Aon has offices in various locations throughout the world. Substantially all of our offices are located in leased premises. The Company's executive offices occupy approximately 530,000 square feet at 200 E. Randolph Street, Chicago, Illinois, under an operating lease agreement that expires in 2013. There are two five-year renewal options at current market rates.
•incurred $46 million in 2007 for workforce reduction and lease consolidation costs, asset impairments and other associated costs, and
These items are discussed further in the remainder of this Management's Discussion and Analysis.
Over the last three years, we have sold the following additional businesses that are also included in discontinued operations:
We estimate our one-time workforce reduction costs related to exit and disposal activities not resulting from an ongoing severance plan based on the benefits available to the employees being terminated. We recognize these costs when we:
2.Assets with unrealized losses due to market conditions or industry-related events.
These increases in expenses were partially offset by a $30 million decrease in depreciation and amortization due to lower write-offs and a lower depreciable base than the prior year.
Differences between the overall effective tax rate and the U.S. federal statutory rate are typically due to U.S. state income taxes and differences between U.S. and international tax rates. Changes in the mix between our U.S. and international pretax income directly affect our effective tax rates. In 2007 and 2006, our effective tax rate also reflects the favorable resolution of tax examination issues, adjustments, and tax credits. In addition, our 2007 rate was impacted by changes in corporate tax rates in certain foreign countries, most notably in the United Kingdom, which reduced the enacted corporate tax rate from 30% to 28%. While the lower U.K. tax rate will benefit Aon's recurring effective tax rate in future periods, we had to remeasure our U.K. deferred tax assets using the new enacted tax rate, resulting in a one-time non-cash expense of $24 million. For a summary of these effects, please see the rate reconciliation provided in Note 8 to the consolidated financial statements.
•Europe, Middle East & Africa revenue increased 7% to $1.6 billion, as a result of acquisitions and organic growth in our retail business.
To compute income per share in 2005, we deducted dividends paid on the redeemable preferred stock from net income. The redeemable preferred stock was redeemed and retired in September 2005.
•$272 million in 2006 ($0.86 and $0.80 per basic and dilutive net income per share, respectively). 2006 discontinued operations include full year results for CICA and Sterling ($0.56 and $0.52 per basic and dilutive net income per share, respectively) and eleven months of operations and gain on sale of AWG and CPG ($0.27 and $0.25 per basic and dilutive net income per share, respectively.)
Aon classifies its businesses into two operating segments: Risk and Insurance Brokerage Services and Consulting (see Note 16 to the consolidated financial statements for further information).
Pretax income increased $196 million or 23% from 2006 to $1,037 million. In 2007, pretax margins in this segment were 17.1%, up 220 basis points from 14.9% in 2006. Contributing to increased margins and pretax income were:
•our net recognized losses and unrecognized prior service credits decreased by $106 million.
•origination and sale of eligible premium finance agreements to the Bank SPEs increase available advances, and
Aon classifies its businesses into two operating segments: Risk and Insurance Brokerage Services and Consulting. Unallocated income and expense, when combined with the operating segments and after the elimination of intersegment revenues, totals to the amounts included in the consolidated financial statements. Results relating to Aon's accident, health and life operations, which were previously reported in a separate Insurance Underwriting segment, have been reclassified to discontinued operations for all periods presented. The remaining operations that were previously reported in the Insurance Underwriting segment, which relate to property and casualty insurance that is in runoff, are now included in unallocated income and expense for all periods presented.
Securities on deposit with insurance regulatory authorities related to the Company's runoff property and casualty operations amounted to $5 million at December 31, 2007.
The amount of income taxes paid in 2007, 2006 and 2005 was $121 million, $431 million and $197 million, respectively.
The following table provides the components of net periodic benefit cost for the plans:
Estimated future benefit payments for plans are as follows at December 31, 2007:
Upon adoption of Statement No. 123(R), Aon changed its method of valuation for stock options granted beginning in 2006 to a lattice-binomial option-pricing model from the Black-Scholes option-pricing model, which was previously used for Aon's pro forma information required under Statement No. 123. Lattice-based option valuation models utilize a range of assumptions over the expected term of the options. Expected volatilities are based on the average of the historical volatility of Aon's stock price and the implied volatility of traded options and Aon's stock. Aon uses historical data to estimate option exercise and employee terminations within the valuation model, stratifying between executives and key employees. The expected dividend yield assumption is based on the Company's historical and expected future dividend rate. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.
Aon has an employee stock purchase plan that provides for the purchase of a maximum of 7.5 million shares of Aon's common stock by eligible U.S. employees. Under the plan, shares of Aon's common stock may be purchased at 3-month intervals at 85% of the lower of the fair market value of the common stock on the first or the last day of each 3-month period. In 2007, 2006, and 2005, 405,000 shares, 457,000 shares and 697,000 shares, respectively, were issued to employees under the plan. Compensation expense recognized was approximately $3 million in both 2007 and 2006. There was no compensation expense associated with this plan in 2005.
Aon also uses foreign currency forward contracts to hedge certain of its net investments in foreign underwriting operations (primarily Canadian dollar, Euro and British pound). During 2007 and 2006, this hedge had no ineffectiveness, and a $26 million and $24 million cumulative pretax loss has been included in OCI at December 31, 2007 and 2006, respectively.
In 2005, Aon subsidiaries entered into cross-currency swaps to hedge the foreign currency risks associated with foreign denominated fixed-rate term intercompany borrowings. These swaps have been designated as cash flow hedges. As of December 31, 2007, an $8 million pretax gain had been deferred to OCI, of which a $2 million pretax loss is expected to be reclassified to earnings in 2008 as an adjustment to interest expense. The reclassification from OCI will offset the related transaction gain or loss arising from the remeasurement of the borrowing due to changes in spot exchange rates and to record interest income at the interest rate implicit in the derivative. This hedge had no material ineffectiveness in 2007 or 2006.
The changes in the net carrying amount of goodwill by operating segment for the years ended December 31, 2007 and 2006, respectively, are as follows: