Marsh & McLennan Companies, Inc. and its consolidated subsidiaries (the "Company") is a global professional services firm offering clients advice and solutions in risk, strategy and people. It is the parent company of a number of leading risk advisors and specialty consultants, including: Marsh, the insurance broker, intermediary and risk advisor; Guy Carpenter, the risk and reinsurance specialist; Mercer, the provider of HR and Investment related financial advice and services; and Oliver Wyman Group, the management, economic and brand consultancy. With approximately 60,000 employees worldwide and annual revenue of more than $13 billion, the Company provides analysis, advice and transactional capabilities to clients in more than 130 countries.
Diluted net income per share from continuing operations was $3.38 in 2016, compared with $2.98 in 2015, reflecting a $169 million increase in net income as well as a 2% decrease in the average number of diluted shares outstanding as compared to the same period last year. Shares issued related to the vesting of share awards and exercise of employee stock options were more than offset by share repurchases over the past four quarters.
Consolidated operating income increased 5% to $2.4 billion in 2015 compared with $2.3 billion in 2014, reflecting the combined impact of a slight decrease in revenue and a 2% decrease in expense as compared with the prior year. The Company achieved this growth despite significant foreign exchange headwinds, caused by the strengthened U.S. dollar, which had the effect of reducing the translated value of the Company's foreign earnings.
Consulting operating income increased $80 million, or 8%, to $1.1 billion in 2015 compared with 2014, reflecting flat revenue and decrease in expense of 1%. The operating income and revenue in 2015 include a pre-tax gain of $37 million from the sale of Mercer's U.S. defined contribution recordkeeping business.
The Company recorded expenses related to the early extinguishment of debt of $137 million in 2014.
Consolidated net income attributable to the Company was $1.8 billion in 2016, compared with $1.6 billion in 2015 and $1.5 billion in 2014.
The Company conducts business in many countries. As a result foreign exchange rate movements may impact period-to-period comparisons of revenue. Similarly, certain other items such as the revenue impact of acquisitions and dispositions, including transfers among businesses, may impact period-to-period comparisons of revenue. Underlying revenue measures the change in revenue from one period to another by isolating these impacts. The impact of foreign currency exchange fluctuations, acquisitions and dispositions, including transfers among businesses, on the Company’s operating revenues by segment was as follows:
Underlying revenue measures the change in revenue using consistent currency exchange rates, excluding the impact of certain items that affect comparability such as: acquisitions, dispositions and transfers among businesses. For 2015, the impact of a $37 million gain from the disposal of Mercer's U.S. defined contribution recordkeeping business is included in acquisitions/dispositions in Mercer's Retirement business.
Consolidated revenue was $13.2 billion in 2016, an increase of 2%, or 3% on an underlying basis. Revenue in the Risk and Insurance Services segment increased 4% in 2016 compared with 2015, or 3% on an underlying basis. Revenue increased 3% and 2% on an underlying basis at Marsh and Guy Carpenter, respectively, as compared with 2015. The Consulting segment's revenue increased 1% on a
reported basis compared with 2015, or 3% on an underlying basis. Both Mercer and Oliver Wyman Group's revenue increased 3% on an underlying basis compared with 2015.
Consolidated revenue was $12.9 billion in 2015, a slight decrease from 2014, but an increase of 4% on an underlying basis. Revenue in the Risk and Insurance Services segment decreased 1% in 2015 compared with 2014, but increased 3% on an underlying basis. Revenue increased 3% and 2% on an underlying basis at Marsh and Guy Carpenter, respectively, as compared with 2014. The Consulting segment's revenue was flat compared with 2014, but increased 5% on an underlying basis. Mercer and Oliver Wyman's revenue increased 4% and 7% on an underlying basis, respectively, compared with 2014.
Expense in the Risk and Insurance Services segment increased 1% on both a reported and underlying basis in 2016 compared with 2015. The impact of foreign currency translation reduced expenses by 3%, which was offset by a 3% increase related to acquisitions. The increase in underlying expense reflects higher base salary and incentive compensation costs, higher identified intangible asset amortization expense and the impact of the net benefit from the termination of the RRA plan which was recorded in the first quarter of 2015, offset by a decrease in defined benefit plan pension expense and lower contingent consideration costs related to acquisitions.
The Company conducts business in its Consulting segment through two main business groups, Mercer and Oliver Wyman Group. Mercer provides consulting expertise, advice, services and solutions in the areas of health, retirement, talent and investments. Oliver Wyman Group provides specialized management, economic and brand consulting services.
Revenue in the Consulting segment is affected by, among other things, global economic conditions, including changes in clients’ particular industries and markets. Revenue is also affected by competition due to the introduction of new products and services, broad trends in employee demographics, including levels of employment, the effect of government policies and regulations, and fluctuations in interest and foreign exchange rates. Revenues from the provision of investment management services and retirement trust and administrative services are significantly affected by the level of assets under management or administration and securities market performance.
