We own and lease a number of properties for use as offices throughout the world and believe that our properties are generally suitable and adequate for the purposes for which they are used. The principal properties are located in the United Kingdom and the United States. Our headquarters at Ten Trinity Square in London is a landmark building which we own.
The selected consolidated financial data presented below for the period from January 1, 1998 to September 1, 1998 have been derived from the audited consolidated financial statements of our predecessor. Those financial statements were presented in sterling and were prepared in accordance with UK GAAP with a reconciliation of net income from UK GAAP to US GAAP.
•restructuring charges relating to implementation of changes to our North American business processes, which were $11 million for the year ended December 31, 2000, representing excess operating lease obligations, and $7 million for the year ended December 31, 1999, representing employee termination benefits; •restructuring charges relating to the exit from certain US business lines for the year ended December 31, 2000 of $7 million. These consisted of $4 million of employee termination benefits, $1 million relating to excess operating lease obligations and $2 million relating to other costs. See Note 3 to the audited consolidated financial statements of the Company included elsewhere in this report; •charges relating to claims and costs associated with the government initiated review of personal pensions plans sold between 1988 and 1994 of $40 million for the year ended December 31, 1999 and $41 million for the period from January 1 to September 1, 1998. See Note 10 to the audited consolidated financial statements of the Company included elsewhere in this report; and •costs incurred in connection with the acquisition of our predecessor of $18 million for the period from January 1 to September 1, 1998.
(d)As an intermediary, we hold funds in a fiduciary capacity for the account of third parties, typically as a result of premiums received from clients that are in transit to insurance carriers and claims due to clients that are in transit from insurance carriers. We report premiums, which are held on account of, or due from policyholders, as assets with a corresponding liability due to the insurance carriers. Claims held by, or due to, us which are due to clients are also shown as both assets and liabilities of ours. All those balances due or payable are included in insurance and reinsurance balances receivable and payable on the balance sheet. We earn interest on those funds during the time between the receipt of the cash and the time the cash is paid out. Fiduciary cash must be kept in certain regulated bank accounts subject to guidelines, which generally emphasize capital preservation and liquidity and is not generally available to service our debt or for other corporate purposes.
We generate revenue from commissions and fees on insurance placements and fees from consulting and other services. We also earn interest on premiums held before remittance to the insurer and on claims held before payment to the insured.
The majority of our revenue is commission based and varies based upon the premiums on the policies we place on behalf of our clients. As such, when premium rates in the insurance market decline, as they have in certain markets in past years, we experience pressure on our revenues and earnings, and when pricing increases, we tend to benefit, although in both cases there are many conflicting factors, including changes in buying and selling behavior. Beginning in late 2000, market pricing generally began to move upward for the first time in recent years and this continued throughout 2001 and 2002. We anticipate premium rates will continue to rise during 2003.
We conduct our business in over 100 currencies. Accordingly, movements in foreign currency exchange rates affect our results. Our exposure to market risk from foreign currency exchange rates is discussed below under "Financial Risk Management". In the discussion below, we have expressed certain percentage changes in terms of constant currency, meaning that we have translated foreign currency amounts included in the totals for both periods using the same exchange rates rather than the applicable actual exchange rates.
acquisitions was $32 million. Subsequent to the 2002 year-end, we acquired the remaining 22% interest in Willis GmbH and increased our ownership of Willis Iberia to 77%, with our French associate, Gras Savoye, owning the other 23%.
During 2002, we disposed of two third-party administration units and several other non-core businesses. In 2001, we disposed of our 51% interest in Willis National, an independent financial advisory business and the PENCO programs division of our North America Wholesale operation.
These options are accounted for under the variable plan method, which required us to record non-cash compensation charges from the third quarter of 2001 when it became probable that the performance conditions would be satisfied. As a result, we recorded a non-cash charge of $158 million ($132 million, net of tax) in 2001 and a further $80 million ($67 million, net of tax) in 2002. These charges are based on the difference between the price of our stock at the respective year-ends and the exercise price, which is generally £2 per share, with the total cost being spread over the performance period. At the end of 2002, 85% of the total performance period had elapsed and a further 10% will elapse during 2003, which will result in a non-cash charge of approximately $28 million, with the remainder thereafter.
rate of return on plan assets, the expected long-term rate of compensation increase and the discount rate applicable to the plan liabilities.
At December 31, 2002, the Company had gross deferred tax assets of $302 million against which a valuation allowance of $100 million had been recognized. To the extent that the actual future taxable income in the periods during which the temporary differences are expected to reverse differs from current projections, or assumed prudent and feasible tax planning strategies fail to materialize, or new tax planning strategies are developed, or material changes occur in actual tax rates or loss carryforward time limits, the Company may adjust the deferred tax asset considered realizable in future periods. Such adjustments could result in a significant increase or decrease in the effective tax rate and have a material impact on our net income, although management does not believe that this is likely.
