step 1 to all of the assets and liabilities of that reporting unit (including any recognized or unrecognized intangible assets) as if the reporting unit had been acquired in a business combination. Then the implied fair value of goodwill would be compared to the carrying amount of goodwill to determine if goodwill is impaired. For the year ended December 31, 2018, we did not record any impairment losses of goodwill or intangibles.
While we are still in the process of analyzing the various ASUs issued by the FASB, those which we believe will have a material impact to our financial statements are listed below. See Note 2 - Basis of Presentation, Significant Accounting Policies and Recent Accounting Pronouncements within Item 8 of this Form 10-K for additional information.
Hindsight practical expedient - We have elected this practical expedient, and therefore will not revisit our estimate of lease terms upon transition to ASC 842.
Short-term lease exemption - We have elected this exemption, and will therefore not recognize any right-of-use assets or liabilities for short-term leases (generally defined as having a term of 12 months or less) on our consolidated balance sheet.
Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 2018
We have audited the accompanying consolidated balance sheets of Willis Towers Watson Public Limited Company and subsidiaries (the "Company") as of December 31, 2018 and 2017, the related consolidated statements of comprehensive income, changes in equity and cash flows, for the two years then ended, and the related notes (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for the two years then ended, in conformity with accounting principles generally accepted in the United States of America.
The consolidated financial statements of the Company for the year ended December 31, 2016 (the “2016 financial statements”), before the effects of the adjustments to retrospectively apply the changes in accounting discussed in Note 2, before the effects of the retrospective adjustments to the disclosures for changes in the composition of reportable segments discussed in Note 5, and before the effects of the retrospective adjustments to the presentation of financial information for issuers and other guarantor subsidiaries as discussed in Note 22 to the financial statements, were audited by other auditors whose report, dated March 1, 2017, expressed an unqualified opinion on those statements. We have also audited the adjustments to the 2016 financial statements to retrospectively apply the changes in accounting related to net periodic pension and postretirement benefit cost and stock compensation as discussed in Note 2, the retrospective adjustments to the disclosures for changes in the composition of reportable segments as discussed in Note 5, and the retrospective adjustments to the presentation of financial information for issuers and other guarantor subsidiaries as discussed in Note 22 to the financial statements. In our opinion, such retrospective adjustments are appropriate and have been properly applied. However, we were not engaged to audit, review, or apply any procedures to the 2016 financial statements of the Company other than with respect to the retrospective adjustments, and accordingly, we do not express an opinion or any other form of assurance on the 2016 financial statements taken as a whole.
As discussed in Note 2 to the financial statements, the Company has changed its method of accounting for revenue from contracts with customers in the year ended December 31, 2018 due to adoption of Accounting Standard Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers.
In our opinion, such 2016 consolidated financial statements, before the effects of the adjustments to retrospectively apply the changes in accounting discussed in Note 2, the adjustment to the disclosures for changes in the composition of reportable segments discussed in Note 5 and the change in presentation of the financial information for issuers and other guarantor subsidiaries discussed in Note 22 to the consolidated financial statements, present fairly, in all material respects, the results of operations and cash flows of Willis Towers Watson Public Limited Company and subsidiaries for the year ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America.
We were not engaged to audit, review, or apply any procedures to the adjustments to retrospectively apply the changes in accounting discussed in Note 2, the adjustment to the disclosures for changes in the composition of reportable segments discussed in Note 5 and the change in presentation of the financial information for issuers and other guarantor subsidiaries discussed in Note 22 to the consolidated financial statements and, accordingly, we do not express an opinion or any other form of assurance about whether such retrospective adjustments are appropriate and have been properly applied. Those retrospective adjustments were audited by other auditors.
(Tabular amounts are in millions of U.S. dollars, except per share data)
We offer our clients a broad range of services to help them identify and control their risks, and to enhance business performance by improving their ability to attract, retain and engage a talented workforce. Our risk control services range from strategic risk consulting (including providing actuarial analysis), to a variety of due diligence services, to the provision of practical on-site risk control services (such as health and safety or property loss control consulting), as well as analytical and advisory services (such as hazard modeling and reinsurance optimization studies). We assist clients in planning how to manage incidents or crises when they occur. These services include contingency planning, security audits and product tampering plans. We help our clients enhance their business performance by delivering consulting services, technology and solutions that help them anticipate, identify and capitalize on emerging opportunities in human capital management as well as offer investment advice to help them develop disciplined and efficient strategies to meet their investment goals.
The accompanying audited consolidated financial statements of Willis Towers Watson and our subsidiaries are presented in accordance with the rules and regulations of the SEC for annual reports on Form 10-K and are prepared in accordance with U.S. GAAP. All intercompany accounts and transactions have been eliminated in consolidation. We have reclassified certain prior year amounts to conform to the current year presentation.
Use of Estimates - These consolidated financial statements conform to U.S. GAAP, which requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as well as disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Our estimates, judgments and assumptions are continually evaluated based on available information and experience. Because of the use of estimates inherent in the financial reporting process, actual results could differ from those estimates. Estimates are used when accounting for revenue recognition and related costs, the selection of useful lives of fixed and intangible assets, impairment testing, valuation of billed and unbilled receivables from clients, discretionary compensation, income taxes, pension assumptions, incurred but not reported claims, legal reserves and goodwill and intangible assets.
The Company periodically reviews its investments in associates for which fair value is less than cost to determine if the decline in value is other than temporary. If the decline in value is judged to be other than temporary, the cost basis of the investment is written down to fair value. The amount of any write-down is included in the consolidated statements of comprehensive income.
Fiduciary Funds - Unremitted insurance premiums and claims are recorded within fiduciary assets on the consolidated balance sheets. Fiduciary funds are generally required to be kept in certain regulated bank accounts subject to guidelines
Fiduciary liabilities on the consolidated balance sheets represent the obligations to remit all fiduciary funds and fiduciary receivables to insurers or insureds.
Income Taxes - The Company recognizes 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 carry forwards. Deferred tax assets and liabilities are measured using enacted rates in effect for the year in which the differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of changes in tax rates is recognized in the consolidated statement of comprehensive income in the period in which the change is enacted. Deferred tax assets are reduced through the establishment of a valuation allowance at such time as, based on available evidence, it is more likely than not that the deferred tax assets will not be realized. The Company adjusts valuation allowances to measure deferred tax assets at the amounts considered realizable in future periods if the Company’s facts and assumptions change. In making such determinations, the Company considers all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies and the results of recent financial operations. We place more reliance on evidence that is objectively verifiable.
Positions taken in the Company’s tax returns may be subject to challenge by the taxing authorities upon examination. The Company recognizes the benefit of uncertain tax positions in the financial statements when it is more likely than not that the position will be sustained on the basis of the technical merits of the position assuming the tax authorities have full knowledge of the position and all relevant facts. Recognition also occurs upon either the lapse of the relevant statute of limitations, or when positions are effectively settled. The benefit recognized is the largest amount of tax benefit that is greater than 50 percent likely to be realized on settlement with the tax authority. The Company adjusts its recognition of uncertain tax benefits in the period in which new information is available impacting either the recognition or measurement of its uncertain tax positions. Such adjustments are reflected as increases or decreases to income taxes in the period in which they are determined.
The Company evaluates whether its contracts include clauses or conditions which would be required to be separately accounted for at fair value as embedded derivatives. See Note 10 - Derivative Financial Instruments for additional information about the Company’s derivatives.
Share-Based Compensation - The Company has equity-based compensation plans that provide for grants of restricted stock units and stock options to employees and non-employee directors of the Company. Additionally, the Company has cash-settled share-based compensation plans that provide for grants to employees.
For the cash-settled share-based compensation, the Company recognizes a liability for the fair-value of the awards as of each reporting date included within other non-current liabilities in the consolidated balance sheets. Expense is recognized over the service period, and as the liability is remeasured at the end of each reporting period, changes in fair value are recognized as compensation cost within Salaries and benefits in the consolidated statements of comprehensive income. The significant assumptions underlying our expense calculations include the estimated achievement of any performance targets and estimated forfeiture rates.