Consulting revenue in 2015 was flat compared with 2014, reflecting a 5% increase on an underlying basis and a 2% increase related to acquisitions, offset by a 7% decrease from the impact of foreign currency translation. Mercer’s revenue was $4.3 billion in 2015, a decrease of 1%, but an increase of 4% on an underlying basis. The year over year revenue change also reflects an increase of 2% from acquisitions/dispositions, offset by a decrease of 7% from the impact of foreign currency translation. Mercer's revenue in 2015 includes a $37 million gain from the disposal of its U.S. defined contribution recordkeeping business, and is reflected in the 2% impact from acquisitions/dispositions. The underlying revenue growth
Consulting expense in 2015 decreased 1%, reflecting increases of 4% in underlying expenses and 1% related to acquisitions, partly offset by a 6% decrease from the impact of foreign currency translation. The increase in underlying expense reflects the impact of higher base salaries and incentive compensation costs and higher retirement benefit costs, partly offset by the impact of the net benefit from the termination of the RRA plan.
Corporate expense in 2015 was $195 million compared with $204 million in 2014. The lower expenses in 2015 were primarily due to the cost of non-recurring corporate initiatives which occurred in 2014, which included strengthening cyber security protections, expenses related to strategic investments and corporate transformation efforts, primarily within the HR and Finance functions.
On December 31, 2014, an agreement was reached between Putnam and the Massachusetts Department of Revenue ("DOR") regarding a tax dispute, which was covered under the indemnity agreement referred to above. In January 2015, all necessary approvals were received, the agreement was executed and the tax was paid. Concurrently, Putnam and the Company executed a settlement agreement to resolve all remaining matters under the indemnity agreement. The Company recorded a gain, net of federal tax, of approximately $28 million in 2014 related to the settlement with Putnam.
The Company's consolidated effective tax rate was 27.6%, 29.1% and 28.5% in 2016, 2015 and 2014, respectively. These rates reflect foreign operations which are taxed at rates below the U.S. statutory tax rate, including the effect of repatriation, as well as the impact of discrete tax matters such as tax legislation, changes in valuation allowances, nontaxable adjustments to contingent acquisition consideration and the true-up of the tax provision to amounts filed in the Company's tax returns. In 2016, pre-tax income in the U.K., Canada, Luxembourg, Australia, Bermuda and Ireland accounted for approximately 60% of the Company's total non-U.S. pre-tax income, with effective rates in those countries of 23% (excluding certain discrete adjustments), 27%, 2%, 30%, 1% and 13%, respectively. The Company anticipates its non-U.S. operations will continue to incur taxes at rates below the U.S. federal tax rate of 35% under current U.S. law. The Company's U.S. revenue over the past three years has been approximately 50% of total revenue, while over that period the pre-tax income from U.S. locations has been approximately 25% of total pre-tax income.
The effective tax rate may vary significantly from period to period for the foreseeable future. It is sensitive to the geographic mix of and repatriation of the Company's earnings, which may result in higher or lower effective tax rates. A proportional increase in U.S. pre-tax income will tend to increase the effective tax rate because U.S. federal and state corporate tax rates exceed tax rates applicable outside the U.S. Losses in certain jurisdictions cannot be offset by earnings from other operations, and may require valuation allowances that affect the rate, depending on estimates of the realizability of associated deferred tax assets. The effective tax rate is also sensitive to changes in unrecognized tax benefits, including the impact of settled tax audits and expired statutes of limitation.
The realization of deferred tax assets depends on generating future taxable income during the periods in which the tax benefits are deductible or creditable. Tax liabilities are determined and assessed
Changes in tax laws, rulings, policies or related legal and regulatory interpretations occur frequently and may also have significant favorable or adverse impacts on our effective tax rate. For example, political activity surrounding proposals for fundamental U.S. tax reform have recently intensified and such reform, if enacted, could have a significant impact on the Company's effective tax rate.
The Company generated $2.0 billion of cash from operations in 2016, compared with $1.9 billion in 2015. These amounts reflect the net income of the Company during those periods, excluding gains or losses from investments, adjusted for non-cash charges and changes in working capital which relate primarily to the timing of payments of accrued liabilities or receipts of assets and pension contributions.
During 2016, the Company contributed $27 million to its U.S. pension plans and $187 million to non-U.S. pension plans. In 2015, the Company contributed $29 million to U.S. plans and $166 million to non-U.S. plans.
The Company contributed $91 million to the U.K. plans in 2016, including an expense allowance of approximately $9 million. Based on the funding test carried out at November 1, 2016, the Company contributions to the U.K. plans in 2017 are expected to be approximately $125 million, including the expense allowance.
Effective September 1, 2015, the Company divided its U.S. qualified defined benefit plan to provide enhanced flexibility to manage the risk associated with those participants not receiving benefit accruals. The existing plan was amended to cover only the retirees currently receiving benefits and terminated vested participants as of August 1, 2015. The Company's active participants as of that date were transferred into a newly established, legally separate qualified defined benefit plan. The benefits offered to the plans' participants were unchanged. As a result of the plan amendment and establishment of the new plan, the Company re-measured the assets and liabilities of the two plans as required under U.S. GAAP, based on assumptions and market conditions at the amendment date. The net periodic pension expense recognized in 2015 reflects the weighted average costs of the December 31, 2014 measurement and the September 1, 2015 re-measurement.
