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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549


FORM 10-K

(Mark One) 

ý

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]

For the fiscal year ended December 31, 20022005


OR

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]

Commission file number: 1-7933

Commission File Number: 1-7933


Aon Corporation
(Exact Name of Registrant as Specified in itsIts Charter)

DELAWARE
(State or Other Jurisdiction of
Incorporation or Organization)
36-3051915
(I.R.S. Employer
Identification No.)

200 E. RANDOLPH STREET
CHICAGO, ILLINOIS

(Address of Principal Executive Offices)
(312) 381-1000
(Telephone Number)


60601
(Zip Code)

Securities registered pursuant to Section 12(b) of the Act:


(312) 381-1000
(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class

Name of Each Exchange
on Which Registered


Common Stock, $1 par value

New York Stock Exchange


Securities registered pursuant to Section 12(g) of the Act: NONE


        Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES ý    NO o

        Indicate by check mark if the registrant is not required to file reports pursuant to Section 12(g)13 or Section 15(d) of the Act: Exchange Act. YES o    NO NONEý

        Indicate by check mark whether the Registrantregistrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrantregistrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

YES ý    NO o

        Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant'sregistrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.

YES ý    NO o

        Indicate by check mark whether the Registrantregistrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer" and "large accelerated filer" in Rule 12b-2 of the Exchange Act.

Large accelerated filer    ý                Accelerated filer    o                Non-accelerated filer    o

        Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act Rule 12b-2)Act).

YES ýo    NO oý

        AggregateAs of June 30, 2005, the aggregate market value of the registrant's common stock held by non-affiliates of the Registrantregistrant was $7,361,791,926 based on the closing sales price as of June 28, 2002 was $7,201,145,049.reported on the New York Stock Exchange—Composite Transaction Listing.

        Number of shares of common stock outstanding as of February 28, 2003January 31, 2006, was 311,518,091.321,956,147.


Documents From Which Information is Incorporated By Reference:
incorporated by reference

        Portions of Aon Corporation's Proxy Statement and 2002 Annual Financial and General Information Report for the 2006 Annual Meeting of Stockholders to be held on May 16, 2003 (Part III)19, 2006 are incorporated by reference in this Form 10-K in response to Part III, Items 10, 11, 12, 13 and 14.







PART I

Item 1.    Business.

        The Registrant is a holding company whoseOVERVIEW

        Aon Corporation ("Aon"), through its various subsidiaries worldwide, serves its clients through three operating subsidiaries carry on business in three distinct operating segments: (i)

        Our clients include corporations and businesses, insurance companies, professional organizations, independent agents and brokers, governments and other services; (ii) consulting;entities. We also serve individuals through personal lines, affinity groups and (iii) insurance underwriting.certain specialty operations.

        Incorporated in 1979, itAon is the parent corporation of long-established and more recently formed companies. Aon has approximately 46,600 employees and does business in more than 120 countries and sovereignties.

SEGMENT OPERATIONS

Risk and Insurance Brokerage Services

        The Risk and Insurance Brokerage and Other Services segment consists principallygenerated approximately 55% of Aon's retail, reinsuranceour total operating segment revenues in 2005. This is the largest of our operating segments, with approximately 29,400 employees worldwide. Risk and wholesaleinsurance brokerage as well asand related insurance services, including claims services, underwriting management, captive insurance company management services and premium financing. These services are provided by certain indirect subsidiaries, of the Registrant, including:including Aon Risk Services Companies, Inc.; Aon Holdings International bv; Aon Services Group, Inc.; Aon Re Worldwide,Global, Inc.; Aon Limited (U.K.); and Cananwill, Inc., which are subsidiaries of Aon Group, Inc. (Aon Group).

Subsegments

        The ConsultingWe measure our revenues in this segment provides a full range of human capitalunder the following areas:

Risk Management and Insurance Brokerage encompasses our retail brokerage services, affinity products, managing general underwriting, placement and captive management services utilizing five practices: employee benefits; compensation; management consulting; outsourcing; and communications. Thesepremium finance services are provided primarily by subsidiariesfor small, mid-sized and affiliates of Aon Consulting Worldwide, Inc., which is also a subsidiary of Aon Group.

        Aon's Insurance Underwriting segment is comprised of supplemental accident and health and life insurance and extended warranty and casualty insurancelarge companies, including Fortune 500 corporations. The Americas' operations provide products and services. Combined Insurance Company ofservices to clients in North and South America, ("Combined Insurance") engages in the marketingCaribbean and underwriting of accident and health and life insurance products. Combined Specialty Insurance Company (formerly known as Virginia Surety Company, Inc.) and London General Insurance Company LimitedBermuda. Our International operations offer extended warranty and casualty insurancesimilar products and services.

        In November 2000,services to clients throughout the Registrant announced a business transformation plan, which began in fourth quarter 2000 and was completed in 2002. The transformation plan affected each operating segment; however, most changes affected the largest operating segment, Insurance Brokerage and Other Services, and occurred in the major countries of operation, the U.S. and the United Kingdom.

        In April 2001, the Registrant announced a plan to spin off its insurance underwriting businesses to Aon's common stockholders, to create two independent, publicly-traded companies. In August 2002, the Company announced that it was no longer planning to spin off allrest of the underwriting businesses, but was considering a sale or partial spin-off. At that time, a sale of all or part of the underwriting operations, at an acceptable price, was believed to be achievable within a reasonable timeframe, especially given unsolicited buying interest in the past. While the Registrant received indications of interest in the underwriting businesses, none were in an acceptable price range due to the unfavorable mergers and acquisitions environment resulting from volatile capital markets. Proceeds from a sale of such businesses would have allowed Aon to pay down short-term debt, but would have resulted in unacceptable earnings dilution. A spin-off of part of the underwriting operations was determined to be impractical due to capital requirements. Therefore, on October 31, 2002, the Registrant announced that it had decided not to sell, or spin off, its major underwriting subsidiaries. In fourth quarter 2002, the Registrant announced its plans to sell Sheffield Insurance Corporation, a small property-casualty company, which was completed in first quarter 2003. In February 2003, the Registrant announced that it would be discontinuing its accident and health insurance underwriting operations in Mexico, Argentina and Brazil, as well as its large company group life business in the U.S. The Registrant will pursue a "back to basics" strategy in the accident and health insurance business, where the focus will be on core products and regions with the best returns on investments.

        During 2002, the Registrant incurred approximately $50 million of expenses related to the planned divestiture of its insurance underwriting businesses which included costs related to the expanded

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corporate and underwriting staff that was added in contemplation of the divestiture. These costs, recorded primarily in general expenses in the consolidated statements of income, represent staff buildup and severance costs, corporate overhead and advisory fees and other costs tied to the specialty property and casualty underwriting initiatives which will not be pursued.

        In November 2002, the Registrant completed a public offering of 36.8 million shares of its common stock, raising net proceeds of approximately $607 million. The offering was made pursuant to an existing shelf registration statement. Also in November 2002, the Registrant completed a separate private offering of $300 million aggregate principal amount of 3.5% senior convertible debentures due 2012. Net proceeds from this offering were approximately $296 million. The debentures are unsecured obligations and, under certain circumstances, are convertible into common stock at an initial conversion price of approximately $21.475 per common share. The debentures were sold to qualified institutional buyers. In January 2003, the Registrant filed a registration statement with the Securities and Exchange Commission to register the resale of the debentures. In December 2002, the Registrant completed a private offering of $225 million aggregate principal amount of 7.375% senior notes due 2012. Net proceeds from this offering were approximately $223 million. The notes were sold to qualified institutional buyers. The Registrant used the net proceeds from these offerings to repay outstanding commercial paper and other short-term debt, to partially repurchase certain debt securities that were due in 2003 and 2004 and to repurchase $98 million of the Registrant's 8.205% Mandatorily Redeemable Preferred Capital Securities. In January 2003, a portion of the remaining funds were utilized to repay $150 million of maturing LIBOR + 1% debt securities.

        The Registrant hereby incorporates by reference note 5, "Business Transformation Plan," and note 16, "Segment Information," of the Notes to Consolidated Financial Statements in Part II, Item 8 of this report, as well as information under the heading "Review by Segments" in Management's Discussion and Analysis of Financial Condition and Results of Operations in Part II, Item 7 of this report.

Competition and Industry Position

(1)  Insurance Brokerage and Other Services

Aon Group, Inc.; Aonworld. Risk Services Companies, Inc.; Aon Limited (U.K.); Aon Holdings International bv; Aon Services Group, Inc.; Aon Re Worldwide, Inc.; Cananwill, Inc; and Premier Auto Finance, Inc.

        These companies conduct the Registrant's brokerage and consulting operations, and have approximately 600 offices around the world in more than 125 countries and sovereignties. In 2002, those companies employed over 44,000 professionals and support personnel to serve the diverse needs of clients.

        Our retail brokerage companies operate in a highly competitive industry and compete with a large number of retail insurance brokerage and agency firms, as well as individual brokers and agents and direct writers of insurance coverage. The companies provide a broad spectrum of advisory and outsourcingmanagement services includingalso include risk identification and assessment, alternative risk financing, safety engineering, claims and loss cost management and program administration for clients. They also design, placeadministration.

        Retail brokerage has practice areas to deliver specialized advice and implement customized insurance products. They have also developed certain specialist areasservices in such segments as entertainment, media, financial institutions, marine, aviation, construction, healthcare and energy, among others.

        As a retail broker, we generally serve as an advisor to corporate clients and can arrange a wide spectrum of risk management solutions, including property, general liability, professional and directors' and officers' liability, workers' compensation and professional liability, financial institutions, construction, energy, media, healthcare and entertainment. In 2002, investments were made in professional talent, technology, process improvement and the development of specializedother exposures. We also provide affinity products and services to meet the evolving needs of clients. These companies operate through offices located in North America, Europe, Latin America, Africa, Australia and Asia/Pacific.for

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        The companies address the highly specialized product development, consulting and administrative risk management needs of professional groups, service businesses, governments, healthcare providers and commercial organizations. They also provide underwriting management skills, claims and risk management expertise and third-party administration services to insurance companies, and insurance brokerage services for individuals. They market and broker both the primary and reinsurance risks of these programs. For individuals, associations and businesses, affinity products are brokered for professional liability, life, disability income and personal lines.lines for individuals, associations and businesses.

        Aon's reinsuranceFormerly, our wholesale brokerage activities are organized primarily under Aon Reoperations, through our Swett & Crawford subsidiary in the U.S. and Aon Limitedcertain other subsidiaries outside the U.S., served retail insurance brokers and independent agents in placing large and small accounts with both standard and specialty carriers. In 2005, we exited this line of business in the United Kingdom, constitutingU.S. by completing the largest reinsurancesale of Swett & Crawford in fourth quarter 2005.

        In our managing general underwriting business, we provide outsourced solutions to insurance companies, such as risk selection, premium rating, form design and client service. Our managing general underwriting units offer more than 450 insurance products and programs. Clients may access them directly, or through the Aon Specialty Product Network (ASPN), which we developed as a single-point-of-contact for agent and broker clients who need specialty insurance solutions for their customers.

        We are also a major provider in the worldmanagement of captive insurance companies that enable our clients to manage risks that would be cost prohibitive or unavailable in traditional insurance markets.

Reinsurance Brokerage and offeringRelated Services offers sophisticated advisory services in program design and claim recoveries that enhance the risk/return characteristics of insurance policy portfolios, and improve capital utilization along with the evaluation ofand evaluate and mitigate catastrophic loss exposures.exposures worldwide. An insurance or reinsurance company may seek reinsurance or other risk-transfer financing on all or a portion of the risks it insures. Reinsurance brokerage services use dynamic financial analysis and capital market alternatives, such as transferring catastrophe risk through securitization.

        Premium-related financingAon Re Global, Inc., its subsidiaries and its affiliates provide reinsurance services are available to clients of Aoninsurance and reinsurance companies and other independent organizationsrisk assumption entities by acting as brokers or intermediaries on all classes of reinsurance. While our reinsurance activities are principally focused on property and casualty lines, our reinsurance activities also include specialty lines such as professional liability, medical malpractice, accident, life and health. Services include advice, placement of reinsurance and alternative risk transfer financing with capital markets and related services such as actuarial, financial and regulatory consulting, portfolio analysis, catastrophe modeling and claims services.

Claim Services offered claims administration and loss cost management services through Cananwill. Certain retail automotive organizations have also beendedicated subsidiaries that were separate from our risk management and reinsurance brokerage services. In the U.S., these services were delivered principally through Cambridge Integrated Services Group ("Cambridge"). During 2004, we exited most of these activities by completing the sale of our U.K. claims operations in second quarter 2004 and our Cambridge business in fourth quarter 2004.

Compensation for Services

        Revenues are generated through commissions, fees from clients and compensation from insurance and reinsurance companies for services provided a serviceto them. In fourth quarter 2004, we announced that we were terminating our contingent commission arrangements with underwriters.

        Commission rates and fees vary depending upon several factors, which purchases a selectmay include the amount of their auto financingpremium, the type of insurance or reinsurance coverage provided, the particular services provided to an insurer or reinsurer and leasing contracts from individualsthe capacity in which the Aon entity acts. We also receive investment income on funds held on behalf of clients and sells them to unaffiliated parties through companies associated with Premier Auto Finance, Inc., a subsidiary of Aon Group, Inc., which then continue the management of collections on the contracts and provide other related services. After March 2001, companies associated with Premier Auto Finance ceased purchasing and securitizing new automobile installment contracts, but continue to service the existing portfolio, which is in run-off.insurance carriers.

(2)  Consulting

subsidiary ("Aon Consulting Worldwide, Inc.Consulting"), is one of the world's largest integrated human capital consulting organizations. The operations of this segmentwe provide a full range of human capital managementconsulting services in two subsegments (Consulting Services and Outsourcing) that serve three major client segments—large corporations, middle market companies and small firms.operate in six practice areas:

        AroundEmployee Benefits advises clients regarding the world, companies have to find advanced ways tostructure, funding and administration of employee benefit programs, which attract, retain and retain workers with the right skill levelsmotivate employees. Benefits consulting includes health and commitments. Aon Consulting, with its expertise in employeewelfare, retirement, executive benefits, compensation,absence management, consulting, outsourcing and communication, and its access to the Registrant's other subsidiaries, is well-positioned to serve this market. Aon Consulting subsidiaries offer services including construction and implementation of benefit packages, proprietary research oncompliance, employee commitment, investment advisory and loyalty; compensation design; assistance in process improvement and design, leadership, organization and human capital development;elective benefits services.

Human Resource Outsourcing offers employment processing, performance improvement, benefits administration and other employment services;employment-related services.

Compensation focuses on designing salary, bonus, commission, stock option and adviceother pay structures, with special expertise in the financial services and technology industries.

Management Consulting assists clients in process improvement and design; leadership, organization and human capital development; and change management.

Communications advises clients on how to companies oncommunicate initiatives tothat support their corporate vision.

        The acquisitionsStrategic Human Resource Consulting advises complex global organizations on talent, change and organization effectiveness issues, including assessment, selection performance management, succession planning, organization design and related people-management programs.

        Aon Consulting works to maximize the value of ASI Solutions, Inc.clients' human resources spending, increase employee productivity and Actuarial Sciences Associates, Inc. expanded the Registrant's abilityimprove employee performance. Our approach addresses a trend toward more diverse workforces (demographics, nationalities, cultures and work/lifestyle preferences) that require more choices and flexibility among employers—with benefit options suited to provideindividual needs.

        Our consulting professionals and their clients also identify options in human resource outsourcing and process improvement. Prime areas where companies choose to use outsourcing services to a broad spectruminclude the assessment and selection of large corporate clients.job candidates, employment processing, training and development, benefits administration and the individual benefits enrollment process.

Compensation for Services

        Aon Consulting revenues are principally derived from fees paid by clients for advice and services. In third quarter 2002, Aon entered into a sizeable new outsourcing contract thataddition, commission revenue is expected to provide favorable returns over the life of the multi-year agreement. The recognition of revenues and expenses, however, will significantly influence financial results over the contract period. Revenues are recorded on a gross basis, inclusive of amounts ultimately passed through to subcontractors, and are recorded ratably over the life of the contract. Also, up-front investment costs to support the new business cause pretax margins to be significantly lower in the early years of the multi-year contract, compared with the later years when margins increase. A significant portion of the up-front investment costs incurredreceived from insurance companies for the new outsourcingplacement of individual and group insurance contracts, can be leveraged to handle increased business volume.primarily life, health and accident coverages. In fourth quarter 2004, we announced that we were terminating our contingent commission arrangements with underwriters.

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(3)  Competitive Conditions

        Our consulting business faces strong competition from other privately and publicly held worldwide and national consulting companies, as well as regional and local firms. Competitors include independent consulting firms and consulting organizations affiliated with accounting, information systems, technology and financial services firms. Some of our competitors provide administrative or consulting services as an adjunct to other primary services.

Insurance Underwriting

        Our insurance underwriting segment, with approximately 9,000 employees worldwide, has operations in the U.S., Canada, Latin America, Europe and Asia/Pacific. This segment generated approximately 32% of Aon's total operating segment revenues in 2005.

Subsegments

        We classify our insurance underwriting businesses into two sub-segments: (1) accident & health and life and (2) warranty, credit and property and casualty.

Accident & Health and Life

        Our Combined Insurance Company of America;America and Combined Life Insurance Company of New York ("CLICNY"Combined"); subsidiaries provide supplemental accident, health and life insurance. We are a leading underwriter and distributor of specialty individual accident, disability, health and life insurance products that are targeted to middle income consumers in the U.S., Europe, Canada and Asia/Pacific.

        A worldwide sales force of approximately 6,900 exclusive career agents service clients regularly to initiate and renew coverage and to sell additional coverage. We offer a wide range of accident and sickness insurance products, including short-term disability, critical conditions and cancer aid, Medicare products, hospital confinement/recovery and long-term care coverage. Most of these products are primarily fixed-indemnity obligations and are not subject to escalating medical cost inflation.

        With the continuing rise of employee benefit costs, Combined Specialty Insurance Company ("CSIC"); London General Insurance Company Limited; Sterling Life Insurance Company;also works with employers to contain those costs while offering quality benefits that appeal to their employees' individual needs. For example, a Worksite Solutions program complements existing benefits packages offered by employers with no additional cost to a company. Individual employees choose among supplemental insurance product options and Aon Warranty Group, Inc..pay for them through payroll deductions.

Compensation for Services

        Accident and health revenues are based on premiums paid by policyholders for insurance coverage and services.

Competitive Conditions

        The Registrant's insurance underwriting subsidiaries are part of a highly competitive industry that serves individual consumers in North America, Europe, Latin America and Asia/Pacific by providing accident and health coverage, traditional life insurance and extended warranty and casualty insurance products and services through distribution networks, most of which are directly owned byindustry in the Registrant's subsidiaries.

        The supplementalU.S. is highly diverse, with more than 1,500 accident and health and life distribution network encompassesinsurance companies competing in various segments of the industry. We believe that competition in our accident, health and life business is based on service, product features, price, commission structure, financial strength, claims-paying ability ratings and name recognition.

Warranty, Credit and Property and Casualty

        We believe we are the world's largest independent provider of extended warranty products. These products are offered primarily through our Virginia Surety Company, Inc. and London General Insurance Company Limited subsidiaries.



Extended warranty,which is the largest line of business in this sub-segment, offers extended service plans and warranties for:

        Other products include extended warranty or insurance protection for items purchased with a credit card and extended warranties on major home systems and appliances.

        Services include compliance support, merchandising, direct marketing, training and customer care management services. Products are sold through retailers, automotive dealers, insurance agents of Combined Insurance and CLICNY (which operates exclusively in the State of New York). Combined Insurance, the Registrant's principalbrokers and real estate brokers.

        Ourcredit life, accident and health and life insurer, has a sales forcedisability insuranceprovides coverage for unpaid loans in the event of 7,500 career agents calling on individuals to sell a broad spectrum of low premium, low limitdeath, illness, accident or involuntary unemployment. This insurance is sold by automobile dealers with automobile financing and health products. In addition, it has developed relationshipsby financial institutions with select brokersconsumer loans.

Select property and consultants to reach specific niche markets. Combined Insurance offers a wide range of accident, sickness, short-term disability and other supplemental insurance products including a simplified accident and sickness long-term disability policy. Most of Combined Insurance's casualtyproducts are primarily fixed-indemnity obligations, thereby not subjectdesigned to escalating medical costs. In recent years, Combined Insurance expanded its product distributionprotect businesses against losses related to include direct response programs, affinity groupsvarious personal and worksite marketing, creating access to new markets and potential new policyholders. We also specialize in healthcare plans for Medicare beneficiaries. Medicare supplement insurance covers expenses not covered by Medicarecommercial risks, such as deductiblesprofessional liability errors and co-payments. In 2000, we became the first private insurer to contract with the Health Care Financing Administration (HCFA) for a Medicare Plus Choice Private Fee for Service Plan. Combined Insurance's business is conducted in the United States, Canada, Latin America, Europeomissions, excess liability and Asia/Pacific. However, in early 2003, Combined Insurance announced that it will discontinue its accident and health insurance underwriting businesses in Mexico, Argentina and Brazil, as well as its large company group life business.

        The Registrant's extended warranty and casualty insurance business, conducted by CSIC, its branches and subsidiaries in North America, South America and Asia/Pacific and London General in Europe, provides warranties on automobiles and a variety of consumer goods, including electronics and appliances. In addition, these subsidiaries provide non-structural home warranties and other warranty products, such as credit card enhancements and affinity warranty programs. CSIC and London General are among the world's largest underwriters of consumer extended warranties. The extended warranty products are sold in the United States, Canada, Latin America, Europe and Asia/Pacific. The administration of certain warranty services on automobiles, electronic goods, personal computers and appliances is handled by certain operations in the Insurance Brokerage and Other Services segment.