Further, as detailed in Note 10 to the financial statements, the Company has established provisions for the costs of the UK review of personal pension plans sold to individuals between 1988 and 1994, for future lease rental payments of leasehold properties surplus to operational requirements and for discontinued operations. Although there remains some uncertainty as to the ultimate liability with respect to these matters, management believes that it is unlikely that the eventual outcome will have a material adverse effect on the Company's reported results.
For a discussion of accounting changes and recent accounting pronouncements, see note 2 of Notes to the Consolidated Financial Statements contained elsewhere in this Report.
Total revenues increased by $311 million (22%) to $1,735 million in 2002 from $1,424 million in 2001. Of this increase in revenues of 22%, approximately 2% arose from the effects of foreign currency exchange rate movements and approximately 2% was attributable to the effects of acquisitions and disposals. Adjusting for these items, total revenues on an underlying basis were 18% higher in 2002 than in 2001. We estimate the increase in revenues was due 55% to net new business growth and 45% due to the impact of higher premium rates prevailing in the market.
Operating income increased by $258 million (160%) to $419 million in 2002 from $161 million in 2001. Excluding the non-cash compensation charge for performance-based stock options ($80 million in 2002 and $158 million in 2001) and the net gain on disposal of operations ($13 million in 2002 and $17 million in 2001), operating income increased by $184 million (61%) to $486 million in 2002 from $302 million in 2001. Of this increase of $184 million, $34 million arose from a change in the basis of amortizing goodwill and other intangible assets as described below. The effect of foreign currency exchange rate movements on operating income in 2002 was not material.
We use revenues less general and administrative expenses (excluding non-cash compensation) as a measure of cash generated by the businesses. Revenues less general and administrative expenses (excluding non-cash compensation), as a percentage of revenues, expanded to 30% from 26% in 2001, calculated as follows:
North America: Revenues generated by our North America business increased by $79 million (16%) to $585 million in 2002 from $506 million in 2001. The disposal of the third-party administration units, offset by the acquisition of Goldman, negatively impacted the increase in revenues by approximately 1%. Adjusting for these items, North America's revenues on an underlying basis increased by 17%. Middle market and upper middle market experienced significant premium rate increases across all lines.
International: Revenues generated by our International business increased by $81 million (46%) to $258 million in 2002 from $177 million in 2001. Of this increase in revenues of 46%, approximately 25% arose from our increased investment in Willis GmbH, which resulted in full consolidation as a subsidiary from January 1, 2002, and other acquisitions. The impact on increased revenues from the effects of foreign currency exchange rate movements was not significant. Adjusting for these items, International's revenues on an underlying basis increased by 21%, led by good performance in Continental Europe, Eastern Hemisphere (especially Australia) and Latin America. We believe that many new business wins resulted from coordinated efforts with our Global specialty businesses.
Net pension expense in 2002 for our defined benefit pension plans was $2 million compared with a credit of $6 million in 2001 and a credit of $3 million in 2000. As a result of lower interest rates and declining values of our pension plan assets, we expect pension expense in 2003 will increase by between $15 million and $20 million.
Operating margin, defined as revenues less general and administrative expenses (excluding non-cash compensation), depreciation and amortization of goodwill and other intangible assets as a percentage of revenues, increased to 21% in 2001 compared with 13% in 2000, calculated as follows:
We use revenues less general and administrative expenses (excluding non-cash compensation) as a measure of cash generated by the business. Revenues less general and administrative expenses (excluding non-cash compensation), as a percentage of revenues, expanded to 26% in 2001 from 19% in 2000, calculated as follows:
Revenues consist of commissions and fees, which increased by $120 million (10%) to $1,357 million in 2001 from $1,237 million in 2000, and interest income, which decreased by $1 million (1%) to $67 million in 2001 from $68 million in 2000.
Global: Revenues generated by our Global business increased by $68 million (10%) to $741 million in 2001 from $673 million in 2000. The effect of foreign exchange rate movements had a negative impact of approximately 2% and the effect of the Willis National disposal in July 2001 had a negative impact of approximately 4% on the 10% increase in revenues. Adjusting for these items, Global's revenues on an underlying basis increased by 16%, with strong new business performance being supplemented by rising premium rates.
International: Revenues generated by our International business increased by $30 million (20%) to $177 million in 2001 from $147 million in 2000. The effect of foreign exchange rate movements had a negative impact of approximately 6% and our acquisitions in Norway, Colombia and South Africa contributed approximately 12% of the 20% increase in revenues. Adjusting for these items, International's revenues on an underlying basis increased by 14%. Most international insurance markets hardened in line with UK and US markets, although rates lagged in some countries.