Depreciation on internally-developed software is amortized over the estimated useful life of the asset ranging from 3 to 10 years. Buildings include assets held under capital leases and are depreciated over the lesser of 50 years, the asset lives or the lease terms. Depreciation on leasehold improvements is calculated over the lesser of the useful lives of the assets or the remaining lease terms. Depreciation on furniture and equipment is calculated based on a range of 3 to 10 years. Land is not depreciated.
Goodwill and Other Intangible Assets - In applying the acquisition method of accounting for business combinations, amounts assigned to identifiable assets and liabilities acquired were based on estimated fair values as of the date of acquisition, with the remainder recorded as goodwill. Intangible assets are initially valued at fair value using generally accepted valuation methods appropriate for the type of intangible asset. Intangible assets with definite lives are amortized over their estimated useful lives and are reviewed for impairment if indicators of impairment arise. Intangible assets with indefinite lives are tested for impairment annually as of October 1, and whenever indicators of impairment exist. The fair values of intangible assets are compared with their carrying values, and an impairment loss would be recognized for the amount by which a carrying amount exceeds its fair value.
Goodwill is tested for impairment annually as of October 1, and whenever indicators of impairment exist. Goodwill is tested at the reporting unit level, and the Company had nine reporting units as of October 1, 2018. In the first step of the impairment test, the fair value of each reporting unit is compared with its carrying value, including goodwill. If the carrying value of a reporting unit exceeds its fair value, the amount of an impairment loss, if any, is calculated in the second step of the impairment test by comparing the implied fair value of reporting unit goodwill with the carrying amount of that goodwill. The Company’s goodwill impairment tests for the years ended December 31, 2018 and 2017 have not resulted in any impairment charges. See Note 9 - Goodwill and Other Intangible Assets for additional information about our goodwill and other intangible assets.
Revenue Recognition (effective from January 1, 2018) - The following policies were effective for the 2018 fiscal year as a result of the adoption, on January 1, 2018, of ASC 606, Revenue From Contracts With Customers (‘ASC 606’). The revenue recognition policies in effect prior to 2018 are reflected in the next section.
We recognize revenue from a variety of services, with broking, consulting and outsourced administration representing our most significant offerings. All other revenue streams, which can be recognized at either point in time or over time, are individually less significant and are grouped in Other in our revenue disaggregation disclosures in Note 4 - Revenue. These Other revenue streams represent approximately 5% of customer contract revenue for the year ended December 31, 2018.
Broking - Representing approximately 48% of customer contract revenue for the year ended December 31, 2018, in our broking arrangements, we earn revenue by acting as an intermediary in the placement of effective insurance policies. Generally, we act as an agent and view our client to be the party looking to obtain insurance coverage for various risks, or an employer or sponsoring organization looking to obtain insurance coverage for its employees or members. Also, we act as an agent in reinsurance broking arrangements where our client is the party looking to cede risks to the reinsurance markets. Our primary performance obligation under the majority of these arrangements is to place an effective insurance or reinsurance policy, but there can also be significant post-placement obligations in certain contracts to which we need to allocate revenue. The most common of these is for claims handling or call center support. The revenue recognition method for these, after the relative fair value allocation, is described further as part of the ‘Outsourced Administration’ description below.
We recognize revenue for most broking arrangements as of a point in time at the later of the policy inception date or when the policy placement is complete, because this is viewed as the date when control is transferred to the client. For Medicare broking, we recognize revenue over time, as we stand ready under our agreements to place retiree Medicare coverage. For this type of broking arrangement, we recognize the majority of our placement revenue in the fourth quarter of the calendar year when the majority of the placement or renewal activity occurs.
The majority of our revenue from these consulting engagements is recognized over time, either because our clients are simultaneously receiving and consuming the benefits of our services, or because we have an enforceable right to payment for performance rendered to date. Additionally, from time to time, we may be entitled to an additional fee based on achieving certain performance criteria. To the extent that we cannot estimate with reasonable assurance the likelihood that we will achieve the performance target, we will ‘constrain’ this portion of the transaction price and recognize it when or as the uncertainty is resolved.
Annual recurring projects and projects of short duration. These projects are typically straightforward and highly predictable in nature with either time-and-expense or fixed fee terms. Time-and-expense fees are recognized as hours or expenses are incurred using the ‘right to invoice’ practical expedient allowed under ASC 606. For fixed-fee arrangements, to the extent estimates can be made of the remaining work required under the arrangement, revenue is based upon the proportional performance method, using the value of labor hours compared to the estimated total value of labor hours. We believe that cost represents a faithful depiction of transfer of value because the completion of these performance obligations is based upon the professional services of employees of differing experience levels and thereby costs. It is appropriate that satisfaction of these performance obligations considers both the number of hours incurred by each employee and the value of each labor hour worked (as opposed to simply the hours worked).
Stand-ready obligations. These projects consist of repetitive monthly or quarterly services performed consistently each period. As none of the activities provided under these services are performed at specified times and quantities, but at the discretion of each customer, our obligation is to stand ready to perform these services on an as-needed basis. These arrangements represent a ‘series’ performance obligation in accordance with ASC 606. Each time increment (i.e. each month or quarter) of standing ready to provide the overall services is distinct and the customer obtains value from each period of service independent of the other periods of service.
often include the use of proprietary systems that are configured for each of our clients’ needs. In total, our outsourced administration services represent approximately 12% of customer contract revenue for the year ended December 31, 2018.
Revenue recognized in excess of billings was recorded as unbilled accounts receivable. Cash collections in excess of revenue recognized were recorded as deferred revenue until the revenue recognition criteria were met. Client reimbursable expenses,
Annual recurring projects and projects of short duration. These projects were typically straightforward and highly predictable in nature. As a result, the project manager and financial staff were able to identify, as the project status was reviewed and bills were prepared monthly, the occasions when cost overruns could lead to the recording of a loss accrual.
Stand-ready obligations. Where we were entitled to fees (whether fixed or variable based on assets under management or a per-participant per-month basis) regardless of the hours, we generally recognized this revenue on either a straight-line basis or as the variable fees were calculated.
Delivered software. We deliver software under arrangements with clients who take possession of our software. The maintenance associated with the initial software fees is a fixed percentage which enabled us to determine the stand-alone value of the delivered software separate from the maintenance. We recognized the initial software fees as software was delivered to the client, and we recognized the maintenance fees ratably over the contract period based on each element’s
For our broking business, the Company must estimate the fulfillment costs incurred during the pre-placement of the broking contracts. These judgments include:
The Company will adopt the standard using the modified retrospective approach whereby it will recognize a transition adjustment at the effective date of ASC 842, January 1, 2019, rather than at the beginning of the earliest comparative period presented.
We have assessed the transition practical expedients available under the guidance and, in addition to selecting the modified retrospective transition approach as noted above, we have made the following elections:
Practical expedient package - We have elected this package, and therefore we will not reassess lease classification for our existing or expired leases, whether any existing or expired contracts contain a lease, or our treatment of any initial direct costs.
In January 2017, the FASB issued ASU No. 2017-04, Simplifying the Test for Goodwill Impairment, which simplifies the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. In computing the implied fair value of goodwill under Step 2, current U.S. GAAP requires the performance of procedures to determine the fair value at the impairment testing date of assets and liabilities (including unrecognized assets and liabilities) following the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. Instead, the amendments under this ASU require the goodwill impairment test to be performed by comparing the fair value of a reporting unit with its carrying amount. An impairment charge would be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. The ASU becomes effective for the Company on January 1, 2020. The amendments in this ASU should be applied on a prospective basis. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017, and the Company is still evaluating when to adopt this ASU. The Company does not expect an immediate impact to its consolidated financial statements upon adopting this ASU since the most recent Step 1 goodwill impairment test resulted in fair values in excess of carrying values for all reporting units at October 1, 2018.
