The principal offices of the Marsh and Mercer subsidiaries in the United Kingdom currently are located in the City of London, comprising 354,000 square feet under a long term lease. Marsh
The principal executive offices of the Putnam subsidiaries comprise approximately 300,000 square feet of leased space located in the financial district of Boston, Massachusetts. Putnam also leases approximately 887,000 square feet (including 231,000 square feet transferred to Mercer HR Services on January 1, 2005) in various locations in the Boston area for investor services and other activities in support of its operations.
Includes restructuring costs of $317 million and $337 million in 2005 and 2004, respectively.
MMC operates in four principal business segments based on the services provided. Risk and Insurance Services includes risk management and insurance and reinsurance broking and services, provided primarily by Marsh and Guy Carpenter. Risk Consulting and Technology, conducted through Kroll, includes risk consulting and related investigative, intelligence, financial, security and technology services. Consulting, which comprises the activities of Mercer Human Resource Consulting and Mercer’s Specialty Consulting Businesses, includes human resource consulting and related services, and specialized management and economic consulting services. We conduct Investment Management through Putnam. A fuller description of our segments’ business activities is included in Part I, Item 1 of this report.
This MD&A contains forward-looking statements, as that term is defined in the Private Securities Litigation Reform Act of 1995. See “Information Concerning Forward-Looking Statements” at the outset of this report.
2005 was a year of transition for MMC. MMC’s historical financial information should be viewed in light of the significant developments discussed below.
MMC’s revenue in 2005 was impacted by a $417 million decrease in market services revenue. In 2005, market services revenue of $124 million, related to insurance placements made prior to October 1, 2004, was recognized in the financial statements. It is expected that market services revenue recognized in 2006 will be significantly lower than in 2005.
In addition to the impact on revenue of the elimination of market services agreements (“MSA”), revenues in the risk and insurance services segment were affected by declining commercial insurance premium rates during most of 2005. Premium rate decreases began to abate in the fourth quarter of 2005 due to the initial effects of the major storms that hit the United States. A more significant impact on reinsurance premium rates as a result of the storms is expected in the first quarter of 2006.
Also as discussed in Note 16 to the consolidated financial statements, on September 21, 2005, working with the National Association of Insurance Commissioners (the “NAIC”), MMC reached a multi-state regulatory settlement. The NAIC settlement agreement adopts the business reforms and the $850 million fund for policyholder clients provided by MMC’s previous settlement with the NYAG and NYSID. The NAIC agreement has been executed by MMC and Marsh, and as of February 17, 2006, has been adopted by insurance commissioners in 33 states and the District of Columbia and Guam.
In response to MMC’s changed business environment, we initiated restructuring activities in the fourth quarter of 2004 and first quarter of 2005. The restructuring plans are described in more detail in Note 13 to the consolidated financial statements.
During 2005, net restructuring expenses were $317 million, primarily related to the 2005 restructuring plan. These charges comprise severance and other termination benefits of $196 million related to the elimination of approximately 2,600 employee positions, future rent under non-cancelable leases of $116 million and other costs of $41 million, partially offset by a $36 million gain from the sale of certain small commercial accounts and other dispositions. In addition, in 2005 MMC incurred incremental expense related to the accelerated amortization of leasehold improvements of $12 million. Additional charges of approximately $50 million are expected to be incurred in 2006, largely in the first half of the year, as the remaining actions contemplated under the 2005 restructuring plan are completed.
In late 2004, and in 2005, MMC initiated a number of actions designed to retain and motivate employees throughout our businesses. Retention awards were granted, primarily in risk and insurance services and consulting, resulting in additional costs of $115 million in 2005. In addition, stock option exchange programs were offered to employees who held deeply underwater MMC or Putnam options. The option exchange programs are discussed in more detail later in this MD&A. MMC also implemented new or expanded long-term incentive programs in several of its businesses.
In October 2005, Marsh completed the sale of Crump Group, Inc., its U.S.-based wholesale insurance broker. The gain on the sale of $14 million, net of tax, was recognized in the fourth quarter. In December 2005 MMC agreed to sell its majority interest in Sedgwick CMS Holdings. The sale was completed on January 31, 2006, and we will recognize the associated gain on the sale in the first quarter of 2006. In the fourth quarter of 2005, MMC determined that the Crump and SCMS businesses met the criteria to be classified as discontinued operations. All previously reported financial information has been reclassified to conform with the current presentation. See Note 5 to the consolidated financial statements for further information regarding these dispositions.
In December 2005, MMC and certain of its foreign subsidiaries entered into a new five-year $1.2 billion multi-currency revolving credit facility. Subsidiary borrowings under the facility are unconditionally guaranteed by MMC. The new facility, which will expire in 2010, replaced MMC’s $1.0 billion and $700 million revolving credit facilities which were scheduled to expire in 2007 and 2009, respectively. In December 2005, certain of MMC’s foreign subsidiaries borrowed approximately $510 million under the new facility, primarily to fund the repatriation of accumulated earnings pursuant to the American Jobs Creation Act of 2004. In connection with the termination of its previous revolving credit facilities, MMC recorded as interest expense a $7 million write-off of unamortized deferred financing costs.
In September 2005, MMC completed two financings to enhance liquidity. MMC returned to the public capital markets, issuing $550 million of 5.15% Senior Notes due 2010 and $750 million of 5.75% Senior Notes due 2015. The proceeds from these notes were used to pay down outstanding bank borrowings that were scheduled to mature in December 2006.
Consolidated operating income in 2005 increased 43% to $856 million, reflecting significantly lower costs related to regulatory settlements at Marsh and Putnam and savings from restructuring initiatives partly offset by lower revenues in risk and insurance services and investment management, employee retention costs and incremental costs from the implementation of SFAS 123(R). Risk and insurance services results in 2005 include the impact of a $402 million decrease in MSA revenue. The segment’s 2004 results were impacted by an $850 million charge relating to the settlement agreement reached with the NYAG and NYSID. Investment management results in 2005 reflect reduced costs for regulatory settlements and related charges, partly offset by a decline in revenue resulting from lower assets under management. Results for Consulting reflect a 4% increase in revenue and lower costs for restructuring and restructuring-related charges. Results for Risk Consulting and Technology in 2005 reflect a full year of operations for Kroll, which was acquired in July 2004. Corporate results in 2005 include restructuring charges of $59 million, incremental compensation expense of $64 million, primarily related to stock options resulting from the adoption of SFAS 123(R) as of July 1, 2005, and $30 million of settlement and other costs. In 2004, corporate expenses included a credit of $105 million for insurance recoveries related to World Trade Center losses.
Risk Capital Holdings owns MMC’s investments in insurance and financial services firms such as Ace Ltd., XL Capital Ltd., and Axis Capital Holdings Ltd., as well as the Trident funds.
Certain reclassifications have been made to prior year amounts to conform with current presentation. The data presented above excludes the results of the U.S. wholesale broking and claims management businesses, which are classified as discontinued operations.
Effective October 1, 2004, Marsh eliminated contingent compensation, or market services agreements with insurers, under which it had earned revenues based upon such factors as the overall volume, growth and, in some cases, profitability, of the total business placed by Marsh with a given insurer. The circumstances under which we terminated our market services agreements, and the related revenue impact in our Risk and Insurance Services segment, are discussed above under “Significant Developments in 2005 - New Business Model in Risk and Insurance Services.”
Following the sale of MMC Capital’s business in May 2005, discussed above under “Significant Developments in 2005 - Businesses Exited in 2005,” we no longer receive fees in connection with the private equity investments previously managed by MMC Capital, nor do we receive management fees or origination fees related to this business. We continue to receive dividends and to recognize capital appreciation or depreciation on the investments held by Risk Capital Holdings, as well as revenue on Risk Capital Holding’s sales of investments from time to time.
Revenue in the risk and insurance services segment decreased 10% in 2005 compared with 2004, reflecting decreases in both insurance services and reinsurance services revenue.
Revenue for the risk and insurance services segment grew 1% in 2004 over 2003. Underlying revenue declined 3%. In insurance services underlying revenue decreased 6% primarily due to a reduction in MSA revenue from $820 million in 2003 to $521 million in 2004. This excludes the market services revenue of $20 million in 2004 and $25 million in 2003 related to the employee benefits business transferred to Consulting effective April 1, 2005. Client revenue increased approximately 1%, reflecting 3% growth in Europe and 4% growth in other international markets, partially offset by a 2% decline in North America. Underlying revenue in reinsurance broking remained unchanged.