General and administrative expenses (excluding non-cash compensation for performance-based stock options) were $1,054 million for 2001, down 1% from 2000. Severance and consulting expenses declined by $19 million in 2001 compared with 2000, equivalent to a decline of approximately 2% in expenses from 2000 to 2001. The effect of acquisitions and disposals was approximately 2% and the impact of foreign currency exchange rate movements was approximately 2%. Adjusting for these items, general and administrative expenses on an underlying basis were 5% higher in 2001 than in 2000. Much of this increase related to higher incentive payments arising from improved revenues and operating profits. Excluding these incentives and other expenses linked to revenue growth, expenses were flat in 2001 compared with 2000 as we eliminated waste and improved productivity.
The gain on disposal of $1 million in 2000 arose from the disposal of the business of E J Welton & Co Limited, a small UK-based wholesale broker.
Income tax expense for 2002 amounted to $141 million, an effective rate of 40%. Adjusting for the non-cash compensation charge for performance options, for which approximately 60% of the total charge was non-deductible, acquisitions and disposals, the underlying tax rate for 2002 was 35%.
Equity in net income of our associates rose by $5 million to $9 million in 2002 as most of our associates, led by Gras Savoye in France, reported higher earnings. In 2001, equity in net income of our associates increased by $2 million to $4 million mainly from higher earnings of Gras Savoye and Willis GmbH. Willis GmbH became a subsidiary from January 1, 2002.
Excluding the dividends on our preference shares, which were repaid in June 2001, minority interest increased by $5 million in 2002 to $12 million. This increase was largely due to the consolidation of Willis GmbH from January 1, 2002, when that former associate became a subsidiary, and higher earnings of our less than wholly-owned subsidiaries, notably within Continental Europe. In 2001, minority interest excluding preference dividends increased by $5 million to $7 million as a result of higher earnings and acquisitions during 2000 in Latin America, South Africa and Norway.
Net income in 2002 increased by $208 million to $210 million ($1.28 per diluted share) from $2 million ($0.01 per diluted share) in 2001 and $9 million ($0.07 per diluted share) in 2000.
Net income in both 2001 and 2002 was impacted by the non-cash charge for performance options and the net gain on disposal of operations. Net income in 2001 was also impacted by a non-recurring tax credit and 2000 was impacted by restructuring costs. The change in basis of amortizing goodwill and other intangible assets also affected the comparison.
Management believes that operating cash earnings is a measure helpful to investors because it shows the results of our trading and finance costs without the impact of non-cash and non-recurring items. Operating cash earnings increased by $124 million (84%) in 2002 over 2001 having increased by
(1)The average number of diluted shares outstanding for 2002, used in calculating Operating Cash Earnings per diluted share, assumes that the performance options had been earned in full from the beginning of 2002. Under US GAAP, performance options are only included in the reported average number of diluted shares outstanding from the beginning of the period in which the actual results exceeded the performance targets, which occurred in the third quarter of 2002. Liquidity and Capital Resources
Cash payments in connection with the UK government-initiated review of personal pensions amounted to $12 million in 2002, $18 million in 2001 and $21 million in 2000. We expect expenditures will reduce further in 2003 as the majority of cases have now been settled.
Capital expenditures for 2002, 2001 and 2000, less the proceeds from disposals of fixed assets, were $44 million, $35 million and $23 million, respectively. Much of the increased capital expenditure in 2002 related to information technology systems. This is being managed in a disciplined manner with future information technology expenditures not being committed ahead of cash generation. We expect capital expenditures for 2003 to rise modestly over 2002 levels. We have funded our requirements for capital expenditures by cash generated internally from operations and expect to continue to do so in the future.
Our operating and investing cash flows excluding cash flows related to acquisitions and disposals of subsidiaries and associates, increased to $291 million in 2002 from $184 million in 2001 and $46 million in 2000. We use this measure as a measure of the cash generated by our operations that is available to finance acquisitions, debt repayments and dividends.
Willis North America entered into an interest rate swap agreement on December 4, 1998 with JPMorgan Chase Bank under which its LIBOR-based floating rate interest payment obligations on the full amount of the term loans have been swapped for fixed rate interest payment obligations, resulting in an effective base rate of 5.099% per annum, plus the applicable margin, until the final maturity of those term loans. The swap agreement provides for a reduction of the notional amount of the swap obligation on a semi-annual basis and, to the extent the actual amount outstanding under the term loans exceeds the notional amount at any time, Willis North America would be exposed to the risk of increased interest rates on that excess.
In 1999, Willis North America issued $550 million of 9% senior subordinated notes, the proceeds from which were used to repay short-term facilities. The notes mature on February 1, 2009 and interest is payable on the notes semi-annually on February 1 and August 1 of each year. During 2002 and 2001, Willis North America, using cash from operations, repurchased in the open market and retired $29 million and $111 million, respectively, of these notes. There was no material gain or loss from the repurchase. As of December 31, 2002, the principal amount outstanding was $410 million.