In February 2018, the FASB issued ASU No. 2018-02, Income Statement - Reporting Comprehensive Income: Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which allows for a reclassification from accumulated other comprehensive income to retained earnings for ‘stranded’ tax effects (those tax effects of items within accumulated other comprehensive income resulting from the historical corporate income tax rate reduction) resulting from U.S. Tax Reform. The amendments within this ASU also require certain disclosures about stranded tax effects. The
ASU became effective for the Company on January 1, 2019, at which time we adopted it. This ASU did not have a material impact on our consolidated financial statements.
In August 2018, the FASB issued two ASU’s as part of its disclosure framework project. The focus of this project is to improve the effectiveness of disclosures in the notes to the financial statements by facilitating clear communication of the information required by GAAP that is most important to users of an entity’s financial statements. Both of these ASU’s remove certain disclosure requirements and add or modify other requirements. The two ASU’s are as follows:
ASU No. 2018-13, Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement - effective for the Company on January 1, 2020, although early adoption is permitted immediately. Additionally, companies are permitted to immediately adopt the removal or modifications of disclosures as provided in this ASU, and adopt the additional disclosures on the effective date of the ASU. Certain provisions of the ASU must be adopted retrospectively, while others must be adopted prospectively. The Company is still assessing when and how it will adopt this ASU, but does not expect there to be a material impact to the notes to the consolidated financial statements.
ASU No. 2018-14, Disclosure Framework-Changes to the Disclosure Requirements for Defined Benefit Plans - this ASU will impact certain 10-K disclosures and will be effective for the Company for its 2020 Annual Report on Form 10-K. Early adoption is permitted and must be applied on a retrospective basis. The Company is still assessing when it will adopt this ASU, but does not expect there to be a material impact to the notes to the consolidated financial statements.
In August 2018, the SEC issued a final rule that amended certain of its disclosure requirements that have become redundant, duplicative or superseded in light of other SEC disclosure requirements, changes in U.S. GAAP, or other information that has become widely available. As part of the SEC’s overall effort to improve the effectiveness of financial reporting requirements, the amendments contained in the final rule were intended to facilitate the disclosure of information to investors and simplify compliance without significantly altering the total mix of information provided to investors. Certain amendments affect this Annual Report on Form 10-K, while others were reflected initially in our Quarterly Report on Form 10-Q filed on November 2, 2018. Specifically, the final rule changes to annual requirements which have been reflected in this Form 10-K include the elimination of the ratio of earnings to fixed charges schedule, as well as changes to the market price information and geographic data contained in Parts I and II of this Form 10-K. None of these changes have a significant impact to our Form 10-K.
notes containing our 2018 information. A full description of each impact, as well as the new disclosures required by ASC 606, is discussed in Note 4 - Revenue.
On January 4, 2016, pursuant to the Agreement and Plan of Merger, dated June 29, 2015, as amended on November 19, 2015, between Willis, Towers Watson, and Citadel Merger Sub, Inc., a wholly-owned subsidiary of Willis formed for the purpose of facilitating this transaction (‘Merger Sub’), Merger Sub merged with and into Towers Watson, with Towers Watson continuing as the surviving corporation and as a wholly-owned subsidiary of Willis.
The Company has preliminarily recognized $36 million of intangible assets, primarily arising from client relationships, and $24 million of goodwill. The purchase price allocation as of the acquisition date and our accounting for the related tax assets and liabilities is not yet complete.
Related Party Transaction - In the third quarter of 2017, the Company divested its Global Wealth Solutions business through a sale to an employee of the business. As part of that transaction, we financed a $50 million note payable from the employee to purchase the business. The note amortizes over 10 years, bears interest at a weighted-average rate of 3% and is guaranteed by $3 million in assets. Following the sale, employees of this business are no longer employees of the Company, and the purchasing employee is no longer considered a related party. The current and non-current portions of the note receivable are
2017 Cumulative Divestiture Impact - Including the divestiture of Global Wealth Solutions, we sold five businesses during the second half of 2017. For the year ended December 31, 2017, the total gain recognized related to business disposals was $13 million, which was recorded in Other income, net on the accompanying consolidated statements of comprehensive income. Results from these disposals prior to the sales represented $54 million of revenue and $13 million of operating income for the year ended December 31, 2017.
As of January 1, 2018, the Company adopted ASC 606. The adoption of this new guidance had a material impact to the amounts and classification of certain balances within our consolidated financial statements and disclosures in the accompanying notes.
We elected to reflect the aggregate effect of all modifications made to contracts prior to the transition date, January 1, 2018, rather than retrospectively restating the contracts for each of these modifications.
We recognized the cumulative effect of initially applying ASC 606 as an adjustment to the opening balance of retained earnings. The comparative periods included within this Annual Report on Form 10-K have not been restated and continue to be reported under the accounting standards in effect for those periods.
Other current liabilities, which include current taxes payable, and deferred tax liabilities, have been adjusted for the tax effects of the individual changes resulting from the adoption of ASC 606. The income tax expense was calculated based on the U.S. and foreign statutory rates applicable to adjustments made. Where applicable, a U.S. statutory rate of 21% was used.
The following changes are now reflected in our consolidated statements of comprehensive income for the year ended December 31, 2018. Each description also includes a discussion of the impact to retained earnings as of the adoption date.
Proportional treaty reinsurance broking - The revenue recognition for proportional treaty reinsurance broking commissions, within our Investment, Risk and Reinsurance segment, has moved from recognition upon the receipt of the monthly or quarterly treaty statements from the ceding insurance carriers, to the recognition of an estimate of expected commissions upon the policy effective date. Since the majority of revenue recognized historically based on these monthly or quarterly statements was received over a two-year period, we reflected a $50 million pretax increase to retained earnings at the adoption date for the portion of revenue that would otherwise have been recognized during our 2018 calendar year related to policies effective in 2017 or prior years. For the year ended December 31, 2018, this accounting change resulted in a revenue increase of $2 million related to this adjustment.
Health and benefits broking - Revenue for certain Health and Benefits broking arrangements, in our Human Capital and Benefits segment, will now be recognized evenly over the year to reflect the nature of the ongoing obligations to our customers as well as receipt of the monthly commissions. These contracts are monthly or annual in nature, and are considered complete as of the transition date. Therefore, no retained earnings adjustment is required. The total effect to revenue as a result of this accounting change for the year ended December 31, 2018 was a decrease of $57 million.
Other adjustments - Certain other revenue changes with individually less significant adjustments were made to retained earnings as of the adoption date totaling a net $28 million. The cumulative change to revenue for the year ended December 31, 2018 for other revenue streams not discussed above resulting from the ASC 606 adoption was a decrease of $7 million.
System implementation activities - For those portions of the business that previously deferred costs, the length of time over which we amortize those costs will extend to a longer estimated contract term. For 2017 and prior years, these costs were amortized over a typical period of 3-5 years in accordance with the initial stated terms of the customer agreements. Additionally, the composition of deferred costs has been adjusted to reflect the guidance in ASC 606. A reduction adjustment to retained earnings of $46 million was recorded on the adoption date to reflect these changes. Further, the amortization of the costs are no longer classified as depreciation expense, but rather included in salaries and benefits. These adjustments resulted in an increase in expense of $6 million for the year ended December 31, 2018.
Other cost adjustments - This guidance now applies to our broking arrangements and certain consulting engagements. While the costs deferred for our broking arrangements will typically be amortized within one year, costs now deferred related to certain consulting arrangements will be amortized over a longer term. We have increased pre-tax retained earnings by $75 million, primarily to reflect the total changes to contract costs as of the adoption date. For the year ended December 31, 2018, these changes resulted in a decrease in expense of $8 million.
The following changes are now reflected in our consolidated statement of cash flows for the year ended December 31, 2018.
Individual revenue streams aggregating to 5% of total revenue for the year ended December 31, 2018 have been included within the Other line in the table above.