        In 2001, the Registrant's underwriting business invested $227 million to obtain an ownership interest in Endurance Specialty Insurance, Ltd., which offersworkers' compensation. We offer select commercial property and casualty insurance and reinsurancebusiness on a worldwide basis. The investment will help provide much needed underwriting capacitylimited basis through managing general underwriters, primarily Aon-owned companies.

Compensation for Services

        Insurance revenues are based on premiums paid by policyholders. Certain other revenues are based on fees paid by clients for administrative and other services.

Competitive Conditions

        We believe that competition in our warranty, credit and specialty property and casualty business is based on service, product features, price, commission structure, financial strength, claims-paying ability ratings and name recognition. In our extended warranty business, we compete with a large number of insurance companies and other financial services providers in addition to commercial firmsthird-party administrators, manufacturers and insurance and reinsurance customers.distributors.

(4)  DiscontinuedDisposal of Operations

        The Registrant hereby incorporates by reference noteNote 6, "Discontinued"Disposal of Operations," of the Notes to Consolidated Financial Statements in Part II, Item 8 of this report.

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Licensing and Regulation

        Regulatory authorities in the states or countries in which the operating subsidiaries of Aon Groupour Risk and Insurance Brokerage Services segment conduct business may require individual or company licensing to act as brokers, agents, third party administrators, managing general agents, reinsurance intermediaries or adjusters. Under the laws of most states in the U.S. and of most foreign countries, regulatory authorities have relatively broad discretion with respect to granting, renewing and revoking brokers' and agents' licenses to transact business in the state or country. The manner of operating in particular states and countries may vary according to the licensing requirements of the particular state or country, which may require, among other things, that a firm operate in the state or country through a local corporation. In a few states and countries, licenses are issued only to individual residents or locally owned business entities. In such cases, Aon Groupour subsidiaries have arrangements with residents or business entities licensed to act in the state or country.



        Insurance companies must comply with laws and regulations of the jurisdictions in which they do business. These laws and regulations are designed to ensure financial solvency of insurance companies and to require fair and adequate service and treatment for policyholders. They are enforced by the states in the U.S., by the Financial Services Authority ("FSA") in the United Kingdom,U.K. and by various regulatory agencies in other countries through the granting and revoking of licenses to do business, licensing of agents, monitoring of trade practices, policy form approval, minimum loss ratio requirements, limits on premium and commission rates and minimum reserve and capital requirements. Compliance is monitored by the state insurance departments through periodic regulatory reporting procedures and periodic examinations. The quarterly and annual financial reports to the regulators in the U.S. utilize statutory accounting principles which are different from accounting principlesU.S. generally accepted in the U.S.accounting principles. The statutory accounting principles, in keeping with the intent to assure the protection of policyholders are based, in general, on a liquidation concept, while accounting principlesU.S. generally accepted in the U.S.accounting principles are based on a going-concern concept.

        The stateState insurance regulators are members of the National Association of Insurance Commissioners ("NAIC"). The NAIC seeks to promote uniformity of and to enhance the state regulation of, insurance. Both the NAIC and the individual states continue to focus on the solvency of insurance companies and their conduct in the marketplace. This focus is reflected in additional regulatory oversight by the states and emphasis on the enactment or adoption of a series of NAIC model laws and regulations designed to promote solvency. Effective January 1, 2001, the

        The NAIC revised its Accounting Practices and Procedures Manual in a process referred to as Codification. The domiciliary states of Aon's major insurance subsidiaries have adopted the provisions of the revised manual. The revised manual has changed, to some extent, prescribed statutory accounting practices and resulted in changes to the accounting practices that Aon's major insurance subsidiaries use to prepare their statutory-basis financial statements.

        Several years ago, the NAIC developed a formula for analyzing insurers called risk-based capital ("RBC"). RBC is intended to establishestablishes "minimum" capital threshold levels that vary with the size and mix of a company's business. It is designed to identify companies with capital levels that may require regulatory attention.

        The stateState insurance holding company laws require prior notice to, and approval of, the domestic state insurance department of certain intracorporate transfers of assets within the holding company structure, including the payment of dividends by insurance company subsidiaries. In addition, the premium finance loans by Cananwill, anour indirect wholly owned subsidiary, of the Registrant, are subject to one or more of truth-in-lending and credit regulations, insurance premium finance acts, retail installment sales acts and other similar consumer protection legislation. Failure to comply with such laws or regulations can result in the temporary suspension or permanent loss of the right to engage in business in a particular jurisdiction as well as other penalties.

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        Recent federal        Beginning in January 2005, our principal subsidiary in the U.K., Aon Limited, must be, and state laws and proposals mandating specific practices by medical insurers and the health care industry will not, because of the nature of the business of the Registrant's subsidiaries, materially affect the Registrant. Numerous states have had legislation introduced to reform the health care system, and such legislation has passed in several states. While it is, impossible to forecast the precise nature of future federal and state health care changes, because most of the policies issuedauthorized by the Registrant's insurance subsidiaries are supplementalFSA. Previously, Aon Limited was a member of a self-regulatory body. Regulation by the FSA has been introduced pursuant to the European Union Insurance Mediation Directive, which sets minimum standards for those involved in natureadvising on, arranging, administering or introducing contracts of insurance. The regulation requires significant operational changes, for example, enhanced disclosures, particularly in connection with retail (private and provide,non-commercial) customers. The FSA has also indicated that it will adopt rules regarding use of funds held on a fixed-indemnity basis, protection against loss-of-time or disability benefits,behalf of clients that will affect all brokers operating in the Registrant does not expect such legislation to have a material impact on its operations. Congress has passed the Financial Services Modernization Act, commonly known as S 900 or the Gramm-Leach-Bliley Act. While S 900 makes substantial changes in allowing financial organizations to diversify, the Registrant does not believe its enactment will have a material effect on the business of its insurance subsidiaries.London market.

Clientele

        No significant part of the Registrant's or itsour subsidiaries' business is dependent upon a single client or on a few clients, theclients. The loss of any one of whichclient would not have a material adverse effect on the Registrantus or itsour operating segments.

Employees

        At December 31, 2002, the Registrant2005, our operating subsidiaries had approximately 55,00046,600 employees, of whom approximately 51,00043,000 are salaried and hourly employees and the remaining 4,0003,600 are career agents who are generally compensated wholly or primarily by commission. In addition, there were approximately 3,500



3,300 international career agents who are considered independent contractors and are not employees of the Registrant.our employees. Of the total number of employees, 26,000approximately 20,200 work in the U.S.

Information Concerning Forward-Looking Statements

        This report contains certain statements related to future results, or states our intentions, beliefs and expectations or predictions for the future which are forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from either historical or anticipated results depending on a variety of factors. Potential factors that could impact results include: general economic conditions in different countries in which we do business around the world, changes in global equity and fixed income markets that could affect the return on invested assets, fluctuations in exchange and interest rates that could influence revenue and expense, rating agency actions that could affect our ability to borrow funds, funding of our various pension plans, changes in the competitive environment, our ability to implement restructuring initiatives and other initiatives intended to yield cost savings, our ability to execute the stock repurchase program, changes in commercial property and casualty markets and commercial premium rates that could impact revenues, changes in revenues and earnings due to the elimination of contingent commissions, other uncertainties surrounding a new compensation model, the impact of investigations brought by state attorneys general, state insurance regulators, federal prosecutors and federal regulators, the impact of class actions and individual lawsuits including client class actions, securities class actions, derivative actions and ERISA class actions, the cost of resolution of other contingent liabilities and loss contingencies, the difference in ultimate paid claims in our underwriting companies from actuarial estimates and other factors disclosed under "Risk Factors" in Item 1A, below.

Website Access to Reports and other Information

        The Registrant'sOur annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports are made available free of charge through the Registrant'sour website (http://www.aon.com) as soon as practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission.Commission ("SEC"). Also posted on our website and available in print upon request, are the charters for our Audit, Compliance, Organization and Compensation, Governance/Nominating and Investment Committees; our Governance Guidelines, our Code of Ethics and our Code of Ethics for Senior Financial Officers. Within the time period required by the SEC and the New York Stock Exchange, we will post on our website any amendment to or waiver of the Code of Ethics for Senior Financial Officers, as well as any amendment to the Code of Ethics or waiver thereto applicable to any executive officer or director. The information provided on our website is not part of this report and is therefore not incorporated herein by reference.


Item 1A.  Risk Factors.

        The following are risks related to our business and the insurance industry.

        Our results historically have been subject to significant fluctuations arising from uncertainties and changes in the insurance industry. Changes in premium rates affect not only the potential profitability of our underwriting businesses but also generally affect the commissions and fees payable to our brokerage businesses. In addition, insurance industry developments that can significantly affect our financial performance include factors such as:


        Since the Attorney General of New York brought charges against one of our competitors in October 2004, there has been a great deal of uncertainty concerning then-longstanding methods of compensating insurance brokers. Soon after the Attorney General brought those charges, Aon and certain other large insurance brokers announced that they would terminate contingent commission arrangements with underwriters. Most insurance brokers, however, currently continue to enter into such arrangements, regulators have not taken action to end such arrangements throughout the industry and thus it is unclear at this time whether other brokers will continue to accept contingent commissions. Because of this uncertainty, there is no assurance that we will be able to develop a new business compensation model that permits us to compete successfully against brokers who have not terminated contingent commission arrangements, nor can we assure that any new business compensation model we develop will generate revenues equivalent to those previously received from contingent commissions.

        We believe that competition in our lines of business is based on service, product features, price, commission structure, financial strength, claims-paying ability ratings and name recognition. In particular, we compete with a large number of national, regional and local insurance companies and other financial services providers, brokers and with respect to our extended warranty business, third-party administrators, manufacturers and distributors.

        Some of our underwriting competitors have penetrated more markets and offer a more extensive portfolio of products and services and have more competitive pricing than we do, which can adversely affect our ability to compete for business. Some underwriters also have higher claims-paying ability ratings and greater financial resources with which to compete and are subject to less government regulation than our underwriting operations.

        We encounter strong competition for both business and professional talent in our insurance brokerage and risk management services operations from other insurance brokerage firms which also operate on a nationwide or worldwide basis, from a large number of regional and local firms throughout the world, from insurance and reinsurance companies that market and service their insurance products without the assistance of brokers or agents and from other businesses, including commercial and investment banks, accounting firms and consultants that provide risk-related services and products. Our consulting operations compete with independent consulting firms and consulting organizations affiliated with accounting, information systems, technology and financial services firms around the world.

        In addition, the increase in competition due to new legislative or industry developments could adversely affect us. These developments include:


        New competition as a result of these developments could cause the supply of, and demand for, our products and services to change, which could adversely affect our results of operations and financial condition.

        In third quarter 2005, we announced that we were reviewing the revenue potential and cost structure of each of our businesses. As a result of this review, we have adopted restructuring initiatives that are expected to result in the elimination of approximately 1,800 employee positions, the closing of several offices, asset impairments and other expenses necessary to implement these initiatives. We currently expect that the restructuring plan will result in cumulative pretax charges of $262 million. The objective of the restructuring and other business reorganization initiatives is to improve our profitability through operational efficiency. Our savings net of restructuring expenses is expected to become positive in 2006, with a targeted annualized savings of approximately $180 million by 2008. We cannot assure you that we will achieve the targeted savings.

        Financial strength and claims-paying ability ratings have become increasingly important factors in establishing the competitive position of insurance companies. These ratings are based upon criteria established by the rating agencies for the purpose of rendering an opinion as to an insurance company's financial strength, operating performance, strategic position and ability to meet its obligations to policyholders. They are not evaluations directed toward the protection of investors, nor are they recommendations to buy, sell or hold specific securities. Periodically, the rating agencies evaluate our insurance underwriting subsidiaries to confirm that they continue to meet the criteria of the ratings previously assigned to them. A downgrade, or the potential for a downgrade, of these ratings could, among other things, increase the number of policy cancellations, adversely affect relationships with brokers, retailers and other distributors of our products and services, negatively impact new sales and adversely affect our ability to compete.

        Virginia Surety Company, Inc., our principal property and casualty insurance company subsidiary, is currently rated "A-" (excellent; fourth highest of 16 rating levels) by A.M. Best Company. Combined Insurance Company of America, the principal insurance subsidiary that underwrites our specialty accident and health insurance business, is currently rated "A" (excellent; third highest of 16 rating levels) by A.M. Best Company, "A-" (strong; third highest of nine rating levels) for financial strength by S&P and "A3" (good; third highest of nine rating levels) for financial strength by Moody's Investors Service. We cannot assure that one or more of the rating agencies will not downgrade or withdraw their financial strength or claims-paying ability ratings in the future.

        Our insurance underwriting subsidiaries own a substantial investment portfolio of fixed-maturity and equity and other long-term investments. As of December 31, 2005, our fixed-maturity investments (approximately 98% was investment grade) had a carrying value of $4.2 billion, our equity investments had a carrying value of $40 million and our other long-term investments and limited partnerships had a


carrying value of $515 million. Accordingly, changes in interest rates and investment prices could reduce the value of our investment portfolio and adversely affect our financial condition or results.

        For example, changes in domestic and international interest rates directly affect our income from, and the market value of, fixed-maturity investments. Similarly, general economic conditions, stock market conditions and other factors beyond our control affect the value of our equity investments. We monitor our portfolio for other-than-temporary impairments in carrying value. For securities judged to have an other-than-temporary impairment, we recognize a realized loss through the statement of income to write down the value of those securities.

        In 2005, we recognized impairment losses of $11 million. We cannot assure that we will not have to recognize additional impairment losses in the future, which would negatively affect our financial results.

        In 2001, our two major insurance companies sold the vast majority of their limited partnership portfolio, valued at $450 million, to Private Equity Partnership Structures I, LLC (PEPS I) a qualifying special purpose entity (QSPE). The common stock interest in PEPS I is held by a limited liability company which is owned by one of our subsidiaries (49%) and by a charitable trust, which is not controlled by us, established for victims of the September 11 attacks (51%). Approximately $171 million of investment grade fixed-maturity securities were sold by PEPS I to unaffiliated third parties. PEPS I then paid our insurance underwriting companies the $171 million in cash and issued to them an additional $279 million in fixed-maturity and preferred stock securities. The fixed-maturity securities our insurance underwriting companies received from PEPS I are rated as investment grade by S&P.

        As part of this transaction, Aon is required to purchase from PEPS I additional fixed-maturity securities in an amount equal to the unfunded limited partnership commitments, as they are requested. As of December 31, 2005, these unfunded commitments amounted to $48 million.

        Although the PEPS I transaction has reduced the reported earnings volatility historically associated with directly owning limited partnership investments, it will not eliminate our risk of future losses. For instance, we must analyze our preferred stock and fixed-maturity interests in PEPS I for other-than-temporary impairment, based on the valuation of the limited partnership interests held by PEPS I and recognize an impairment loss if necessary. We cannot assure that we will not have to recognize impairment losses with respect to our PEPS I interests in the future.

        The FASB has a current project on its agenda that is expected to result in a change to U.S. generally accepted accounting principles with respect to financial asset transfers such as the PEPS I transaction. We cannot assure that the current accounting for our PEPS I investments will be unaffected by these possible changes.

        To the extent that the present value of the benefits incurred to date for pension obligations in the major countries in which we operate continue to exceed the market value of the assets supporting these obligations, our financial position and results of operations may be adversely affected. As a result of the decline in the equity markets over the past several years as well as declines in interest rates, some of our defined benefit pension plans, particularly in the U.K., have suffered significant valuation losses in the assets backing the related pension obligation.

        Current projections indicate that our 2006 defined benefit pension expense for our major pension plans will increase by approximately $4 million compared with 2005 and that cash contributions of approximately $186 million will be required in 2006, although we may elect to contribute more. Total cash contributions to these major defined benefit pension plans in 2005 were $463 million, an increase



of $274 million over 2004. Future estimates are based on certain assumptions, including discount rates, interest rates, fair value of assets for some of our plans and expected return on plan assets. We are currently taking actions to manage our pension liabilities, including closing certain plans to new participants. However, changes in our pension benefit obligations and the related net periodic costs or credits may occur in the future due to any variance of actual results from our assumptions and changes in the number of participating employees. As a result, there can be no assurance that we will not experience future decreases in stockholders' equity, net income, cash flow and liquidity or that we will not be required to make additional cash contributions in the future beyond those which have been announced.

        We are subject to numerous claims, tax assessments, lawsuits and proceedings that arise in the ordinary course of business. The damages claimed in these matters are or may be substantial, including, in many instances, claims for punitive, treble or extraordinary damages. The litigation naming us as a defendant ordinarily involves our activities as a broker or provider of insurance products or as an employer. It is possible that, if the outcomes of these contingencies and legal proceedings were not favorable to us, it could materially adversely affect our future financial results. In addition, our results of operations, financial condition or liquidity may be adversely affected if in the future our insurance coverage proves to be inadequate or unavailable or there is an increase in liabilities for which we self-insure. Aon has purchased errors and omissions ("E&O") insurance and other insurance to provide protection against losses that arise in such matters. Accruals for these items, net of insurance receivables, when applicable, have been provided to the extent that losses are deemed probable and are reasonably estimable. These accruals and receivables are adjusted from time to time as developments warrant.

        In 2004, Aon, other insurance brokers, insurers and numerous other industry participants received subpoenas and other requests for information from the office of the Attorney General of the State of New York and from other states relating to certain practices in the insurance industry.

        On March 4, 2005, Aon entered into an agreement (the "Settlement Agreement") with the Attorney General of the State of New York, the Superintendent of Insurance of the State of New York, the Attorney General of the State of Connecticut, the Illinois Attorney General and the Director of the Division of Insurance, Illinois Department of Financial and Professional Regulation (collectively, the "State Agencies") to resolve all the issues related to investigations conducted by the State Agencies.

        As has been described in detail in Aon's previous financial filings, the Settlement Agreement requires Aon to pay between 2005-2007 a total of $190 million into a fund (the "Fund") to be distributed to certain Eligible Policyholder clients. The Settlement Agreement sets forth the procedures under which Aon mailed notices to its Eligible Policyholder clients and distributes the Fund to Participating Policyholder clients. In order to obtain a payment from the Fund, Participating Policyholders were required to tender a release of claims against the Company arising from acts, omissions, transactions or conduct that are the subject of the lawsuits.

        As required by the Settlement Agreement, within 60 days of the effective date of that agreement, the Company commenced the implementation of certain business reforms, including agreeing not to accept contingent compensation as defined in the Settlement Agreement.

        Purported clients have also filed civil litigation against Aon and other companies under a variety of laws and legal theories relating to broker compensation practices and other issues under investigation by New York and other states. As previously reported, a putative class action styledDaniel v. Aon (Affinity) has been pending in the Circuit Court of Cook County, Illinois since August 1999. On March 9, 2005, the Court gave preliminary approval to a nationwide class action settlement within the



$40 million reserve established in the fourth quarter of 2004. The Court held hearings in the fourth quarter of 2005 to consider whether to grant final approval to the settlement and is expected to issue a decision in first quarter 2006.

        Beginning in June 2004, a number of other putative class actions have been filed against Aon and other companies by purported clients under a variety of legal theories, including state tort, contract, fiduciary duty, antitrust and statutory theories and federal antitrust and the Racketeer Influenced and Corrupt Organizations Act theories. These actions are currently pending at early stages in state court in California and Illinois and in federal court in New Jersey. Aon believes it has meritorious defenses in all of these cases and intends to vigorously defend itself against these claims. The outcome of these lawsuits, and any losses or other payments that may occur as a result, cannot be predicted at this time.

        Beginning in late October 2004, several putative securities class actions have been filed against Aon in the U.S. District Court for the Northern District of Illinois. Also beginning in late October 2004, several putative ERISA class actions were filed against Aon in the U.S. District Court for the Northern District of Illinois. Aon believes it has meritorious defenses in all of these cases and intends to vigorously defend itself against these claims. The outcome of these lawsuits, and any losses or other payments that may occur as a result, cannot be predicted at this time.

        In May 2005, the Office of the U.S. Attorney for the Southern District of New York and the Securities and Exchange Commission sent to Aon subpoenas seeking information relevant to these agencies' industry-wide investigations of finite risk insurance. Aon is fully cooperating with these investigations.

        In July 2004, several subsidiaries of Aon were joined as defendants in an action in a U.K. court between British Petroleum ("BP") and underwriters who subscribed to policies of insurance covering various offshore energy projects on which BP and its co-venturers have incurred losses. BP settled on confidential terms with underwriters, but asserted a claim against Aon for approximately $96 million, which BP claims is a shortfall between its total losses and what it recovered in the settlements with underwriters, plus interest and costs. The trial in this matter concluded in December 2005, and judgment is expected to be issued sometime in the first half of 2006. Aon believes it has meritorious defenses and has vigorously defended itself against these claims. The ultimate outcome of this matter, and any losses or other payments that may occur as a result, cannot be predicted at this time.

        In February 2006, Lloyds announced that it had brought suit in London against Benfield and a subsidiary of Aon to recover alleged losses relating to these brokers' placement of insurance for Lloyds's New Central Fund. Lloyds alleges that its brokers did not fairly present the risk to reinsurers and thus that the brokers should be held liable for reinsurers' failure to pay approximately £325 million ($563 million based on the December 31, 2005 exchange rate) in claims. Aon disputes Lloyds's allegations, believes that it has meritorious defenses and intends to vigorously defend itself against Lloyd's claims.