The Company continues to manage the cost and assess the competitiveness of its benefits programs, and also to manage the risks related to its defined benefit pension plan liabilities. In October 2016, the Company modified its U.S. defined benefit pension plans to discontinue further benefit accruals for participants after December 31, 2016. At the same time, the Company amended its U.S. defined contribution retirement plans for most of its U.S. employees to add an automatic Company contribution equal to 4% of eligible base pay beginning on January 1, 2017. This new Company contribution, together with the Company’s current matching contribution, provides eligible U.S. employees with the opportunity to receive a total contribution of up to 7% of eligible base pay. As required under GAAP, the defined benefit plans that were significantly impacted by the modification were re-measured in October 2016 using market data and assumptions as of the modification date. The net periodic pension expense recognized in 2016 reflects the weighted average costs of the December 31, 2015 measurement and the October 2016 re-measurement. In addition, the U.S. qualified plans were merged effective December 30, 2016, since no participants would be receiving benefit accruals after December 2016.
After completion of a consultation period with affected colleagues, in January 2014, the Company amended its U.K. defined benefit pension plans to close those plans to future benefit accruals effective August 1, 2014 and replaced those plans, along with its existing defined contribution plans, with a new, comprehensive defined contribution arrangement. This change resulted in a curtailment of the U.K. defined benefit plans, and as required under GAAP, the Company re-measured the defined benefit plans’ assets and liabilities at the amendment date, based on assumptions and market conditions at that date. The Company recognized a curtailment gain of $65 million in the first quarter of 2014, primarily resulting from the recognition of the remaining unamortized prior service credit related to a plan amendment made
Overall, based on the measurement at December 31, 2016, expenses related to the Company’s defined benefit pension plans are expected to decrease in 2017 by approximately $120 million from 2016. This is driven by expense decreases in U.S. plans resulting from the modification of those plans which discontinued further benefit accruals for participants after December 31, 2016, as mentioned above. This decrease will be partially offset by an increase in defined contribution expense due to the additional automatic company contribution also mentioned above. The impact of the reduction in expense from the modification of the U.S. plans offset by the additional expense from the additional Company contributions to the defined contribution plan is expected to result in a net expense reduction of approximately $30 million, net of bonus. Pension expenses in the Company’s non-U.S. defined benefit plans are expected to increase approximately $5 million from 2016.
Historically, service and interest costs were estimated using a single weighted average discount rate derived from the yield curves used to measure the benefit obligations at the beginning of the period. In 2016, the Company changed the approach used to estimate the service and interest cost components of net periodic benefit cost for its significant non-U.S. plans. This change in approach was made to improve the correlation between the projected benefit cash flows and the corresponding yield curve spot rates and to provide a more precise measurement of service and interest costs. The change did not impact the measurement of the plans’ total projected benefit obligation. The Company accounted for this change as a change in estimate, that was applied prospectively beginning in 2016 and resulted in pension expense being approximately $45 million lower than if the prior approach had been used.
Net cash used for financing activities was $1.1 billion in 2016 compared with $906 million used in 2015.
In September 2014, the Company issued $300 million of 2.35% five-year senior notes and $500 million of 3.50% 10.5-year senior notes. In October 2014, a significant portion of the net proceeds of this offering was used to redeem $630 million of debt, including $230 million of 5.75% senior notes due in September 2015 and $400 million of 9.25% senior notes due in 2019. Total cash outflow related to this transaction was approximately $765 million, including a $137 million cost for early redemption, which was reflected as a charge in the consolidated statements of income in the fourth quarter of 2014.
In January 2017, the Company issued $500 million of 2.75% senior notes due in 2022 and $500 million of 4.35% senior notes due in 2047. The Company intends to use the net proceeds for general corporate purposes, which may include the repayment of a $250 million debt maturity in April 2017.
The Company and certain of its subsidiaries maintain a $1.5 billion multi-currency five-year unsecured revolving credit facility. The interest rate on this facility is based on LIBOR plus a fixed margin which varies with the Company's credit ratings. This facility expires in November 2020 and requires the Company to maintain certain coverage and leverage ratios which are tested quarterly. There were no borrowings outstanding under this facility at December 31, 2016.
The Company also maintains other credit facilities, guarantees and letters of credit with various banks, aggregating $376 million at December 31, 2016 and $379 million at December 31, 2015. There were $1.6 million of outstanding borrowings under these facilities at December 31, 2016 and $0.4 million of outstanding borrowings under these facilities at December 31, 2015.
During 2015, the Company repurchased 24.8 million shares of its common stock for total consideration of $1.4 billion at an average price per share of $56.46.
Net cash used for investing activities amounted to $1.1 billion in 2016 compared with $1.3 billion used for investing activities in 2015.
The Company’s additions to fixed assets and capitalized software, which amounted to $253 million in 2016 and $325 million in 2015, primarily relate to computer equipment purchases, the refurbishing and modernizing of office facilities and software development costs.