Total long-term debt outstanding at December 31, 2002 was $567 million, down 28% from $787 million at the end of 2001. Total stockholders' equity at December 31, 2002 was $854 million, resulting in a total long-term debt to capital ratio of 40%.
As part of our acquisition of 33% of Gras Savoye, we entered into a put arrangement, whereby the other shareholders in Gras Savoye (primarily two families, two insurance companies and Gras Savoye's executive management team) could put their shares to us. Until 2011, we will be obligated to buy the shares of certain shareholders to the extent that those shareholders put their shares, potentially increasing our ownership from 33% to 90% if all shareholders put their shares, at a price determined by a contractual formula based on earnings and revenue. Management shareholders of Gras Savoye (representing approximately 10% of shares) do not have general put rights before 2011, but have certain put rights on their death, disability or retirement from which payments, at December 31, 2002 based on the formula, would not have exceeded $35 million. Until 2005, the incremental 57% of Gras Savoye may be put to us at a price equal to the greater of approximately 800 million French francs ($128 million at December 31, 2002 exchange rates), or a price based on the formula, which at December 31, 2002 amounted to approximately $197 million. After 2005, the put price is determined solely by the formula. The shareholders may put their shares individually at any time during the put period.
While neither we nor the management of Gras Savoye expect significant exercises of the puts, on a separate or aggregate basis, in the near to medium term, we nevertheless believe that, should the aggregate amount of shares be put to us, sufficient funds would be available to satisfy this obligation. In addition, we have a call option to move to majority ownership under certain circumstances and in any event by 2009. Upon exercising this call option, the remaining Gras Savoye shareholders have a put.
Apart from commitments, guarantees and contingencies, as disclosed in Note 17 of Notes to the Consolidated Financial Statements, the Company has no off-balance sheet arrangements that have, or are reasonably likely to have, a material effect on the Company's financial condition, results of operations or liquidity.
Business-Willis Group Holdings Limited ("Willis Group Holdings") and subsidiaries (collectively, the "Company") provide a broad range of value-added risk management consulting and insurance brokerage services, both directly and indirectly through its associates, to a diverse base of clients internationally. The Company provides specialized risk management advisory and other services on a global basis to clients in various industries, including the construction, aerospace, marine and energy industries. In its capacity as an advisor and insurance broker, the Company acts as an intermediary between clients and insurance carriers by advising clients on risk management requirements, helping clients determine the best means of managing risk, and negotiating and placing insurance risk with insurance carriers through the Company's global distribution network. The Company also provides other value-added services.
and liabilities in currencies other than the functional currency are translated at the rates of exchange prevailing at the balance sheet date and the related transaction gains and losses are reported in the statements of operations. Certain intercompany loans are determined to be of a long-term investment nature. The Company records transaction gains and losses from remeasuring such loans as a component of other comprehensive income.
Accounts receivable are stated at estimated net realizable values. Allowances are recorded, when necessary, in an amount considered by management to be sufficient to meet probable future losses related to uncollectible accounts. The write-off of accounts receivable was $2 million, $2 million and $7 million in the years ended December 31, 2002, 2001 and 2000, respectively.
Investments in Associates-Investments in entities less than 50% owned in which the Company has the ability to exercise significant influence are accounted for by the equity method of accounting whereby the investment is carried at cost of acquisition, plus the Company's equity in undistributed net income since acquisition, less dividends received. Investments in entities less than 20% owned are accounted for by the cost method. Such investments are not publicly traded. The Company periodically reviews its investments in associates for which fair value is less than cost to determine if the decline in value is other than temporary. If the decline in value is judged to be other than temporary, the cost basis of the investment is written down to fair value. The amount of any write-down is included in the results of operations as a realized loss.
Derivative Financial Instruments-The Company uses derivative financial instruments for other than trading purposes to alter the risk profile of an existing underlying exposure. Interest rate swaps are used to manage interest risk exposures. Forward foreign currency exchange contracts are used to manage currency exposures arising from future income. The fair value of derivative contracts are recorded in other assets and other liabilities with changes in fair value of effective hedges recorded in other comprehensive income and changes in fair value of ineffective hedges recorded in general and administrative expenses. Amounts are reclassified from other comprehensive income into earnings when the hedged exposure affects earnings.
Income Taxes-The Company accounts for income taxes under the provisions of SFAS No. 109, Accounting for Income Taxes ("SFAS 109"). SFAS 109 requires recognition of deferred tax assets and liabilities for the estimated future tax consequences of events attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating and capital loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted rates in effect for the year in which the differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of changes in tax rates is recognized in the statement of operations in the period in which the enactment date changes. Deferred tax assets and liabilities are reduced through the establishment of a valuation allowance at such time as, based on available evidence, it is more likely than not that the deferred tax assets will not be realized.