The Company reports accounts receivable, net on the consolidated balance sheet, which includes billed and unbilled receivables and current contract assets. In addition to accounts receivable, net, the Company had the following non-current contract assets and deferred revenue balances at December 31, 2018 and January 1, 2018:
The Company receives payments from customers based on billing schedules or terms as written in our contracts. Those balances denoted as contract assets relate to situations where we have completed some or all performance under the contract, however our right to consideration is conditional. Contract assets result most materially in our Medicare broking and proportional treaty broking businesses. Billed and unbilled receivables are recorded when the right to consideration becomes unconditional. Deferred revenue relates to payments received in advance of performance under the contract, and is recognized as revenue as (or when) we perform under the contract.
During the year ended December 31, 2018, revenue of approximately $389 million was recognized that was reflected as deferred revenue at January 1, 2018. There were no other primary drivers for the changes in contract assets and liabilities from January 1, 2018 to December 31, 2018 besides the recognition of revenue and receipts of cash.
In addition, the Company has elected not to disclose the remaining performance obligations when one or both of the following circumstances apply:
Since most of the Company’s contracts are cancellable with less than one year’s notice, and have no substantive penalty for cancellation, the majority of the Company’s remaining performance obligations as of December 31, 2018 has been excluded from the table above.
Willis Towers Watson’s chief operating decision maker is its chief executive officer. We determined that the operational data used by the chief operating decision maker is at the segment level. Management bases strategic goals and decisions on these segments and the data presented below is used to assess the adequacy of strategic decisions and the method of achieving these strategies and related financial results. Management evaluates the performance of its segments and allocates resources to them based on net operating income on a pre-bonus, pre-tax basis.
The Company experiences seasonal fluctuations of its revenue. Revenue is typically higher during the Company’s first and fourth quarters due to the timing of broking-related activities, and although the mix of quarterly income changed as a result of the adoption of ASC 606, we expect our revenue to remain highest in our first and fourth quarters.
Beginning in 2018, we made certain changes that affect our segment results that are not material. These changes include the following:
As part of the continued integration of our businesses, we have applied our 2018 corporate expense allocation methodology to our 2017 and 2016 segment results in order to standardize our methodologies and allocate those expenses for period over period comparatives. Such methodology updates include (1) an increased allocation for Gras Savoye as it no longer benefits as a new acquisition; (2) adjustments relating to changes in segment and total headcount; and (3) the addition of certain allocable direct expenses, which lowers the corporate expense allocation.
In connection with our segment realignment, we reassigned a proportional amount of the carrying value of goodwill between the CRB and IRR segments. See Note 9 - Goodwill and Other Intangible Assets for further information.
Previously during the year ended December 31, 2017, the Company made changes to our segment results which standardized the allocation of corporate expenses directly attributable to business segments, reassigned Max Matthiessen to IRR and Fine Art, Jewellery & Specie to CRB to better align with their specializations, and revised the presentation of certain costs impacting fixed assets and internally-developed software which arose from the purchase accounting for the Merger.
Under the segment structure and for internal and segment reporting, Willis Towers Watson segment revenue includes commissions and fees, interest and other income. U.S. GAAP revenue includes amounts that were directly incurred on behalf of our clients and reimbursed by them (reimbursable expenses), which are removed from segment revenue. Segment operating income excludes certain costs, including (i) amortization of intangibles; (ii) restructuring costs; (iii) certain transaction and integration expenses; (iv) certain litigation provisions; (v) significant pension settlement and curtailment gains or losses; and (vi) to the extent that the actual expense based upon which allocations are made differs from the forecast/budget amount, a reconciling item will be created between internally-allocated expenses and the actual expenses that we report for U.S. GAAP purposes.
Below are our revenue and long-lived assets for Ireland, our country of domicile, countries with significant concentrations, and all other foreign countries for each of the years ended December 31, 2018, 2017 and 2016:
The changes in the Company’s liability under the Operational Improvement Program from its commencement to December 31, 2018, are as follows:
On December 22, 2017, the U.S. government enacted comprehensive tax legislation, commonly referred to as ‘U.S. Tax Reform’. U.S. Tax Reform makes broad and complex changes to the U.S. tax code, including, but not limited to: (1) requiring a one-time transition tax on certain unremitted earnings of foreign subsidiaries that may be payable over eight years; (2) bonus depreciation that will allow for full expensing of qualified property; (3) reduction of the federal corporate tax rate from 35% to 21%; (4) a new provision designed to tax global intangible low-taxed income (‘GILTI’), which allows for the possibility of using foreign tax credits (‘FTCs’) and a deduction of up to 50% to offset the income tax liability (subject to some limitations); (5) a new limitation on deductible interest expense; (6) limitations on the deductibility of certain executive compensation; (7) limitations on the use of FTCs to reduce the U.S. income tax liability; (8) the creation of the base erosion anti-abuse tax (‘BEAT’), a new minimum tax; and (9) a general elimination of U.S. federal income taxes on dividends from foreign subsidiaries.
Also on December 22, 2017, the SEC staff issued Staff Accounting Bulletin No. 118 (‘SAB 118’), which provided guidance on accounting for the tax effects of the U.S. Tax Reform. SAB 118 provided a measurement period that should not extend beyond one year from the U.S. Tax Reform enactment date for companies to complete the accounting under ASC 740, Income Taxes (‘ASC 740’). In accordance with SAB 118, a company was required to reflect the income tax effects of those aspects of U.S. Tax Reform for which the accounting under ASC 740 was complete. Adjustments to incomplete and unknown amounts were required to be recorded and disclosed during the measurement period. To the extent that a company’s accounting for certain income tax effects of U.S. Tax Reform was incomplete but it was able to determine a reasonable estimate, a provisional estimate in the financial statements was required to be recorded. If a company was unable to determine a provisional estimate, it was required to continue to apply ASC 740 on the basis of the provisions of the tax laws that were in effect immediately before the enactment of U.S. Tax Reform.
clarification. However, as of December 31, 2018, the Company's accounting for U.S. Tax Reform is complete based on its interpretation of the guidance issued as of the balance sheet date.
One-time transition tax - The one-time transition tax is based on the Company’s total post-1986 earnings and profits (‘E&P’) that it previously deferred from U.S. income taxes. At December 31, 2017, the Company recorded a provisional amount for the one-time transition tax liability for our foreign subsidiaries owned by U.S. corporate shareholders, resulting in an increase in U.S. Federal income tax expense of $70 million and state income tax expense of $2 million. This transition tax liability was recorded as a long-term liability in the 2017 financial statements. Subsequent to the December 31, 2017 reporting period, the Internal Revenue Service (‘IRS’) clarified the application of the ‘with’ and ‘without’ approach for calculating the transition tax liability in determining the amount payable over eight years. Based on this guidance the Company revised its provisional estimate for the U.S. federal transition tax liability in the first quarter of 2018, which was reduced by $64 million due to the utilization of interest loss carryforwards resulting from the transition tax income inclusion. This reduction has no impact on the 2018 effective tax rate. Additionally, on the basis of revised E&P computations that were completed during the year ended December 31, 2018, we recognized an additional increase to income tax expense of $8 million, which was recorded in current income tax payable. This has an approximate 1% impact on the Company’s 2018 effective tax rate. The tax expense recorded includes the final measurement period adjustment related to the Company’s November 30, 2018 foreign subsidiaries. While the measurement period under SAB 118 is now closed, we may in future periods need to further refine the U.S. federal and state transition tax calculations of the November 30, 2018 foreign subsidiaries as the taxing authorities provide additional guidance and clarification.
Indefinite reinvestment assertion - Beginning in 2018, U.S. Tax Reform provides a 100% deduction for dividends received from 10-percent owned foreign corporations by U.S. corporate shareholders, subject to a one-year holding period. Although dividend income is now exempt from U.S. federal tax for U.S. corporate shareholders, companies must still account for the tax consequences of outside basis differences and other tax impacts of their investments in non-U.S. subsidiaries. At December 31, 2017, we analyzed our global working capital and cash requirements and the potential tax liabilities attributable to a repatriation and determined we might repatriate up to $219 million which was previously deemed indefinitely reinvested. For those investments from which we were able to make a reasonable estimate of the tax effects of such repatriation, we recorded a provisional estimate for foreign withholding and state income taxes of $1 million. In addition, we re-measured the existing deferred tax liability accrued on certain acquired Towers Watson subsidiaries and released the associated deferred tax liability. This resulted in an income tax benefit of $76 million as these foreign earnings were subject to the one-time transition tax. These estimates are now considered final and no further adjustments have been made in the year ended December 31, 2018 as a result of U.S. Tax Reform.