The following sets forth the Company’s future contractual obligations by the types identified in the table below as of December 31, 2016:
The above includes the senior notes issued in January 2017. The above does not include the liability for unrecognized tax benefits of $65 million as the Company is unable to reasonably predict the timing of settlement of these liabilities, other than approximately $2 million that may become payable during 2017. The above does not include net pension liabilities of approximately $1.9 billion because the timing and amount of ultimate payment of such liability is dependent upon future events, including, but not limited to, future returns on plan assets and changes in the discount rate used to measure the liabilities. The amounts of estimated future benefits payments to be made from pension plan assets are disclosed in Note 8 to the consolidated financial statements. In 2017, the Company expects to contribute approximately $32 million and $224 million to its U.S. and non-U.S. defined benefit pension plans, respectively.
The target asset allocation for the U.S. Plans is 64% equities and equity alternatives and 36% fixed income. At the end of 2016, the actual allocation for the U.S. Plans was 65% equities and equity alternatives and 35% fixed income. The target asset allocation for the U.K. Plans, which comprise approximately 81% of non-U.S. Plan assets, is 48% equities and equity alternatives and 52% fixed income. At the end of 2016, the actual allocation for the U.K. Plans was 48% equities and equity alternatives and 52% fixed income.
Holding all other assumptions constant, a half-percentage point change in the rate of return on plan assets and discount rate assumptions would affect net periodic pension cost for the U.S. and U.K. plans, which together comprise approximately 86% of total pension plan liabilities, as follows:
The impact of discount rate changes shown above relates to the increase or decrease in actuarial gains or losses being amortized through net periodic pension cost, as well as the increase or decrease in interest expense, with all other facts and assumptions held constant. It does not contemplate nor include potential future impacts a change in the interest rate environment and discount rates might cause, such
As of December 31, 2016, there was $14.4 million of unrecognized compensation cost related to stock option awards. The weighted-average period over which the costs are expected to be recognized is 1.42 years. Also as of December 31, 2016, there was $127.2 million of unrecognized compensation cost related to the Company’s restricted stock, restricted stock unit and performance stock unit awards. The weighted-average period over which that cost is expected to be recognized is approximately 1.05 years.
Fiduciary Assets and Liabilities: In its capacity as an insurance broker or agent, the Company generally collects premiums from insureds and, after deducting its commissions, remits the premiums to the respective insurance underwriters. The Company also collects claims or refunds from underwriters on behalf of insureds. Unremitted insurance premiums and claims proceeds are held by the Company in a fiduciary capacity. Risk and Insurance Services revenue includes interest on fiduciary funds of $26 million, $21 million and $24 million in 2016, 2015 and 2014, respectively. The Consulting segment recorded fiduciary interest income of $3 million, $4 million and $6 million in 2016, 2015 and 2014, respectively. Since fiduciary assets are not available for corporate use, they are shown in the consolidated balance sheets as an offset to fiduciary liabilities.
Mercer manages approximately $158 billion of assets in trusts or funds for which Mercer’s management or trustee fee is not considered a variable interest, since the fees are commensurate with the level of effort required to provide those services. Mercer is not the primary beneficiary of these trusts or funds. Mercer’s maximum exposure to loss of its interests is, therefore, limited to collection of its fees.
Depreciation of buildings, building improvements, furniture, and equipment is provided on a straight-line basis over the estimated useful lives of these assets. Furniture and equipment is depreciated over periods ranging from three to ten years. Leasehold improvements are amortized on a straight-line basis over the periods covered by the applicable leases or the estimated useful life of the improvement, whichever is less. Buildings are depreciated over periods ranging from thirty to forty years. The Company periodically reviews long-lived assets for impairment whenever events or changes indicate that the carrying value of assets may not be recoverable.
There were 13.2 million, 14.8 million and 18.0 million stock options outstanding as of December 31, 2016, 2015 and 2014, respectively.
New Accounting Pronouncements: In November 2016, the Financial Accounting Standards Board ("FASB") issued new guidance which requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents and amounts generally described as restricted cash or restricted cash equivalents. As a result, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The new guidance is effective for public companies for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The guidance must be applied retrospectively to all periods presented. Early adoption is permitted. The adoption of this guidance is not expected to have an impact on the Company's consolidated balance sheets or consolidated statement of cash flows.
In October 2016, the FASB issued new guidance which changes the evaluation of whether a reporting entity is the primary beneficiary of a variable interest entity by changing how a reporting entity that is a single decision maker of a variable interest entity treats indirect interests in the entity held through related parties that are under common control with the reporting entity. If a reporting entity satisfies the first characteristic of a primary beneficiary (such that it is the single decision maker of a variable interest entity), the new guidance requires that reporting entity, in determining whether it satisfies the second characteristic of a primary beneficiary, to include all of its direct variable interest in a variable interest entity and, on a proportionate basis, its indirect variable interests in a variable interest entity held through related parties, including related parties that are under common control with the reporting entity. The new guidance is effective for public companies for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. Early adoption is permitted. The Company does not expect the adoption of this guidance to have a significant impact on its financial position, results of operations and statement of cash flows.
In October 2016, the FASB also issued new guidance which requires an entity to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. The new guidance eliminates the exception for an intra-entity transfer of an asset other than inventory. The new guidance is effective for public companies for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted. The new guidance must be applied on a modified retrospective basis through a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption. The Company is currently evaluating the impact the adoption of this standard will have on its financial position or results of operations.