        Fiduciary Counselors, Inc., a former Aon subsidiary, has asked Aon Consulting, Inc. of New Jersey to defend and indemnify it with regard to claims that may be asserted in an arbitration relating to the former subsidiary's service from November 1999 to November 2000 as an independent fiduciary for the development and construction of the Diplomat Resort and Country Club in Hollywood and Hallendale, Florida (the "Project"). Aon has conditionally agreed to defend and indemnify Fiduciary Counselors with respect to the potential arbitration demand. The prospective claimants, a labor union pension fund that owns the Project and its current independent fiduciary, allege that Fiduciary Counselors breached fiduciary duties and other obligations under ERISA. The prospective claimants have asserted that their claims are valued at over $100 million. Aon believes that there are meritorious defenses both as to liability and damages and continues to evaluate whether the matter may be resolved without formal arbitration.



        Although the ultimate outcome of all matters referred to above cannot be ascertained, and liabilities in indeterminate amounts may be imposed on us, on the basis of present information, amounts already provided, availability of insurance coverages and legal advice received, it is the opinion of management that the disposition or ultimate determination of such claims will not have a material adverse effect on the consolidated financial position of Aon. However, it is possible that future results of operations or cash flows for any particular quarterly or annual period could be materially affected by an unfavorable resolution of these matters.

        Our future success depends on our ability to attract and retain experienced personnel, including underwriters, brokers and other professional personnel. Competition for such experienced professional personnel is intense. If we cannot hire and retain talented personnel, our business, operating results and financial condition could be adversely affected.

        In our insurance brokerage and consulting businesses, we often assist our clients with matters which include the placement of insurance coverage or employee benefit plans and the handling of related claims. Errors and omissions claims against us may allege our potential liability for all or part of the amounts in question. Errors and omissions claims could include, for example, the failure of our employees or sub-agents, whether negligently or intentionally, to place coverage correctly or notify carriers of claims on behalf of clients or to provide insurance carriers with complete and accurate information relating to the risks being insured. It is not always possible to prevent and detect errors and omissions and the precautions we take may not be effective in all cases. In addition, errors and omissions claims may harm our reputation or divert management resources away from operating our business.

        Our businesses are subject to extensive federal, state and foreign governmental regulation and supervision, which could reduce our profitability or limit our growth by increasing the costs of regulatory compliance, limiting or restricting the products or services we sell or the methods by which we sell our products and services or subjecting our businesses to the possibility of regulatory actions or proceedings. With respect to our insurance brokerage businesses, this supervision generally includes the licensing of insurance brokers and agents and third-party administrators and the regulation of the handling and investment of client funds held in a fiduciary capacity. Our continuing ability to provide insurance brokering and third-party administration in the jurisdictions in which we currently operate depends on our compliance with the rules and regulations promulgated from time to time by the regulatory authorities in each of these jurisdictions. Also, we can be affected indirectly by the governmental regulation and supervision of other insurance companies. For instance, if we are providing managing general underwriting services for an insurer, we may have to contend with regulations affecting our client. Further, regulation affecting the insurance companies with whom our brokers place business can affect how we conduct those operations.

        Most insurance regulations are designed to protect the interests of policyholders rather than stockholders and other investors. In the U.S., this system of regulation, generally administered by a department of insurance in each state in which we do business, affects the way we can conduct our insurance underwriting business. Furthermore, state insurance departments conduct periodic examinations of the affairs of insurance companies and require the filing of annual and other reports relating to the financial condition of insurance companies, holding company issues and other matters.


        Although the federal government does not directly regulate the insurance business, federal legislation and administrative policies in several areas, including employee benefit plan regulation, age, race, disability and sex discrimination, investment company regulation, financial services regulation, securities laws and federal taxation, do affect the insurance industry generally and our insurance underwriting subsidiaries in particular. With respect to our international operations, we are subject to various regulations relating to, among other things, licensing, currency, policy language and terms, reserves and the amount of local investment. These various regulations also add to our cost of doing business through increased compliance expenses, the financial impact of use of capital restrictions and increased training and employee expenses. Furthermore, the loss of a license in a particular jurisdiction could restrict or eliminate our ability to conduct business in that jurisdiction.

        In all jurisdictions the applicable laws and regulations are subject to amendment or interpretation by regulatory authorities. Generally, such authorities are vested with relatively broad discretion to grant, renew and revoke licenses and approvals and to implement regulations. Accordingly, we may be precluded or temporarily suspended from carrying on some or all of our activities or otherwise fined or penalized in a given jurisdiction. No assurances can be given that our businesses can continue to be conducted in any given jurisdiction as they have been in the past.

        A significant portion of our operations is conducted outside the U.S. Accordingly, we are subject to legal, economic and market risks associated with operating in foreign countries, including:

        Some of our foreign brokerage subsidiaries receive revenues in currencies that differ from their functional currencies. We must also translate the financial results of our foreign subsidiaries into U.S. dollars. Although we use various derivative financial instruments to help protect against adverse transaction and translation effects due to exchange rate fluctuations, we cannot eliminate such risks and significant changes in exchange rates may adversely affect our results.

        We maintain reserves as an estimate of our liability under insurance policies issued by our insurance underwriting subsidiaries. The reserves that we maintain that could cause variability in our financial results consist of (1) unearned premium reserves, (2) policy and contract claim reserves and (3) future policy benefit reserves. Unearned premium reserves generally reflect our liability to return premiums we have collected under policies in the event of the lapse or cancellation of those policies. Under U.S. generally accepted accounting principles, premiums we have collected generally become "earned" over the life of a policy by means of a reduction in the amount of the unearned premium reserve associated with the policy. Unearned premium reserves are particularly significant with respect


to our warranty business, given that the premiums we receive for warranty products generally cover an extended period of time. If there are significant lapses or cancellations of these types of policies, or expected losses for existing policies develop adversely and therefore premiums are not earned as expected, it may be necessary to accelerate the amortization of deferred policy acquisition expenses associated with the policies, because these deferred expenses are amortized over the projected life of the policies, or establish additional reserves to cover premium deficiencies.

        Policy and contract claim reserves reflect our estimated liability for unpaid claims and claims adjustment expenses, including legal and other fees and general expenses for administering the claims adjustment process and for reported and unreported losses incurred as of the end of each accounting period. If the reserves originally established for future claims prove inadequate, we would be required to increase our liabilities, which could have an adverse effect on our business, results of operations and financial condition.

        The obligation for policy and contract claims does not represent an exact calculation of liability. Rather, reserves represent our best estimate of what we expect the ultimate settlement and administration of claims will cost. These estimates represent informed judgments based on our assessment of currently available data, as well as estimates of future trends in claims severity, frequency, judicial theories of liability and other factors. Many of these factors are not quantifiable in advance and both internal and external events, such as changes in claims handling procedures, inflation, judicial and legal developments and legislative changes, can cause our estimates to vary. The inherent uncertainty of estimating reserves is greater for certain types of liabilities, where the variables affecting these types of claims are subject to change and long periods of time may elapse before a definitive determination of liability is made. Reserve estimates are periodically refined as experience develops and further losses are reported and settled. Adjustments to reserves are reflected in the results of the periods in which such estimates are changed. Because setting the level of reserves for policy and contract claims is inherently uncertain, we cannot assure that our current reserves will prove adequate in light of subsequent events.

        Future policy benefit reserves generally reflect our liability to provide future life insurance benefits and future accident and health insurance benefits on guaranteed renewable and non-cancelable policies. Future policy benefit reserves on accident and health and life products have been provided on the net level premium method. These reserves are calculated based on assumptions as to investment yield, mortality, morbidity and withdrawal rates that were determined at the date of issue and provide for possible adverse deviations.

        The demand for property and casualty insurance generally rises as the overall level of economic activity increases and generally falls as such activity decreases, affecting both the commissions and fees generated by our brokerage and consulting businesses and the premiums generated by our underwriting businesses. In particular, a growing number of insolvencies associated with an economic downturn, especially insolvencies in the insurance industry, could adversely affect our brokerage business through the loss of clients or by hampering our ability to place insurance and reinsurance business. Moreover, the results of our consulting business are generally affected by the level of business activity of our clients, which in turn is affected by the level of economic activity in the industries and markets these clients serve. As our clients become adversely affected by declining business conditions, they may choose to delay or forgo consulting engagements with us.

        We have substantial debt outstanding. As of December 31, 2005, we had total consolidated debt outstanding of approximately $2.1 billion. This substantial amount of debt outstanding could adversely affect our financial flexibility.


        In 2004, Standard & Poor's (S&P) lowered its ratings on our senior debt to the current rating of "BBB+" from "A-". In addition, S&P placed all their ratings for Aon on credit watch with negative implications. Also in 2004, Moody's Investor Services (Moody's) and Fitch, Inc. placed both our senior debt and commercial paper ratings on negative outlook and credit watch with negative implications, respectively.

        In 2005, Fitch, Inc. lowered its ratings on our senior debt from "A-" to "BBB+" and affirmed our commercial paper rating of "F2." They removed us from credit watch and changed their outlook from negative to stable. S&P affirmed its ratings for Aon, removed us from credit watch and changed their outlook from negative to stable and later to positive. Moody's affirmed its ratings on our senior debt and changed their outlook from negative to stable.

        A downgrade in the credit ratings of our senior debt and commercial paper would increase our borrowing costs and reduce our financial flexibility. In addition, any further downgrade may trigger obligations of our company to fund certain amounts with respect to our premium finance securitizations. Moreover, some of our debt instruments, such as our 6.20% notes due January 2007 ($250 million of which are outstanding), expressly provide for interest rate increases in the case of certain ratings downgrades. Similarly, any such downgrade would increase our commercial paper interest rates or may result in our inability to access the commercial paper market altogether. We cannot assume that our financial position would not be adversely affected if we are unable to access the commercial paper market. A downgrade in the credit ratings of our senior debt may also adversely affect the claims-paying ability or financial strength ratings of our insurance company subsidiaries. See "A decline in the financial strength or claims-paying ability ratings of our insurance underwriting subsidiaries may increase policy cancellations and negatively impact new sales of insurance products" above.

        The FASB is considering several accounting rule changes, including proposals on pension accounting, intangibles and SPEs, among others. Whether these proposals will become final rules are uncertain, as is their final content. However, if enacted, these proposals could negatively affect our financial position and results of operations.

        In December 2004, the FASB issued Statement No. 123 (revised 2004)Share-Based Payment ("Statement No. 123(R)") which is a revision of Statement No. 123. Statement No. 123(R) supersedes APB Opinion No. 25 and amends FASB Statement No. 95,Statement of Cash Flows. Generally, the approach in Statement No. 123(R) is similar to the approach described in Statement No. 123.

        Through 2005, we followed APB No. 25 for share-based payments to employees. As such, we expensed the cost of stock awards over the period during which an employee is required to provide service in exchange for the award. Generally, we were required to disclose proforma compensation expense for stock options but were not required to recognize compensation expense. Beginning in the first quarter of 2006, Statement No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Proforma disclosure is no longer an alternative.

        See Note 1 to the consolidated financial statements for further information.

        Our principal assets are the shares of capital stock of our subsidiaries, including our insurance underwriting companies. We have to rely on dividends from these subsidiaries to meet our obligations for paying principal and interest on outstanding debt obligations and for paying dividends to


stockholders and corporate expenses. Payments from our underwriting subsidiaries are limited by governmental regulation and depend on the surplus and future earnings of these subsidiaries. In some circumstances, specific payments from our insurance underwriting subsidiaries may require prior regulatory approval and we may not be able to receive dividends from these subsidiaries at times and in the amounts we anticipate or require.

        The level of business that our insurance underwriting subsidiaries are able to write depends on the size and adequacy of their capital base. Many state insurance laws to which they are subject impose risk-based capital requirements for purposes of regulating insurer solvency. Insurers having less statutory surplus than that required by the risk-based capital model formula generally are subject to varying degrees of regulatory scrutiny and intervention depending on the level of capital inadequacy. As of December 31, 2005, each of our insurance company subsidiaries substantially exceeds NAIC risk-based statutory surplus requirements.

        We purchase reinsurance for certain of the risks underwritten by our insurance company subsidiaries. Market conditions beyond our control determine the availability and cost of the reinsurance protection we purchase, which may affect the level of business we are able to write and our profitability. We cannot assure that we will be able to maintain our current reinsurance facilities or that we can obtain other reinsurance facilities in adequate amounts and at favorable rates. If we are unable to renew our expiring facilities or to obtain new reinsurance facilities, either our net exposures would increase or, if we are unwilling to bear an increase in net exposures, we would have to reduce the level of our underwriting commitments. Either of these potential developments could adversely affect our underwriting business.

        To better manage our portfolio of underwriting risk, we purchase reinsurance by transferring part of the risk that we assume (known as ceding) to a reinsurance company in exchange for part of the premium that we receive in connection with the risk. Although reinsurance makes the reinsurer liable to us to the extent the risk is transferred (or ceded) to the reinsurer, it does not relieve us of our liability to our policyholders. Accordingly, we bear credit risk with respect to our reinsurers. Recently, due to industry and general economic conditions, there is an increasing risk of insolvency among reinsurance companies, resulting in a greater incidence of litigation and affecting the recoverability of claims. We cannot assure that our reinsurers will pay the reinsurance recoverables owed to us or that they will pay these recoverables on a timely basis.


Item 1B.  Unresolved Staff Comments.

        None.


Item 2.    Properties.

        TheOur business activities of the Registrant and its subsidiaries are conducted principally in leased office space in cities throughout the world. The Registrant'sCertain of our subsidiaries do own and occupy a few office buildings, primarily in five states and certain foreign countries. In general, no difficulty is anticipated in negotiating renewals as leases expire or in finding other satisfactory space if the premises become unavailable. In certain circumstances, the Registrantwe may have unused space and may seek to sublet such space to third parties, depending upon the demands for office space in the locations involved.


Item 3.    Legal Proceedings.

        The RegistrantWe hereby incorporatesincorporate by reference noteNote 15, "Contingencies," of the Notes to Consolidated Financial Statements in Part II, Item 8 of this report.




Item 4.    Submission of Matters to a Vote of Security Holders.

        None.

7



Executive Officers of the Registrant

        ExecutiveOur executive officers of the Registrant are regularly elected by itsour Board of Directors at the annual meeting of the Board which is held following each annual meeting of the stockholders of the Registrant. With the exception of David P. Bolger, who joined the Registrant on January 9, 2003, theour stockholders. Our executive officers of the Registrant were elected to their current positions on April 19, 2002. Each of the executive officers of the Registrant willMay 20, 2005 to serve until the meeting of the Board following the annual meeting of stockholders to be held on May 16, 2003.19, 2006. Ages shown for executive officers are as of December 31, 2002.

        For information concerning certain executive officers of the Registrant, see Item 10 of this report. As of March 1, 2003, the following individuals were also executive officers of the Registrant as defined in Rule 16a-1(f):2005.

Name Age, and
Current Office
or Principal Position

 Has Continuously Served as an Officer of Registrant or One or More of its Subsidiaries SinceAge
 Business Experience
Past 5 years
Position

Harvey N. Medvin, 66Patrick G. Ryan68Executive Chairman. Mr. Ryan currently serves as Aon's Executive Chairman. Mr. Ryan has been Chairman of the Board of Aon since 1990 and was Chief Executive Officer of Aon from 1982 until April 4, 2005.

Gregory C. Case


43


President and Chief Executive Officer. Mr. Case became Chief Executive Officer of Aon in April 2005. Prior to joining Aon, Mr. Case was with McKinsey & Company, the international management consulting firm, for 17 years, most recently serving as head of the Financial Services Practice.

Michael D. O'Halleran


55


Senior Executive Vice President. Mr. O'Halleran currently serves as Senior Executive Vice President of Aon and previously served as President and Chief Operating Officer of Aon from April 1999 until September 2004. Mr. O'Halleran has served in other significant senior management positions within Aon's group of companies since 1987.

David P. Bolger


48


Executive Vice President, and Chief
Financial Officer
1972Mr. Medvin became Vice President and Chief Financial Officer of the Registrant in 1982 and was elected to his current position in 1987. Mr. Medvin will retire as Chief Financial Officer in April 2003. He also serves as a Director or officer of certain of the Registrant's subsidiaries.
David P. Bolger, 45
Executive Vice President
2003Administrative Officer. Mr. Bolger became Executive Vice President—Finance and Administration of the Registrant in January 2003. In April 2003, Mr. Bolger will assumeassumed the additional positionrole of Chief Financial Officer succeeding Mr. Medvin in that position.Officer. Prior to joining Aon, Mr. Bolger was served for 21 years in various capacities for Bank One Corporation and its predecessor companies, most recently serving as Executive Vice President.

Ted T. Devine


42


Executive Vice President and Head of Bank One Corporation from 1999Corporate Strategy. Mr. Devine became Executive Vice President and Head of Corporate Strategy in May 2005. Prior to 2001. From 1996joining Aon, Mr. Devine worked at McKinsey & Company for 12 years, most recently serving as a director in the firm's Chicago office and leader of the firm's North American Insurance Practice and North American Insurance Operations and Technology efforts.

D. Cameron Findlay


46


Executive Vice President and General Counsel. Mr. Findlay became Executive Vice President and General Counsel in August 2003. Prior to 1999,joining Aon, Mr. BolgerFindlay served as the U.S. Deputy Secretary of Labor. Before joining the Labor Department in June 2001, Mr. Findlay was a partner at the law firm now known as Sidley Austin LLP.

Dennis L. Mahoney


55


Chairman and Chief Executive Officer, Aon Limited. Mr. Mahoney serves as Chairman and Chief Executive Officer of Aon Limited. Mr. Mahoney was previously the Chairman of Alexander Howden Limited, which was acquired by Aon in 1997.



D.P.M. Verbeek


55


Chairman and Chief Executive Officer, Aon Risk Services International. Mr. Verbeek serves as Chairman and Chief Executive Officer of Aon Risk Services International. Mr. Verbeek joined Aon in 1989.

Michael D. Rice


63


Chairman, Aon Risk Services Americas. Mr. Rice serves as Chairman of Aon Risk Services Americas. Mr. Rice has served Aon and its predecessor, Ryan Insurance Group, in various capacities for 40 years.

Steve McGill


47


Chief Executive Officer, Aon Risk Services Americas. Mr. McGill joined Aon in May 2005 as Chief Executive Officer of the Global Large Corporate business unit, and was named Chief Executive Officer of Aon Risk Services Americas in January 2006. Previously, Mr. McGill served as Chief Executive Officer of Jardine Lloyd Thompson Group plc.

Andrew M. Appel


41


Chief Executive Officer, Aon Consulting Worldwide, Inc. Mr. Appel became Chief Executive Officer of Aon Consulting Worldwide, Inc. in July 2005. Mr. Appel joined Aon from McKinsey & Company, where he was a senior partner in the firm's Financial Services and Technology practices.

Richard M. Ravin


62


Chairman, President and Chief Executive Officer, Combined Insurance Company of American National Bank.America. Mr. Ravin has served as Chairman and Chief Executive Officer of Combined Insurance Company of America since 1993.

Diane Aigotti


41


Senior Vice President and Treasurer. Ms. Aigotti serves as Senior Vice President and Treasurer of Aon. Prior to joining Aon in 2000, Ms. Aigotti was Vice President Finance for the University of Chicago Health Systems and budget director for the City of Chicago.

Michael A. Conway


58


Senior Vice President and Senior Investment Officer. Mr. Conway has served as Senior Vice President and Senior Investment Officer of Aon since 1990.

Jeremy G.O. Farmer


56


Senior Vice President and Head of Human Resources. Mr. Farmer joined Aon in 2003 as Senior Vice President and Head of Human Resources. Prior to joining Aon, Mr. Farmer spent 22 years with Bank One Corporation and its predecessor companies.

Daniel F. Hunger


54


Senior Vice President and Controller. Mr. Hunger was named Senior Vice President and Controller of Aon in June 2004. Mr. Hunger joined Aon in 1989, and has served Aon in a number of capacities, including Chief Financial Officer of Aon Consulting.

8




PART II

Item 5.    Market for the Registrant's Common Equity, and Related Stockholder Matters.Matters and Issuer Purchases of Equity Securities.

        The Registrant'sAon's common stock, par value $1.00 per share, is traded on the New York Stock Exchange. The RegistrantWe hereby incorporatesincorporate by reference the "Dividends paid per share" and "Price range" data under the heading "Quarterly Financial Data" in Part II, Item 8 of this report.

        The RegistrantAon had approximately 11,35010,507 holders of record of its common stock as of February 28, 2003.January 31, 2006.

        The RegistrantWe hereby incorporatesincorporate by reference noteNote 11, "Redeemable Preferred Stock, Capital Securities and Stockholders' Equity", of the Notes to Consolidated Financial Statements in Part II, Item 8 of this report.

9        The following information relates to the repurchase of equity securities by Aon or any affiliated purchaser during any month within the fourth quarter of the fiscal year covered by this report:


Period

 Total Number of
Shares Purchased

 Average Price
Paid per Share

 Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
 Maximum Dollar Value of Shares that May
Yet Be Purchased Under the Plans or Programs


10/1/05 - 10/31/05  N/A N/A N/A
11/1/05 - 11/30/05 675,000 $36.58 675,000 $975,311,617
12/1/05 - 12/31/05  N/A N/A N/A
  
  675,000 $36.58 675,000 $975,311,617
  

        On November 3, 2005, the Company announced that its Board of Directors had authorized the repurchase of up to $1 billion of Aon's common stock. Shares may be repurchased through the open market or in privately negotiated transactions.