Executive compensation - Starting with compensation paid in 2018, Section 162(m) will limit the Company from deducting compensation, including performance-based compensation, in excess of $1 million paid to anyone who,
GILTI - U.S. Tax Reform creates a new requirement that certain income (i.e., GILTI) earned by controlled foreign corporations (‘CFCs’) must be included currently in the gross income of the CFCs’ U.S. shareholders. GILTI is the excess of the shareholder’s ‘net CFC tested income’ over the net deemed tangible income return, which is currently defined as the excess of (1) 10 percent of the aggregate of the U.S. shareholder’s pro rata share of the qualified business asset investment of each CFC with respect to which it is a U.S. shareholder over (2) the amount of certain interest expense taken into account in the determination of net CFC-tested income. Under U.S. GAAP, the Company is allowed to make an accounting policy choice of either (1) treating taxes due on future U.S. inclusions in taxable income related to GILTI as a current-period expense when incurred (the ‘period cost method’) or (2) factoring such amounts into a company’s measurement of its deferred taxes (the ‘deferred method’). The Company has concluded it is treating the taxes due on U.S. inclusions in taxable income related to GILTI as a current-period expense when incurred (the ‘period cost method’). The estimated tax impact of GILTI, net of available foreign tax credits, is approximately $15 million at December 31, 2018.
Included in the 2018 U.S. state and local tax expense is an approximate $25 million deferred tax benefit related to a valuation allowance release on certain state deferred tax assets offset with the write-off of certain state net operating losses that are no longer realizable.
Willis Towers Watson plc is a non-trading holding company tax resident in Ireland where it is taxed at the statutory rate of 25%. In 2018, the provision for income tax on operations has been reconciled above to the U.S. federal statutory tax rate of 21% due to significant operations in the U.S. The prior year effective tax rates have not been restated to reflect a U.S. federal statutory tax rate of 21%.
At December 31, 2018 and 2017, the Company had valuation allowances of $81 million and $162 million, respectively, to reduce its deferred tax assets to estimated realizable value. The valuation allowance at December 31, 2018 primarily relates to deferred tax assets for U.K. capital loss carryforwards of $30 million, which have an unlimited carryforward period but can only be utilized against capital gains and U.S. and non-U.S. net operating losses of $27 million and $20 million, respectively. The valuation allowance at December 31, 2017 related to deferred tax assets for U.K. capital loss carryforwards of $28 million, which have an unlimited carryforward period and U.S. and non-U.S. net operating losses of $80 million and $34 million, respectively.
In 2018, the net change in valuation allowance was an $81 million decrease, of which $80 million was a reduction to tax expense primarily related to an internal U.S. restructuring. In 2017, the amount charged to tax expense in the table above differs from the 2017 rate reconciliation of $13 million because a portion of the valuation allowance increase is related to the U.S. federal corporate tax rate reduction impact on the U.S. state valuation allowance and is included in the impact of U.S. Tax Reform. The amount charged to tax expense in the table above for 2016 differs from the effect of $74 million disclosed in the 2016 rate reconciliation primarily because the movement in this table includes the effects of acquisition accounting, which does not impact tax expense.
At December 31, 2018, as a result of an international restructuring, we have determined that we may repatriate an additional $2.1 billion, which was previously deemed indefinitely reinvested. As a result we recorded an estimate for foreign withholding and state income tax expense of approximately $11 million.
At December 31, 2018, the amount of unrecognized tax benefits associated with uncertain tax positions, determined in accordance with ASC 740-10, excluding interest and penalties, was $49 million. A reconciliation of the beginning and ending balances of the liability for unrecognized tax benefits is as follows:
Interest and penalties related to unrecognized tax benefits are included as a component of income tax expense. At December 31, 2018, we had cumulative accrued interest of $3 million. At December 31, 2017, the cumulative accrued interest was $5 million. Penalties accrued in 2018 were immaterial and $2 million in 2017.
Willis North America Inc. is not currently under examination by the IRS. We have ongoing state income tax examinations in certain states for tax years ranging from calendar years ended December 31, 2013 through December 31, 2016. The statute of limitations in certain states extends back to the fiscal year ended June 30, 2014.
Pertains to costs related to certain system implementation activities that have now been included in other non-current assets based on the guidance in ASC 606. See Note 4 - Revenue for further information.
Depreciation related to capital leases was $2 million for each of the years ended December 31, 2018, 2017 and 2016.
In-process research and development intangible assets acquired as part of the Merger on January 4, 2016 of $39 million ($36 million at the date placed into service due to changes in foreign currency exchange rates) had been placed in service during the year ended December 31, 2017 and are included as intangible assets acquired in this presentation.
Our acquired unfavorable lease liabilities were $21 million and $26 million as of December 31, 2018 and December 31, 2017, respectively, and are recorded in other non-current liabilities in the consolidated balance sheet.
We are exposed to certain interest rate and foreign currency risks. Where possible, we identify exposures in our business that can be offset internally. Where no natural offset is identified, we may choose to enter into various derivative transactions. These instruments have the effect of reducing our exposure to unfavorable changes in interest and foreign currency rates. The Company’s board of directors reviews and approves policies for managing each of these risks as summarized below. Additional information regarding our derivative financial instruments can be found in Note 2 - Basis of Presentation, Significant Accounting Policies and Recent Accounting Pronouncements, Note 12 - Fair Value Measurements and Note 17 - Accumulated Other Comprehensive Loss.
During 2015, in order to manage interest rate risk arising from these financial assets, the Company entered into interest rate swaps to receive a fixed rate of interest and pay a variable rate of interest. These derivatives, with total notional amounts of $300 million, were designated as hedging instruments at December 31, 2017 and had a net fair value liability of $1 million. These derivatives matured during 2018.
Certain non-U.S. subsidiaries receive revenue and incur expenses in currencies other than their functional currency, and as a result, the foreign subsidiary’s functional currency revenue will fluctuate as the currency rates change. Additionally, the forecast Pounds sterling expenses of our London brokerage market operations may exceed their Pounds sterling revenue, and they may also hold significant foreign currency asset or liability positions in the consolidated balance sheet. To reduce such variability, we use foreign exchange contracts to hedge against this currency risk.
These derivatives were designated as hedging instruments and at December 31, 2018 and December 31, 2017 had total notional amounts of $438 million and $937 million, respectively, and had net fair value liabilities of $15 million and $21 million, respectively.
At December 31, 2018, the Company estimates, based on current interest and exchange rates, there will be $12 million of net derivative losses on forward exchange rates reclassified from accumulated other comprehensive loss into earnings within the next twelve months as the forecast transactions affect earnings. At December 31, 2018, our longest outstanding maturity was 2 years.
The effects of the material derivative instruments that are designated as hedging instruments on the consolidated statements of comprehensive income for the years ended December 31, 2018, 2017 and 2016 are as follows:
Short-term debt and current portion of long-term debt consists of the following:
All direct obligations under the 5.750% senior notes are issued by Willis Towers Watson and guaranteed by Willis Netherlands B.V., Willis Investment U.K. Holdings Limited, TA I Limited, Trinity Acquisition plc, Willis Group Limited, Willis North America Inc., Willis Towers Watson Sub Holdings Unlimited Company and Willis Towers Watson U.K. Holdings Limited.