In August 2016, the FASB issued new guidance which adds or clarifies guidance on the classification of certain cash receipts and payments in the statement of cash flows, including cash payments for debt prepayments or debt extinguishment costs, contingent consideration payments made after a business
combination and distributions received from equity method investees. The guidance is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The guidance must be applied retrospectively to all periods presented unless retrospective application is impracticable. Early adoption is permitted. The Company is currently evaluating the impact the adoption the guidance will have on its statement of cash flows.
The Company continues to evaluate the impact of the standard on our Risk and Insurance Services ("RIS") segment. Based on the results of our review to date, the Company expects there will be some movement in the timing of revenue recognition between quarterly and annual periods. However, since the vast majority of our brokerage arrangements involve contracts that cover a single year of placements, on a year over year basis, the Company does not believe there will be a significant change to the amount of revenue recognized in an annual period.
In September 2015, the FASB issued new guidance intended to simplify the accounting for adjustments made to provisional amounts recognized in business combinations. The guidance requires the acquirer to recognize adjustments to estimated amounts that are identified during the measurement period in the reporting period in which the adjustments are determined, and to record, in the same period's financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if
In May 2015, the FASB issued new guidance which removes the requirement to present certain investments for which the practical expedient is used to measure fair value at net asset value within the fair value hierarchy table. Instead, an entity is required to include those investments as a reconciling item so that the total fair value amount of investments in the disclosure is consistent with the fair value investment balance on the statement of net assets. This guidance is effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. The adoption of this new guidance affects footnote disclosure only, and therefore did not have a material impact on the Company's financial position or results of operations.
The following amounts are included in the consolidated statements of cash flows as a financing activity. The Company paid deferred and contingent consideration of $98 million in the year ended December 31, 2016, consisting of deferred purchase consideration of $54 million and contingent purchase consideration of $44 million. In the year ended December 31, 2015 the Company paid deferred and contingent consideration of $49 million, consisting of deferred purchase consideration of $36 million and contingent consideration of $13 million, and in the year ended December 31, 2014 the Company paid deferred and contingent consideration of $55 million, consisting of deferred purchase consideration of $25 million and contingent consideration of $30 million.
The following amounts are included in the operating section of the consolidated statements of cash flows. For the year ended December 31, 2016, the Company recorded a net charge for adjustments to acquisition related accounts of $9 million and contingent consideration payments of $42 million. For the year ended December 31, 2015, the Company recorded a net charge for adjustments to acquisition related accounts of $45 million and contingent consideration payments of $34 million, and for the year ended December 31, 2014 the Company recorded a net charge for adjustments to acquisition related accounts of $31 million and contingent consideration payments of $12 million.
March - MMA acquired Corporate Consulting Services, Ltd., a New York-based insurance brokerage and human resource consulting firm.
September - MMA acquired Vero Insurance, Inc., a Florida-based agency specializing in private client insurance services.
November - MMA acquired Benefits Resource Group Agency, LLC, an Ohio-based benefits consulting firm and Presidio Benefits Group, Inc., a California-based employee benefits consulting firm.
Total purchase consideration for acquisitions made during 2016 was approximately $901 million, which consisted of cash paid of $865 million and deferred purchase and estimated contingent consideration of $36 million. Contingent consideration arrangements are based primarily on EBITDA and/or revenue targets over periods of two to four years. The fair value of the contingent consideration was based on projected revenue and earnings of the acquired entities. Estimated fair values of assets acquired and liabilities assumed are subject to adjustment when purchase accounting is finalized. During 2016, the Company also paid $54 million of deferred purchase consideration and $86 million of contingent consideration related to acquisitions made in prior years.
Other intangible assets acquired are based on initial estimates and subject to change based on final valuations during the measurement period post acquisition date. The following chart provides information of other intangible assets acquired during 2016:
During 2015, the Risk and Insurance Services segment completed the following thirteen acquisitions:
June - MMA acquired MHBT, Inc., a Texas-based insurance broker and Marsh acquired SIS Co. Ltd., a Korea-based insurance broker and advisor.
August - Oliver Wyman acquired the Hong Kong and Shanghai franchises of OC&C Strategy Consultants.
November - Mercer acquired HR Business Solutions (Asia) Limited, a Hong Kong-based compensation and employee benefits consulting firm, and Gama Consultores Associados Ltda, a Brazil-based retirement consulting firm.
Total purchase consideration for acquisitions made during 2015 was $1.2 billion, which consisted of cash paid of $1.0 billion and deferred purchase and estimated contingent consideration of $176 million. Contingent consideration arrangements are primarily based on EBITDA and revenue targets over two to four years. The fair value of the contingent consideration was based on projected revenue and earnings of the acquired entities. During 2015, the Company also paid $36 million of deferred purchase consideration and $47 million of contingent consideration related to acquisitions made in prior years. In addition, the Company purchased other intangible assets in the amount of $2 million.