In 2004, risk and insurance services expenses increased 35% over 2003. Approximately 20% of the increase was due to an $850 million charge for the settlement agreement with the NYAG and the NYSID and legal and other costs of $31 million related to this matter. Expenses in 2004 included restructuring charges of $231 million, including severance and other termination benefits, future rent under non-cancelable leases and lease termination costs and incremental amortization of $7 million related to accelerated amortization or abandonment of leasehold improvements. Expenses in 2004
MMC’s Risk Consulting and Technology segment consists of Kroll and its subsidiaries, acquired by MMC in July 2004. The segment also includes portions of the risk consulting business previously managed by Marsh under the Risk and Insurance Services segment. The services previously managed by Marsh include forensic accounting, insurance claims accounting, and preparation and crisis consulting. Kroll delivers its services through four business groups: consulting services; corporate advisory & restructuring; security; and technology services.
Kroll receives compensation for its risk consulting and technology services in the form of fees paid by clients. These fees are typically earned on an hourly, project, fixed fee or per unit basis. Kroll’s revenue is subject to changes in international economic and regulatory conditions. Some of Kroll’s revenue sources are counter-cyclical to the performance of the economy in general. These sources may include, for example, fees from restructuring, turnaround and forensic engagements relating to commercial bankruptcies and bond defaults. Kroll is also subject to normal competitive forces such as pricing pressures, demand for professional staff and new product development on the part of competitors, particularly in technology services.
The major component of Mercer’s revenue, in both Mercer Human Resource Consulting and the Mercer Specialty Consulting Businesses, is fees paid by clients for advice and services. Mercer Human Resource Consulting, principally through its Health & Benefits line of business, also earns significant revenue in the form of commissions received from insurance companies for the placement of group (and occasionally individual) insurance contracts, primarily life, health and accident coverages. Revenue for Mercer Global Investment’s discretionary investment management business and certain of Mercer HR Services and Investment’s defined contribution administration services consists principally of fees based on assets under administration.
Consulting revenue in 2004 increased 11% over 2003. Acquisitions, which accounted for 4% of the revenue growth in 2004, include Synhrgy HR Technologies which closed in January, 2004, and Oliver, Wyman & Company (“OWC”) which closed on April 1, 2003. On an underlying basis, revenue increased 3%. In Mercer HR Consulting, underlying revenue was flat. In Mercer’s specialty consulting businesses, underlying revenue increased 13%.
Consulting expenses increased 4% in 2005 compared with 2004. On an underlying basis, expenses increased 3%, as savings from restructuring activity and lower costs for restructuring were offset by employee retention costs, increased benefits costs and higher expenses in specialty consulting due to a higher volume of business.
Consulting expenses increased 14% in 2004 compared with 2003. Expenses in 2004 included restructuring charges of $62 million, including severance and other termination benefits and future
Putnam’s revenue is derived primarily from investment management and 12b-1 fees (described more fully below) received from the Putnam Funds and investment management fees for institutional accounts. Putnam also receives fees from the Putnam Funds for administrative services performed by PFTC.
Putnam companies receive fees for the investment management services provided to the Putnam Funds and institutional accounts pursuant to investment advisory contracts under which the mutual fund or institutional investor pays fees to the Putnam company that manages the fund or account. The amount of the fees varies depending on the individual mutual fund or institutional account. Fees are usually based on a sliding scale in relation to assets under management, and, in some cases are also based on investment performance. These advisory contracts generally may be terminated by either party without penalty, and contracts with the Putnam Funds must be approved annually by the fund’s shareholders or trustees, including a majority who are not affiliated with Putnam. Putnam management and the fund trustees regularly review the Putnam Fund contract fee structures in light of fund performance, the level and range of services provided, and current industry conditions.
All open-end Putnam funds other than money market funds have adopted distribution plans pursuant to Rule 12b-1 under the Investment Company Act of 1940, commonly referred to as 12b-1 plans. Pursuant to these 12b-1 plans, the Putnam Funds make payments to PRM to cover costs relating to distribution of the Putnam Funds and services provided to shareholders, at rates that differ by class of fund shares. These payments, known as Rule 12b-1 fees, enable PRM to pay service fees and other continuing compensation to firms that distribute shares of the Putnam Funds and provide services to fund shareholders. PRM retains some Rule 12b-1 fees as compensation for the costs of distribution and other services provided by Putnam and its affiliates to shareholders and for commissions advanced by Putnam at the point of sale (and recovered through fees received over
Putnam’s revenue decreased 12% in 2005, reflecting a decrease in fees due to a decline in assets under management, lower 12b-1 fee revenue, and decreased investment gains. Assets under management averaged $196 billion in 2005, a 10% decline from the $217 billion managed in 2004. Assets under management aggregated $189 billion at December 31, 2005, compared with $213 billion at December 31, 2004. The change in assets under management from December 31, 2004 results primarily from net redemptions of $31 billion, partly offset by the positive impact of market performance. We expect average assets under management to decline in 2006.
At the end of 2005, assets held in equity securities represented 68% of assets under management , compared with 69% in 2004 and 72% in 2003, while investments in fixed income products represented 32%, compared with 31% in 2004 and 28% in 2003.
Putnam’s revenue decreased 13% in 2004, reflecting a decrease in fees due to a decline in average assets under management, partially offset by higher investment gains, higher equity income resulting from THL transaction fees related to private equity investments and increased transfer agent fees. Assets under management averaged $217 billion for the year ended December 31, 2004, a 16% decline from the $258 billion managed in 2003. Assets under management aggregated $213 billion at
December 31, 2004 compared with $240 billion at December 31, 2003. The change from December 31, 2003 primarily resulted from net redemptions of $51 billion, partly offset by increases due to market appreciation of $16 billion and the consolidation of PanAgora’s $8 billion of assets under management as of July 2004.
Expenses in 2004, which increased 11% from 2003, included $224 million for Putnam’s regulatory settlements with the SEC and the Commonwealth of Massachusetts. Restructuring costs totaled
Corporate expenses in 2004 included $18 million of restructuring costs, including severance and other termination benefits, future rent under non-cancelable leases and lease termination costs. The impact of the final settlement for insured losses related to the WTC reduced Corporate expenses in 2004. The replacement value of the assets exceeded their book value by $105 million which was recorded as a reduction of other operating expenses.
Note 13 to the consolidated financial statements discusses integration and restructuring costs. The following chart summarizes the costs incurred and the savings realized and projected for MMC’s restructuring activities.
Restructuring activities under the 2005 plan, which we initiated in the first quarter of 2005 are nearing completion. In 2005, MMC incurred expenses in connection with the 2005 plan of $310 million (approximately two-thirds of which was severance cost). Additional expenses of $50 million are expected to be incurred primarily in the first half of 2006. Once the 2005 plan is fully implemented, MMC expects to achieve annualized cost savings of $375 million, all of which is in the Risk and Insurance Services segment. Results in 2005 reflect approximately $160 million of the savings
provided on net operating losses in certain state and foreign jurisdictions. In 2003 the effective tax rate was 32.8%. The increase in the effective rate in 2004 compared with 2003 results primarily from the tax impact of the aforementioned settlements, and a partially offsetting benefit for foreign earnings taxed at lower rates.
The effective tax rate is sensitive to the geographic mix of MMC’s earnings, which may have a favorable or unfavorable impact on the rate. Furthermore, losses in certain jurisdictions cannot be offset by earnings from other operations, and may require valuation allowances affecting the rate, depending on estimates of their realizability.
MMC establishes allowances for potential liabilities that may arise out of tax audits and litigation to the extent that such liabilities are probable and can be estimated in accordance with SFAS No. 5. Once established, allowances are evaluated based on the facts and circumstances that exist at each reporting period. Adjustments may result, for example, upon resolution of an issue with the taxing authorities, or expiration of a statute of limitations barring an assessment for an issue for which an allowance had previously been recorded. Such adjustments could have a material impact on MMC’s effective tax rate, net income, and cash flows for a particular future period.
MMC generated $399 million of cash from operations in 2005 compared with $2.1 billion in 2004. These amounts reflect the net income earned by MMC during those periods adjusted for non-cash charges and changes in working capital which relate primarily to the timing of payments for accrued liabilities or receipts of assets. In addition to the routine timing of payments and receipts, MMC had several significant events which impacted its cash flow over the past two years, due to differences between when the items are recognized in net income and when they are paid. These include payments in 2005 of approximately $308 million for regulatory settlements accrued in 2004, payment of restructuring costs and discretionary contributions of $235 million to the pension plans in the U.K.