        Information relating to the compensation plans under which equity securities of Aon are authorized for issuance is set forth under Part III, Item 12 of this report and is incorporated herein by reference.




Item 6.    Selected Financial Data.

 
 2002
 2001
 2000
 1999
 1998
 
 (millions except common stock and per share data)

INCOME STATEMENT DATA(1)               
 Brokerage commissions and fees $6,202 $5,436 $4,946 $4,639 $4,197
 Premiums and other  2,368  2,027  1,921  1,854  1,706
 Investment income  252  213  508  577  590
  
 
 
 
 
  Total revenue $8,822 $7,676 $7,375 $7,070 $6,493
  
 
 
 
 
 Income before accounting change $466 $147 $481 $352 $541
 Cumulative effect of change in accounting principle(2)      (7)   
  
 
 
 
 
  Net income $466 $147 $474 $352 $541
  
 
 
 
 
DILUTIVE PER SHARE DATA(1)               
 Income before accounting change $1.64 $0.53 $1.82 $1.33 $2.07
 Cumulative effect of change in accounting principle(2)      (0.03)   
  
 
 
 
 
  Net income $1.64 $0.53 $1.79 $1.33 $2.07
BASIC PER SHARE DATA(1) $1.65 $0.54 $1.81 $1.35 $2.11
  
 
 
 
 
BALANCE SHEET DATA               
ASSETS               
 Investments $6,587 $6,146 $6,019 $6,184 $6,452
 Brokerage and consulting receivables  8,430  7,033  6,952  6,230  5,423
 Intangible assets  4,324  4,084  3,916  3,862  3,500
 Other  5,993  5,067  5,364  4,856  4,313
  
 
 
 
 
  Total assets $25,334 $22,330 $22,251 $21,132 $19,688
  
 
 
 
 
LIABILITIES AND STOCKHOLDERS' EQUITY               
 Insurance premiums payable $9,904 $8,233 $8,212 $7,643 $6,948
 Policy liabilities  5,310  4,990  4,977  5,106  4,823
 Notes payable  1,671  1,694  1,798  1,611  1,423
 General liabilities  3,802  3,098  3,026  2,871  2,627
  
 
 
 
 
  Total liabilities  20,687  18,015  18,013  17,231  15,821
 Redeemable preferred stock  50  50  50  50  50
 Capital securities  702  800  800  800  800
 Stockholders' equity  3,895  3,465  3,388  3,051  3,017
  
 
 
 
 
  Total liabilities and stockholders' equity $25,334 $22,330 $22,251 $21,132 $19,688
  
 
 
 
 
COMMON STOCK DATA               
 Dividends paid per share $0.825 $0.895 $0.87 $0.82 $0.73
 Stockholders' equity per share  12.56  12.82  13.02  11.91  11.83
 Price range  39.63-13.50  44.80-29.75  423/4-2011/16  462/3-261/16  503/8-323/16
 Market price at year-end  18.890  35.520  34.250  40.000  36.917
 Common stockholders  11,419  13,273  13,687  13,757  12,294
 Shares outstanding (in millions)  310.2  270.2  260.3  256.1  255.0
  
 
 
 
 

(1)
In the first quarter of 2002, Aon adopted FASB Statement No. 142, Goodwill and Other Intangible Assets, effective January 1, 2002. Beginning in 2002, amortization of goodwill is no longer included in net income. (See note 2 to the consolidated financial statements).

Selected Financial Data

(millions except common stock and per share data)

 2005
 2004
 2003
 2002
 2001

INCOME STATEMENT DATA               
 Brokerage commissions and fees $6,646 $6,822 $6,545 $5,853 $5,193
 Premiums and other  2,848  2,788  2,609  2,368  2,027
 Investment income  343  321  310  249  206
  
  Total revenue $9,837 $9,931 $9,464 $8,470 $7,426

 Income from continuing operations $642 $545 $642 $464 $146
 Discontinued operations  95  1  (14) 2  1
  
  Net income $737 $546 $628 $466 $147

DILUTED PER SHARE DATA               
 Income from continuing operations $1.89 $1.63 $1.94 $1.63 $0.53
 Discontinued operations  0.28    (0.04) 0.01  
  
  Net income $2.17 $1.63 $1.90 $1.64 $0.53

BASIC NET INCOME PER SHARE

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
 Income from continuing operations $1.99 $1.70 $2.01 $1.64 $0.54
 Discontinued operations  0.29    (0.04) 0.01  
  
  Net income $2.28 $1.70 $1.97 $1.65 $0.54

BALANCE SHEET DATA               
ASSETS               
 Investments $9,064 $8,453 $7,240 $6,443 $6,090
 Brokerage and consulting receivables  8,072  8,235  8,335  8,120  6,843
 Intangible assets  4,506  4,744  4,659  4,296  4,062
 Other  6,176  6,897  6,793  6,475  5,335
  
  Total assets $27,818 $28,329 $27,027 $25,334 $22,330

LIABILITIES AND STOCKHOLDERS' EQUITY               
 Insurance premiums payable $9,427 $9,775 $9,816 $9,420 $7,933
 Policy liabilities  6,508  6,393  5,932  5,310  4,990
 Notes payable  2,105  2,115  2,095  1,671  1,694
 General liabilities  4,475  4,893  4,636  4,286  3,398
  
  Total liabilities  22,515  23,176  22,479  20,687  18,015
 Redeemable preferred stock    50  50  50  50
 Capital securities        702  800
 Stockholders' equity  5,303  5,103  4,498  3,895  3,465
  
  Total liabilities and stockholders' equity $27,818 $28,329 $27,027 $25,334 $22,330

COMMON STOCK AND OTHER DATA               
 Dividends paid per share $0.60 $0.60 $0.60 $0.825 $0.895
 Price range  37.14-20.65  29.40-18.17  26.79-17.41  39.63-13.50  44.80-29.75
 
At year-end:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
  Stockholders' equity per share $16.51 $16.11 $14.32 $12.56 $12.82
  Market price $35.95 $23.86 $23.94 $18.89 $35.52
  Common stockholders  10,523  11,291  11,777  11,419  13,273
  Shares outstanding (in millions)  321.2  316.8  314.0  310.2  270.2
  Number of employees  46,600  47,900  54,400  55,100  53,300



(2)
Adoption of SEC Staff Accounting Bulletin 101, effective January 1, 2000, net of tax.

10



Item 7.    Management's Discussion and Analysis of Financial Condition and Results of Operations.

Overview

        This Management's Discussion and Analysis is divided into seven sections.organized as follows:


I.


OVERVIEW
Key Drivers of Financial Performance
Executive Summary of 2005 Financial Results

II.


KEY RECENT EVENTS
Restructuring and Other Business Reorganization Initiatives
Investigation by the New York Attorney General and Other
Regulatory Authorities
Sale and Strategic Analysis of Certain Businesses
New Chief Executive Officer
Stock Repurchase Program

III.


CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Restructuring
Pensions
Contingencies
Policy Liabilities
Valuation of Investments
Intangible Assets

IV.


REVIEW OF CONSOLIDATED RESULTS
General
Summary Results for 2003 through 2005
Consolidated Results for 2005 Compared to 2004
Consolidated Results for 2004 Compared to 2003
Consolidated Results for Fourth Quarter 2005 Compared to
Fourth Quarter 2004

V.


REVIEW BY SEGMENT
General
Risk and Insurance Brokerage Services
Consulting
Insurance Underwriting
Corporate and Other

VI.


FINANCIAL CONDITION AND LIQUIDITY
Liquidity
Cash Flows
Financial Condition
Investments
Borrowings
Stockholders' Equity
Off Balance Sheet Arrangements

OVERVIEW

Key Drivers of Financial Performance

Segments

        The key drivers of financial performance vary among our segments.

        Risk and Insurance Brokerage Services.    Brokerage segment results are affected by a number of key drivers, including:

        In addition, in 2005 and 2004, this segment was affected by matters discussed under "Key Recent Events—Investigation by the New York Attorney General (NYAG) and Other Regulatory Authorities" and our related decision to terminate contingent commission arrangements.

        Consulting.    Consulting segment results are principally affected by:


        In addition, in 2005 and 2004, this segment was also affected by the matters discussed under "Key Recent Events—Investigation by the New York Attorney General (NYAG) and Other Regulatory Authorities" and our related decision to terminate contingent commission arrangements.

        Insurance Underwriting.    Underwriting segment results are affected by:

        Corporate and Other.    The key drivers of results in this segment are investment income and debt financing costs.



Liquidity

        Liquidity is derived from cash flows from our business, excluding funds held on behalf of clients and from financing. We use liquidity for capital expenditures, to repay debt, to fund acquisitions and pension obligations, to repurchase shares and to pay dividends to our stockholders. Because we are a holding company, our subsidiaries may not have available cash to pay us dividends; in the case of the insurance underwriting subsidiaries, this ability is limited by regulatory and rating agency considerations. Our access to cash generated from operations outside the U.S. may be affected by tax considerations and by pension funding requirements in our international pension plans.

Executive Summary of 2005 Financial Results

        Our revenues from continuing operations were down 1% or $94 million compared to 2004 due to:

        These factors more than offset higher revenues generated by our core brokerage businesses, especially in the U.S.

        Organic revenue growth (which adjusts revenue growth for the effects of foreign exchange and other factors) was flat for the year. Excluding contingent commissions, organic revenue growth was 1%.

        Income from continuing operations before provision for income tax and minority interest increased $138 million from 2004. The primary drivers for this change were:

        Income from discontinued operations included a $239 million pretax gain resulting from the fourth quarter sale of our Swett & Crawford operation. The goodwill allocated to Swett & Crawford was not tax deductible, resulting in a high effective tax rate for the transaction.

        We continue to do a better job of generating and managing our cash and investments. More specifically, we:


        All of operationsAon's financial information reflects the application of critical accounting policies, estimates, assumptions and our financial condition during the periods covered by the financial statements included in this report. In the second section,judgments, as discussed below under "Critical Accounting Policies and Estimates,Estimates." we discuss certain accounting judgments that

        These items are important to understanding our financial statements. Withdiscussed further in the information from those first two sections providing important background, we then proceed with the sections providing year-to-year comparisonsremainder of our results on a consolidated basis and on a segment basis. These sections are designated by the captions "Review of Consolidated Results" and "Review by Segments," respectively. "Financial Condition and Liquidity," covers several items including disclosures related to the statement of financial position and information on special purpose entities. The "Risks and Outlook" section addresses the issues and factors that can influence future results. The final section, "Recent Developments," covers items that have occurred since February 12, 2003.

        More specifically, this Management's Discussion and Analysis is organized using the following outline:Analysis.

11


KEY RECENT EVENTS

Restructuring and Other Business Transformation Reorganization Initiatives

Plan Summary

        In fourth quarter 2000, after final approvalAugust 2005, we announced that we were reviewing the revenue potential and cost structure of each of our businesses. As a result of this review, we adopted restructuring initiatives and currently expect these initiatives to result in cumulative pretax charges totaling $262 million over a three-year period, of which we have incurred $158 million. Expected restructuring costs include workforce reductions and lease consolidation costs, asset impairments and other expenses. We expect the remaining expenses to affect our continuing operations through the end of 2007. We anticipate that these initiatives will lead to annualized cost savings of approximately $180 million by its Board2008.

        The 2005 Restructuring Plan is expected to result in the elimination of Directors, Aon began1,800 job positions and space consolidation in certain locations. Office closures will require that we recognize losses on subleases or lease buy-outs and may also trigger asset impairments. See the Critical Accounting Policies and Estimates section for detailed information on significant judgments and estimates, key assumptions and relevant accounting guidance related to our accounting for restructuring costs.

        The following chart details the restructuring and related expenses incurred in 2005 and estimated for 2006 and 2007 by geographic region:

(millions)

 United
States

 United
Kingdom

 Continent of
Europe

 Rest of
World

 Total

2005 $28 $92 $30 $8 $158
2006 estimated  25  44  10  2  81
2007 estimated  12  11      23

Total incurred and remaining estimated $65 $147 $40 $10 $262


        The following chart is a comprehensive business transformation plan designed to:summary of the 2005 restructuring costs and estimated restructuring and related expenses by type through the end of 2007.

 
 Actual
 Estimated (1)
(millions)

 Third Quarter
2005

 Fourth
Quarter 2005

 Total
2005

 Full Year
2006

 Full Year
2007

 Total

 
Workforce reduction $2 $114 $116 $33 $8 $157
Lease consolidation  15  5  20  31  6  57
Asset impairments  15  2  17  2  4  23
Other related expenses  3  2  5  15  5  25

 
Total restructuring and related expenses $35 $123 $158 $81 $23 $262

 
(1)
Our estimated costs are forward looking and should be read in connection with our risk factors. Actual costs may vary due to changes in the assumptions built into this plan. Some of the assumptions likely to change when plans are finalized and approved include changes in severance calculations, the assumptions underlying our sublease loss calculations due to changing market conditions and our overall analysis that might cause us to add or cancel component initiatives.

        Year-to-date, restructuring and related expenses amounted to $158 million, which include:

Most plan$20 million in lease consolidation costs, relate to the Insurance Brokerage and Other Services segment, principallymostly reflecting leases terminated or abandoned in the U.S. and the United Kingdom, where mostU.K.

$17 million in asset impairments, of which $13 million related to an automated client renewal software program in the U.K. that was abandoned as part of our offices and employees are located.

restructuring efforts.

$5 million in other related expenses, which represents fees paid to outside parties for work related to the restructuring.

StatusPerformance objective of business transformation plan implementationrestructuring initiative

        We have implementedare restructuring to improve our profitability through operational efficiency. We project that our savings, net of restructuring expenses, will become positive by 2006, with a targeted annualized savings of approximately $180 million by 2008. However, we cannot guarantee that we will achieve the business transformation plan, which has delivered many, buttargeted savings given the factors discussed in the note to the preceding table.

Investigation by the New York Attorney General (NYAG) and Other Regulatory Authorities

        In March 2005, we settled regulatory investigations for $190 million with the NYAG and other state regulatory authorities. In the settlement, we agreed not allto seek or accept indemnification pursuant to any insurance policy or other reimbursement with respect to any amounts payable under the Settlement Agreement.

        The settlement had two significant effects on our operations:

(1)
Our revenue was $100 million lower in 2005 than 2004 because we terminated contingent commission arrangements.

(2)
The impact of the expected benefits. In U.S. retail brokerage,March 2005 settlement was included in our 2004 operations. Since the plan entailed extensive process redesign followingsettlement amount was fixed and determinable, we discounted the rolloutliability to the net present value of a new policy management and accounting system (completed in 2000), and substantial job redesignthe payments based on functional expertiseour incremental borrowing rate, following Accounting Principle Board's (APB) Opinion No. 21. This discount is reflected in the $10 million difference between the

These delays negatively impacted new business production, as our attention was diverted from generating new accounts to completing client conversions and maintaining service to our New York region clients from our offices throughout the U.S.

        In addition, expenses were higher than expected, due in part to:

In addition, in the aftermath of the World Trade Center tragedy, the dynamics of the insurance marketplace have changed, increasing time requirements and expense for handling certain job functions.

12



        The table below summarizes our business transformation costs by calendar year and provides a breakdown of pretax expenses.

 
 2002
 2001
 2000
 Plan
Total

 
 (millions except per share and employee data)

Business Transformation Costs            
 Pretax expense (credit) $(6)$218 $82 $294
 After-tax expense (credit)  (4) 133  50  179
 Dilutive earnings per share loss (credit)  (0.01) 0.49  0.19  0.67

Pretax Expense (Credit) by Type:

 

 

 

 

 

 

 

 

 

 

 

 
 Termination Benefits $(6)$109 $54 $157
  Approximate No. of employees(1)  (200) 3,150  750  3,700
 Exit Costs, Impairments and Other Expenses    109  28  137
  Abandoned real estate or equipment losses    10  2  12
  Impairment of fixed assets    10  20  30
  Obligations related to automobile dealer partnerships    44    44
  Exit of certain joint venture operations    12    12
  Litigation matters and discontinuance of A&H business in one state    14    14
  Commission receivable write-off    5    5
  Direct costs to complete transformation and cash settlements    11  4  15
  Other costs    3  2  5
  
 
 
 
   Total pretax expense (credit) $(6)$218 $82 $294
  
 
 
 

(1)
The approximate number of employees shown is on a gross basis, based upon notice of termination. Given effect to approximately 900 new hires, the expected ultimate net reduction will be approximately 2,800 in the units affected by the business transformation plan.

        The $294 million plan total excludes:

In recording these expenses, we followed the accounting guidance from Emerging Issues Task Force (EITF) 94-3, Staff Accounting Bulletin (SAB) 100, Financial Accounting Standards Board (FASB) Statement No. 121, and FASB Statement No. 5. In each year that we recorded accruals for either termination benefits or other costs to exit an activity, we met all of the requirements contained in EITF 94-3 and SAB 100 before recording an accrual, although our Board approved the high-level plan in the fall of 2000.

        We incurred these expenses over two years because different Aon units completed detailed plans and satisfied the employee notification requirements in different timeframes. The expenses for our U.S. retail brokerage operation were approximately 19% of the plan total costs. We do not anticipate any additional expenses from the business transformation plan.


Termination benefits

        We incurred expenses totaling $54 million in 2000 and $109 million in 2001 for termination benefits, covering the costs to sever approximately 750 employees in 2000 and 3,150 employees in 2001. Approximately 200 of the notified employees were to have their jobs terminated under a U.S. retail brokerage exit plan; however, the tragic events of September 11th have reduced the total number of employees who will be terminated. As a result, we recorded a $6 million credit in general expenses in 2002. A portion of the overall employment reduction was expected to be accomplished through normal attrition and, therefore, no expense was attributable to those reductions. Therefore, the approximate number of employees to be terminated was 3,700. Giving effect to approximately 900 new hires, the expected ultimate net reduction of employees will be approximately 2,800 in the units affected by the business transformation plan.

        Almost all of the affected employees had been removed from the payrollsettlement as of December 31, 2002. All of the 198 remaining notified, but not yet terminated, employees work outside the U.S.; the exit plans for these employees have later termination dates because employment laws in certain countries require extended periods before we can terminate a notified employee. Our exit plans in these cases were targeted to specific employee groups, and in some cases, specific employees.

        At or before the expense accrual date, we properly notified these employee groups and gave them adequate information about their severance benefits. The run-off of the associated liability will trail the time by which we complete these exit plans because our policy is to pay severance over the eligible period, rather than in a lump sum amount, whenever possible.

Costs to exit activities

        Approximately $27 million in other costs to exit an activity have also been included in the total expense of $294 million. Of that amount, we incurred $6 million in 2000, which included $2 million in abandoned real estate or equipment leases and $4 million of direct costs necessary to complete portions of the business transformation plan and cash settlements necessary to exit contractual obligations. In 2001, we recorded $21 million of expenses, which included $10 million for abandoned leases and $11 million for direct costs necessary to complete portions of the business transformation plan and cash settlements necessary to exit contractual obligations.

Other costs

        As part of our business transformation and other strategic initiatives, we incurred other expenses of $110 million. Of this total, $22 million was recorded in 2000. Impairment of fixed assets accounted for $20 million of the 2000 expense, including $16 million for information systems assets. The net book value of these assets was written off, as these assets no longer had value to Aon. The assets were considered impaired and without value because of one of the following reasons:

1.
We removed the system from service.

2.
We abandoned system development as a result of the transformation.

3.
We outsourced the relevant function for some fixed assets, including certain technology infrastructure equipment.

        There were $2 million of other costs also recognized in 2000.

        We recorded $88 million as other expenses in 2001. More specifically, Aon has acted as a servicing agent for a limited partnership affiliated with our automobile dealership clients to provide auto financing to dealerships on a cooperative basis through various financing conduit facilities. We also have a general partnership interest in the limited partnership. Our primary client relationship with automobile dealers is to provide extended warranty products to their customers.

14



        In first quarter 2001, we elected to cease servicing new business and run off our existing service obligation, given competition from financing provided by the financing arms of automobile manufacturers. The limited partnership records allowances for uncollectible loan balances.

        In conjunction with our decision to discontinue new auto financing receivables, the limited partners are not obligated to contribute additional capital beyond what they have already provided for any shortfall in the reserves for their individual book of business. We are required to fund any shortfalls in accordance with our limited recourse to the funding facility, arranged by the servicing agent.

        The servicing agent estimated an expense of $44 million as our liability for the shortfall when we decided to discontinue new auto loan financing under the facility. We recorded a charge to establish this obligation in accordance with FASB Statement No. 5 in 2001. For2004, changes during the year 2000,and the last full yearending liability as of normal operation, these servicing operations, which were partDecember 31, 2005.

(millions)

  
 

 
Balance as of December 31, 2004 $180 
Accretion of discount  5 
Cash payment to settlement fund  (76)

 
Balance as of December 31, 2005 $109 

 

Sale and Strategic Analysis of our Insurance Brokerage and Other Services segment, generated revenue of $42 million and pretax income of $3 million.Certain Businesses

        During 2001,2003, 2004 and 2005, we exited four other joint venture operations as a part of our business transformation process. For the year 2000, the last full year of operation, these joint ventures, which were part of our Insurance Brokerage and Other Services segment, generated less than $1 million of revenue and nearly $3 million of pretax losses. The total cost to exit these four joint ventures was $12 million.

        Additional expenses in 2001 included:sold certain businesses, including:

In 2001, we also incurred additional fixed asset impairments of $10 million (of which $9 million related to information systems assets) and $3 million of other costs.