The following unaudited pro-forma financial data gives effect to the acquisitions made by the Company during 2016, 2015 and 2014. In accordance with accounting guidance related to pro-forma disclosures, the information presented for current year acquisitions is as if they occurred on January 1, 2015 and reflects acquisitions made in 2015 as if they occurred on January 1, 2014. The pro-forma information adjusts for the effects of amortization of acquired intangibles. The unaudited pro-forma financial data is presented for illustrative purposes only and is not necessarily indicative of the operating results that would have been achieved if such acquisitions had occurred on the dates indicated, nor is it necessarily indicative of future consolidated results.
The consolidated statement of income for 2016 includes approximately $25 million of revenue and $4 million of operating income related to acquisitions made during 2016. The consolidated statement of income for 2015 includes approximately $124 million of revenue and $7 million of operating income related to acquisitions made during 2015.
The Company is required to assess goodwill and any indefinite-lived intangible assets for impairment annually, or more frequently if circumstances indicate impairment may have occurred. The Company performs the annual impairment assessment for each of its reporting units during the third quarter of each year. In accordance with applicable accounting guidance, the Company assesses qualitative factors to determine whether it is necessary to perform the two-step goodwill impairment test. The Company considers numerous factors, which included that the fair value of each reporting unit exceeded its carrying value by a substantial margin in its most recent estimate of reporting unit fair values, whether significant acquisitions or dispositions occurred which might alter the fair value of its reporting units, macroeconomic conditions and their potential impact on reporting unit fair values, actual performance compared with budget and prior projections used in its estimation of reporting unit fair values, industry and market conditions, and the year-over-year change in the Company’s share price. The Company completed its qualitative assessment in the third quarter of 2016 and concluded that a two-step goodwill impairment test was not required in 2016 and that goodwill was not impaired.
The goodwill acquired of $556 million in 2016 (approximately $71 million of which is deductible for tax purposes) is comprised of $321 million related to the Risk and Insurance Services segment and $235 million related to the Consulting segment.
The gross cost and accumulated amortization at December 31, 2016 and 2015 are as follows:
Aggregate amortization expense was $130 million for the year ended December 31, 2016, $109 million for the year ended December 31, 2015 and $86 million for the year ended December 31, 2014. The estimated future aggregate amortization expense is as follows:
Valuation allowances had net decreases of $8 million and $69 million in 2016 and 2015, respectively, and an increase of $15 million in 2014. During the respective years, adjustments of the beginning of the year balances of valuation allowances decreased income tax expense by $7 million, $14 million and $9 million in 2016, 2015 and 2014, respectively. The decrease in the valuation allowance in 2015 also reflects the write down of a deferred tax asset along with its full valuation allowance because the Company cannot utilize a net operating loss. Approximately 77% of the Company’s net operating loss carryforwards expire from 2017 through 2036, and others are unlimited. The potential tax benefit from net operating loss carryforwards at the end of 2016 comprised federal, state and local, and non-U.S. tax benefits of $7 million, $48 million and $31 million, respectively, before reduction for valuation allowances.
Following is a reconciliation of the Company’s total gross unrecognized tax benefits for the years ended December 31, 2016, 2015 and 2014:
Of the total unrecognized tax benefits at December 31, 2016, 2015 and 2014, $53 million, $53 million and $51 million, respectively, represent the amount that, if recognized, would favorably affect the effective tax rate in any future periods. The total gross amount of accrued interest and penalties at December 31, 2016, 2015 and 2014, before any applicable federal benefit, was $11 million, $8 million and $7 million, respectively.
The target asset allocation for the U.S. Plans is 64% equities and equity alternatives and 36% fixed income. At the end of 2016, the actual allocation for the U.S. Plans was 65% equities and equity alternatives and 35% fixed income. The target asset allocation for the U.K. Plans, which comprise approximately 81% of non-U.S. Plan assets, is 48% equities and equity alternatives and 52% fixed income. At the end of 2016, the actual allocation for the U.K. Plans was 48% equities and equity alternatives and 52% fixed income. The assets of the Company's defined benefit plans are diversified and are managed in accordance with applicable laws and with the goal of maximizing the plans' real return within acceptable risk parameters. The Company uses threshold-based portfolio re-balancing to ensure the actual portfolio remains consistent with target asset allocation ranges.
* No assumption is required since the U.S. plans were frozen to future benefits after December 31, 2016.
The projected benefit obligation and fair value of plan assets for U.S. pension plans with projected benefit obligations in excess of plan assets was $5.9 billion and $4.4 billion, respectively, as of December 31, 2016 and $5.7 billion and $4.2 billion, respectively, as of December 31, 2015.
expense recognized in 2015 reflects the weighted average costs of the December 31, 2014 measurement and the September 1, 2015 re-measurement.
The projected benefit obligation and fair value of plan assets for non-U.S. pension plans with projected benefit obligations in excess of plan assets was $2.1 billion and $1.7 billion, respectively, as of December 31, 2016 and $1.9 billion and $1.5 billion, respectively, as of December 31, 2015.
Effective August 1, 2015, the Company amended its Ireland defined benefit pension plans to close those plans to future benefit accruals and replaced those plans with a defined contribution arrangement. The Company re-measured the assets and liabilities of the plans, based on assumptions and market conditions on the amendment date. The net periodic pension costs recognized in 2015 reflect the weighted average costs of the December 31, 2014 measurement and the August 1, 2015 re-measurement.