At December 31, 2005, the balance of accounts receivable related to accrued market services revenue earned prior to October 1, 2004 was $130 million. Following the announcement of the settlement with the NYAG and NYSID, MMC reaffirmed its intention to collect outstanding MSA revenue earned prior to October 1, 2004, and will seek to enforce its rights under the relevant contracts. In December 2005, MMC initiated arbitration proceedings against certain insurance carriers for this purpose. However, there is no assurance that MMC will be successful in collecting all amounts due. To the extent such accrued amounts are not collected, a charge to earnings would result.
During 2005, MMC contributed approximately $229 million to the U.S. pension plans and $498 million to the significant non-U.S. pension plans, compared with $44 million for U.S. plans and $239 million for significant non-U.S. plans in 2004. The contributions in 2005 include discretionary contributions of 8 million unregistered shares of MMC stock valued at $205 million to the U.S. qualified plan and $235 million of cash to the U.K. plans. These contributions resulted in an increase in prepaid pension expense for certain plans. The minimum pension liability related to any plan is recorded as part of the Pension, postretirement and post-employment liability in the consolidated balance sheets.
During 2005, the net funded status of the U.S. and significant non-U.S. pension plans increased by $299 million and $303 million, respectively, due primarily to the discretionary contributions mentioned previously. In addition, changes made to the U.S. pension plan, discussed below under “Management’s Discussion of Critical Accounting Policies - Retirement Benefits”, reduced the benefit obligation of that plan by $138 million and a plan curtailment in the U.K. reduced the benefit obligations of non-U.S. plans by $40 million. Benefit obligations of the U.S. and significant non-U.S. pension plans exceeded the fair value of plan assets by $79 million and $818 million, respectively, at December 31, 2005. Contribution rates are determined by the local foreign actuaries based on local funding practices and requirements. Funding amounts may be influenced by future asset performance, discount rates and other variables impacting the assets and/or liabilities of the plan. In addition, amounts funded in the future, to the extent not required under regulatory requirements, may be affected by alternative uses of MMC’s cash flows, including dividends, investments, and share repurchases.
Under generally accepted accounting principles, if the accumulated benefit obligation of a plan exceeds the fair value of that plan’s assets (an “ABO deficit”), an additional minimum liability is recorded for the amount of the ABO deficit. The additional minimum liability, plus the amount of prepaid pension cost recognized for that plan is charged to other comprehensive income (equity), net of applicable taxes. At December 31, 2005, MMC has prepaid pension costs of approximately $1.6 billion, which relate primarily to the U.S. qualified plan and two U.K. plans, as well as some smaller plans in various countries.
Net cash provided by financing activities was $128 million in 2005 compared with $1.2 billion in 2004.
MMC paid total dividends of $363 million in 2005 ($0.68 per share) and $681 million ($1.30 per share) in 2004. MMC made no share repurchases in 2005. In 2004, MMC repurchased 11.4 million shares for $524 million, substantially all of which was purchased in the first and second quarters.
MMC also maintains other credit facilities, guarantees and letters of credit with various banks, primarily related to operations located outside the United States, aggregating $354 million at December 31, 2005 and $331 million at December 31, 2004. There was $83 million outstanding under these facilities at December 31, 2005.
Cash provided by investing activities amounted to $153 million in 2005 compared with cash used for investing activities of $2.6 billion in 2004. Cash used for acquisitions decreased to $74 million from $2.4 billion in 2004. Acquisitions in 2004 included Kroll, Inc., Synhrgy HR Technologies, Corporate Systems, and the Australia and New Zealand operations of Heath Lambert. Remaining deferred cash payments of approximately $48 million related to acquisitions completed in 2005 and prior years are recorded in Accounts payable and accrued liabilities or in Other liabilities in the consolidated balance sheets at December 31, 2005. In addition, cash generated by the sale of securities totaled $333 million in 2005 versus $199 million for 2004.
years, which would indicate an expected capital call of approximately $35-$50 million per year. Actual capital calls may occur more quickly. The majority of MMC’s other investment commitments for funds managed by Stone Point are related to Trident II, the investment period for which is now closed for new investments. Any remaining capital calls for Trident II would relate to follow-on investments in existing portfolio companies or for management fees or other partnership expenses. Significant future capital calls related to Trident II are not expected. Although it is anticipated that Trident II will be harvesting its remaining portfolio in 2006 and thereafter, the timing of any portfolio company sales and capital distributions is unknown and not controlled by MMC.
Putnam has investment commitments of $101 million for three active THL funds, of which Putnam believes approximately $50 million will not be called. Putnam is authorized to commit to invest up to $187 million in future THL investment funds, but is not required to do so. At December 31, 2005 none of that additional $187 million is committed.
Based on the above balances, if short-term interest rates increase by 10% or 40 basis points over the course of the year, annual interest income, including interest earned on fiduciary funds, would increase by approximately $14 million. However, this would be partially offset by a $3 million increase in interest expense resulting in a net increase to income before income taxes and minority interest of $11 million.
MMC holds investments in both public and private companies, as well as certain private equity funds managed by Stone Point and T.H. Lee. The majority of the public investments are accounted for as available for sale securities under SFAS No. 115. Where applicable, certain investments are accounted for under APB Opinion No. 18. MMC periodically reviews the carrying value of its investments to determine if any valuation adjustments are appropriate under the applicable accounting pronouncements. MMC bases its review on the facts and circumstances as they relate to each investment. Fair value of private equity investments is determined by the Funds’ investment managers. Factors considered in determining the fair value of private equity investments include: implied valuation of recently completed financing rounds that included sophisticated outside investors; performance multiples of comparable public companies; restrictions on the sale or disposal of the investments; trading characteristics of the securities; and the relative size of the holdings in comparison to other private investors and the public market float. In those instances where quoted market prices are not available, particularly for equity holdings in private companies, or formal restrictions limit the sale of securities, significant management judgment is required to determine the appropriate value of MMC’s investments. MMC reviews the appropriateness of valuation results for significant private equity investments with the fund manager.
The consulting segment provides advice and services to the managements of organizations in the areas of Human Resource Consulting, comprising retirement and investment consulting, HR services and investments, health and benefits and human capital; and Specialty Consulting, comprising management consulting, organization change, and economic consulting.
Unremitted insurance premiums and claims are held in a fiduciary capacity. Interest income on these fiduciary funds, included in service revenue, amounted to $151 million in 2005, $130 million in 2004, and $114 million in 2003. Since fiduciary assets are not available for corporate use, they are shown in the balance sheet as an offset to fiduciary liabilities. At December 31, 2005, Putnam managed the investment of approximately $1.3 billion of the fiduciary assets.
Revenue: Risk and Insurance Services revenue includes insurance commissions, fees for services rendered, interest income on certain fiduciary funds and market service fees from insurers earned on placements made prior to October 2004. Effective October 1, 2004 Marsh agreed to eliminate contingent compensation agreements with insurers. Insurance commissions and fees for risk transfer services generally are recorded as of the effective date of the applicable policies or, in certain cases (primarily in MMC’s reinsurance and London market operations), as of the effective date or billing date, whichever is later. Commissions are net of policy cancellation reserves, which are estimated based on historic and current data on cancellations. Fees for non-risk transfer services provided to clients are recognized over the period in which the services are provided, using a proportional performance model. Fees resulting from achievement of certain performance thresholds are recorded when such levels are attained and such fees are not subject to forfeiture. Revenue also includes compensation for services provided in connection with the organization, structuring and management of insurance, financial and other industry-focused investments, as well as appreciation or depreciation that has been recognized on holdings in such investments. Although MMC no longer receives management fees or origination fees related to Stone Point’s business, it will continue to receive dividends and to recognize capital appreciation or depreciation on these investment holdings. In addition, Crump Group, Inc. and Sedgwick CMS Holdings were part of this segment.
accordance with APB Opinion No. 18 (“APB 18”). Changes in the fair value of trading securities are recorded in earnings when they occur. Changes in the fair value of available for sale securities are recorded in stockholders’ equity, net of applicable taxes, until realized. Securities classified as trading or available for sale under SFAS 115, or carried at cost under APB 18, are included in Long-term investments in the consolidated balance sheets.
Gains or losses recognized in earnings from the investment securities described above are included in Investment income (loss) in the consolidated statements of income. Costs related to management of MMC’s investments, including incentive compensation partially derived from investment income and loss, are recorded in operating expenses.