On September 10, 2018, the Company, together with its wholly-owned subsidiary, Willis North America Inc. as issuer (see Note 22 for further information), completed an offering of $600 million of 4.500% senior notes due 2028 (‘2028 senior notes’) and $400 million of 5.050% senior notes due 2048 (‘2048 senior notes’). The effective interest rates of the 2028 senior notes and 2048 senior notes are 4.504% and 5.073%, respectively, which include the impact of the discount upon issuance. The 2028 senior notes will mature on September 15, 2028 and the 2048 senior notes will mature on September 15, 2048. Interest has accrued on both the 2028 senior notes and 2048 senior notes from September 10, 2018 and will be paid in cash on March 15 and September 15 of each year, commencing on March 15, 2019. The net proceeds from this offering, after deducting underwriter discounts and commissions and estimated offering expenses, were $989 million, and were used to prepay in full $127 million outstanding under the Company’s term loan due December 2019, and to repay a portion of the amount outstanding under the Company’s RCF.
On May 16, 2017, Willis North America Inc. (see Note 22 for further information) issued $650 million of 3.600% senior notes due 2024 (‘2024 senior notes’). The effective interest rate of the 2024 senior notes is 3.614%, which includes the impact of the discount upon issuance. The 2024 senior notes will mature on May 15, 2024, and interest has accrued on the 2024 senior notes from May 16, 2017 and will be paid in cash on May 15 and November 15 of each year. The net proceeds from this offering, after deducting underwriter discounts and commissions and estimated offering expenses, were $644 million, and were used to pay down amounts outstanding under the RCF and for general corporate purposes.
On May 26, 2016, Trinity Acquisition plc issued €540 million ($609 million) of 2.125% senior notes due 2022 (‘2022 senior notes’). The effective interest rate of these senior notes is 2.154%, which includes the impact of the discount upon issuance. The 2022 senior notes will mature on May 26, 2022. Interest has accrued on the notes from May 26, 2016 and will be paid in cash on May 26 of each year. The net proceeds from this offering, after deducting underwriter discounts and commissions and estimated offering expenses, were €535 million ($600 million). We used the net proceeds of this offering to repay Tranche A of the previous 1-year term loan facility, which matured in 2016, and related accrued interest.
On November 20, 2015, Legacy Willis entered into a 1-year term loan facility. The 1-year term loan had two tranches: Tranche A was for €550 million, of which €544 million ($592 million) was drawn on December 19, 2015 and used to finance the acquisition of Gras Savoye. Tranche B was for $400 million and was drawn on January 4, 2016 and used to re-finance debt held by Legacy Towers Watson which became due on acquisition. Tranche A was repaid in its entirety on May 26, 2016 from the proceeds from the issuance of our 2022 senior notes discussed above. Tranche B was repaid in its entirety on March 22, 2016 from a portion of the proceeds from the issuance of our senior notes discussed above.
The Company has categorized its assets and liabilities that are measured at fair value on a recurring and non-recurring basis into a three-level fair value hierarchy, based on the reliability of the inputs used to determine fair value as follows:
Available-for-sale securities are classified as Level 1 because we use quoted market prices in determining the fair value of these securities.
Contingent consideration payable is classified as Level 3, and we estimate fair value based on the likelihood and timing of achieving the relevant milestones of each arrangement, applying a probability assessment to each of the potential outcomes, and discounting the probability-weighted payout. Typically, milestones are based on revenue or EBITDA growth for the acquired business.
There were no significant transfers between Levels 1, 2 or 3 during the years ended December 31, 2018 and 2017.
Willis Towers Watson sponsors both qualified and non-qualified defined benefit pension plans and other post-retirement welfare (‘PRW’) plans throughout the world. The majority of our plan assets and obligations are in the United States and the United Kingdom. We have also included disclosures related to defined benefit plans in certain other countries, including Canada, France, Germany, Ireland and the Netherlands. Together, these disclosed funded and unfunded plans represent 99% of Willis Towers Watson’s pension and PRW obligations and are disclosed herein.
Germany (Legacy Willis and Legacy Towers Watson) - Both defined benefit plans are closed to new entrants and include certain legacy employee populations hired before 2011. These benefits are primarily account-based, with some long-service participants continuing to accrue benefits according to grandfathered final-average-pay formulas. Other employees, including new entrants, participate in defined contribution arrangements.
Ireland (Legacy Willis) - The defined benefit plans provide pension benefits for approximately one-third of legacy Willis employees in Ireland. The defined benefit plans are now closed to new entrants.
The following schedules provide information concerning the defined benefit pension plans and PRW plan as of and for the years ended December 31, 2018 and 2017:
Amounts recognized in accumulated other comprehensive loss as of December 31, 2018 and 2017 consist of:
The components of the net periodic benefit income and other amounts recognized in other comprehensive (income)/loss for the years ended December 31, 2018, 2017 and 2016 for the defined benefit pension and PRW plans are as follows:
During the year ended December 31, 2016, we adopted the granular approach to calculating service and interest costs. This was treated as a change in accounting estimate, and resulted in a credit of $51 million included in our total net periodic benefit income reflected above.
Assumptions Used in the Valuations of the Defined Benefit Pension Plans and PRW Plan
The following tables present the assumptions used in the valuation to determine the projected benefit obligation for the fiscal years ended December 31, 2018 and 2017:
A one percentage point change in the assumed healthcare cost trend rates would have an immaterial effect on the post-retirement benefit cost and obligation as of December 31, 2018.
The fair values of our U.S. plan assets by asset category at December 31, 2018 and 2017 are as follows:
We evaluate the need to transfer between levels based upon the nature of the financial instrument and size of the transfer relative to the total net assets of the plans. There were no significant transfers between Levels 1, 2 or 3 in the fiscal years ended December 31, 2018 and 2017.
Other fixed income: Foreign and municipal bonds are valued at the closing price reported in the active market in which the bond is traded.
Funding is based on actuarially-determined contributions and is limited to amounts that are currently deductible for tax purposes. Since funding calculations are based on different measurements than those used for accounting purposes, pension contributions are not equal to net periodic pension costs.
At December 31, 2018 and 2017, the Company had certain capital lease obligations totaling $43 million and $48 million, respectively, primarily in respect of the Company’s Nashville property.
Guarantees issued by certain of Willis Towers Watson’s subsidiaries with respect to the senior notes and revolving credit facilities are discussed in Note 11 - Debt and Note 22 - Financial Information for Issuers and Other Guarantor Subsidiaries.
Certain of Willis Towers Watson’s subsidiaries have given the landlords of some leasehold properties occupied by the Company in the U.K. and the U.S. guarantees with respect to the performance of the lease obligations of the subsidiary
holding the lease. The operating lease obligations subject to such guarantees amounted to $570 million and $669 million at December 31, 2018 and 2017, respectively. The capital lease obligations subject to such guarantees amounted to $7 million and $8 million at December 31, 2018 and 2017, respectively.
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 their shares (a put option) to the Company at various dates in the future. Generally, the exercise price of such put options and call options is formula-based (using revenue and earnings) and is designed to reflect fair value. Based on current projections of profitability and exchange rates, and assuming the put options are exercised, the potential amount payable from these options is not expected to exceed $33 million.
Willis Towers Watson has various agreements which provide that it may be obligated to indemnify the other party to the agreement with respect to certain matters. Generally, these indemnification provisions are included in contracts arising in the normal course of business and in connection with the purchase and sale of certain businesses. Although it is not possible to predict the maximum potential amount of future payments that may become due under these indemnification agreements because of the conditional nature of the Company’s obligations and the unique facts of each particular agreement, we do not believe that any potential liability that may arise from such indemnity provisions is probable or material. There are no provisions for recourse to third parties, nor are any assets held by any third parties that any guarantor can liquidate to recover amounts paid under such indemnities.
The Company provides for contingent liabilities based on ASC 450, Contingencies, when it is determined that a liability, inclusive of defense costs, is probable and reasonably estimable. The contingent liabilities recorded are primarily developed actuarially. Litigation is subject to many factors which are difficult to predict so there can be no assurance that in the event of a material unfavorable result in one or more claims, we will not incur material costs.