        The implementation and effects of the business transformation plan must be viewed in the context of the World Trade Center tragedy.

World Trade Center Tragedy

        The attack on the World Trade Center significantly impacted our employees, our clients and industry, our business transformation plan and our financial results.

Employee Impact

15


Client and Industry Impact

Business Transformation Plan Impact

        The insuranceU.K. reinsurance brokerage industry worldwide has expanded significantly since September 11th with increased client demand for risk management services not anticipated when we first developed the business transformation. This unanticipated expansion delayed our ability to implement some parts of the plan. It also required that we incur additional spending, primarily in the U.S., to take advantage of this industry expansion, which partially explains the offset in savings.

Financial Results Impact

        In 2001, Aon recorded pretax unusual charges of $158 million, net of insurance and reinsurance reimbursements, related to losses sustained as a result of the destruction of the World Trade Center and the death of 175 employees. The financial costs we incurred for this tragedy included $192 million of insurance benefits paid by Aon's Combined Insurance Company of America subsidiary (CICA) under life insurance policies issued for the benefit of deceased employees, a cost which is partially offset by anticipated reinsurance reimbursements of $147 million, resulting in a net charge of $45 million.

        Reinsurers have disputed their liability for about $90 million of reinsurance reimbursements under a Business Travel Accident (BTA) policy issued by CICA to cover U.S.-based employees of subsidiaries of Aon; both parties have filed legal actions. We recorded a pretax $90 million allowance for a potentially uncollectible receivable related to this dispute in fourth quarter 2001.

        In September 2002, the Court dismissed CICA's action with respect to the BTA policy for the lack of subject matter jurisdiction. Prior to year-end, CICA was granted an expedited appeal.

        Other World Trade Center charges also included:

        In addition, at December 31, 2005, we were in the process of selling a small non-core brokerage business in Australia. We completed the transaction in January 2006.



        We have classified the operating results of all of these businesses as discontinued operations and reclassified prior year's operating results to discontinued operations, as follows:

(millions)            Years ended December 31,

 2005
 2004
 2003
 

 
Revenues $193 $274 $359 

Pretax income (loss):

 

 

 

 

 

 

 

 

 

 
 Operations $(6)$33 $4 
 Gain (loss)  236  (23) (23)
  
 
  Total $230 $10 $(19)

 
After-tax income (loss):          
 Operations $(6)$19 $ 
 Gain (loss)  101  (18) (14)
  
 
  Total $95 $1 $(14)

 

        See Note 6 to the Aon Memorial Education fundconsolidated financial statements, "Disposal of Operations," for further information.

        In November 2004, we sold our Cambridge claims administration business to supportScandent Holdings Mauritius Limited ("SHM") for $90 million in cash plus convertible preferred stock in SHM, valued at $15 million. Because of our convertible preferred stock holding and other factors, we included Cambridge's results before the educational needs of the children of Aon employees who were victims of the September 11th attacks.

Offsetting these expenses were estimated reimbursements of $60 million.

        We reached a settlement with our property insurance carriers in 2002 pertaining to reimbursement for depreciable assets destroyed. This settlement resulted insale's effective date, as well as a pretax creditgain on the sale of $29$15 million, which is

16



reported as an Unusual credit—World Trade Center in the consolidated statements of income. Aon continues to present additional claims to insurers for losses related to extra expenses, leasehold interests and business interruption coverage, and we expect additional recoveries and gains when specific claims are settled.

Previously Planned Divestiture of Insurance Underwriting Businesses and Discontinuance of Certain Operationsincome from continuing operations.

        As disclosed in April 2001, Aon's Board of Directors approved a preliminary planFrom time to spin off its insurance underwriting businesses to Aon's common stockholders, creating two independent, publicly traded companies.

        Whentime, we reportedexplore strategic alternatives for our secondvarious businesses. In fourth quarter 2002 results,2005, we announced that we were no longer planningexploring alternatives to spin off allour ownership of our underwriting operations, but were continuing to consider either selling or partially spinning them off. At that time, we believed we could promptly sell all or part of the underwriting operations at an acceptable price within a reasonable time given unsolicited buying interest in the past.

        We decided not to pursue this revised plan in October 2002 for these reasons:

1.
While we received indications of interest in our underwriting businesses, none reflected an acceptable price due to the unfavorable mergerswarranty, credit and acquisitions environment resulting from volatile capital markets. Although proceeds from selling such businesses would have allowed us to pay down short-term debt, the sale would have resulted in unacceptable earnings dilution.

2.
We determined that spinning off part of our underwriting operations was impractical due to capital requirements and possible rating agency reactions.

        During 2002, Aon incurred $50 million of pretax expenses related to the planned divestiture of our insurance underwriting businesses, which included costs related to the expanded corporate and underwriting staff added in anticipation of the divestiture. These costs, of which $33 million are reflected in our Insurance Underwriting segment results and $17 million are reflected in our Corporate and Other segment, are recorded primarily in general expenses in the consolidated statements of income, and represent staff buildup and severance costs, corporate overhead and advisory fees and other costs tied to the specialty property and casualty underwriting initiatives.businesses to determine if the potential of these businesses can be more fully realized under different ownership.

New Chief Executive Officer

        In fourth quarter 2002, Aon announced its plans to sell Sheffield Insurance Corporation, a small property-casualty company.

        In February 2003,April 2005, we announced that we would be discontinuingGregory C. Case had become our accidentpresident and health insurance underwriting operations in Mexico, Argentina and Brazil,chief executive officer, effective immediately. Mr. Case was also elected to our Board of Directors. He succeeds Patrick G. Ryan, who had served as wellAon's CEO since the company's founding. Mr. Ryan continues to serve as our large company group life business inExecutive Chairman of the U.S. Total premiums earned in 2002, related to these linesAon Board of businesses, were approximately $100 million. We will pursue a "back to basics" strategy in the accident and health insurance business, where the focus will be on core products and regions with the best returns on investments.Directors.

SEC Comment Letter (Division of Corporation Finance)Stock Repurchase Program

        In July 2002,November 2005, we received a comment letter fromannounced that our Board of Directors had authorized the SEC's Divisionrepurchase of Corporation Finance regarding our 2001 Form 10-K and first quarter 2002 Form 10-Q. The SEC sent this letter as part of its publicly announced planup to review periodic reports of large public corporations. Aggregate stockholders' equity was not impacted as a result of our resolution of issues with the SEC.

17



        The SEC letter asked questions pertaining to three main areas:

1.
A $90 million disputed reinsurance recoverable initially recorded in the third quarter 2001 relating to benefits paid to beneficiaries$1 billion of Aon's World Trade Center employeescommon stock. Any repurchased common stock will be available for employee stock plans and for other corporate purposes. From time to time, we may purchase shares through our CICA subsidiary that underwrote the insurance coverage. Originally, we had recorded an allowance for potential uncollectibility of the reinsurance recoverableopen market or in the first quarter 2002privately negotiated transactions based on a dispute with reinsurers and certain court actions in an unrelated case. The SEC commented on the timing of the establishment of the allowance.
2.
The investment portfolio of our subsidiaries. We have always had a policy of reviewing the investment portfolio of our subsidiaries for potential impairments. The SEC staff believed that with respect to equity and certain below investment grade fixed-maturity securities that had been trading below cost for an extended period of time, we should recognize other than temporary impairments through our income statement more quickly.
3.
The addition or exclusion of certain disclosures and items. The SEC staff requested that Aon add certain disclosures and not report certain items. To respond to this request, we amended our consolidated financial statements and management's discussion and analysis of financial condition and results of operations in our 2001 Form 10-K/A and first quarter 2002 Form 10-Q/A.

Capital Enhancement Actions

        During the fourth quarter 2002, Aon raised net proceeds of approximately $519 million through the issuance of 3.5% convertible debt securities and 7.375% debt securities, and approximately $607 million by issuing 36.8 million shares of new common stock. The 3.5% debt securities are convertible into Aon common stock at an initial price of approximately $21.475 per common share under certain circumstances (see note 8 to the consolidated financial statements). Funds received by these offerings were used to pay down commercial paper, other short-term debt, long-term debt and to repurchase a portion of our trust preferred capital securities. See Capital Resources, below, for further information.$25 million.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

        Aon's consolidated financial statements have been prepared according to accounting principlesU.S. generally accepted in the United Statesaccounting principles (GAAP). To prepare these financial statements, we made estimates, assumptions and judgments that affect affect:


        In accordance with our policies, we:

        The results allow us to makeinvolve judgments about ourthe carrying values of assets and liabilities that are not readily apparent from other sources. TheIf our assumptions or conditions change, the actual results we report may differ from these estimates if our assumptions or conditions change.estimates.

We believe the following critical accounting policies among others, affect the more significant estimates, assumptions and judgments we used to prepare these consolidated financial statements.

PensionsRestructuring

        We account for our defined benefit pension plans        Restructuring costs are expensed as incurred in accordance with FASB Statement No. 87, "Employers'112,Employers Accounting for Pensions"Postemployment Benefits and FASB Statement No. 146,Accounting for Costs Associated with Exit or Disposal Activities. Statement No. 146 applies to one-time workforce reduction benefits and requires companies to use Statement No. 112 when severance is paid under an ongoing severance policy. Lease consolidation costs, asset impairments and other costs associated with restructuring are accounted for under Statement No. 146 and FASB Statement No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets.

Workforce reduction costs

        We account for workforce reduction costs that result from an ongoing severance plan under Statement No. 112. Such instances occur when (1) we have an established severance policy, (2) statutory requirements dictate the severance amounts, or (3) we have an established pattern of paying by a specific formula.

        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:

        When employees are receiving incentives to stay beyond the legally required notification period, we spread the entire cost of their severance over the remaining service period.

Lease consolidation costs

        Where we have provided notice of cancellation pursuant to a lease agreement or abandoned space and have no intention of reoccupying it, we recognize a loss. The loss reflects our best estimate of the net present value of the future cash flows associated with the lease at the date we vacate the property or sign a sublease arrangement. To determine the loss, we make assumptions about the time period over which the building will remain vacant and the sublease terms.



        We estimate sublease income based on current market quotes for similar properties. When we finalize definitive agreements with the sublessee, we adjust our sublease losses for actual outcomes.

Fair value concepts of severance arrangements and sublease losses

        Accounting guidance requires that amountsour exit and disposal accruals reflect the fair value of the liability. Where material, we discount back sublease loss calculations to arrive at their net present value.

        Most workforce reductions happen over a short span of time, so no discounting is necessary. However, we discount the severance arrangement when we terminate an employee who will provide no future service and we pay their severance over an extended period. Accretion of the discount occurs over the remaining life of the liability.

        For the remaining lease term or severance payout, we decrease the liability for payments and increase the liability for accretion of the discount. The discount reflects our incremental borrowing rate, which matches the lifetime of the liability.

Other associated costs of exit and disposal activities

        We recognize other restructuring costs as they are incurred, including moving costs and consulting and legal fees.

        Asset impairments may result from large-scale restructurings and we account for these impairments in the period when they become known. Furthermore, we record impairments in accordance with Statement No. 144 by:


Income statement classification of restructuring expenses

        As we incur restructuring expenses, we classify them in our income statement in these categories:

Pensions

U.S. Plans

        The U.S. pension plans are closed to new employees. All employees hired after 2003 participate in a defined contribution plan. Over time, this change will reduce the volatility inherent in the accounting for the U.S. pension plans.

        Aon uses a market-related valuation of assets to calculate pension expense. This valuation reflects a five-year average of the difference between the expected return on plan assets and the actual market value return. The prior year market-related value is projected to the current date by adjusting for contributions, benefit payments and expected returns. The asset gain or loss is the difference between the expected return on assets and the actual return on assets. Twenty percent of the asset gain or loss is recognized in the financial statementscurrent year's market-related value, with the remaining eighty percent spread evenly over the next four years.



        As of year-end 2005, the market-related value of assets does not yet reflect accumulated asset losses of $69 million. These losses will increase pension expense as they are graded into the market-related asset value and may be determinedoffset by future asset gains. As of year-end 2005, we reported a fair value of pension assets of $1,326 million, while the market-related value of assets is $1,395 million. The Company contributed $300 million to the major U.S. pension plan during 2005 to strengthen the funding of the program.

        Under FASB Statement No. 87,Employers' Accounting for Pensions, the full gain or loss on an actuarial basis. A substantial portion of Aon's pension amounts relate to its defined benefit plansassets and obligations is not recorded as expense in the United States,current period. Statement No. 87 allows changes in the United Kingdomprojected benefit obligation and market value of assets to be deferred and amortized as a component of pension expense over several years, based on the Netherlands.average expected future service of active employees, which is currently nine years. Gains and losses on pension obligations include the net effects of changes in the discount rate and other actuarial assumptions, as well as demographic changes in the employee data.

        For the 2005 valuation year, the pension plans have a combined deferred loss of $623 million (comprised of unrecognized asset losses of $69 million and other than deferred asset losses of $554 million) that has not yet been recognized through income in the financial statements. We amortize the non-asset losses of $554 million outside of a corridor, over about nine years; this corridor is defined as 10% of the greater of the market-related value of plan assets or the projected benefit obligation. For 2006, the estimated amortization amount to be recognized in expense is projected to be $46 million. To the extent not offset by future gains, the incremental amortization as calculated above will continue to affect future pension expense in a similar manner until fully amortized.

        To determine future pension expense, we currently assume a long-term rate of return of approximately 8.4%. This expected long-term return was based on capital market expectations for various asset classes (see following table). U.S. equities and fixed income expectations were built using a theoretical Capital Asset Pricing ("CAP") Model. The CAP Model included three factors for equities: current dividend yield (1.6%); corporate earnings nominal growth (7.2%); and P/E ratio repricing (0.0%). The 5.8% fixed income expectation factor included the then current 10-year U.S. Treasury Note yields and simulations of future yields based on expected inflation and other factors. Other asset classes expectations were based on risk premiums relative to U.S. equities and fixed income expected returns. Estimates of volatilities and correlations among asset classes were based on historical data. We then weight the expected returns for each asset class by the plan's target allocation.

        This table shows the result of the calculation based on the target asset allocation for year-end 2005. The actual return for the 2005 valuation year of 11.8% was in excess of the assumed return.

Asset Class
 Target
Allocation

 Expected
Returns

 Weighted Average
Expected Rate
of Return

 

 
Equities 80%     
 Domestic equities 45     8.8%4.0%
 Limited partnerships and other 15     10.2 1.5 
 International equities 15     8.8 1.3 
 Real estate and REITs 5     7.1 0.4 

Debt Securities

 

20   

 

 

 

 

 
 Fixed maturities 20     5.8 1.2 
 Invested cash No Target 2.4  

 
   Total     8.4%

 

        There are several assumptions whichthat impact the actuarial calculation of pension plan obligations and, in turn, net periodic pension expense in accordance with FASB Statement No. 87. These assumptions require various degrees of judgment. The most significant assumptions are (1) are:

        The same assumptions are used for our pension plans and postretirement benefit plans where applicable. Changes in these assumptions can have a material impact on pension obligations and pension expense. For example, holding all other assumptions constant, a one percentage point:

        Similarly, holding other assumptions constant, a one percentage point:

        Required cash contributions are also sensitive to prior periods.

        As ofassumptions, however the annual measurement date for each plan, we determine the discount rate to beassumptions used to discountdetermine contributions to the plan obligations.are changed infrequently. We anticipate cash funding requirements of $6 million in 2006. Under current rules and assumptions, we anticipate funding requirements of $199 million in 2007. Legislation being considered in Congress may reduce the 2007 requirement to $43 million if passed. Pension reform legislation may further change this requirement.

Major U.K. Plans

        The discount rate reflectsU.K. pension plans are closed to new entrants and all employees hired after 1999 become participants in a defined contribution plan. As with the current rate at whichU.S. plans, this change will reduce the pension obligations could be effectively settled. In estimating this rate, we look to rates of return on long-term, high quality, fixed-income investments that receive one of the two highest ratings given by a recognized ratings agency. Decreasesvolatility inherit in the discount rate overaccounting for U.K. pension plans. The other international plans and the past few years have been driven by a decrease in long-term interest rates and have had twoU.K. plans are solely obligations of Aon Corporation subsidiaries.

        For the 2005 valuation year, the major impacts on our consolidated financial statements:

1.
They contributed, along with decreases in the expected return on plan assets and other assumptions, to increases to our Projected Benefit Obligation (PBO).

19


2.
They contributed, along with decreases instatements. We amortize the expected return on plan assets and other assumptions, to increases to our Accumulated Benefit Obligation (ABO), which representsaccumulated loss outside of a corridor over 16 years; this corridor is defined as 10% of the measurementgreater of pension obligations relating to services performed by active and terminated, as well as retired employees through the current measurement date.

        For Aon's significant defined benefit pension plans, a combination of declines in the fair value of plan assets and an increase in the ABO has necessitated over time an aggregate pretax charge to accumulated other comprehensive loss related to minimum pensions of $1.2 billion, or $720 million after-tax, as of December 31, 2002.which would reduce stockholders' equity.

Contingencies

        We define as a contingency as any material condition that involves a degree of uncertainty that will ultimately be resolved. Under GAAP, we are required to establish reserves for contingencies when a loss is probable and we can reasonably estimate its financial impact.

        For instance, weWe are required to assess the likelihood of material adverse judgments or outcomes as well as potential ranges or probability of losses. A determination ofWe determine the amount of reserves required, if any, for contingencies are made after careful analysis ofcarefully analyzing each individual issue. The required reserves may change in the future due to new developments in each matter,issue, or changes in approach, such as a change inchanging our settlement strategy in dealing with these matters.strategy.

Policy Liabilities

        Through our insurance underwriting operations, we collect premiums from policyholders and we establish liabilities (reserves) to pay benefits to policyholders. The liabilityliabilities for policy benefits, claims and unearned premiums is oneare a large portion of the largesttotal policy liabilities included inshown on our statements of financial position. This liability isbalance sheet and are comprised primarily comprised of estimated future payments to policyholders, policy and contract claims and unearned and advance premiums and contract fees.

Accident & Health and Life

        To establish policy liabilities, we rely upondevelop estimates forof reported and anticipated claims, based on our historical experience, other actuarial data and with respect to accident, health and life liabilities, assumptions on investment yields. InterestWe base interest rate assumptions are based on factors such as market conditions and expected investment returns. Although mortality, morbidity, persistency and interest rate assumptions are locked-inset when we issue new insurance business,policies, we may need to provide for expectedadditional losses on a product by increasing reserves, reducing previously capitalized acquisition costs established for that product, and/or establishing premium deficiency reserves if there are significant changes in our experience or assumptions. Since estimating and establishing policy and contract liabilities is inherently uncertain, the actual ultimate cost of a claim may vary materially from the estimated amount reserved.

        WhileLiabilities for incurred but unpaid claims include estimated costs relating to incurred and reported claims and incurred but not reported claims. We base the liability for unpaid claims on the estimated



ultimate cost of settling claims using best estimates of past experience. These estimates reflect current trends and any other factors that influence historical data. Actual experience, however, may vary from our estimates, due to changes in claim reporting, processing patterns and variations from historic averages for the amount paid per claim. Variations from historic patterns and averages could result in additional changes that increase or decrease unpaid claim liabilities. As of December 31, 2005, there were no known changes in reporting or processing patterns.

        Except for products that meet the definition of FASB Statement No. 97,Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments, we accrue a liability for future policy benefits relating to long-duration contracts when we recognize premium revenue. The liability represents the present value of future benefits to be paid to policyholders less the present value of future premiums and we estimate the liability using methods that include estimates of expected investment yields, mortality, morbidity and policy persistency.

        Of course, actual experience may vary from our estimates, due to emerging trends in morbidity, mortality, persistency and asset yields—and some of these trends can fluctuate significantly over time. As we realize the actual experience, we take into account the financial impacts of these changes to our original assumptions. When current estimates of the present value of future benefits exceed the present value of future premiums for a product line, we recognize all excess amounts as a loss. There are no current estimates of the overall net gain resulting from improvements from original assumptions.

        We account for long-duration contracts meeting the definition of Statement No. 97, such as universal life type products, consistent with the way we account for interest-bearing or other financial instruments. We do not report payments received on those contracts as revenue and, correspondingly, we do not establish a policy benefit reserve. The liability for policy benefits is equal to:

Claim Liabilities

        Reserves for claim liabilities were $428 million, $422 million and $447 million as of December 31, 2005, 2004 and 2003, respectively. A 1% increase in the assumed medical cost trends would reduce pretax income by approximately $3 million.

Future Policy Benefits

        Reserves for future policy benefits were $1,671 million, $1,542 million and $1,396 million as of December 31, 2005, 2004 and 2003, respectively. If a 1% unfavorable change were to occur in the mortality and morbidity assumptions for both the accident & health and life books of business, pretax income would be decreased by approximately $7 million.

Warranty

        Compared to traditional underwriting businesses, our warranty business is unique, in that we typically (1) receive a multi-year single premium and (2) claims have low severity and relatively high frequency. Individual program reserves are reviewed quarterly to verify an appropriate amount is held for past and future warranty claims. Our coverage on new products has a long waiting period and does not begin until after the underlying manufacturers warranty expires. Despite an average 31/2 year duration overall, terms may extend as far as seven years with a few warranties lasting up to ten years.



Used product warranties are also sold but without underlying manufacturer warranty and so revenue recognition begins immediately.

        In addition to the term of the warranty, we take other characteristics into account when we estimate reserves. We review considerations such as the manufacturer or classes of products and embed them in our calculation methodology.