Stock-Based Compensation-The Company accounts for its stock option and stock-based compensation plans using the intrinsic-value method prescribed in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB 25"). Accordingly, the Company computes compensation costs for each employee stock option granted as the amount by which the quoted market price (or estimated fair value for options granted before the initial public offering) of the Company's shares on the date of the grant exceeds the amount the employee must pay to acquire the shares. As required by SFAS No. 123, Accounting for Stock-Based Compensation ("SFAS 123"), the Company has included, in Note 13, the required SFAS 123 pro forma disclosures of net income and net income per share as if the fair value-based method of accounting had been applied.
The Company takes credit for commissions (or fees negotiated in lieu of commission) in respect of insurance placements at the date when the insured is billed or at the inception date of the policy, whichever is later. Commissions on additional premiums and adjustments are recognized as and when advised. Fees for consulting services are recorded as the services are provided or, for short-term projects, on completion of the project. Fees for other services, including captive management and third party administration, are recognized over the period for which the services are rendered. The Company establishes contract cancellation reserves where appropriate. At December 31, 2002, 2001 and 2000, such amounts were not material.
Commissions receivable from insurance carriers such as commissions contingent on the performance of insurance policies placed are recognized at the earlier of the date when cash is received, or when formal, written notification of the actual amount due is received from the insurance carrier. If some of the commissions received are potentially subject to full or partial repayment to the carrier, then recognition is deferred until the conditions for repayment have passed. Interest income is recognized as earned.
Accounting Changes and Recent Accounting Pronouncements-SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS 133") as amended by SFAS No. 137, Accounting for Derivative Instruments and Hedging Activities-Deferral of the Effective Date of FASB Statement No. 133, and SFAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities, was effective for the Company from January 1, 2001. SFAS 133 requires that all derivative instruments be recorded on the balance sheet at fair value. Gains or losses resulting from changes in the value of derivatives are accounted for depending on the intended use of the derivative and whether they qualify for hedge accounting. The adoption of SFAS 133, effective January 1, 2001, resulted in an increase in other comprehensive income, net of tax, of $8 million reported as the cumulative effect of adopting an accounting principle.
The Company recorded a restructuring charge of $18 million primarily for employee termination benefits and excess operating lease obligations as a result of restructuring plans during the year ended December 31, 2000.
In 2000, the Company developed a plan to exit certain business lines including the sale of the municipality business of Public Entities National Company ("PENCO"), part of the US wholesale operations, and the sale of certain other non-strategic businesses. As a result of this plan, it was expected that approximately 250 employees would be terminated. The sale of the municipality business of PENCO was completed in January 2001 and the sale of certain third party administration businesses were completed during 2002. Restructuring charges of $7 million were recorded by the Company in the fourth quarter of 2000, representing $4 million of employee termination benefits and $3 million of other exit costs relating to these plans. At December 31, 2002, 239 employees had been transferred or terminated.
The amounts used in the year ended December 31, 2002, were $3 million (2001: $6 million; 2000: $10 million) representing employee termination benefits of $nil (2001: $3 million; 2000: $6 million) and excess operating lease obligations and other exit costs of $3 million (2001: $3 million; 2000: $4 million). Consequently, at December 31, 2002, the balance of restructuring charges was $6 million (2001: $9 million; 2000: $15 million), representing employee termination benefits $2 million (2001: $2 million; 2000: $5 million) and excess operating lease obligations and other exit costs of $4 million (2001: $7 million; 2000: $10 million).
The Company adopted SFAS No. 142, Goodwill and Other Intangible Assets ("SFAS 142"), with effect from January 1, 2002. Upon initial adoption of SFAS 142, reclassification of the carrying amounts of previously acquired intangible assets was not required.
Acquisitions-On January 1, 2002 the Company acquired a further 22%, in addition to the 45% already owned, in Willis GmbH, Germany's third largest insurance broker, to improve the Company's market position and broaden its global offering and capabilities on behalf of its clients. Accordingly, Willis GmbH has been accounted for as a subsidiary from January 1, 2002. A further 11% interest was acquired on September 30, 2002. The aggregate cash purchase price for the further 33% interest was $23 million, of which $5 million was deferred to 2003. The Company initially recorded goodwill of $20 million pending completion of the purchase price allocation. In January 2003, the Company acquired the remaining 22% interest in Willis GmbH.
During 2002, in addition to the acquisition of Willis GmbH, the Company also acquired, or increased its investments in, a number of other businesses. The aggregate purchase price of these acquisitions approximated $9 million, inclusive of deferred payments amounting to $4 million. During 2001 and 2000, the Company acquired, or increased its investments in, a number of businesses. The aggregate purchase price of all acquisitions completed during 2001 and 2000 approximated $25 million and $12 million, respectively, inclusive of deferred payments amounting to $4 million in 2000. Additional consideration of up to $4 million is payable in future periods contingent upon future revenues of the acquired businesses reaching specified thresholds.