Income Taxes: MMC’s tax rate reflects its income, statutory tax rates and tax planning in the various jurisdictions in which it operates. Significant judgment is required in determining the annual tax rate and in evaluating tax positions. Tax allowances are established for uncertain tax positions when, despite the belief that the tax return positions are consistent with applicable law, there is the potential that they may be successfully challenged. The allowances are established for all identified liabilities, and related interest, that are probable and can be estimated in accordance with SFAS
No. 5. The possibility that a taxing authority may not assert an issue is not taken into account. It is assumed that the taxing authority will become fully aware of all facts relating to an issue and propose adjustments as appropriate. Allowances are evaluated based upon the facts and circumstances that exist at each reporting period. Allowances for issues that have been asserted by tax authorities and resolved by agreement are adjusted in the quarter when agreement is reached. If the statute of limitations operates to bar assessment of an issue that has not been asserted by a taxing authority, the related allowance is reversed at that time.
Tax law requires items to be included in MMC’s tax returns at different times than the items are reflected in the consolidated statements of income. As a result, the annual tax expense reflected in the consolidated statements of income is different than that reported in the tax returns. Some of these differences are permanent, such as expenses that are not deductible in the returns, and some differences are temporary and reverse over time, such as depreciation expense. Temporary differences create deferred tax assets and liabilities. Deferred tax assets generally represent items that can be used as a tax deduction or credit in tax returns in future years for which benefit has already been recorded in the financial statements. Valuation allowances are established for deferred tax assets when it is estimated that it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax liabilities generally represent tax expense recognized in the financial statements for which payment has been deferred, or expense for which a deduction has been taken already in the tax return but the expense has not yet been recognized in the financial statements.
U.S. Federal income taxes are provided on unremitted foreign earnings except those that are considered permanently reinvested, which at December 31, 2005 amounted to approximately $1.4 billion. However, if these earnings were not considered permanently reinvested, the incremental tax liability which otherwise might be due upon distribution, net of foreign tax credits, would be approximately $40 million.
MMC sold Crump Group, Inc., its U.S.-based wholesale insurance broker, during the fourth quarter of 2005, and its majority interest in Sedgwick CMS Holdings, a provider of claims management and associated productivity services, on January 31, 2006. As previously discussed, the account balances and activities of these entities were segregated and reported as discontinued operations in the accompanying consolidated financial statements at December 31, 2005 and 2004 and for each of the three years in the period ended December 31, 2005. Both of these entities were part of MMC’s Risk and Insurance Services segment.
Aggregate amortization expense for the years ended December 31, 2005 and 2004, was $99 million and $64 million, respectively, and the estimated future aggregate amortization expense is as follows:
The net changes in the valuation allowances for the years ended December 31, 2005 and 2004 were increases of $26 million and $19 million respectively. Approximately $22 million of the cumulative valuation allowances relates to amounts which if realized would reduce goodwill or increase contributed capital in the future. Approximately 70% of the Company’s net operating loss carryforwards expire over various periods from 2006 through 2025, and others are unlimited. In assessing the realizability of deferred tax assets, the Company considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized and adjusts the valuation allowance accordingly. MMC evaluates all significant available positive and negative evidence, including the existence of losses in recent years and its forecast of future taxable income, in assessing the need for a valuation allowance. The underlying assumptions the Company uses in forecasting future taxable income require significant judgment and take into account the Company’s recent performance. The ultimate realization of deferred tax assets is dependent on the generation of future taxable income during the periods in which temporary differences are deductible. Based on the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, MMC believes it is more likely than not that it will realize the benefits of the deferred tax assets, net of existing valuation allowances at December 31, 2005. The amount of the deferred tax assets considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced.
The long-term rate of return assumption is selected for each plan based on the facts and circumstances that exist as of the measurement date, and the specific portfolio mix of each plan’s assets. MMC uses Mercer actuaries to perform the valuations of its pension plans. MMC utilizes a model developed by its actuaries to assist in the setting of this assumption. The model takes into account several factors including: actual and target portfolio allocation; investment, administrative and trading expenses incurred directly by the plan trust; historical portfolio performance; relevant forward-looking economic analysis; and expected returns, variances, and correlations for different asset classes. All returns utilized and produced by the model are geometric averages. These measures are used to determine probabilities using standard statistical techniques to calculate a range of expected returns on the portfolio. MMC generally does not adjust the rate of return assumption from year to year if, at the measurement date, it is within the best estimate range, defined as between the 25th and 75th percentile of the expected long-term annual returns in accordance with the “American Academy of Actuaries Pension Practice Council Note May 2001 Selecting and Documenting Investment Return Assumptions” and consistent with Actuarial Standards of Practice No. 27. The historical five and ten-year average asset returns of each plan are also reviewed to ensure they are consistent and reasonable compared with the best estimate range. The expected return on plan assets is determined by applying the assumed long-term rate of return to the market-related value of plan assets as defined by SFAS No. 87. This market-related value recognizes investment gains or losses over a five-year period from the year in which they occur. Investment gains or losses for this purpose are the difference between the expected return calculated using the market-related value of assets and the actual return based on the market value of assets. Since the market-related value of assets recognizes gains or losses over a five-year period, the future market-related value of the assets will be impacted as previously deferred gains or losses are recorded.
The discount rate selected for each U.S. plan is based on a model bond portfolio with durations that match the expected payment patterns of the plan. Discount rates for non-U.S. plans are based on appropriate bond indices such as the IBoxx £ Corporates 15-year index in the U.K. Projected compensation increases reflect current expectations as to future levels of inflation.
In September 2005 the Company contributed 8 million unregistered shares of MMC stock, valued at $205 million, to the U.S. qualified plan. Prior to this contribution, the U.S. qualified plan held no MMC securities. Plan assets of approximately $2.0 billion and $1.9 billion at December 31, 2005 and 2004, respectively, were managed by Putnam, which includes both separately managed and publicly available investment funds.
The assets and liabilities of the U.S. defined benefit pension plans were re-measured at October 31, 2005 to reflect a change in substantive plan as defined by SFAS No. 87, “Employer’s Accounting for Pensions.” The changes include changing the benefit formula from a final average salary to a career average salary as well as a change in the calculation for early retirement benefits. The change in substantive plans reduced the projected benefit obligation by approximately $138 million.
The projected benefit obligation, accumulated benefit obligation, and fair value of plan assets for the U.S. pension plans with accumulated benefit obligations in excess of plan assets were $326 million, $315 million and $0, respectively, as of December 31, 2005 and $340 million, $315 million and $0, respectively, as of December 31, 2004.
In December 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 became law. The net periodic benefit cost for 2005 shown above includes the subsidy.
The benefit obligation, accumulated benefit obligation, and fair value of plan assets for the non-U.S. pension plans with accumulated benefit obligations in excess of plan assets were $3.5 billion, $3.3 billion and $2.8 billion, respectively, as of December 31, 2005 and $3.4 billion, $3.1 billion and $2.5 billion, respectively, as of December 31, 2004.
The non-U.S. defined benefit plans do not have any direct or indirect ownership of MMC stock.
The assumed health care cost trend rate was approximately 7.0% in 2005, gradually declining to 2.4% in the year 2015. Assumed health care cost trend rates 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:
Contribution Plans: MMC maintains certain defined contribution plans for its employees, including the Marsh & McLennan Companies Stock Investment Plan (“SIP”) and the Putnam Investments, LLC Profit Sharing Retirement Plan (the “Putnam Plan”). Under these plans, eligible employees may contribute a percentage of their base salary, subject to certain limitations. For the SIP, MMC matches a portion of the employees’ contributions, while under the Putnam Plan the contributions are at the discretion of MMC subject to IRS limitations. The SIP contains an Employee Stock Ownership Plan under U.S. tax law and plan assets of approximately $572 million at December 31, 2005 and $715 million at December 31, 2004 were invested in MMC stock. Effective October 25, 2004, all participants became eligible to direct their Company matching contributions and all of their employee contribution account balances to any of the available investment options. If a participant does not choose an investment direction for his or her future Company matching contributions, they are automatically invested in the Putnam Fixed Income Fund. SIP plan assets of approximately $1,028 million and $973 million at December 31, 2005 and 2004, respectively, were managed by Putnam. The cost of these defined contribution plans was $90 million, $97 million and $97 million for 2005, 2004 and 2003, respectively.