        Similar to other underwriting activities, we use historic loss development factors to project the ultimate loss. For recent periods, we use the Bornhuetter-Ferguson method, commonly used in underwriting businesses. Bornhuetter-Ferguson:

        These methods result in a point estimate of our liability, which was $759 million as of December 31, 2005. We believe that the ultimate development of the recorded liability could be as much as 10% more or 5% less.

        Sources of uncertainty include technological innovations such as plasma TVs and liquid crystal displays. In addition, some of our policies include profit sharing, where the client participates in underwriting profits, but we pay all underwriting losses.

Property & Casualty

        We estimate loss reserves for all property and casualty lines of business by accident year, using a minimum of five standard actuarial techniques; these techniques include, but are not limited to, incurred and paid loss development factors based on both program history and industry development patterns for similar lines of business. We also use the Bornhuetter-Ferguson Method, which incorporates historical loss ratio performance weighted with case emergence to date. When we have estimatedthe data available, we use frequency and severity methods to evaluate any data on claim count emergence and severity trends.

        We base the selected ultimate loss estimates on the range of estimates discussed above. Typically, we select the average of the estimates, but that selection may be influenced by the consistency of the estimates, knowledge of emerging loss trends and rate or benefit changes.

        We evaluate selected ultimate losses for business on a direct, assumed, ceded and net basis. From the selected ultimate losses, we deduct paid losses to arrive at the total reserve. The total reserve includes case reserves and incurred but not reported reserves.

        At December 31, 2005, our recorded liability was $292 million. Given the current knowledge of the overall variability of property and casualty exposures, we expect loss reserves to fall within 10 loss ratio points (or approximately $22 million) of our selected estimate 95% of the time.

Valuation of Investments

        We periodically review securities with material unrealized losses and evaluate them for other-than-temporary impairment. We analyze various risk factors and determine if any specific asset impairment exists. If there is a specific asset impairment, we recognize a realized loss and adjust the cost basis of the impaired asset to its fair value.



        Each quarter, we review invested assets with material unrealized losses. Those assets are separated into two categories:

Assets with unrealized losses due to issuer-specific events

        Fixed maturity investments.    At least quarterly, we:

        Publicly-traded preferred stocks.    At least quarterly, we review issuer creditworthiness, including changes in ratings by nationally recognized credit agencies and changes in financial performance of the underlying issuer. We monitor all preferred stock investments with declining financial performance for other-than-temporary impairment.

        Publicly-traded common stocks.    Quarterly, we review each common stock investment to determine if its decline in value is deemed other-than-temporary. Our review includes analyzing issuer financial trends and market expectations based on third-party forward-looking analytical reports, when available.

        Private common and preferred stocks and other invested assets.    Every quarter, we review private issue valuations, which include recent transaction valuations between the issuer and a third party; financial performance reviews; and financial trend comparisons with publicly-traded companies in the same or similar industries.

        We recognize an other-than-temporary impairment loss when appropriate for these liabilities effectively,investments with continuous material unrealized losses due to issuer-specific events. We base our decision on the resultsfacts and circumstances for each investment.

Assets with unrealized losses due to market conditions or industry-related events

        Invested assets with unrealized losses due to market conditions or industry-related events include those impacted by increasing U.S. Treasury or local sovereign interest rates; corporate and asset-backed credit spread widening; common stock price volatility due to conditions in the overall market or a particular industry; and illiquid market conditions.

        Sometimes, we finally reportassume that a decline in Aon'svalue below cost is temporary for fixed-maturity investments with unrealized losses due to market conditions or industry-related events when the market is expected to recover and we can hold the investment until maturity or the market recovers, which is a decisive factor when considering an impairment loss. If we decide that holding the investment is no longer appropriate, we will reevaluate that investment for other-than-temporary impairment.

        We evaluate other-than-temporary impairment for preferred and common stock and other investments with continuous material unrealized losses for two consecutive quarters due to market conditions or industry-related events. We recognize an other-than-temporary impairment loss based upon each investment's facts and circumstances. We continue to monitor these securities quarterly to ensure that unrealized losses are not the result of issuer-specific events.



        Note 7 to the consolidated financial statements provides additional information regarding our investments, including unrealized losses segregated by type and period of continuous unrealized loss at December 31, 2005.

Intangible Assets

        Intangible assets represent the excess of cost over the value of net tangible assets of acquired businesses.

        We:

        Although goodwill is not amortized, we reporttest it for impairment at least annually. We test more frequently if there are indicators of impairment or whenever business circumstances suggest that the period whencarrying value of goodwill may not be recoverable. We perform impairment reviews at the reporting unit level. If the fair value of a reporting unit is determined to be less than the carrying value of the reporting unit, we changed our estimate.complete further analysis to determine whether there was an impairment loss. No further analysis was required in 2005 or 2004. We always consider trends in actual experience as a significant factor in helping us determine claim reserve levels.fair value based on estimates and assumptions related to the amount and timing of future cash flows and future interest rates. Different estimates or assumptions could produce different results.

20



REVIEW OF CONSOLIDATED RESULTS

General

        When we refer to organic revenue growth in theIn our discussion of operating results, we excludesometimes refer to supplemental information derived from consolidated financial information, which U.S. GAAP does not require in the financial statements.

        We use supplemental information related to organic revenue growth to help us and our investors evaluate business growth from existing operations. Organic revenue growth excludes from reported revenues the impact of foreign exchange, acquisitions, dispositions,divestitures, transfers between business units, investment income, foreign exchange,reimbursable expenses, unusual items and other unusual items. Written premiums arefor the basis forunderwriting segment only, an adjustment between written and earned premium.

        Supplemental organic revenue growth within the Insurance Underwriting segment, butinformation should be viewed in addition to, not instead of, our reported revenues reflect earned premiums.consolidated statements of income. Industry peers provide similar supplemental information about their revenue performance, although they may not make identical adjustments.


        When         Since we refer to income before income tax, we exclude minority interest relatedconduct business in more than 120 countries, foreign exchange rate fluctuations have a significant impact on our business. In comparison to the 8.205% mandatorily redeemable preferred capital securities (capital securities) (see note 11 toU.S. dollar, foreign exchange rate movements may be significant and may distort true period-to-period comparisons of changes in revenue or pretax income. Therefore, we have:

        Some tables in the consolidated financial statements).

Financial Overview of 2002

        Aon achieved goodsegment discussions reconcile organic revenue growth in 2002, but earnings were below original targets due to several factors. Aon was:

Although these issues negatively impacted earnings because of the increased expenses, revenues grew more than 10% in each operating segment, showing good demand for our products and services. In addition, we completed our business transformation plan and reported the following:

21


        Duringaggregate. If there is a significant individual reconciling item within the year,"all other" category, we strengthened our capital structure, raising $607 millionprovide additional disclosure in new common stock and $519 million of new debt, including proceeds of $296 million for convertible debt, to extend existing debt maturities, pay down near-term debt, repurchase preferred capital securities and for other general corporate purposes. Partially offsetting the increase in stockholders' equity were increased minimum pension obligations, due mostly to unfavorable financial markets, which reduced stockholders' equity by $552 million at year-end.a note.

Summary of Results for 20002003 through 20022005

        The consolidated results of continuing operations follow:

 
 Years ended December 31
 
 2002
 2001
 2000
 
 (millions)

Revenue:         
Brokerage commissions and fees $6,202 $5,436 $4,946
Premiums and other  2,368  2,027  1,921
Investment income  252  213  508
  
 
 
 Total consolidated revenue  8,822  7,676  7,375
  
 
 
Expenses:         
General expenses  6,505  5,813  5,190
Benefits to policyholders  1,375  1,111  1,037
Interest expense  124  127  140
Amortization of intangible assets  54  158  154
Unusual charges (credits)—World Trade Center  (29) 158  
  
 
 
 Total expenses  8,029  7,367  6,521
  
 
 
Income before income tax and minority interest $793 $309 $854
  
 
 
(millions)            Years ended December 31,

 2005
 2004
 2003
 

 
Revenue:          
 Brokerage commissions and fees $6,646 $6,822 $6,545 
 Premiums and other  2,848  2,788  2,609 
 Investment income  343  321  310 
  
 
  Total consolidated revenue  9,837  9,931  9,464 

 
Expenses:          
 General expenses  6,914  6,969  6,569 
 Benefits to policyholders  1,551  1,516  1,427 
 Depreciation and amortization  277  303  307 
 Interest expense  125  136  101 
 Provision for New York and other state settlements  5  180   
 Unusual credit — World Trade Center      (14)
  
 
  Total expenses  8,872  9,104  8,390 

 
Income from continuing operations before provision for income tax and minority interest $965 $827 $1,074 

 
Pretax margin — continuing operations  9.8%  8.3%  11.3% 

 

Consolidated Results for 20022005 Compared to 20012004

Revenue

        In 2002:

22further detail.


        Consolidated revenue by geographic area follows:

 
 Years ended December 31
 
 
 2002
 % of
Total

 2001
 % of
Total

 2000
 % of
Total

 
 
 (millions)

 
Revenue by geographic area:                
 United States $5,034 57%$4,463 58%$4,350 59%
 United Kingdom  1,621 18  1,390 18  1,363 19 
 Continent of Europe  1,117 13  938 12  833 11 
 Rest of World  1,050 12  885 12  829 11 
  
 
 
 
 
 
 
  Total revenue $8,822 100%$7,676 100%$7,375 100%
  
 
 
 
 
 
 
(millions)            Years ended December 31,

 2005
 % of
Total

 2004
 % of
Total

 2003
 % of
Total

 

 
Revenue by geographic area:                
 United States $4,859 50%$5,020 51%$4,956 52%
 United Kingdom  1,567 16  1,732 17  1,756 19 
 Continent of Europe  1,802 18  1,719 17  1,469 15 
 Rest of World  1,609 16  1,460 15  1,283 14 
  
 
  Total revenue $9,837 100%$9,931 100%$9,464 100%

 

        U.S. consolidated revenue, which represents 57%50% of total revenue, increased 13%decreased $161 million or 3% in 20022005 compared to 2001, as2004. The decrease primarily reflects the 2004 sale of Cambridge.

        U.K. revenue decreased $165 million or 10%. Excluding the effects of foreign currency exchange, revenue decreased $158 million. This reflects a result of strong organic growth. More specifically:

Brokerage commissions and fees increased 14% to $6.2 billion primarily from organic growth including increased premium rates, increased new business and outsourcing contracts. This was somewhat offset by revenue disruptions in the early part of the year with our managing general underwriter unit. Acquisitions contributed $90 million of incremental revenue in 2002.

        Premiums and other, primarily related to insurance underwriting operations, improved to $2.4 billion, a 17% increase over 2001. The increase:weaker U.S. dollar.

        Investment income, which includes related expenses and income or loss on disposals and impairments, increased by 18% over 2001, despite a drop in interest rates. The increase was driven by:

Offsetting these improvements were impairment write-downs for certain directly owned investments, including those classified as other than temporary, which were $73 million higher than last year.

        Investment income from our Insurance Brokerage and Other Services and Consulting segments, primarily relating to fiduciary funds, decreased $46 million compared to 2001 primarily due to declining interest rates.

23



Expenses

        Total expenses increased $662decreased $232 million or 9% over 2001. Total expenses rose 15%, excluding the following items:3% from 2004. Driving factors of this decrease are:


        General expenses increased 12% over 2001. Excluding the costs related to the business transformation plan, general expenses rose 16%, reflecting:

        These favorable impacts were partially offset by $158 million in restructuring related to National Program Services, Inc. (NPS), as described below

costs relatedexpenses. For further detail on expenses refer to the planned spin-off

discontinued underwriting businesses

        Benefits to policyholders rose $264 million or 24% due to new business volume increases, an increased payout ratio of benefits to policyholders versus net premiums earned and a shift in business mix to products with higher benefit payout ratios.

        Interest expense was down slightly due to lower short-term interest rates.

        Amortization of intangible assets declined $104 million from 2001 as goodwill was not amortized in 2002 in accordance with FASB Statement No. 142 (see note 1 to the consolidated financial statements).Review by Segment section.

Income from Continuing Operations Before Provision for Income Tax and Minority Interest

        Income from continuing operations before provision for income tax and minority interest increased significantly from $309$138 million in 2001 to $793 million in 2002. This increase is due primarily to$965 million. A number of significant items account for the net change in expenses related to the World Trade Center ($187 million), the business transformation plan ($224 million) and the improvement in Corporate and Other revenue ($150 million).fluctuation, as previously discussed. Approximately 79%68% of Aon's 2005 consolidated income from continuing operations before the provision for income tax and minority interest was from international operations.

Provision for Income Taxes

        The effective tax rate on income from continuing operations was 33.5% in 2005 and 34.1% in 2004. Differences between the overall effective tax rate and the U.S. federal statutory rate are typically due to U.S. state income taxes and differentials 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 2005 and 2004, our effective tax rate reflects the favorable resolution of tax examination issues, partially offset by the impact of deferred tax adjustments. In 2004, a one-time tax benefit resulting from the



difference between our tax and book basis in Cambridge reduced our effective tax rate. For a summary of these effects, please see the rate reconciliation provided in Note 9 to the consolidated financial statements.

Income from Continuing Operations

        Income from continuing operations increased to $642 million ($1.89 per diluted share) from $545 million ($1.63 per diluted share) in 2004. Basic income per share from continuing operations was $1.99 and $1.70 for 2005 and 2004, respectively. Hedging and currency translation gains added $0.08 and $0.05 per share, respectively, to income from continuing operations in 2005.

        To compute income per share, we have deducted dividends paid on the redeemable preferred stock from net income. In accordance with Emerging Issues Task Force (EITF) No. 04-8,The Effect of Contingently Convertible Investments on Diluted Earnings per Share, diluted shares outstanding were increased by 14 million to reflect the possible conversion of Aon's 3.5% convertible debt securities. When calculating the diluted income per share, we added after-tax interest expense on these debt securities to income from continuing operations.

Discontinued Operations

        After-tax income from discontinued operations in 2005 was $95 million ($0.29 and $0.28 per basic and diluted income per share, respectively). In comparison, after-tax income in 2004 from discontinued operations was $1 million (with no impact on basic and diluted income per share). The increase was primarily attributable to the sale of Swett & Crawford, partially offset by losses from certain insurance underwriting subsidiaries acquired with Alexander and Alexander Services, Inc. (A&A).

Consolidated Results for 2004 Compared to 2003

Revenue

        In 2004, revenue increased $467 million or 5% over 2003 to $9.9 billion. This increase was mostly from the movement in foreign exchange rates, as revenue increased $67 million excluding foreign exchange effects.

        Brokerage commissions and fees increased by $277 million or 4% from the prior year, driven almost entirely by favorable foreign exchange rates. There was no organic revenue growth in the Risk and Insurance Brokerage Services segment in large part due to the termination of contingent commission arrangements, as well as a softer insurance market. Consulting organic revenue grew 1%.

        Premiums and other increased $179 million or 7% from the prior year due to increased retentions, a change in an insurance program for a specialty accident and health line and favorable foreign exchange rates. Growth in specialty property and casualty and core accident, health and life business was offset by a planned decrease in the runoff businesses.

        Investment income increased by $11 million or 4% over 2003. The net increase reflects improved results at the operating segments driven primarily by an increase in short-term rates that was partially offset by a decline at Corporate.

        U.S. revenue, which represents 51% of total consolidated revenue, increased $64 million or 1% in 2004 compared to 2003. The low revenue growth reflected the softer U.S. retail market that began late in 2003 after a two-year rapid increase in premiums following the September 11 tragedy and lower contingent commission revenue. Additionally, the November 2004 sale of Cambridge resulted in a $19 million loss of revenue in 2004 as compared to 2003.

        U.K. revenue decreased $24 million or 1%. Excluding the positive effects of foreign currency exchange, revenue decreased $198 million or 10%. The decrease in revenue is attributable to the soft



market, which resulted in lower premiums and commissions. Additionally, the sale of our U.K. claims services business resulted in an $82 million loss of revenue in 2004 as compared to 2003.

        Continent of Europe revenue increased $250 million or 17% and Rest of World revenue increased $177 million or 14%, principally reflecting a weakening of the U.S. dollar.

Expenses

        Total expenses increased $714 million or 9% over 2003.

        General expenses increased $400 million or 6% over 2003, reflecting the impact of:


        Net gains on currency derivative transactions reduced expenses by $45 million in 2004.

        The 6% increase in benefits to policyholders was driven by the combination of growth in underwriting revenue, the change in an insurance program for a specialty accident and health line and foreign exchange rates. In 2003, expenses increased due to higher claims for National Program Services, Inc. (NPS) of $79 million. NPS was hired to handle quoting, binding, premium collection, claims adjusting and other servicing related to general liability insurance policies issued by one of Aon's subsidiaries. In 2002, we stopped NPS from initiating any new business on our behalf. In 2003, actuaries examined the business that NPS had written and reviewed assumptions, such as historical loss development patterns and expected ultimate loss ratio. As a result of this review, we strengthened our reserves, mainly for accident years 2001 and 2002.

        Interest expense increased $35 million or 35% primarily due to the adoption of FIN 46 on December 31, 2003, which required the deconsolidation of our trust preferred capital securities and which was offset by an increase in notes payable. Interest expense on the notes payable was $58 million for 2004. Without this item, interest expense declined $23 million due principally to lower debt levels during most of the year (see Notes 1 and 11 to the consolidated financial statements for more information).

        Our results include a $180 million provision for settlements resulting from investigations by the NYAG and other regulatory authorities and $40 million for the Daniel class action lawsuit.

        In 2003, total expenses included a $14 million credit related to the World Trade Center property insurance settlement. The 2003 credit represents a $60 million final settlement of our World Trade Center property insurance claim, net of $46 million paid to a third party relating to temporary office space in Manhattan after the World Trade Center was destroyed.

Income from Continuing Operations Before Provision for Income Tax and Minority Interest

        Because the increase in expenses exceeded the increase in revenues (for the reasons described above), income from continuing operations before income tax and minority interest decreased $247 million or 23% in 2004 to $827 million. Approximately 92% of Aon's 2004 consolidated income from continuing operations before provision for income tax was from international operations. The $220 million provisions for settlements resulting from investigations by the NYAG and other regulatory authorities and for costs to settle the Daniel class action lawsuit were considered domestic expenses.



Provision for Income Taxes

        The effective tax rate was 39.5%34.1% in 20012004 and 37%36.9% in 2002. The decline from 2001 was due to2003. Typically, differences between the non-deductibility of certain goodwill, which, beginning in 2002, is no longer amortized for book purposes.

        The overall effective tax rates are higher thanrate and the U.S. federal statutory rate primarily because ofare due to U.S. state income taxes and differentials between U.S. and international tax provisions.rates. Changes in the mix between our U.S. and international pretax income directly impact our effective tax rates. In 2004, a one-time tax benefit resulting from the difference between our tax and book basis in Cambridge reduced our effective tax rate. For a summary of these effects, see the rate reconciliation provided in Note 9 to the consolidated financial statements.

Net Income from Continuing Operations

        Current year's netIncome from continuing operations decreased to $545 million ($1.63 per diluted income increased to $466 million ($1.64 per dilutive share) from $147$642 million ($0.531.94 per dilutivediluted income per share) in 2001.2003. Basic net income per share from continuing operations was $1.65$1.70 and $0.54$2.01 for 20022004 and 2001,2003, respectively. Hedging and currency translation gains added $0.11 and $0.07 per share, respectively, to 2004 income from continuing operations.

24



respectively. Dividends        To compute income per share, we have deducted dividends paid foron the redeemable preferred stock have been deducted from net incomeincome. In accordance with EITF No. 04-8, we increased diluted shares outstanding by 14 million to computereflect the possible conversion of Aon's 3.5% convertible debt securities. When calculating the diluted income per share.share, we added the after-tax interest expense on these debt securities to income from continuing operations.

Discontinued Operations

        After-tax income from discontinued operations in 2004 was $1 million (no impact on basic and diluted income per share). In comparison, after-tax losses in 2003 from discontinued operations were $14 million (a loss of $0.04 per both basic and diluted income per share).

Consolidated Results for Fourth Quarter 20022005 Compared to Fourth Quarter 20012004

        Total revenues in the quarter rose 16% to $2.4 billion. On a comparable currency basis, revenue climbed 13%. The higher revenue growth reflects:

        In detail, the higher revenue growth reflects:

        Income before income taxes and minority interest increased by $225 million. Excluding the impact of the World Trade Center credit in 2002 and charge in 2001, income before income taxes and minority interest rose 64%.

        Strong revenue growth and the absence of goodwill amortization in 2002 was partially offset by:

Consolidated Results for 2001 Compared to 2000

Revenue

        Total revenues were $7.7 billion, an increase of 4%. Excluding the effects of foreign exchange rates, revenues increased 6% over the comparable period. Improvements in brokerage commissionsBrokerage commission and fees as well as premiums earned, were partially offsetdecreased by a$66 million or 4% from 2004, driven primarily by $37 million in lower revenue from the disposition of Cambridge in 2004 and $9 million less in contingent commission revenue. This decline in investment income resulting from decreased valuations of limited partnerships, lower interest rates and higher losses on disposals of investments. In addition, there was a falloff in parts of U.S. retail brokerage revenue primarily due to slower new account generation and below normal client retention.

        Consolidated organic revenue growth was 8% in 2001. For the year, acquisitions net of dispositions improved operating revenues by $207 million.

25



        U.S. revenues, which represent 58% of total revenue, increased 3% in 2001 compared to 2000 as organic growth and acquisition activity was partially offset by declines in parts of the retail brokerage business as well as a significant drop in investment income.

        U.K. and Continent of Europe revenues combined increased 6% to $2.3 billion and Rest of World revenue of $885 million increased 7% reflecting acquisitions, new business and the impact of increasing premium rates that tend to increase commissions.

        Brokerage commissions and fees increased 10% to $5.4 billion, primarily from organic growth in non-U.S. retail brokerage and worldwide reinsurance brokerage, business combination activity, increased new business and the impactstrengthening U.S. dollar of increased property and casualty premium rates. This growth was offset somewhat by unfavorable results in parts of U.S. retail brokerage due to delays in implementing the business transformation plan.$36 million.

        Premiums and other increased 6% in 2001 to $2.0 billion. This increase$13 million or 2% from the prior year, primarily reflects:

a supplemental health product and other warranty programs, which more than offset a decline in our European credit business.

This        In total, investment income is down $17 million or 14% from fourth quarter 2004. The Risk and Insurance Brokerage Services segment is up $16 million primarily due to an increase was somewhat offset by the loss of some accounts in the warranty business, in addition to a general slowdown in the economy.

        Investment income, which includes related expenses and income or loss on disposals and impairments, decreased significantly when compared to 2000, primarily reflecting:

virtually all of our Endurance common stock in 2004.

Expenses

        GeneralTotal expenses increased 12% over 2000. Excluding costs related to business transformation in 2001 and 2000, general expenses increased $487 million or 10% over 2000 primarily reflecting:

        Benefits to policyholders rose $74 million or 7% as a result of new underwriting initiatives and an unusual increase in warranty claims related to an isolated program that will not affect future periods.

        Interest expense decreased 9% or $13$183 million from prior year, partly attributable to decreases in short-term interest rates and lower average debt balances.

        Unusual charges—World Trade Center represent:2004. The significant drivers of the change include:

26


        These favorable impacts were partially offset by $123 million in restructuring related expenses.

Income from Continuing Operations Before Provision for Income Tax and Minority Interest

        Income from continuing operations before provision for income tax and minority interest declined significantlyincreased from $854$93 million in 20002004 to $309$206 million in 2001,2005. This increase is due to:

All of our consolidated income before income tax is from non-U.S. operations.2005.

Provision for Income Taxes

        The effective tax rate was 39.5%30.1% in 2005 and 21.5% in 2004. The tax rate for 2001the quarter was positively impacted by favorable resolution of tax issues and 39% for 2000. The overalllower effective state tax rates, partially offset by the impact of restructuring charges. In 2004, a one-time benefit resulting from the difference between the tax and book basis in Cambridge reduced our effective tax rates are higher than the U.S. federal statutory rate primarily because of state income tax provisions and the non-deductibility of certain goodwill amortization.rate.

Net Income from Continuing Operations

        NetIncome from continuing operations increased to $144 million ($0.42 per diluted income for 2001 was $147per share) from $73 million or $0.53($0.22 per dilutive share compared to $474 million or $1.79diluted income per dilutive shareshare) in 2000.2004. Basic net income per share from continuing operations was $0.54$0.44 and $1.81$0.23 for 20012005 and 2000,2004, respectively. In 2000, Aon adopted the Securities and Exchange Commission's Staff Accounting Bulletin (SAB) No. 101, which resulted in a one-time cumulative non-cash charge of $7 million after-tax ($0.03

        To compute income per share).    Weshare, we have deducted dividends paid on the redeemable preferred stock from net income. In September 2005, we redeemed all of the preferred stock from the holders and cancelled the shares (see Note 11 to the consolidated financial statements for further information). In accordance with EITF No. 04-8, we increased diluted shares outstanding by 14 million to reflect the


possible conversion of Aon's 3.5% convertible debt securities. We have added after-tax interest expense on these debt securities back to income to computefrom continuing operations when calculating the diluted income per share.

Discontinued Operations

        After-tax income from our discontinued businesses in 2005 was $80 million ($0.25 and $0.23 per basic and diluted income per share, respectively), reflecting primarily the sale of Swett & Crawford. In comparison, income in 2004 from these discontinued operations was $8 million ($0.02 per basic and diluted income per share).

REVIEW BY SEGMENT

General

        Aon classifies its businesses into three operating segments: Risk and Insurance Brokerage and Other Services, Consulting and Insurance Underwriting (see noteNote 16 to the consolidated financial statements)statements for further information).

        Aon's operating segments are identified as those that:

        Total revenue for each of the operating segments is presented both by major product and service and by geographic area in note 16 to the consolidated financial statements. Revenues are attributedWe attribute revenues to geographic areas based on the location of the resources producing the revenues.

        Because our culture fosters interdependence among the operating units, allocating expenses by product and geography is difficult. While we track and evaluate revenue for each segment, expenses are allocated to products and services within each of the operating segments. In addition to revenue, we also measure each segment's financial performance using its income before income tax.

27



        Operating segmentSegment revenue includes investment income generated by invested assets of that segment, as well as the impact of related derivatives, generated by operating invested assets of that segment.derivatives. Investment characteristics mirror liability characteristics of the respective operating segments:


        The following tables and commentary provide selected financial information on the operating segments.

 
 Years ended December 31
 
 2002
 2001
 2000
 
 (millions)

Operating segment revenue:         
 Insurance Brokerage and Other Services $5,263 $4,659 $4,367
 Consulting  1,054  938  770
 Insurance Underwriting  2,526  2,250  2,167
  
 
 
Total operating segments $8,843 $7,847 $7,304
  
 
 
Income before income tax:         
 Insurance Brokerage and Other Services $763 $524 $690
 Consulting  120  126  106
 Insurance Underwriting  152  150  300
  
 
 
Total income before income tax—operating segments $1,035 $800 $1,096
  
 
 
(millions)            Years ended December 31,

 2005
 2004
 2003

Operating segment revenue: (1)         
 Risk and Insurance Brokerage Services $5,400 $5,497 $5,339
 Consulting  1,255  1,247  1,185
 Insurance Underwriting  3,188  3,150  2,883

Income before income tax:         
 Risk and Insurance Brokerage Services $719 $576 $791
 Consulting  110  105  110
 Insurance Underwriting  314  254  196

Pretax margins:         
 Risk and Insurance Brokerage Services  13.3% 10.5% 14.8%
 Consulting  8.8% 8.4% 9.3%
 Insurance Underwriting  9.8% 8.1% 6.8%

(1)
Intersegment revenues of $62 million, $72 million and $68 million were included in 2005, 2004 and 2003, respectively. See Note 16 to the consolidated financial statements for further information.

Risk and Insurance Brokerage and Other Services

        Aon is a leader in many sectors of the insurance industry: globally, it is the second largest insurance broker, the largest reinsurance broker and the leading manager of captive insurance companies worldwide. InUntil the U.S., Aon is the second largest multi-line claims services provider, andfourth quarter of 2005, we were the largest wholesale broker and underwriting manager.broker; however, we sold our U.S. wholesale brokerage business (Swett & Crawford) in the fourth quarter. These rankings are based on the most recent surveys compiled and reports printed byBusiness Insurance.

        Changes in premiums have a direct and potentially material impact on the insurance brokerage industry, as commission revenues are generally based on a percentage of the premiums paid by insureds. More specifically, lower premium rates, or a "soft market," generally result in decreased commission revenues.

        Risk and Insurance Brokerage and Other Services generated approximately 60%55% of Aon's total operating segment revenues in 2002.2005. Revenues are generated primarily through:

        Our revenues vary from quarter to quarter throughout the year as a result of:

28



        Although expenses generally tend to be more uniform throughout the year,         Our risk brokerage companies operate in 2001 expenses were increased by the business transformation plana highly competitive industry and the terrorist attackscompete with many retail insurance brokerage and agency firms, as well as with individual brokers and agents and direct writers of September 11th.insurance coverage. Specifically, this segment:

        This segment:

        We review our revenue results using the following sub-segments:

The Insurance

Reinsurance Brokerage and OtherRelated Services segment revenues vary because a large part(Reinsurance) offers sophisticated advisory services in program design and claim recoveries that:

enhance the risk/return characteristics of insurance policy portfolios

improve capital utilization

evaluate and mitigate catastrophic loss exposures worldwide.

Claims Services (Claims) offered claims administration and loss cost management services. We exited most of these activities in 2004 by selling our compensation is tied to the premiums paid by those we insure,U.S. and both premium rate levels in the property and casualty insurance markets and available insurance capacity also fluctuate.

U.K. claims administration businesses.

Revenue

        Total 2002This table details Risk and Insurance Brokerage Services revenue by sub-segment.

(millions)            Years ended December 31,

 2005
 2004
 2003

Brokerage—Americas $2,172 $2,067 $2,040
Brokerage—International  2,383  2,357  2,074
Reinsurance  845  861  873
Claims    212  352
  
 Total revenue $5,400 $5,497 $5,339

        The insurance market remained soft in 2005. Total 2005 Risk and OtherInsurance Brokerage Services revenue was $5.3$5.4 billion, up 13% on a decline of 2% from last year reflecting the impact of $85 million of lost contingent commissions and $212 million due to the sale of our claims services businesses, partially offset by favorable foreign exchange and strong growth in our U.S. retail business.

        This table reconciles organic revenue growth to reported basis. Excludingrevenue growth in 2005 versus 2004.

Year ended December 31, 2005

 Reported
Revenue
Growth

 Less:
Currency
Impact

 Less:
Acquisitions,
Divestitures
& Transfers

 Less:
All
Other

 Organic
Revenue
Growth

 

 
Brokerage—Americas 5%1%%2%2%
Brokerage—International 1 1 2  (2)
Reinsurance (2)1  2 (5)
Claims (100) (100)  
  
 
 Total revenue (2)%1%(3)%1%(1)%

 

        In total, excluding the effectimpact of contingent commissions, organic revenue growth would have been 1%.

        The 5% reported growth in Brokerage-Americas is driven by strong renewals, new business and the positive foreign currency impact of $26 million, partially offset by eliminating $58 million in contingent commissions.

        International Brokerage revenue results include a positive impact of foreign exchange, rates, revenue rose 12% over last year. Most of this growth was organic, includingacquisitions and the impact of hardening premium rates. U.S. and international retail, reinsurance and wholesale brokerage all posted solid revenue growth. Insurance Brokerage and Other Services operatingrefining our techniques for estimating revenue on an organic basis, grew approximately 12%installment policies in the U.K., resulting in a very competitive environment. Investment income decreased $43$23 million in 2002 as short-term interest rates declined.

        Continuing the trend from last year, increases in insurance premium rates benefited revenues in 2002. After September 11th, insurance markets whose premium rates were rising already rose further as a result of restrictions on the availability of some coverages and the pressure on the financial strength of some insurance companies.increase to revenue. The property and casualty insurance market is very competitive. As premium rates rise, clients often retain more risk. This dynamic has, and may continue to, limitorganic revenue growth of (2)% is driven largely by pricing, less new business and changes in the model for pure brokerage services, but it provides opportunities to offer more captive insurancecompensation from underwriters in U.K. Specialty.

        Reinsurance is down 2%, despite a favorable foreign exchange impact of $7 million. Organic revenue growth of (5)% is driven primarily by weaker pricing, lower renewal rates, loss of certain accounts in 2004 and claims management services, as well as safetyhigher risk retention by clients.

        Claims Services revenue included results from Cambridge, which was sold in fourth quarter 2004.



        This table shows Risk and loss control services.

29


        This chart shows Insurance Brokerage and Other Services revenue by geographic area and total pretax income:

 
 Years ended December 31
 
 2002
 2001
 2000
 
 (millions)

Revenue by geographic area:         
 United States $2,604 $2,425 $2,277
 United Kingdom  1,087  918  889
 Continent of Europe  857  733  654
 Rest of World  715  583  547
  
 
 
Total revenue $5,263 $4,659 $4,367
  
 
 
Income before income tax $763 $524 $690
  
 
 

        In 2002,
(millions)            Years ended December 31,

 2005
 % of total
 2004
 % of total
 2003
 % of total
 

 
Revenue by geographic area:                
 United States $2,007 37%$2,151 39%$2,224 42%
 United Kingdom  1,014 19  1,056 19  1,093 20 
 Continent of Europe  1,279 24  1,265 23  1,112 21 
 Rest of World  1,100 20  1,025 19  910 17 
  
 
Total revenue $5,400 100%$5,497 100%$5,339 100%

 
Income before income tax $719   $576   $791   

 


Income Before Income Tax

        Pretax income increased $239$143 million or 25% from 20012004 to $763$719 million. In 2002,2005, pretax margins in this segment were 14.5%13.3%, up from 11.2%10.5% in 2001.2004.

        These increases were due:The primary drivers of the improvement in our results were:

        PretaxNegative impacts to this year's income excluding these items, fell 1% from 2001 to $728 million. Pretaxand margins excluding these items, were 13.8% for 2002 versus 15.8% last year. The margin decline was principally driven by higherincluded:


Consulting

        Aon Consulting is one of the world's largest integrated human capital consulting organizations. ThisOur consulting segment:

        We review our revenue results using the following sub-segments:

Revenue

        In 2002,2005, revenues of $1.1 billion increased 12%$1,255 million were 1% over 2001. Excluding the impact of foreign exchange rates, the2004. Revenue on an organic basis was down 2% from last year.

        Contingent commissions decreased $15 million from 2004 in connection with terminating our contingent fee arrangements.

        This table details Consulting revenue by sub-segment.

(millions)            Years ended December 31,

 2005
 2004
 2003

Consulting services $981 $949 $898
Outsourcing  274  298  287
  
 Total revenue $1,255 $1,247 $1,185


        This table reconciles organic revenue growth rate was 11%. Globally, the improvementto reported revenue growth in 2005 versus 2004.

Year ended December 31, 2005

 Reported
Revenue
Growth

 Less:
Currency
Impact

 Less:
Acquisitions,
Divestitures
& Transfers

 Less:
All
Other

 Organic
Revenue
Growth

 

 
Consulting services 3%1%2%%%
Outsourcing (8) (2)1 (7)
  
 
 Total revenue 1%%1%2%(2)%

 

        Overall Consulting revenue was influencedup $8 million from 2004, as growth from small acquisitions more than offset $15 million of lost contingent commissions.

        On a subsegment basis, Consulting services was up $32 million or 3% due to growth in core services partially offset by 9% organic growth as well as acquisitions. Organicthe loss of contingent commission revenue. Outsourcing revenue owed a significant portion of its growth to a sizeable human resources outsourcing agreement which we initiated in third quarter 2002. Good growth also occurred in the Continent of Europe and the Pacific region, as well as the management consulting group.

        Despite this year's growth, economic conditions continue to be difficult for this segment: the sluggish global economy, a slowdown in client hiring and slower discretionary spending by clients, has put pressure on organic revenue growth. Investment income in the Consulting segment was down $3 million from 20018% due to loss of certain clients and lower interest rates.employment levels at certain clients.

31



        This charttable shows Consulting revenue by geographic area and pretax income:

 
 Years ended December 31
 
 2002
 2001
 2000
 
 (millions)

Revenue by geographic area:         
United States $703 $628 $486
United Kingdom  160  157  151
Continent of Europe  105  77  67
Rest of World  86  76  66
  
 
 
 Total revenue $1,054 $938 $770
  
 
 
Income before income tax $120 $126 $106
  
 
 

        From 2001:

(millions)            Years ended December 31,

 2005
 % of total
 2004
 % of total
 2003
 % of total
 

 
Revenue by geographic area:                
 United States $730 58%$754 61%$762 64%
 United Kingdom  206 16  213 17  182 15 
 Continent of Europe  186 15  162 13  139 12 
 Rest of World  133 11  118 9  102 9 
  
 
  Total revenue $1,255 100%$1,247 100%$1,185 100%

 
Income before income tax $110   $105   $110   

 

Income Before Income Tax

        Pretax income was $120$110 million, aup $5 million or 5% decline from last year. In 2002,2004. 2005 pretax margins in this segment were 11.4%8.8%, downup from 13.4%8.4% in 2001. Excluding expenses related to business transformation in 2001, pretax income fell 10% in 2002, and in 2001, pretax margin was 14.2%.2004.

        Pretax margins were reduced by a large new human resources outsourcing contract. Although this contract is expected to provide favorable returns overThe following items affected the life of the multi-year agreement, it pressured margins in 2002 for the following reasons:year-to-year comparisons:

Insurance Underwriting

        The Insurance Underwriting segment:


32        We have:


        InRevenue

        Written premiums and fees are the accident, healthbasis for organic revenue growth in this segment; however, reported revenues reflect earned premiums and life operations,fees.

        We review our revenue results using the following sub-segments:


        The table below reflects written and earned from non-risk bearing activitiespremiums and the administration of certain extended warranty services on automobiles, electronic goods, personal computers and appliances are reflected in the Insurance Brokerage and Other Services segment based on how the business is reviewed by management.associated reserves:

Revenue

(millions)            Years ended December 31,

 2005
 2004
 2003

Written premiums:         
 Accident & Health and Life $1,476 $1,461 $1,460
 
Warranty and Credit

 

 

1,049

 

 

1,081

 

 

986
 Property & Casualty  239  264  221
  
  Total Warranty, Credit, Property & Casualty  1,288  1,345  1,207

Total Insurance Underwriting $2,764 $2,806 $2,667

Earned premiums:         
 Accident & Health and Life $1,696 $1,620 $1,502
 
Warranty and Credit

 

 

918

 

 

920

 

 

830
 Property & Casualty  234  248  217
  
  Total Warranty, Credit, Property & Casualty  1,152  1,168  1,047

Total Insurance Underwriting $2,848 $2,788 $2,549

Policy and Contract Claim Liabilities:         
 Accident & Health and Life $428 $422 $447
 
Warranty and Credit

 

 

177

 

 

211

 

 

207
 Property & Casualty  1,222  1,221  955
  
  Total Warranty, Credit, Property & Casualty  1,399  1,432  1,162

Total Insurance Underwriting $1,827 $1,854 $1,609

        In 2002,2005, revenues of $2.5$3.2 billion increased 12%1% over 2001.2004. Excluding the effect of foreign exchange rates, revenues rosewere flat to last year.

        This table details Insurance Underwriting revenue by 11%. Improvement over last yearsub-segment.

(millions)            Years ended December 31,

 2005
 2004
 2003

Accident & health and life $1,805 $1,721 $1,594
Warranty, credit and property & casualty  1,383  1,429  1,289
  
 Total revenue $3,188 $3,150 $2,883

        This table reconciles organic revenue growth to reported revenue growth in 2005 versus 2004.

Year ended December 31, 2005

 Reported
Revenue
Growth

 Less:
Currency
Impact

 Less:
All
Other(1)

 Organic
Revenue
Growth

 

 
Accident & health and life 5%1%(1)%5%
Warranty, credit and property & casualty (3) (2)(1)
  
 
 Total revenue 1%1%(2)%2%

 
(1)
The difference between written and earned premiums and fees, as a percentage change, was driven by:

    (1)% for accident & health, 1% for warranty and 0% for total revenue.

            In accident & health and life, revenue increased $84 million, reflecting a 5% increase. The primary drivers of this increase were strong organic growth in a supplemental health product, improved international revenue and a $16 million favorable impact from foreign exchange rates.



            The favorable impacts were partially offset by planned reductions in certain programs and our runoff businesses.

            Warranty, credit and property & casualty revenue decreased $46 million, primarily due to planned run-off of 14%

new specialty propertyprograms and casualty insurancedeclines in our European credit business, and newer accident and health insurance programs.

        Partially offsetting core business growth was lowerpartially offset by increased investment income, of $65positive foreign exchange and growth in our core business. During the fourth quarter, we determined certain transactions between our warranty businesses were not being properly eliminated. This matter resulted in an $11 million as well as the loss of several accounts in the extended warranty business.reduction to pretax income.

        This charttable details Insurance Underwriting revenue by geographic area and pretax income:

 
 Years ended December 31
 
 2002
 2001
 2000
 
 (millions)

Revenue by geographic area:         
United States $1,784 $1,615 $1,545
United Kingdom  363  302  308
Continent of Europe  151  125  111
Rest of World  228  208  203
  
 
 
 Total revenue $2,526 $2,250 $2,167
  
 
 
Income before income tax $152 $150 $300
  
 
 

(millions)            Years ended December 31,

 2005
 % of total
 2004
 % of total
 2003
 % of total
 

 
Revenue by geographic area:                
 United States $2,175 68%$2,108 67%$1,953 68%
 United Kingdom  340 11  456 14  460 16 
 Continent of Europe  330 10  284 9  211 7 
 Rest of World  343 11  302 10  259 9 
  
 
  Total revenue $3,188 100%$3,150 100%$2,883 100%

 
Income before income taxes $314   $254   $196   

 

Income Before Income Tax

        Pretax income of $152$314 million increased 1%24% from 2001.2004. Pretax margins fellrose from 6.7%8.1% in 20012004 to 6.0%9.8% in 2002.2005.

        Excluding spin-off plan expenses in 2002 ($33 million pretax) and the World Trade Center ($135 million pretax) and business transformation costs ($24 million pretax) in 2001, pretax income of $185 million in 2002 fell significantly from $309 million in 2001. Pretax margins declined from 13.7% in 2001 to 7.3% in 2002. The remainder of the spin-off costs are included in the Corporate and Other segment.

        Reasons for the declineincrease in pretax income and margin include:

the warranty, credit and property & casualty area as discussed above.

Corporate and Other

        Corporate and Other segment revenue consists primarily of investment income (including income or loss on investment disposals includingand other-than-temporary impairment losses), which is not otherwise reflected in the operating segments. This segment includes includes:


        Corporate and Other segment revenue included income from Endurance common stock, which was accounted for under the equity method before the sale of virtually all of our holdings in December 2004 and changes in the valuation of Endurance warrants. We carry our investment in Endurance warrants at fair value and record changes in the fair value through Corporate and Other segment revenue.