Dispositions-In November 2002, the Company completed the sale of its Life and Health third-party administration business. The gain on disposal of $14 million included a goodwill write off of
$3 million and has been recorded in the statement of operations. Total proceeds relating to other disposals in 2002 were not material.
The Company recognizes a deferred tax liability related to the undistributed earnings of subsidiaries when the Company expects that it will recover those undistributed earnings in a taxable
Unaudited condensed financial information for associates, in the aggregate, as of and for the years ended December 31, is presented below. For convenience purposes: (i) balance sheet data has been
(1)Cash and cash equivalents primarily consist of time deposits and certificates of deposit with original maturities of three months or less.
Provisions as of and for the years ended December 31, are as follows:
The claims provision represents management's assessment of liabilities that may arise from asserted and unasserted claims for errors and omissions that arise in the ordinary course of the Company's business. Where some of the potential liability is recoverable under the Company's external insurance arrangements, the full assessment of the liability is included in the provision with the associated insurance recovery shown separately as an asset. There were no insurance recoveries recognized as of December 31, 2002 and 2001.
The surplus properties provision relates to future lease rentals of leasehold properties which are surplus to the Company's operational requirements. The provision amount represents the discounted contracted lease payments less an allowance for future rental income.
The provision for discontinued operations includes estimates for future costs of administering the run-off of the Company's former US and UK underwriting operations. The US underwriting operation was disposed of in 1986 and put into liquidation in 1994. In the UK, Willis Faber (Underwriting Management) Limited ("WFUM"), a wholly-owned subsidiary of the Company provided underwriting
agency and other services to certain insurance companies including Sovereign Marine & General Insurance Company Limited ("Sovereign") (in Scheme of Arrangement) (collectively, the "stamp companies") and in 1991 ceased arranging new business on behalf of the stamp companies. Willis Faber Limited has agreed with certain of the stamp companies to fund certain costs of the run-off, subject to agreed guidelines as to timing and amount. Although the Company expects the run-off to be conducted in an orderly manner, it may ultimately prove to be a lengthy and expensive process. The amounts to be funded under the run-off arrangements are currently within the aggregate of the provisions made.
Pursuant to the credit agreement, the Company makes loan repayments based on the amortization schedule specified in the credit agreement. In addition, during 2002, 2001 and 2000, the Company made non-mandatory early repayments totaling $191 million, $60 million and $30 million, respectively. As a consequence, the Company's next scheduled repayment under the facility is not due until 2005. For the years ended December 31, 2002 and 2001, the weighted-average interest rate relating to all loans under the Senior Credit Facility ranged from 2.75% to 4.31% and 5.63% to 6.88%, respectively; net of an interest rate swap, the ranges were 6.02% to 7.58% and 6.26% to 7.50%, respectively.
The revolving credit facility is available for working capital requirements and general corporate purposes, subject to certain limitations, until 2005. The revolving credit facility is available for loans denominated in US dollars, pounds sterling and certain other currencies and for letters of credit, including to support loan note guarantees.
The credit agreement contains numerous operating and financial covenants, including, without limitation, requirements to maintain minimum ratios of adjusted earnings before interest, tax, depreciation and amortization ("EBITDA"), to interest and maximum levels of indebtedness in relation to adjusted EBITDA. In addition, the credit agreement includes covenants relating to limitation on liens, limitations on sales and other disposals of assets, limitations on indebtedness and other liabilities, limitations on capital expenditures, limitations on investments, mergers, acquisitions, loans and advances, limitations on dividends and other distributions, limitations on prepayment, redemption or amendment of the senior subordinated notes, maintenance of property, environmental matters, employee benefit matters, maintenance of insurance, nature of business, compliance with applicable
laws, corporate existence and rights, payment of taxes and access to information and properties. At December 31, 2002, the Company was in compliance with all covenants.
9% Senior Subordinated Notes-In February 1999, Willis North America refinanced a short-term loan by issuing 9% senior subordinated notes due 2009 (the "Notes") in the aggregate principal amount of $550 million. The interest on the Notes is payable semi-annually on February 1 and August 1.
From and after February 1, 2004, Willis North America may redeem the Notes, in whole or in part, at a redemption price equal to 104.5% of the aggregate principal amount of the Notes being redeemed in 2004, which percentage declines by 1.5% per annum over the next years to 100% in 2007, plus accrued and unpaid interest.
During 2002 and 2001, Willis North America bought back and canceled Notes totaling $29 million and $111 million, respectively. The difference between the market price paid and the book value was not material.