As a result of adopting SFAS 123 (R) on July 1, 2005, MMC’s income before income taxes is $64 million lower than if it had continued to account for share-based payment arrangements under APB 25. The incremental tax benefit resulting from the adoption of SFAS 123 (R) was $20 million for the year ended December 31, 2005. The cumulative effect of the change in accounting was not material. Basic and diluted earnings per share in 2005 would have been $0.83 and $0.82,
respectively, if MMC had not adopted SFAS 123 (R), compared to reported basic and diluted earnings per share of $0.75 and $0.74, respectively.
Prior to the adoption of SFAS 123 (R), restricted stock units and deferred stock units were recorded as a liability at their respective grant date fair value. Prepaid compensation cost was recognized for the unearned portion of such awards. Upon implementation of SFAS 123 (R), the respective accrued fair value of such awards of approximately $110 million was reclassified to equity.
The pro forma information reflected above includes stock options issued under MMC’s incentive and stock award plans and the Putnam Investments Equity Partnership Plan and stock issued under MMC’s stock purchase plan. In addition, the pro forma information reflected above is based on recognizing the costs of employee stock option awards granted prior to July 1, 2005 to retiree-eligible individuals over the full vesting term of the award. Beginning July 1, 2005, MMC began recognizing new employee stock option awards granted to retiree-eligible individuals over a shorter period, consistent with the retirement vesting acceleration provisions of these grants. If the costs of employee stock option awards granted prior to July 1, 2005 to retiree-eligible individuals had been recognized for these individuals under this accelerated method, pro forma net income for the years ended 2005, 2004, and 2003 would have amounted to $340 million, $44 million, and $1.4 billion, respectively.
In 2000, the Marsh & McLennan Companies, Inc. 2000 Employee Incentive and Stock Award Plan (the “2000 Employee Plan”) and the Marsh & McLennan Companies, Inc. 2000 Senior Executive Incentive and Stock Award Plan (the “2000 Executive Plan”) were adopted. The types of awards permitted under these plans include stock options, restricted stock, stock bonus units, restricted and deferred stock units payable in MMC common stock or cash, and other stock-based and performance-based awards. The Compensation Committee of the Board of Directors (the “Compensation Committee”) determines, at its discretion, which affiliates may participate in the plans, which eligible employees will receive awards, the types of awards to be received, and the terms and
Stock Options: Options granted under the 2000 Plans may be designated as either incentive stock options or non-qualified stock options. The Compensation Committee determines the terms and conditions of the option, including the time or times at which an option may be exercised, the methods by which such exercise price may be paid, and the form of such payment. Options are generally granted with an exercise price equal to the market value of MMC’s stock at the date of grant. These option awards generally vest 25% per annum and have a contractual term of 10 years. On March 16, 2005, MMC began granting stock option awards that provide for a performance-based triggering event before a vested option can be exercised. The terms and conditions of these stock option awards provide that (i) options will vest at a rate of 25% a year beginning one year from the date of grant and (ii) each vested tranche will only become exercisable if the market price of MMC’s stock appreciates to a level of 15% above the exercise price of the option and maintains that level for at least ten (10) consecutive trading days after the award has vested. For awards without a performance triggering event, compensation cost is generally recognized on a straight-line basis over the requisite service period which is normally the vesting period. For awards with a performance triggering event, each vesting tranche is accounted for as a separate award with its own grant date fair value and requisite service period.
The assumptions used in the Black-Scholes option pricing valuation model for options granted by MMC in 2005, 2004 and 2003 are as follows:
The weighted-average grant-date fair value of MMC’s option awards granted during the years ended December 31, 2005, 2004 and 2003 was $6.51, $7.51 and $7.45, respectively. The total intrinsic value of options exercised during the same periods was $36 million, $46 million and $177 million, respectively.
As of December 31, 2005, there was $152 million of unrecognized compensation cost related to MMC’s option awards. The weighted-average period over which that cost is expected to be recognized is
1.5 years. Cash received from the exercise of stock options for the years ended December 31, 2005, 2004 and 2003 was $44.6 million, $110.5 million, and $157.8 million, respectively.
The weighted-average grant-date fair value of MMC’s restricted stock awards granted during the years ended December 31, 2004 and 2003 was $46.12 and $42.99, respectively. The total fair value of MMC’s restricted stock distributed during the years ended December 31, 2005, 2004 and 2003 was $9.9 million, $5.1 million and $4.2 million, respectively.
A summary of the status of MMC’s restricted stock unit awards as of December 31, 2005 and changes during the period then ended is presented below:
A summary of the status of MMC’s deferred stock unit awards as of December 31, 2005 and changes during the period then ended is presented below:
The weighted-average grant-date fair value of MMC’s deferred stock units granted during the years ended December 31, 2004 and 2003 was $44.08 and $42.90, respectively. The total fair value of MMC’s deferred stock units distributed during the years ended December 31, 2005, 2004, and 2003 was $48.2 million, $57.5 million and $41.2 million, respectively.
As of December 31, 2005, there was $219 million of unrecognized compensation cost related to MMC’s restricted stock, restricted stock unit and deferred stock unit awards.
Options on Class B shares of Putnam’s common stock, which may be awarded under Putnam’s Equity Partnership Plan are subject to restrictions on transferability and other restrictions, if any, as the Compensation Committee may impose. Unless the Compensation Committee determines otherwise, the exercise price for each option is the fair market value of a Class B share on the date of the option grant. All options granted to a participant become exercisable in accordance with the vesting schedule set forth in the applicable award agreement, provided that the compensation committee has the right to accelerate the exercisability of any option. Notwithstanding any other provision of the Plan, each option shall terminate on and shall not be exercisable after the tenth or sixth anniversary of the Grant Date of such option, as applicable.
The assumptions used in the Black-Scholes option pricing valuation model for options granted by Putnam in 2005, 2004 and 2003 are as follows:
As of December 31, 2005, there was $19 million of unrecognized compensation cost related to Putnam’s option awards. The weighted-average period over which that cost is expected to be recognized is 3.5 years.
The weighted-average grant-date fair value of Putnam’s restricted stock awards granted during the years ended December 31, 2004 and 2003 was $33.48 and $37.00, respectively. The total fair value of Putnam’s restricted stock vested during the years ended December 31, 2005, 2004 and 2003 was $19 million, $22 million, and $33 million, respectively.
As of December 31, 2005, there was $110 million of unrecognized compensation cost related to Putnam’s restricted stock awards.
MMC has entered into agreements with various service companies to outsource certain information systems activities and responsibilities. Under these agreements, MMC is required to pay minimum annual service charges. Additional fees may be payable depending upon the volume of transactions processed with all future payments subject to increases for inflation. At December 31, 2005, the aggregate fixed future minimum commitments under these agreements are as follows:
headquarters building in New York City. MMC prepaid its existing $200 million 9.8% mortgage due 2009. The incremental proceeds from the refinancing, net of mortgage prepayment costs, were used to repay outstanding short-term debt. In the event the mortgage is foreclosed following a default, MMC would be entitled to remain in the space and would be obligated to pay rent sufficient to cover interest on the notes or at fair market value if greater. Mortgage prepayment costs of $34 million related to this transaction are included in interest expense in the consolidated statements of income.
In September 2005, MMC issued $550 million of 5.15% Senior Notes due 2010 and $750 million of 5.75% Senior Notes due 2015 (the “2005 Notes”). The net proceeds from the 2005 Notes were used to pay down the $1.3 billion term loan facility, discussed below.
Additional credit facilities, guarantees and letters of credit are maintained with various banks, primarily related to operations located outside the United States, aggregating $354 million at December 31, 2005 and $331 million at December 31, 2004. There was $83 million outstanding at December 31, 2005 and there was $61 million outstanding under these facilities at December 31, 2004.
In December 2004, MMC completed financing with respect to a $1.3 billion term loan facility and the amendment of its existing $1 billion revolving credit facility which was scheduled to expire in June 2007 and $700 million revolving credit facility which was scheduled to expire in June 2009. The term loan facility, which was repaid with proceeds from the issuance of the 2005 Notes, was scheduled to mature on December 31, 2006 and replaced revolving credit facilities of $700 million and $355 million, which were scheduled to expire in 2005. The proceeds from the term loan facility were used to pay down outstanding balances on revolving credit facilities. The interest rates on the Term Loan and amended facilities varied based upon the level of usage of each facility and MMC’s credit ratings. Each of these facilities required MMC to maintain certain coverage and leverage ratios and the facility guarantors to meet certain guaranty minimum coverage percentages.