The assumed health care cost trend rate was approximately 5.20% in 2016, gradually declining to 4.48% in 2026. Assumed health care cost trend rates can have a significant effect on the amounts reported for the non-U.S. health care plans. A one percentage point change in assumed health care cost trend rates would have the following effects:
The Company expects to contribute approximately $224 million to its non-U.S. pension plans in 2017. Funding requirements for non-U.S. plans vary by country. Contribution rates are generally based on local funding practices and requirements, which may differ significantly from measurements under U.S. GAAP. Funding amounts may be influenced by future asset performance, the level of discount rates and other variables impacting the assets and/or liabilities of the plan. Discretionary contributions may also be affected by alternative uses of the Company’s cash flows, including dividends, investments and share repurchases.
The following table sets forth, by level within the fair value hierarchy, a summary of the U.S. and non-U.S. plans' investments measured at fair value on a recurring basis at December 31, 2016 and 2015:
The tables below set forth a summary of changes in the fair value of the plans’ Level 3 assets for the years ended December 31, 2016 and December 31, 2015:
Common stocks, preferred stocks, convertible equity securities, rights/warrants and real estate investment trusts (included in Corporate stocks): Valued at the closing price reported on the primary exchange.
Private equity and real estate partnerships: Investments in private equity and real estate partnerships are valued based on the fair value reported by the manager of the corresponding partnership and reported on a one quarter lag. The managers provide unaudited quarterly financial statements and audited annual financial statements which set forth the value of the fund. The valuations obtained from the managers are based on various analyses on the underlying holdings in each partnership, including financial valuation models and projections, comparable valuations from the public markets, and precedent private market transactions. Investments are valued in the accompanying financial statements based on the Plan’s beneficial interest in the underlying net assets of the partnership as determined by the partnership agreement.
Insurance group annuity contracts: The fair values for these investments are based on the current market value of the aggregate accumulated contributions plus interest earned.
The Company maintains certain defined contribution plans for its employees, including the Marsh & McLennan Companies 401(k) Savings & Investment Plan ("401(k) Plan"), that are qualified under U.S. tax laws. Under these plans, eligible employees may contribute a percentage of their base salary, subject to certain limitations. For the 401(k) Plan, the Company matches a fixed portion of the employees’ contributions. The 401(k) Plan contains an Employee Stock Ownership Plan feature under U.S. tax law. Approximately $436 million of the 401(k) Plan’s assets at December 31, 2016 and $398 million in December 31, 2015 were invested in the Company’s common stock. If a participant does not choose an investment direction for his or her future contributions, they are automatically invested in a BlackRock LifePath Portfolio that most closely matches the participant’s expected retirement year. The cost of these defined contribution plans was $53 million in 2016, $51 million in 2015 and $49 million in 2014. In addition, the Company has a significant defined contribution plan in the U.K. As noted above, effective August 1, 2014, a newly formed defined contribution plan replaced the existing defined contribution and defined benefit plans with regard to future service. The cost of the U.K. defined contribution plan was $81 million, $93 million and $65 million in 2016, 2015 and 2014, respectively. The decrease in cost from 2016 as compared to 2015 is primarily due to the impact of foreign currency translation.
The estimated fair value of options granted is calculated using the Black-Scholes option pricing valuation model. This model takes into account several factors and assumptions. The risk-free interest rate is based on the yield on U.S. Treasury zero-coupon issues with a remaining term equal to the expected life assumption at the time of grant. The expected life (estimated period of time outstanding) is estimated using the contractual term of the option and the effects of employees' expected exercise and post-vesting employment termination behavior. The Company uses a blended volatility rate based on the following: (i) volatility derived from daily closing price observations for the 10-year period ended on the valuation date, (ii) implied volatility derived from traded options for the period one week before the valuation date and (iii) average volatility for the 10-year periods ended on 15 anniversaries prior to the valuation date, using daily closing price observations. The expected dividend yield is based on expected dividends for the expected term of the stock options.
As of December 31, 2016, there was $14.4 million of unrecognized compensation cost related to the Company's option awards. The weighted-average period over which that cost is expected to be recognized is approximately 1.42 years. Cash received from the exercise of stock options for the years ended December 31, 2016, 2015 and 2014 was $105.4 million, $134.7 million and $178.1 million, respectively.
As of December 31, 2016, there was $127.2 million of unrecognized compensation cost related to the Company's restricted stock units and performance stock unit awards. The weighted-average period over which that cost is expected to be recognized is approximately 1.045 years.
Assets and liabilities whose values are based on prices, or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. These inputs reflect management’s own assumptions about the assumptions a market participant would use in pricing the asset or liability (certain commercial mortgage whole loans, and long-dated or complex derivatives including certain foreign exchange options and long-dated options on gas and power).
Liabilities using Level 3 inputs include liabilities for contingent purchase consideration.
During the year ended December 31, 2016, there were no assets or liabilities that were transferred between any of the levels.