The indenture for the Notes contains covenants that, among other things, limit the ability of Willis North America, Willis Group Limited, Willis Partners and some of their subsidiaries to incur additional indebtedness and issue preferred stock; pay dividends or make other distributions; repurchase capital stock or subordinated indebtedness; create liens; enter into some transactions with associates; sell assets and assets of subsidiaries; issue or sell capital stock of some subsidiaries; and enter into some mergers and acquisitions. At December 31, 2002, the Company was in compliance with all covenants.
Two of Willis Group Holdings' wholly owned subsidiaries, Willis Group Limited and Willis Partners, have jointly and severally and fully and unconditionally guaranteed the prompt and complete performance of Willis North America in respect of the Notes.
Scheduled Debt Repayments-Aggregate maturities of long-term debt for the five years subsequent to December 31, 2002 are as follows:
Lines of Credit-The Company also has available $2 million in lines of credit, of which $nil (2001: $nil) was drawn as of December 31, 2002 (excluding the $150 million revolving credit facility).
Willis North America has a 401(k) plan covering all eligible employees of Willis North America and its subsidiaries. The plan allows participants to make pre-tax contributions and the Company provides a matching contribution of 3% of employees' annual eligible compensation. All investment assets of the plan are held in a trust account administered by independent trustees. The Company's 401(k) mandatory matching contributions for 2002, 2001 and 2000 were approximately $5 million, $5 million and $6 million, respectively.
The Company has two principal defined benefit pension plans funded externally which cover all eligible employees. One plan exists in the UK and the other in the US. It is the Company's policy to fund pension costs as required by applicable laws and regulations.
The weighted-average actuarial assumptions utilized in determining the above amounts for the UK and US defined benefit plans were as follows:
The projected benefit obligation, accumulated benefit obligation and fair value of plan assets for the US plan with accumulated benefit obligations in excess of plan assets were $416 million, $384 million and $303 million, respectively, as of December 31, 2002. The projected benefit obligation, accumulated benefit obligation and fair value of plan assets for the UK plan with accumulated benefit obligations in excess of plan assets were $1,190 million, $1,155 million and $1,020 million, respectively, as of December 31, 2002.
Time-based options are earned upon the fulfilment of vesting requirements. Options are generally exercisable in equal instalments of 20% per year over a five-year period commencing on or after December 18, 2000.
2001 Share Purchase and Option Plan-This plan, which was established on May 3, 2001, provides for the granting of time-based options and various other share-based grants at fair market value to employees of the Company. There are 10,000,000 shares available for grant under this plan. Options are exercisable from the third, sixth or eighth anniversary of grant, although for certain options the exercisable date may accelerate depending on the achievement of certain performance goals. Unless terminated sooner by the board of directors, the 2001 Plan will expire 10 years after its adoption. That termination will not affect the validity of any grant outstanding at that date.
Compensation expense resulting from awards under variable plans (performance-based options) is measured as the difference between the quoted market price and the exercise price at the date when the number of shares is known (the date the performance conditions are satisfied). The cost is recognized over the period the employee performs related services. Estimates of compensation expense were recorded before the measurement date based on the quoted market price of the shares at the intervening dates in situations where it was probable that the performance conditions would be attained.
Had compensation expense for such plans been determined consistent with the fair value method prescribed by SFAS 123 using the Black-Scholes option-pricing model, the Company's pro forma net income and net income per share would have been:
(1)Certain options are exercisable at £2 per share. Year-end exchange rates of £1 = $1.61, £1 = $1.45 and £1 = $1.50 have been used as of December 31, 2002, 2001 and 2000, respectively. A summary of time-based options outstanding and exercisable at December 31, 2002 is as follows:
Interest Rate Risk-The Company's operations are financed principally through the Senior Credit Facility, which has a variable interest rate and the Notes, which have a 9% fixed interest rate. Interest rate swaps are used to generate the desired interest rate profile and to manage the Company's exposure to interest rate fluctuations.
The Company has designated the interest rate swap agreement as a cash flow hedge as defined by SFAS 133 with the fair value recorded in other liabilities on the balance sheet. Changes in fair value are recorded as a component of other comprehensive income. Gains of $1 million were recorded for the year ended December 31, 2002 (2001: loss $9 million). Amounts are reclassified from other comprehensive income into earnings when the hedged exposure affects earnings.
As a result of the Company's operating activities, the Company receives cash for premiums and claims which it deposits in short-term investments denominated in US dollars and other currencies. The Company earns interest on these funds, which is included in the Company's financial statements as interest income. These funds are regulated in terms of access and the instruments in which they may be invested, most of which are short-term in maturity. In order to manage interest rate risk arising from these financial assets, the Company enters into interest rate swaps to receive a fixed rate of interest and pay a variable rate of interest fixed in the various currencies related to the short-term investments. The use of interest rate contracts essentially converts groups of short-term investments to fixed rates.
income relating to changes in fair value on contracts which are effective cashflow hedges as defined in SFAS 133 (2001: gain $8 million). For contracts which were not designed for hedge accounting as defined in SFAS 133, the Company has recorded losses of $1 million in general and administrative expenses representing the change in fair value for the year ended December 31, 2002 (2001: gain $8 million).