Scheduled repayments of long-term debt in 2006 and in the four succeeding years are $69 million, $1.12 billion, $258 million, $408 million and $558 million, respectively.
The estimated fair value of MMC’s significant financial instruments is provided below. Certain estimates and judgments were required to develop the fair value amounts. The fair value amounts shown below are not necessarily indicative of the amounts that MMC would realize upon disposition nor do they indicate MMC’s intent or ability to dispose of the financial instrument.
MMC had available for sale securities and trading investments with an aggregate fair value of $223 million and $483 million at December 31, 2005 and 2004, respectively, which are carried at market value under SFAS 115. Gross unrealized gains amounting to $82 million and $212 million at December 31, 2005 and 2004, respectively have been excluded from earnings and reported, net of deferred income taxes, in accumulated other comprehensive loss, which is a component of stockholders equity.
MMC recorded net gains associated with its available for sale securities of $158 million, $102 million and $34 million, in 2005, 2004 and 2003, respectively. Proceeds from the sale of available for sale securities for the years ended December 31, 2005, 2004 and 2003 were $293 million, $170 million and $94 million, respectively. Gross realized gains on available for sale securities sold during 2005, 2004 and 2003 amounted to $158 million, $107 million and $49 million, respectively. In 2005, 2004 and 2003, MMC recorded losses of $0 million, $5 million and $15 million, respectively, related to the decline in value of certain available for sale securities that were other than temporary. The cost of securities sold is determined using the average cost method for equity securities. The gains and losses described above are included in Investment income (loss) in the consolidated statements of income.
In March 2005, MMC announced that it would undertake restructuring initiatives involving staff reductions and consolidations of facilities in response to MMC’s business environment (the “2005 Plan”). In connection with this plan, MMC incurred restructuring charges of $310 million in the twelve months ended December 31, 2005,of which $255 million was recorded in risk and insurance services and $55 million was recorded in corporate. The amounts incurred and paid in 2005 and the liability as of December 31, 2005 are as follows:
Includes approximately $36 million of payments received on the disposals of small commercial accounts and other dispositions.
In November 2004, MMC announced that it would undertake restructuring initiatives involving staff reductions and consolidations of facilities in response to MMC’s business environment (the “2004 Plan”). In connection with the 2004 Plan, MMC incurred restructuring charges of $337 million in the year ended December 31, 2004 and $3 million in 2005. The breakdown by segment was $234 million, $62 million, and $26 million in risk and insurance services, consulting and investment management, respectively. An additional $18 million of restructuring expense was recorded in corporate. Utilization of the 2004 charges is summarized as follows:
The expenses associated with the 2005 Plan and the 2004 Plan are included in Compensation and benefits or in Other operating expenses in the consolidated statements of income, and liabilities associated with these initiatives are classified on the consolidated balance sheets as Accounts payable, Other liabilities, or Accrued salaries, depending on the nature of the items.
Restructuring costs in 2005 also include a $4 million increase to the estimated liability for future rent under non-cancelable leases related to the Johnson and Higgins and Sedgwick acquisitions.
New York State Attorney General Investigation and Related Litigation and Regulatory Matters
On October 14, 2004, the Office of the New York State Attorney General (“NYAG”) filed a civil complaint in New York State court (the “NYAG Lawsuit”) against MMC and Marsh Inc. (collectively, “Marsh”) asserting claims under New York law for fraudulent business practices, antitrust violations, securities fraud, unjust enrichment, and common law fraud. The complaint alleged that market service agreements between Marsh and various insurance companies (the “Agreements”) created an improper incentive for Marsh to steer business to such insurance companies and to shield them from competition. The complaint further alleged that the Agreements were not adequately disclosed to Marsh’s clients or MMC’s investors. In addition, the complaint alleged that Marsh engaged in bid-rigging and solicited fraudulent bids to create the appearance of competitive bidding. The complaint sought relief that included an injunction prohibiting Marsh from engaging in the alleged wrongful conduct, disgorgement of all profits related to such conduct, restitution and unspecified damages, attorneys’ fees, and punitive damages.
On October 21, 2004, the New York State Insurance Department (the “NYSID”) issued a citation, amended on October 24, 2004 (the “Amended Citation”), that ordered MMC and a number of its
Following the announcement of the NYAG Lawsuit and related actions taken by MMC, the MMC stock price dropped from approximately $45 per share to a low of approximately $22.75 per share.
In 2004, MMC recorded a charge of $850 million for the amount to be paid into the Fund in accordance with the Settlement Agreement. In addition, in the fourth quarter of 2004 and the first quarter of 2005, MMC recorded charges totaling $16 million for the expected cost to calculate and administer payments out of the Fund.
In placing, renewing, consulting on or servicing any insurance policy, Marsh will not knowingly use wholesalers for the placement, renewal, consultation on or servicing of insurance without the agreement of its client;
On October 25, 2004, NYAG announced that it would not bring criminal charges against Marsh. The Settlement Agreement does not resolve any investigation, proceeding or action commenced by NYAG or NYSID against any former or current employees of Marsh. As part of the Settlement Agreement, Marsh apologized for the improper conduct of certain employees. Marsh also agreed to continue to cooperate with NYAG and NYSID in connection with their ongoing investigations of the insurance industry, and in any related proceedings or actions. Since the filing of the NYAG lawsuit, ten former Marsh employees have pleaded guilty to criminal charges relating to the matters under investigation. On September 15, 2005, eight former Marsh employees (including one individual who has since pleaded guilty) were indicted on various counts relating to these same matters. NYAG has indicated that its investigation of the insurance industry is continuing. Trial against the remaining 7 defendants is scheduled for January 2007.
Approximately 21 putative class actions purportedly brought on behalf of policyholders were filed in various federal courts. A number of these federal cases were transferred to the District of New Jersey for coordination or consolidated pretrial proceedings (the “MDL Cases”). On August 1, 2005, two consolidated amended complaints were filed in the MDL Cases (one on behalf of a purported class of “commercial” policyholders and the second on behalf of a purported class of “employee benefit” policyholders), which as against MMC and certain affiliates allege statutory claims for violations of the Racketeering Influenced and Corrupt Organizations Act and federal and state antitrust laws, together with common law claims for breach of fiduciary duty and unjust enrichment. The complaints seek a variety of remedies, including unspecified monetary damages, treble damages, disgorgement, restitution, punitive damages, declaratory and injunctive relief, and attorneys’ fees and costs. The class periods alleged in the MDL Cases begin on August 26, 1994 and purport to continue to the date of any class certification. On November 29, 2005, MMC and the other defendants moved to dismiss the two consolidated amended complaints.
Six class or representative actions on behalf of policyholders are pending in state courts. There are also 16 actions brought by individual policyholders and others in federal and state courts relating to matters alleged in the NYAG Lawsuit, and additional policyholder suits may be filed. MMC expects that all policyholder actions filed in the U.S. federal courts will be transferred to the District of New Jersey as described above. In addition, two putative class actions are pending in Canada.
The consolidated complaint alleges, among other things, that MMC inflated its earnings during the class period by engaging in unsustainable business practices based on contingent commissions, and caused the plaintiffs and other members of the purported class to purchase MMC’s securities at artificially inflated prices. The consolidated complaint further alleges that MMC failed to disclose that the revenue derived from market service agreements with insurers was part of an unlawful scheme, which could not be sustained and which exposed MMC to significant regulatory sanctions, and that MMC failed to disclose certain alleged anti-competitive and illegal practices, such as “bid rigging” and soliciting fictitious quotes, at MMC’s subsidiaries. The consolidated complaint further alleges that MMC’s revenues and earnings would have been significantly lower had MMC’s subsidiaries not engaged in these allegedly unlawful business practices, and that MMC’s earnings were overstated because MMC failed to establish a reserve for contingent losses associated with its allegedly improper activities.
Four individual shareholder actions have been filed against MMC and others in various state courts around the country. MMC and other defendants removed these four actions to federal court. Two actions have since been remanded to state court. One remains pending in federal court, and one has been transferred for inclusion in the consolidated proceeding described immediately above.
A number of shareholder derivative actions are pending against MMC’s current and former directors and officers. Five actions in the Court of Chancery of the State of Delaware have been consolidated as a single action (the “Delaware Derivative Action”). Five actions in the United States District Court for the Southern District of New York have been consolidated as a single action (the “Federal Derivative Action”). One action is pending in the New York Supreme Court for New York County. These shareholder derivative actions allege, among other things, that current and former directors and officers of MMC breached their fiduciary duties with respect to the alleged misconduct described in the NYAG Lawsuit, are liable to MMC for damages arising from their alleged breaches of fiduciary duty, and must contribute to or indemnify MMC for any damages MMC has suffered. The Delaware Derivative Action is stayed pending a ruling on a motion to dismiss the Southern District of New York securities class action. The derivative action pending in the New York Supreme Court has also been stayed pending resolution of the Federal Derivative Action.