On March 9, 2018, Regents filed a putative class action complaint on behalf of a putative class of Legacy Towers Watson stockholders against the Company, Legacy Willis, ValueAct, and Messrs. Haley, Casserley, and Ubben, in the Delaware Court of Chancery, captioned The Regents of the University of California v. John J. Haley, et al., C.A. No. 2018-0166. Based on similar allegations as the Eastern District of Virginia action described above, the complaint asserts claims against Mr. Haley for breach of fiduciary duty and against all other defendants for aiding and abetting breach of fiduciary duty. Also on March 9, 2018, Regents filed a motion for consolidation of all pending and subsequently filed Delaware Court of Chancery actions, and for appointment as Lead Plaintiff and for the appointment of Bernstein as Lead Counsel for the putative class. On March 29, 2018, Fort Myers and Alaska responded to Regents’ motion and cross-moved for appointment as Co-Lead Plaintiffs and for the appointment of their counsel, Grant & Eisenhofer P.A. and Kessler Topaz Meltzer & Check, LLP as Co-Lead Counsel. On April 2, 2018, the court consolidated the Delaware Court of Chancery actions and all related actions subsequently filed in or transferred to the Delaware Court of Chancery. On June 5, 2018, the court denied Regents’ motion for appointment of Lead Plaintiff and Lead Counsel and granted Fort Myers’ and Alaska’s cross-motion. On June 20, 2018, Fort Myers and Alaska designated the complaint previously filed by Alaska (the ‘Alaska Complaint’) as the operative complaint in the consolidated action. On September 14, 2018, the defendants filed motions to dismiss the Alaska Complaint. On October 31, 2018, Fort Myers and Alaska filed an amended complaint, which, based on similar allegations, asserts claims against the former directors of legacy Towers Watson for breach of fiduciary duty and against ValueAct and Mr. Ubben for aiding and abetting breach of fiduciary duty. On January 11, 2019, the defendants filed motions to dismiss the amended complaint.
On October 18, 2018, three additional purported former stockholders of Legacy Towers Watson, Naya Master Fund LP, Naya 174 Fund Limited and Naya Lincoln Park Master Fund Limited (collectively, ‘Naya’), filed a complaint against the Company, Legacy Towers Watson, Legacy Willis and John Haley, in the Supreme Court of the State of New York, County of New York, captioned Naya Master Fund LP, et al. v. John J. Haley, et al., Index No. 654968/2018. Based on similar allegations as the Eastern District of Virginia and Delaware actions described above, the complaint asserts claims for common law fraud and negligent misrepresentation. On December 18, 2018, the defendants filed a motion to dismiss the complaint.
On October 27, 2011, the court in Troice entered an order (i) dismissing with prejudice those claims asserted in the Third Amended Class Action Complaint on a class basis on the grounds set forth in the Roland decision discussed above and (ii) dismissing without prejudice those claims asserted in the Third Amended Class Action Complaint on an individual basis. Also on October 27, 2011, the court entered a final judgment in the action.
On March 19, 2014, the plaintiffs in Troice filed a Motion to Defer Resolution of Motions to Dismiss, to Compel Rule 26(f) Conference and For Entry of Scheduling Order.
On September 16, 2014, the court (a) denied the plaintiffs’ request to defer resolution of the defendants’ motions to dismiss, but granted the plaintiffs’ request to enter a scheduling order; (b) requested the submission of supplemental briefing by all parties on the defendants’ motions to dismiss, which the parties submitted on September 30, 2014; and (c) entered an order setting a schedule for briefing and discovery regarding plaintiffs’ motion for class certification, which schedule, among other things, provided for the submission of the plaintiffs’ motion for class certification (following the completion of briefing and discovery) on April 20, 2015.
Circuit consolidated the appeal with the appeal in the Rishmague, et ano. v. Winter, et al. action discussed below, and the consolidated appeal, was fully briefed as of March 24, 2015. Oral argument on the consolidated appeal was held on September 2, 2015. On September 16, 2015, the Fifth Circuit affirmed. The defendants have not yet responded to the complaint in Rupert.
The plaintiffs in Janvey and Troice and the other actions above seek overlapping damages, representing either the entirety or a portion of the total alleged collective losses incurred by investors in Stanford certificates of deposit, notwithstanding the fact that Legacy Willis acted as broker of record for only a portion of time that Stanford issued certificates of deposit. In the fourth quarter of 2015, the Company recognized a $70 million litigation provision for loss contingencies relating to the Stanford matters based on its ongoing review of a variety of factors as required by accounting standards.
associate referenced above (collectively, ‘Defendants’), on the other hand. Under the terms of the Settlement Agreement, the parties agreed to settle and dismiss the Janvey and Troice actions (collectively, the ‘Actions’) and all current or future claims arising from or related to Stanford in exchange for a one-time cash payment to the Receiver by the Company of $120 million to be distributed to all Stanford investors who have claims recognized by the Receiver pursuant to the distribution plan in place at the time the payment is made.
In the amended complaint, plaintiff alleged various deficiencies in pension actuarial work-product and advice stated to have been provided by Legacy Towers Watson’s predecessor firm, Towers Perrin, in its capacity as principal actuary to the Houston Firefighters’ Relief and Retirement Fund (the ‘Fund’). Towers Perrin is stated to have acted in this capacity between ‘the early 1980s until 2003.’
In particular, the amended complaint alleged ‘misrepresentations and miscalculations’ in valuation reports allegedly issued by Towers Perrin from 2000 through 2002 upon which plaintiff claimed to have relied. Plaintiff asserted that Towers Perrin assigned a new team of actuaries to the Fund in 2002 ‘to correct Towers’ own earlier mistakes’ and that the new team ‘altered’ certain calculations which ‘increased the actuarial accrued liability by $163 million.’ Plaintiff claimed that the reports indicated that the City’s minimum contribution percentages to the Fund would remain in place through at least 2019 and that existing benefits under the Fund could be increased, and new benefits could be added, without increasing plaintiff’s financial burden, and without increasing plaintiff’s rate of annual contributions to the Fund. The amended complaint alleged that plaintiff relied on these reports when supporting a new benefits package for the Fund. These reports, and other advice, were alleged, among other things, to have been negligent, to have misrepresented the present and future financial condition of the Fund and the contributions required to be made by plaintiff to support those benefits. Plaintiff asserted that, but for Towers Perrin’s alleged negligence and misrepresentations, plaintiff would not have supported the benefits increase, and that such increased benefits would not and could not have been approved or enacted. It is further asserted that Towers Perrin’s alleged ‘negligence and misrepresentations damaged the City in the amount of tens of millions of dollars in annual contributions.’ The amended complaint sought the award of punitive damages, actual damages, exemplary damages, special damages, attorney’s fees and expenses, costs of suit, pre- and post- judgment interest at the maximum legal rate, and other unspecified legal and equitable relief.
On October 10, 2014, Legacy Towers Watson filed a motion to dismiss plaintiff’s entire complaint on the basis that the complaint fails to state a claim upon which relief can be granted. On November 21, 2014, the City filed its response in opposition to Legacy Towers Watson’s motion to dismiss. On September 23, 2015, Legacy Towers Watson’s motion to dismiss was denied by the United States District Court for the Southern District of Texas, Houston Division. The court entered a Scheduling Order setting trial for May 30, 2017. On June 20, 2016, the Court entered a Second Amended Scheduling Order setting trial for October 31, 2017. On March 27, 2017, the Court entered a Third Amended Scheduling Order setting trial for January 16, 2018.
On May 8, 2017, Legacy Towers Watson received the City’s expert’s damages report, which asserted the City had incurred actual damages of approximately $430 million through July 1, 2017, and would incur future damages that have a present value of approximately $400 million as of July 1, 2017 if the Fund pension benefits remained unchanged. On June 30, 2017, Legacy Towers Watson served its expert reports in rebuttal to the City’s expert reports. Legacy Towers Watson’s experts concluded that Legacy Towers Watson’s work was reasonable and conformed with the actuarial standards of practice, and that Legacy Towers Watson did not cause any damages to the City. Legacy Towers Watson’s experts also concluded that the City’s damages model is flawed.