Foreign Currency Risk-The Company's objective is to maximize its cash flow in US dollars. In all locations with the exception of the UK, the Company predominantly generates revenues and expenses in the local currency. In the UK, however, the Company earns revenues in a number of different currencies but expenses are almost entirely in pounds sterling. This mismatch creates a currency exposure.
The table below summarizes by major currency the contractual amounts of the Company's forward contracts to exchange foreign currencies for pounds sterling. Foreign currency notional amounts are reported in US dollars translated at spot rates at December 31.
(1)Forward exchange contracts range in maturity from 2003 to 2005. Credit Risk and Concentrations of Credit Risk-Credit risk represents the accounting loss that would be recognized at the reporting date if counterparties failed to perform as contracted and from movements in interest rates and foreign exchange rates. The Company does not anticipate non-performance by counterparties. The Company generally does not require collateral or other security to support financial instruments with credit risk; however, it is the Company's policy to enter into master netting arrangements with counterparties as practical.
As of December 31, 2002, the aggregate future minimum rental commitments under all non-cancellable operating lease agreements are as follows:
Rent expense amounted to $71 million, $63 million and $66 million for the years ended December 31, 2002, 2001 and 2000, respectively. The Company's rental income from subleases was $9 million, $6 million and $4 million for the years ended December 31, 2002, 2001 and 2000, respectively.
such guarantees amounted to $140 million and $120 million at December 31, 2002 and 2001, respectively.
In addition, the Company has given guarantees to bankers and other third parties relating principally to letters of credit amounting to $8 million and $7 million at December 31, 2002 and 2001, respectively.
Put and Call Options Relating to Subsidiaries and Associates-For certain subsidiaries and associates, the Company has the right to purchase shares (a call option) from co-shareholders at various dates in the future. In addition, the co-shareholders of certain subsidiaries and associates have the right to sell (a put option) their shares to the Company at various dates in the future. Generally, the exercise price of such puts and calls is formula-based (using revenues and earnings) and is designed to reflect fair value. Based on current projections of profitability and exchange rates, the potential amount payable in 2003 from these options is not expected to exceed $246 million. Of this balance, $197 million relates to Gras Savoye, as disclosed in Note 7.
Claims, Lawsuits and Proceedings-The Company is subject to various actual and potential claims, lawsuits and proceedings relating principally to alleged errors and omissions in connection with the placement of insurance and reinsurance in the ordinary course of business. Similar to other corporations, the Company is also subject to a variety of other claims, including those relating to the Company's employment practices. Some of those claims, lawsuits and proceedings seek damages in amounts which could, if assessed, be significant.
Most of the claims, lawsuits and proceedings arising in the ordinary course of business are covered by professional indemnity or other appropriate insurance. In respect of self-insured deductibles, the Company has established provisions against these items which are believed to be adequate in the light of current information and legal advice, and the Company adjusts such provisions from time to time according to developments. On the basis of current information, the Company does not expect that the outcome of the actual claims, lawsuits and proceedings to which the Company is subject or potential claims, lawsuits and proceedings, either individually or in the aggregate, will have a material adverse effect on the Company's financial condition, results of operations or liquidity.
(3)Other than in the UK and the US, the Company does not conduct business in any country in which its commissions and fees and/or long-lived assets exceed 10% of consolidated commissions and fees and/or long-lived assets, respectively. The Company has not reported revenues from external customers for each product and service or each group of similar products and services as the Company's internal systems do not allow for the generation of such information.
In addition, the Company and Fisher Capital Corp. LLC entered into a share option agreement dated January 27, 1999, whereby the Company granted to Fisher Capital Corp. LLC 422,501 options to purchase an equivalent number of shares. The options vest upon grant date and are exercisable any time up to January 27, 2014. During 2002, options over 38,341 shares were exercised. The fair value of the options, computed on grant date using the Black-Scholes option-pricing model and assuming a dividend yield of 0%, expected volatility of 30%, a risk-free interest rate of 6.42% and a weighted-average expected life of three years, amounts to $334,905. This cost may not be indicative of the future benefit to be received by Fisher Capital Corp. LLC. Mr. J.R. Fisher, as the managing member and majority owner of Fisher Capital Corp. LLC may be deemed to share beneficial ownership of any options owned by Fisher Capital Corp. LLC but disclaims such beneficial ownership.
During 2000, Willis North America acquired from Mr. J.J. Plumeri, the Chairman and Chief Executive Officer of Willis Group Holdings, a 121/2% undivided interest in a Citation V Ultra Aircraft for $693,719; as of December 31, 2000, this balance was recorded as a payable. This transaction was consummated on terms equivalent to those that prevail in arm's-length transactions.