On August 24, 2005, two purported stockholders of MMC filed an action in the Delaware Court of Chancery, allegedly on behalf of MMC and Marsh, Inc., naming MMC’s independent registered public accounting firm as a defendant and alleging claims of breach of professional duty, aiding and abetting and breach of contract against such firm in connection with actions taken by its personnel with respect to MMC and its subsidiaries. The parties to
On February 23, 2005, the plaintiffs in a shareholder derivative suit pending in the Delaware Court of Chancery against the directors and officers of American International Group, Inc. (“AIG”) filed a consolidated complaint which, as subsequently amended, names as additional defendants MMC, Marsh, Inc., Marsh USA Inc., Marsh Global Broking Inc. (collectively, the “MMC Corporate Defendants”), MMC’s former CEO, and five former Marsh employees who have pleaded guilty to certain criminal charges (the former CEO and former employees, together with the MMC Corporate Defendants, the “MMC Defendants”). This action alleges, among other things, that the MMC Defendants, certain AIG employees and others engaged in conspiracy and common law fraud with respect to the alleged misconduct described in the NYAG Lawsuit, including, but not limited to, illegal bid rigging and kickback schemes, and
that AIG was harmed thereby. This action further alleges that the MMC Corporate Defendants aided and abetted the current and former directors and officers of AIG in breaching their fiduciary duties to AIG with respect to AIG’s participation in the alleged misconduct described in the NYAG Lawsuit and that the MMC Corporate Defendants were unjustly enriched. The consolidated complaint asserts that the MMC Defendants are liable to AIG for damages and also seeks the return of all contingent commission payments made by AIG to the MMC Corporate Defendants.
In addition, on May 6, 2005, the plaintiffs in a shareholder derivative suit pending in the United States District Court for the Southern District of New York (the “AIG Federal Suit”) against the directors and officers of AIG filed a consolidated complaint which, as subsequently amended, names MMC, Marsh USA, Inc., Marsh Global Broking, Inc. and MMC’s former CEO as additional defendants and asserts claims against MMC and the former CEO for allegedly aiding and abetting breaches of fiduciary duties by AIG’s directors and officers and for unjust enrichment. The complaint seeks damages and the disgorgement of contingent commissions.
On May 13, 2005, the plaintiffs in a purported securities fraud class action suit pending in the United States District Court for the Southern District of New York against Axis Capital Holdings Limited (“Axis”) and certain of its officers filed a consolidated complaint that named MMC, among others, as an additional defendant. This purported class action is on behalf of all persons and entities that purchased or acquired Axis’s publicly traded common stock during a purported class period from August 6, 2003 to October 14, 2004. The complaint alleges violations of federal securities laws in connection with defendants’ purported failure to disclose alleged improper business practices concerning incentive commission payments by Axis to (among others) Marsh Inc. With regard to MMC, the complaint also alleges that various entities and partnerships managed by or associated with MMC Capital Inc. sold Axis common stock to members of the purported class knowing of the alleged inflated valuation of such stock, and seeks damages for alleged violations of federal securities laws. MMC and the other defendants have moved to dismiss this action.
Following the filing of the NYAG Lawsuit, MMC and certain of its subsidiaries received notices of investigations and inquiries, together with requests for documents and information, from attorneys general, departments of insurance and other state and federal governmental entities in a number of jurisdictions (other than New York) that relate to the allegations in the NYAG Lawsuit. As of February 24, 2006, offices of attorneys general in 22 jurisdictions have issued one or more requests for information or subpoenas calling for the production of documents or for witnesses to provide testimony. Subpoenas, letters of inquiry and other information requests have been received from departments of insurance or other state agencies in 38 jurisdictions. MMC and its subsidiaries are cooperating with these requests from regulators. MMC has been contacted by certain of the above state entities indicating that they may file civil actions or otherwise seek additional monetary or other remedies from MMC. In addition, MMC or its subsidiaries may face administrative
The settlements permit Putnam to apply up to $25 million of the $110 million settlement payment against any amount the IAC determines to be due as restitution to Putnam Fund shareholders. Therefore, any amount of restitution above $25 million requires a separate additional payment by Putnam. In March 2005, the IAC concluded that $108.5 million was the total amount of restitution payable by Putnam to Putnam Fund shareholders. Accordingly, Putnam recorded a charge for $83.5 million ($108.5 million, less $25 million) in 2004. In addition to the $108.5 million in restitution, Putnam Funds shareholders will receive a distribution of $45 million from the civil penalty Putnam previously paid to the SEC. The IAC is acting as the independent distribution consultant and developing a plan that will provide for the distribution of these restitution amounts to Putnam Funds shareholders. Putnam will incur additional costs in connection with implementing the distribution plan.
In a separate action, the SEC is seeking an injunction against two of the former Putnam employees involved in the short-term trading referenced above.
In the Spring of 2004, Putnam received document requests and subpoenas from the Massachusetts Securities Division, NYAG, the SEC and the Department of Labor relating to plan expense reimbursement agreements between Putnam and certain multi-employer deferred compensation plans that are Putnam clients, and also relating to Putnam’s
relationships with consultants retained by multi-employer deferred compensation plans. At that time, the Massachusetts Securities Division took testimony from a number of Putnam employees relating to these matters.
Commencing in 2004, the Enforcement Staff of the SEC’s Boston Office investigated certain matters that arose in the defined contribution plan administration business formerly conducted by Putnam Fiduciary Trust Company (“PFTC”). One of the matters related to the manner in which certain operational errors were corrected in connection with a January 2001 transfer and investment of assets on behalf of a 401(k) defined contribution plan. The manner in which these errors were corrected affected the plan and five of the Putnam Funds in which certain plan assets were invested. Following the discovery of this matter, Putnam notified the regulatory authorities, made restitution to the plan and the affected Putnam Funds and made a number of changes in its personnel and procedures. A second matter related to the source and use of funds paid to a third-party vendor by PFTC in exchange for information consulting services. Putnam has re-processed the payment of these consulting expenses in accordance with Putnam’s corporate expense payment procedures.
Since December 2003, Putnam has received various requests for information from the Department of Labor regarding the Putnam Profit Sharing Retirement Plan, including requests for information relating to (i) Plan governance, (ii) Plan investments, including investments in MMC stock, (iii) the purported ERISA class actions relating to MMC’s receipt of contingent commissions and other matters, which are discussed above, (iv) the market timing-related “ERISA Actions,” which are discussed below, and (v) the suspensions of trading in MMC stock imposed by Putnam on its employees in October and November 2004.
settlement, Putnam reimbursed the Putnam Research Fund in a total amount of $1.65 million. The reimbursement represents a retroactive adjustment to the fee structure from April 1, 1997 (the date when the performance fee was put in effect) through September 27, 2004 (when the performance fee was terminated).
Starting in May 2004, Putnam received and responded to requests for information from the Washington staff of the SEC’s Office of Compliance Inspections and Examinations, in the context of an SEC sweep concerning closed-end fund distributions. In April and July 2005, Putnam received and responded to follow-up requests concerning the same subject matter from the SEC’s Division of Enforcement, which has indicated its belief that Putnam’s issuance of notices to shareholders in connection with dividend payments by certain of Putnam’s closed-end funds did not comply with applicable SEC disclosure requirements. Putnam is currently engaged in discussions with the SEC staff regarding a resolution of this matter.
MMC and Putnam, along with certain of their former officers and directors, were named in a consolidated amended class action complaint (the “MMC Class Action”) purportedly brought on behalf of all purchasers of the publicly-traded securities of MMC between January 3, 2000 and November 3, 2003 (the “Class Period”). In general, the MMC Class Action alleges that the defendants, including MMC, allowed certain mutual fund investors and fund managers to engage in market-timing in the Putnam Funds. The complaint further alleges that this conduct was not disclosed until late 2003, in violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. The complaint alleges that, as a result of defendants’ purportedly misleading statements or omissions, MMC’s stock traded at inflated levels during the Class Period. The suit seeks unspecified damages and equitable relief. In an opinion dated February 27, 2006, the district court granted defendants’ motions to dismiss all claims against them.