The table below sets forth a summary of the changes in fair value of the Company’s Level 3 liabilities for the years ended December 31, 2016 and December 31, 2015 that represent contingent purchase consideration related to acquisitions:
The Company holds investments in certain private equity investments, public companies and private companies that are accounted for using the equity method of accounting. The carrying value of these investments was $389 million and $347 million at December 31, 2016 and 2015, respectively.
Alexander Forbes: The Company owns approximately 33% of the common stock of Alexander Forbes, a South African company listed on the Johannesburg Stock Exchange, which it purchased in 2014 for 7.50 South African Rand per share. As of December 31, 2016, the carrying value of the Company’s investment in Alexander Forbes was approximately $247 million. As of December 31, 2016, the market value of the approximately 443 million shares owned by the Company, based on the December 31, 2016 closing share price of 7.95 South African Rand per share, was approximately $251 million.
The Company’s investment in Alexander Forbes and its other equity investments in private insurance and consulting companies are accounted for using the equity method of accounting, the results of which are included in revenue in the consolidated income statements and the carrying value of which is included in other assets in the consolidated balance sheets. The Company records its share of income or loss on its equity method investments on a one quarter lag basis.
The information above includes twelve months of income statement activity for Alexander Forbes in 2016, 2015 and two months of activity in 2014, reflecting the timing of the Company's investment.
The consolidated statements of income include net rental costs of $367 million, $381 million and $393 million for 2016, 2015 and 2014, respectively, after deducting rentals from subleases ($9 million in 2016, $14 million in 2015 and $12 million in 2014). These net rental costs exclude rental costs and sublease income for previously accrued restructuring charges related to vacated space.
The Company and certain of its foreign subsidiaries maintain a $1.5 billion multi-currency five-year unsecured revolving credit facility. The interest rate on this facility is based on LIBOR plus a fixed margin which varies with the Company's credit ratings. This facility expires in November 2020 and requires the Company to maintain certain coverage and leverage ratios which are tested quarterly. There were no borrowings outstanding under this facility at December 31, 2016.
Scheduled repayments of long-term debt in 2017 and in the four succeeding years are $262 million, $262 million, $313 million, $514 million and $515 million, respectively.
Details of the restructuring liability activity from January 1, 2015 through December 31, 2016, including actions taken prior to 2016, are as follows:
As of January 1, 2014, the liability balance related to restructuring activity was $124 million. In 2014, the Company accrued $12 million and had cash payments and other adjustments of $44 million related to restructuring activities that resulted in the liability balance at January 1, 2015 reported above.
The expenses associated with the above initiatives are included in compensation and benefits and other operating expenses in the consolidated statements of income. The liabilities associated with these initiatives are classified on the consolidated balance sheets as accounts payable and accrued liabilities, other liabilities, or accrued compensation and employee benefits, depending on the nature of the items.
The Company and its subsidiaries are subject to a significant number of claims, lawsuits and proceedings in the ordinary course of business. Such claims and lawsuits consist principally of alleged errors and omissions in connection with the performance of professional services, including the placement of insurance, the provision of actuarial services for corporate and public sector clients, the provision of investment advice and investment management services to pension plans, the provision of advice relating to pension buy-out transactions and the provision of consulting services relating to the drafting and interpretation of trust deeds and other documentation governing pension plans. These claims typically seek damages, including punitive and treble damages, in amounts that could be significant. In establishing liabilities for errors and omissions claims in accordance with FASB ASC Subtopic No. 450-20 (Contingencies-Loss Contingencies), the Company uses case level reviews by inside and outside counsel, and internal actuarial analysis by Oliver Wyman Group, a subsidiary of the Company, and other methods to estimate potential losses. A liability is established when a loss is both probable and reasonably estimable. The liability is reviewed quarterly and adjusted as developments warrant. In many cases, the Company has not recorded a liability, other than for legal fees to defend the claim, because we are unable, at the present time, to make a determination that a loss is both probable and reasonably estimable.
In connection with its acquisition of U.K.-based Sedgwick Group in 1998, the Company acquired several insurance underwriting businesses that were already in run-off, including River Thames Insurance Company Limited ("River Thames"), which the Company sold in 2001. Sedgwick guaranteed payment of claims on certain policies underwritten through the Institute of London Underwriters (the "ILU") by River Thames. The policies covered by this guarantee were reinsured up to £40 million by a related party of River Thames. Payment of claims under the reinsurance agreement is collateralized by segregated assets held in a trust. As of December 31, 2016, the reinsurance coverage exceeded the best estimate of the projected liability of the policies covered by the guarantee. To the extent River Thames or the reinsurer is unable to meet its obligations under those policies, a claimant may seek to recover from the Company under the guarantee.
We have audited the accompanying consolidated balance sheets of Marsh & McLennan Companies, Inc. and subsidiaries (the "Company") as of December 31, 2016 and 2015, and the related consolidated statements of income, comprehensive income, cash flows and equity for each of the three years in the period ended December 31, 2016. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Marsh & McLennan Companies, Inc. and subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2016, based on the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 24, 2017 expressed an unqualified opinion on the Company’s internal control over financial reporting.
As of February 16th, 2017, there were 5,718 stockholders of record.