On January 9, 2018, Legacy Towers Watson and the City participated in a mediation and reached a settlement in principle. On April 4, 2018, the City of Houston City Council approved the settlement. On April 13, 2018, the court entered an order dismissing the case with prejudice, and the settlement became effective on that date. The settlement provided that in exchange for a dismissal of the claims of the City related to Legacy Towers Watson’s pension actuarial advice to the Fund, and any potential claims the City may have related to Legacy Towers Watson’s pension actuarial advice to the Houston Municipal Employees Pension System and the Houston Police Officers Pension System, Legacy Towers Watson agreed to pay a total of $40 million, which was paid in full in April 2018. The Company accrued its portion of the settlement prior to 2018.
When the Commission initiated these proceedings, the FCA closed its related competition investigation, but still retained jurisdiction over broking regulatory matters arising from this conduct. In early 2018, the FCA advised that it will not be taking enforcement action against Willis Limited in connection with any such broking regulatory matters.
Given the status of these investigations, the Company is currently unable to assess the terms on which they will be resolved, or any other regulatory matter or civil claims emanating from the conduct being investigated, will be resolved, and thus is unable to provide an estimate of the reasonably possible loss or range of loss.
The CMA released its final report on December 12, 2018, finding that there is an adverse effect on competition. To address these findings, the CMA has proposed certain remedies, including mandatory tendering when trustees first purchase fiduciary management services, the reporting of investment performance to customers using a set of common standards, transparency in reporting of fees in fiduciary management and the expansion of the FCA’s regulatory perimeter to include the main activities of investment consultancy and fiduciary management providers. The Company is generally supportive of these proposed remedies. The CMA will implement the remedies by way of an order on pension scheme trustees and firms providing the relevant services. Before finalizing the order, the CMA will consult with all interested parties until March 13, 2019 on the details of the order. The remedies are expected to be effective later in 2019.
In November 2017, the FCA published its Terms of Reference for its Market Study into insurance broking activities in the London Wholesale Market including market power, conflicts of interest and broker conduct. This was an industry-wide inquiry and not particular to the Company. The FCA used its powers under the UK Financial Services and Markets Act 2000 to collate information and originally aimed to issue an interim report in or about the first quarter of 2019. The Study had been expected to take two years to conclude. Two of the Company’s subsidiaries responded to extensive data requests which had phased response times through May 2018. It was possible that outcomes of the Study could include new rules, changes to market practices, referral to the U.K. Competition & Markets Authority for a market investigation, and/or individual firm investigations on specific issues. On February 20, 2019, the FCA published its report in final form and closed its study, finding amongst other things that it had ‘not found evidence of significant levels of harm to competition that require intrusive remedies’. The FCA also said it planned to continue to monitor the market as part of its normal supervision function, including in relation to broker business models and the effectiveness of competition. It also said it planned to engage with
As a result of the retrospective adoption of ASU 2017-07 within the consolidated statements of comprehensive income, the service-cost component of net periodic benefit (income)/cost remained within salaries and benefits expense, while the remainder of the components are now included within other income, net. See Note 2 - Basis of Presentation, Significant Accounting Policies and Recent Accounting Pronouncements for further details.
Reclassification adjustments from accumulated other comprehensive loss related to foreign currency translation and cash flow hedges are included in Other income, net in the accompanying consolidated statements of comprehensive income. See Note 10 - Derivative Financial Instruments for additional details regarding the reclassification adjustments for the hedge settlements.
Reclassification adjustments from accumulated other comprehensive loss are included in the computation of net periodic pension cost (see Note 13 - Retirement Benefits). These components are included in Other income, net in the accompanying consolidated statements of comprehensive income.
There were approximately 7 million shares remaining available for grant under this plan as of December 31, 2018. Options are exercisable on a variety of dates, including from the second, third, fourth or fifth anniversary of the grant date. Unless terminated sooner by the board of directors, the 2012 Plan will expire 10 years after the date of its adoption. That termination will not affect the validity of any grants outstanding at that date.
There were no options granted during the year ended December 31, 2018.
Classification of options as time-based or performance-based is dependent on the original terms of the award. Performance conditions on the majority of options have been met. A summary of option activity under the plans at December 31, 2018, and changes during the year then ended is presented below:
Certain options are exercisable in Pounds sterling and are converted to dollars using the exchange rate at December 31, 2018.
The fair value of each time-based RSU is based on the grant date fair value, or the fair value on the acquisition date in the case of acquired awards. The fair value of each performance-based RSU is estimated on the grant date using a Monte-Carlo simulation that uses the assumptions noted in the following table. The awards also contain a market-based performance target. For the awards granted in 2018, the performance measure is entirely based on this market target. Expected volatility is based on the historical volatility of the Company’s shares. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of the grant. The assumptions noted in the table below represent the weighted-average of each assumption for each grant during the year.
The total number of performance-based RSUs that vested during the year ended December 31, 2018 was 249,901 shares at an average share price of $154.99. The total number of performance-based RSUs that vested during the year ended December 31, 2017 was 318,714 shares at an average share price of $140.32. The total number of performance-based RSUs that vested during the year ended December 31, 2016 was 258,536 shares at an average share price of $119.75. At December 31, 2018 there was $12 million of total unrecognized compensation cost related to the performance-based RSU plan; that cost is expected to be recognized over a weighted-average period of 1.9 years.
The actual tax benefit recognized for the tax deductions from RSUs that vested totaled $12 million, $19 million and $25 million for the years ended December 31, 2018, 2017 and 2016, respectively.
The Company granted 268,956 units of phantom stock with a market-performance feature in the year ended December 31, 2018. These are cash-settled awards with final payout based on the performance of Company stock. The grant date fair value of the awards was $83.57 per share. The fair value of each phantom RSU is estimated using a Monte Carlo simulation. The Company’s stock price as of the last day of the period is one of the inputs into the model. Expected volatility is based on the historical volatility of the Company’s shares. The expected term of the plan is three years, based on the vesting terms of the award. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant.
At December 31, 2018, 2017 and 2016, there were 0.4 million, 0.8 million and 1.2 million time-based share options; 0.5 million, 0.7 million and 0.9 million performance-based options; and 0.8 million, 0.9 million and 1.2 million performance-based RSUs outstanding, respectively. The Company’s time-based RSUs were immaterial at December 31, 2018; there were 0.1 million and 0.4 million time-based RSUs outstanding at December 31, 2017 and 2016, respectively. In addition, the Company had 0.3 million performance-based phantom units outstanding at December 31, 2018; there were no phantom units outstanding at December 31, 2017 and 2016.
Note 22 - Financial Information for Issuers and Other Guarantor Subsidiaries
As of December 31, 2018 Willis Towers Watson has issued the following debt securities (‘WTW Debt Securities’):
Willis North America Inc. (‘Willis North America’) has $1.8 billion senior notes outstanding, of which $187 million were issued on September 29, 2009, $650 million were issued on May 16, 2017, and $1.0 billion were issued on September 10, 2018; and
Trinity Acquisition plc has $2.1 billion senior notes outstanding, of which $525 million were issued on August 15, 2013, $1.0 billion were issued on March 22, 2016 and €540 million ($609 million) were issued on May 26, 2016, and $130 million currently outstanding on a consolidated basis under the $1.25 billion revolving credit facility issued on March 7, 2017.
Willis Group Limited, Willis North America, Willis Towers Watson Sub Holdings Unlimited Company and Willis Towers Watson U.K. Holdings Limited.
The notes issued by Trinity Acquisition plc are guaranteed on a joint and several basis by the Company and each of the subsidiaries that guarantees the Company notes, except for Trinity Acquisition plc itself.
All intercompany receivables/payables have been presented in the condensed consolidating financial statements as non-current on a net presentation basis, rather than a gross basis, as this better reflects the nature of the intercompany positions and presents the funding or funded position that is due or owed. The equity method has been used for investments in subsidiaries in the condensed consolidating balance sheets of Willis Towers Watson plc, Willis North America, Trinity Acquisition plc and the other guarantors.