Putnam, the derivative suit names as defendants various Putnam affiliates, certain trustees of Putnam Funds, certain present and former Putnam officers and employees, and persons and entities that allegedly engaged in or facilitated market-timing or late trading activities in Putnam Funds. The complaints allege violations of Sections 11, 12(a), and 15 of the Securities Act of 1933, Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, Sections 36(a) and (b), 47 and 48(a) of the Investment Company Act of 1940, and Sections 206 and 215 of the Investment Advisers Act, as well as state law claims for breach of fiduciary duty, breach of contract, unjust enrichment and civil conspiracy. On November 3, 2005, with regard to the class action complaint, the court dismissed all claims against Putnam except for claims alleging violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder and Sections 36(b) and 48(a) of the Investment Company Act of 1940. The court deferred ruling on MMC’s motion to dismiss claims against MMC. With regard to the derivative complaint, the court further dismissed all claims against Putnam and MMC except for claims alleging violations of Section 36(b) and Section 48(a). Putnam has also been named as a defendant in its capacity as a sub-advisor to a non-Putnam fund in a class action suit pending in the District of Maryland against another mutual fund complex.
A consolidated amended complaint asserting shareholder derivative claims has been filed, purportedly on behalf of MMC, against current and former members of MMC’s Board of Directors, two of Putnam’s former officers, and MMC as a nominal defendant (the “MMC Derivative Action”). The MMC Derivative Action generally alleges that the members of MMC’s Board of Directors violated the fiduciary duties they owed to MMC and its shareholders as a result of a failure of oversight of market-timing in the Putnam Funds. The MMC Derivative Action alleges that, as a result of the alleged violation of defendants’ fiduciary duties, MMC suffered damages. The suit seeks unspecified damages and equitable relief. MMC has also received two demand letters from stockholders asking the MMC Board of Directors to take action to remedy alleged breaches of duty by certain officers, directors, trustees or employees of MMC or Putnam, based on allegations of market-timing in the Putnam Funds. The first letter asked to have the Board of Trustees of the Putnam Funds, as well as the MMC Board, take action to remedy those alleged breaches of fiduciary duty. The second letter demanded that MMC commence legal proceedings against the MMC directors, the senior management of Putnam, the Putnam Funds’ Trustees and MMC’s auditor to remedy those alleged breaches of fiduciary duty.
Putnam Investment Management, LLC and Putnam Retail Management Limited Partnership have been sued in the United States District Court for the District of Massachusetts for alleged violations of Section 36(b) of the Investment Company Act of 1940 in connection with the receipt of purportedly excessive advisory and distribution fees paid by certain Putnam Funds in which plaintiffs purportedly owned shares. Plaintiffs seek, among other things, to recover the “excessive” advisory and distribution fees paid to defendants by those funds beginning one year prior to the filing of the complaint, rescission of the management and distribution agreements between defendants and the funds, and a prospective reduction in fees. On March 28, 2005, the Court granted in part and denied in part defendants’ motion to dismiss the complaint. Plaintiffs served an amended complaint on April 4, 2005. On January 19, 2006, the Court granted plaintiffs’ motion for leave to file a second amended complaint, and granted defendants’ motion for partial summary judgment, limiting the scope of the suit to the fees paid by the five Putnam Funds.
Certain Putnam entities have been named as defendants in a suit brought in the District Court of Travis County, Texas by a former institutional client, the Employee Retirement System of Texas (“ERS”). ERS alleges that Putnam breached its investment management agreement and did not make appropriate disclosures to ERS at the time the investment management agreement was executed. Putnam has removed the action to the United States District Court for the Western District of Texas, and ERS has moved to remand the action to state court. Putnam also is awaiting the conclusion of an arbitration process involving similar issues with another former institutional client. Putnam has provided for the estimated liability related to this matter.
Putnam may be subject to employment-related claims by former employees who left Putnam in connection with various regulatory inquiries, including claims relating to deferred compensation. A former Putnam senior executive has notified Putnam of his intention to initiate an arbitration proceeding against Putnam arising from the circumstances of his separation from Putnam. To date, no such action has been commenced.
On May 19, 2005, the SEC issued a subpoena to MMC relating to certain loss mitigation insurance and reinsurance products. The SEC had previously issued a subpoena to MMC in early 2003 relating to loss mitigation products. MMC and its subsidiaries have received similar inquiries from regulators and other authorities in several states. On April 18, 2005, the Office of Insurance Regulation in the State of Florida issued a subpoena to Guy Carpenter & Company, Inc. concerning certain reinsurance products. On May 4, 2005, the Office of Insurance and Fire Safety Commissioner in the State of Georgia issued a subpoena to MMC that requested, among other things, information relating to finite insurance placements. On May 23, 2005, the Office of the Attorney General in the State of Connecticut issued a subpoena to MMC concerning finite insurance. MMC and its subsidiaries are cooperating with these and other informal inquiries.
On February 8, 2005 the Department of Labor served a subpoena on MMC seeking documents pertaining to services provided by MMC subsidiaries to employee benefit plans, including but not limited to documents relating to how such subsidiaries have been compensated for such services. The request also sought information concerning market service agreements and the solicitation of bids from insurance companies in connection with such services. MMC is cooperating with the Department of Labor.
concerning related-party transactions of MMC or MMC subsidiaries in which transactions a director, executive officer or 5% stockholder of MMC had a direct or indirect material interest. On April 29, 2005, MMC received a subpoena from the SEC broadening the scope of the original request. MMC is cooperating in the investigation. Certain current and former employees of MMC have been noticed to testify in connection with this matter.
On February 7, 2005, Olwyco LLC (“Olwyco”) commenced a lawsuit in the United States District Court for the Southern District of New York, and, after voluntarily dismissing that action, subsequently filed a new complaint in New York State Supreme Court, County of New York (the “State Lawsuit”). The claims in the State Lawsuit, which named MMC, Mercer Management Consulting, Inc. (“Mercer Management”) and Mercer Inc. as defendants, arose from a February 21, 2003 agreement in which Mercer Management agreed to purchase substantially all of Olwyco’s assets and, as part of the consideration, to transfer shares of MMC stock to Olwyco in April 2005, 2006 and 2007. Olwyco alleged that the price of MMC stock at the time of the agreement was inflated artificially as a result of a failure to disclose alleged violations of law that later became the subject of the NYAG Lawsuit and the Putnam “market timing” litigation. In December 2005, the parties agreed to settle this matter, and the State Lawsuit has been dismissed with prejudice.
In connection with its acquisition of U.K.-based Sedgwick Group in 1998, MMC acquired several insurance underwriting businesses that were already in run-off, including River Thames Insurance Company Limited (“River Thames”), which MMC sold in 2001. Sedgwick guaranteed payment of claims on certain policies underwritten through the Institute of London Underwriters (the “ILU”) by River Thames (such guarantee being hereinafter referred to as the “ILU Guarantee”). The policies covered by the ILU Guarantee are reinsured up to £40 million by a related party of River Thames. Payment of claims under the reinsurance agreement is collateralized by segregated assets held in a trust. As of December 31, 2005, the reinsurance coverage exceeded the best estimate of the projected liability of the policies covered by the ILU Guarantee. To the extent River Thames or the reinsurer is unable to
During 2005, the management of certain businesses was transferred between operating segments, which included the transfer of the U.S. and U.K. employee benefits businesses from Marsh to Mercer HR and the transfer of certain risk consulting practices from Kroll to Marsh.
Risk and Insurance Services, comprising insurance services (Marsh), reinsurance services (Guy Carpenter), and Risk Capital Holdings;
Includes interest income on fiduciary funds ($151 million in 2005, $130 million in 2004 and $114 million in 2003).
Includes inter-segment revenue ($10 million in 2005 and 2004, and $8 million in 2003).
Total consulting assets are higher than previously reported in 2004 due to the Investment in Delta held by Human Resource Consulting not eliminated after the split of the two consulting product lines. Offset included in Corporate/Eliminations.
MMC has reclassified prior period reported amounts to reflect organizational changes that affected MMC’s reportable segments. The following changes are reflected in the segment data presented below:
The transfer of Marsh’s U.K. employee benefits business from Insurance Services to Human Resource Consulting.
The discontinued operations classifications for the U.S. wholesale broking and claims management businesses, which were previously part of Related Insurance Services.
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, 2005 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2005, in conformity with accounting principles generally accepted in the United States of America.
As disclosed in Note 1 to the consolidated financial statements, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-Based Payment,” effective July 1, 2005.