        Private equities are principally carried at cost exceptcost; however, where Aon haswe have significant influence, in which case they are carried under the equity method. These investments usually do not pay dividends.

        Limited partnerships (LP) are accounted for onunder the equity method and changes in the value of the underlying limited partnershipLP investments flow through Corporate and Other segment revenue. Because the limited partnership investments include exchange-traded securities, Corporate and Other segment revenue fluctuates with the market values of underlying publicly traded equity investments. Limited partnership investments have historically provided higher returns over a longer time than broad market common stock. However, in the short run, the returns are inherently more variable.

        On December 31, 2001, we securitized $450 million of our limited partnership investments plus associated limited partnership commitments, which represented the majority of our limited partnership interests. In connection with the securitization, we received a combination of cash ($171 million) and securities ($279 million). This transaction has lessened the variability of revenue reported in the Corporate and Other segment. The limited partnership investments were included in our consolidated

34



statement of financial position prior to the securitization and the cash and securities received from the securitization are also included in Aon's consolidated statement of financial position.

        Although our portfolios are highly diversified, they still remain exposed to market, equity and credit risk.

        Our fixed-maturity portfolio had a $37 million gross unrealized loss at December 31, 2002, including $6 million related to deferred amortizable derivative losses, and is subject to interest rate, market and credit risks. With a carrying value of $2.1 billion at December 31, 2002, our total fixed-maturity portfolio is 94% investment grade based on market value. Fixed-maturity securities with an unrealized loss are 87% investment grade and have a weighted average rating of "A" based on amortized cost.

        The equity portfolio is comprised of:

        The following table analyzes our investment positions with unrealized losses segmented by quality and period of continuous unrealized loss (excluding deferred amortizable derivative losses of $6 million) as of December 31, 2002.

35


Analysis of Investment Positions with Unrealized Losses Segmented by
Quality and period of Continuous Unrealized Loss*

 
 As of December 31, 2002
 
 
 Investment Grade
 Non-Investment Grade
 Not Rated
  
 
 
 0 - 6
Months

 6 - 12
Months

 > 12
Months

 Total
 0 - 6
Months

 6 - 12
Months

 > 12
Months

 Total
 0 - 6
Months

 6 - 12
Months

 > 12
Months

 Total
 Grand
Total

 
 
 ($ in millions)

 
FIXED MATURITIES                                        
 # of positions  14  4  38  56  6  4    10          66 
 Fair Value $44 $15 $224 $283 $25 $16 $ $41 $ $ $ $ $324 
 Amortized Cost  46  16  248  310  27  18    45          355 
 Unrealized Loss  (2) (1) (24) (27) (2) (2)   (4)         (31)
EQUITIES: PREFERRED                                        
 # of positions  3  2    5                  5 
 Fair Value $11 $5 $ $16 $ $ $ $ $ $ $ $ $16 
 Cost  12  6    18                  18 
 Unrealized Loss  (1) (1)   (2)                 (2)
EQUITIES: COMMON                                        
 # of positions          1      1    1  1  2  3 
 Fair Value $ $ $ $ $ $ $ $ $ $1 $2 $3 $3 
 Cost                    1  2  3  3 
 Unrealized Loss                           
OTHER                                        
 # of positions                  1      1  1 
 Fair Value $ $ $ $ $ $ $ $ $14 $ $ $14 $14 
 Cost                  27      27  27 
 Unrealized Loss                  (13)     (13) (13)
  
 
 
 
 
 
 
 
 
 
 
 
 
 
TOTAL                                        
 # of positions  17  6  38  61  7  4    11  1  1  1  3  75 
 Fair Value $55 $20 $224 $299 $25 $16 $ $41 $14 $1 $2 $17 $357 
 Cost  58  22  248  328  27  18    45  27  1  2  30  403 
 Unrealized Loss  (3) (2) (24) (29) (2) (2)   (4) (13)     (13) (46)
 % of Total Unrealized Loss  7% 4% 53% 64% 4% 4% 0% 8% 28% 0% 0% 28% 100%

*
For categorization purposes, Aon considers any rating of Baa or higher by Moody's or equivalent rating agency to be investment grade.

36


        At December 31, 2002, our:

We:

Assets with unrealized losses due to issuer-specific events:

        Fixed-maturity investments.    At least quarterly, we:

37


        Preferred stocks.    We review issuer creditworthiness at least quarterly. Creditworthiness factors reviewed include nationally recognized credit rating agency rating changes and changes in financial performance of the underlying issuer. We monitor all preferred stock investments with declining financial performance for other than temporary impairment.

        Publicly traded common stocks.    Quarterly, we review each common stock investment to determine if its decline in value is deemed other than temporary. Criteria include a review of issuer financial trends, and market expectations based on third-party forward-looking analytical reports, when available.

        Private common stocks and other invested assets.    We review quarterly private issue valuations, which include recent transaction valuations between the issuer and a third party; financial performance reviews; and financial trend comparisons with publicly traded companies in the same or similar industries.

        We recognize an other than temporary impairment loss when appropriate for fixed-maturity investments, common and preferred stock and other investments with continuous material unrealized losses due to issuer-specific events. We base this decision upon the facts and circumstances for each investment in accordance with SAB 59, FASB Statement No. 115 and related guidance.

        Invested assets with unrealized losses due to market conditions or industry-related events include those negatively impacted by increasing U.S. Treasury or local sovereign interest rates; corporate and asset-backed credit spread widening; common stock price volatility due to conditions in the overall market or a particular industry; and illiquid market conditions.

        Under some conditions, we assume that a decline in value below cost is not other than temporary. We make this assumption for fixed-maturity investments with unrealized losses due to market conditions or industry-related events when:

        We recognize an other than temporary impairment loss based upon each investment's facts and circumstances, in accordance with SAB 59, FASB Statement No. 115 and related guidance. We continue to monitor these securities quarterly to ensure that unrealized losses do not result from issuer-specific events.

        We evaluate for other than temporary impairment preferred and common stock and other investments with continuous material unrealized losses for two consecutive quarters due to market conditions or industry-related events. We recognize an other than temporary impairment loss based upon each investment's facts and circumstances. We continue to monitor these securities quarterly to ensure that unrealized losses are not the result of issuer-specific events.

        There are three risks inherent in the assessment methodology:

38


This charttable shows the components of Corporate and Other revenue and expenses:

(millions)            Years ended December 31,

 2005
 2004
 2003
 

 
Revenue:          
Income from marketable equity securities and other investments:          
 Income from change in fair value of Endurance warrants $10 $ $80 
 Equity earnings—Endurance    38  46 
 Other  34  11  11 
  
 
   44  49  137 
Limited partnership investments  1  6  1 
Net gain (loss) on disposals and related expenses:          
 Gain on sale of Endurance stock  1  48   
 Impairment write-downs  (11) (3) (36)
 Other  21  9  23 
  
 
   11  54  (13)
  
 
   Total revenue  56  109  125 

Expenses:

 

 

 

 

 

 

 

 

 

 
 General expenses  109  81  61 
 Interest expense  125  136  101 
 Unusual credit —World Trade Center      (14)
  
 
   Total expenses  234  217  148 
  
 
Loss before income tax $(178)$(108)$(23)

 
 
 Years ended December 31
 
 
 2002
 2001
 2000
 
 
 (millions)

 
Corporate and other revenue:          
Limited partnership investments $14 $(94)$73 
Income from marketable equity securities and other investments  31  7  9 
  
 
 
 
Corporate and other revenue before net loss on disposals and related expenses and one-time items  45  (87) 82 
Interest on tax refund  48     
Net loss on disposals and related expenses  (114) (84) (11)
  
 
 
 
Corporate and other revenue $(21)$(171)$71 
  
 
 
 
Non-operating expenses:          
 General expenses $97 $75 $59 
 Interest expense  124  127  140 
 Amortization of goodwill    118  114 
  
 
 
 
  Loss before income tax $(242)$(491)$(242)
  
 
 
 

Revenue

        Corporate and Other revenue improved by $150decreased $53 million to a negative $21$56 million in 2002 from2005, due primarily to:

        These declines were offset in part by:

        Offsetting the positive valuation gains were impairment write-downs of certain fixed-maturity and equity investments of $130 million in 2002 (including $51 million cumulative effect of the change in policy for recognizing other than temporary impairments from previous years) compared to $57 million in 2001.

Loss Before Income Tax

        Corporate and Other total expenses were $221$17 million an improvementor 8% higher than in 2004 as a result of $99 millionincreased consulting, recruiting and other employee benefit costs, certain transferred costs from the comparable period in 2001. This decrease in expenses issegments to Corporate, as well as $4 million of restructuring and related expenses.

        Interest expense declined $11 million, primarily due to goodwill amortization. Beginningthe repayment of our $250 million 6.9% notes that matured in 2002, goodwill was no longer amortized (see note 1 to the consolidated financial statements). Compared to 2001:July 2004.

        These revenue and expense comparisons contributed to the overall Corporate and Other pretax loss of $242$178 million in 20022005 versus a pretax loss of $491$108 million in 2001.

Discontinued Operations

        Discontinued operations include certain insurance underwriting subsidiaries acquired with Alexander and Alexander Services, Inc. (A&A) that are in run-off and the indemnification by A&A of certain liabilities relating to subsidiaries sold by A&A before its acquisition by Aon.

39



        Management believes that, based on current estimates, these discontinued operations are adequately reserved. The net liability is included as a component of other liabilities on the consolidated statements of financial position. In 2002, Aon settled certain of these liabilities. The settlement had no material effect on the consolidated financial statements.2004.

FINANCIAL CONDITION AND LIQUIDITY

Liquidity

        Our routine liquidity needs are primarily for servicing debt and for paying dividends on outstanding stock and capital securities.stock. Our primary source for meeting these requirements is from dividends and internal financing from our operating subsidiaries. After meeting our routine dividend and debt servicing requirements, we used a portion of the remaining funding we received throughout the year for capital expenditures and to expand our operating segment businesses and invest in acquisitions. (Note 11 to the consolidated financial statements discusses regulatory restrictions relating to dividend capacityrepurchase 675,000 shares of our insurance subsidiaries.)common stock.

        Our major U.S. insurance subsidiaries' statutory capital and surplus at year-end 20022005 significantly exceeded the risk-based capital target set by the National Association of Insurance Commissioners by a satisfactory level. We have advised the rating agencies that we do not expect our two major U.S. insurance subsidiaries to pay dividends to Aon in 2003. Beyond 2003, we expect these U.S. subsidiaries to consider resuming paying dividends.NAIC.

        Our operating subsidiaries anticipate that there will be adequate liquidity to meet their needs in the foreseeable future and to provide funds to the parent company. We have used cash flow primarily for:

        We expect our subsidiaries' positive cash flow to continue, and with it, our ability to access adequate short-term lines of credit.treasury stock purchases.

        Cash onin our consolidated statements of financial position includes funds available for general corporate purposes andpurposes. We segregate funds we are holding on behalf of clients and to satisfy policyholder liabilities.



        During 2005, we paid the first $76 million installment of the $190 million required under the settlement reached with the NYAG and other regulatory authorities. The remaining payments are scheduled to be paid over the next two years as follows:

(millions)

 Cash to be paid
  

2006 $76  
2007  38  
  
Total cash payments $114  

        In addition to the NYAG and other regulatory authorities' investigations, we have $40 million accrued for costs to settle the Daniel class action lawsuit.

        In 2005, total cash contributions to our major defined benefit pension plans were $463 million, an increase of $274 million from 2004. In 2004, we made an early contribution of $18 million to our Netherlands defined benefit pension plan. Under current rules and assumptions, we currently anticipate approximately $186 million in 2006 contributions to our major defined benefit pension plans.

        In connection with one of our U.K. pension plans, our principal U.K. subsidiary has agreed with the trustees of the plan to contribute £20 million ($35 million) per year to the plan for six years with the amount payable increasing by 5.3% on each January 1, beginning in 2005. These contributions are in addition to the normal employer contributions to the plan. The trustees of the plan:

        At the last valuation date, September 30, 2005, the estimated deficit between the value of the plan assets and the projected benefit obligation, calculated under U.S. GAAP, was $232 million, of which $199 million was recorded as a minimum pension liability. The U.K. pension plans have been closed to new employees since 1999.

Cash Flows

        Cash flows from operations represent the net income we earned in the reported periods adjusted for non-cash charges and changes in operating assets and liabilities.

        Cash flows provided by operating activities for 2002 were $1.2 billion. However, not allthe years ended December 31, 2005 and 2004 are as follows:

(millions)            As of December 31,

  
 2005
 2004
 

 
Insurance Underwriting operating cash flows   $423 $541 
All other operating cash flows    463  693 
    
 
    $886 $1,234 
Change in funds held on behalf of brokerage and consulting clients      (50)

 
Cash provided by operating activities   $886 $1,184 

 

        Cash flows from operations, excluding the change in funds generated were available for use by us.

        Net income attributableheld on behalf of brokerage and consulting clients declined $348 million compared with 2004. This decline is primarily attributed to our insurance subsidiaries was approximately $50 million, net of losses on disposals recognized in our Corporate and Other segment, and changes in their operating assets and liabilities, net of reinsurance, represented $335 million in 2002. This was primarily due to unearned premiums and other fees recorded and collected by the specialty property and casualty group (which includes extended warranty) as a result of an increase in its insurance retention on several client programsU.S. defined benefit pension contributions to major plans of $274 million and new property and casualty business. The majority of these funds will be useda payment pursuant to satisfy future benefits to policyholdersthe settlement agreement with the remainder being available, after taxesNYAG and other regulatory authorities of $76 million, somewhat offset by lower income tax payments of approximately $104 million.

Insurance Underwriting operating cash flows

        Our insurance underwriting operations include accident & health and expense, for dividend to Aonlife and warranty, credit and property & casualty businesses. These insurance products have distinct differences in the timing of premiums earned and payment of future years.liabilities.

        The operating cash flow from our insurance subsidiaries, which also includes related corporate items, was $423 million for 2005, down $118 million compared to 2004, primarily due to the timing of $385tax payments and changes in operating assets. For 2005, operating cash flows, analyzed by major income statement component, indicated that premium and other fees collected, net of reinsurance, were $3,193 million compared to $3,167 million in 2004. Investment and other miscellaneous income received was $227 million and $159 million in 2005 and 2004, respectively. Investment income improved in 2005 due to favorable interest rates and an increase in invested assets. Additionally, we moved to longer-term, higher yield investments.

        We used revenues generated from premiums, investments and other miscellaneous income to pay claims and other cash benefits, commissions and general expenses and taxes. Claims and other cash benefits paid were $1,393 million in 2005 versus $1,382 million in 2004. Commissions and general expenses paid were $1,446 million for 2005, compared to $1,325 million in 2004. Tax payments for 2005 were $158 million compared to $78 million last year. The increase reflects payments made on the gain on sale of virtually all our Endurance common stock investment.

        We will invest and use operating cash flows to satisfy future benefits to policyholders and when appropriate, make them available to pay dividends to the Aon parent company. During 2005, Combined Insurance Company of America, one of our major underwriting subsidiaries, declared and paid a cash dividend of $100 million to Aon.

        Generally, we invest in highly liquid and marketable investment grade securities to support policy liabilities. These invested assets are subject to insurance regulations set forth by the various governmental jurisdictions in which we operate, both domestically and internationally. The insurance regulations may restrict both the quantity and quality of various types of assets within the portfolios.

        Our insurance subsidiaries' policy liabilities are segmented among multiple accident and health and property casualty portfolios. Those portfolios have widely varying estimated durations and interest rate characteristics. Generally, our policy liabilities are not available for general corporate purposessubject to interest rate volatility risk. Therefore, in 2002. Also, in 2002, we decided not

40



to upstream anymany of the insurance underwriting subsidiaries' earnings to Aon parent company in order to enhance their financial positions even further.portfolios, asset and policy liability duration are not closely matched. Interest rate sensitive policy liabilities are generally supported by floating rate assets.

Funds held on behalf of clients

        In our Risk and Insurance Brokerage Services and Consulting segments, we typically hold funds on behalf of clients as a result of:


        These funds held on behalf of clients can fluctuate significantly depending on when we collect cash from our clients and when premiums are remitted to the insurance carriers.

All other operating cash flows

        The operating cash flow from our Risk and Insurance Brokerage Services and Consulting segments, as well as related corporate items, was $463 million in 2005 compared to $693 million in 2004. These amounts exclude the change in funds held on behalf of clients as described above. The operating cash flows depend on the timing of receipts and payments related to revenues, incentive compensation, other operating expenses and income taxes. Comparing 2005 to 2004, the net decrease in cash from our Risk and Insurance Brokerage Services and Consulting segments and related corporate items of $230 million was primarily affected by an increase in defined benefit pension contributions, a payment pursuant to the settlement agreement with the NYAG and other regulatory authorities and the timing of income tax payments.

        Aon uses the excess cash generated by our brokerage and consulting businesses we collect cash paymentsas well as dividends received from clients that include both premiums (payable to insurance companies for policies they issue) and commissions and fees (payable to us for our brokerage and consulting services). The commissions and fees are recorded by us as income. For a short time period, we hold clients' premiums in fiduciary accounts before remitting them to insurers. When a payment is due from a client for premiums, commissions and fees, we establish a receivable for the gross amount and a payable to the insurance company forsubsidiaries to meet its liquidity needs, which consist of servicing its debt, paying dividends to its stockholders and repurchasing outstanding shares.

Investing and Financing Activities

        We used the premium portions. The net balance for these are reflected in "Other receivables and liabilities, net". For 2003, the net difference between these receivables and payables added approximately $300 million toconsolidated cash flow from operations but are only(net of funds held temporarily by us on behalf of our clients and/or carriers.

        During the fourth quarter 2002, we raised $607clients) of $886 million by issuing 36.8 million shares of new common equity and $519 million by issuing long-term debt.

        A total of $1.7 billion in cash from available operating cash flows and debt and equity net proceeds was primarily used for the following purposes:for:

        WithdrawalsIn fourth quarter 2005, we announced that our Board of $682 million from "interest sensitive, annuityDirectors had authorized the repurchase of up to $1 billion of Aon's common stock. Any repurchased common stock will be available for use in connection with employee stock plans and investment-type contracts" were funded primarily by salesfor other corporate purposes. During 2005, we repurchased 675,000 shares at a cost of fixed maturity investments. We have decided to stop issuing these contracts and we are exiting the business.$25 million.

Financial Condition

        Since year-end 2001,2004, total assets increased $3.0decreased $0.5 billion to $25.3 billion. Invested assets$27.8 billion at December 31, 20022005.

        In 2005, total investments increased $441$0.6 billion to $9.1 billion from December 31, 2004. Fixed maturities increased $736 million, from last year:

clients.

        Most of the funds raised were used to:

        We also used $150Insurance Brokerage Services and Consulting receivables decreased $163 million in January 2003 to repay maturing debt securities.

        Insurance brokerage and consulting services receivables increased $1.5 billion in 2002 with a corresponding increase in2005. Corresponding insurance premiums payable of $1.7 billion. These increases reflect:decreased $348 million over the same period. The decrease in receivables and payables reflects:

41


        Other assets decreased $527 million from December 31, 2004. Other assets are comprised principally of prepaid premiums related to reinsurance, and prepaid pension assets.assets and assets from



companies considered held for sale. The increase of $56 milliondecrease from 2001 represents higher prepaid premiums, which offset a reduction in the pension assetsyear-end 2004 is due to the additional minimum pension liability adjustmentsale of Swett & Crawford in fourth quarter 2002. During 2002, some2005. In 2004, the assets of our defined benefit pension plans, particularly in the United Kingdom, incurred significant valuation losses in the investments backing the related pension obligation, as a result of a decline in the international equity markets and a decline in interest rates.Swett & Crawford, $511 million, were considered held-for-sale.

        OtherPolicy liabilities increased $602$115 million, from 2001 due to thebut were partially offset by a corresponding increase in reinsurance receivables (reflected in other receivables).

Investments

        We invest in broad asset categories related to our minimum pension liability. We arediversified operations. In managing our investments, our objective is to maximize earnings while monitoring asset and liability durations, interest and credit risks and regulatory requirements.

        The Corporate and Other segment contains invested assets and related investment income not directly required to maintain, at a minimum, a liability equal tosupport the difference betweeninsurance brokerage and consulting businesses, together with the present valueassets in excess of benefits incurred to date for pension obligations and the fair valuenet policyholder liabilities of the underwriting business and related income. These insurance assets supporting these obligations.

        Other policyholder funds decreased $674 million in 2002, due primarily to interest sensitiveare publicly traded equities, as well as less liquid private equities and investment-type contracts maturing and our decision to stop offering these programs.

        Aon's consolidated statement of financial position as of December 31, 2002 contains:LPs. These assets, owned by the insurance underwriting companies:

        We anticipate paying most of the outstanding termination benefits over the next few years. The remaining items primarily reflect lease obligations and will run off over a period of up to ten years. We do not expect that payments for termination benefits and lease obligations will have a material impact on cash flows in subsequent periods. As planned,In 2001, we have made payments that have reduced our restructuring liabilities related to recent acquisitions and prior year charges.

Capital Resources

Capital Enhancement Actions

        During the fourth quarter 2002, Aon raised net proceeds of $519 million by issuing long-term debt as follows:

        During that same quarter, Aon raised $607 million by issuing 36.8 million shares of new common equity at $17.18 per share. The offering was made pursuant to an existing shelf registration statement.

42



        In 2002, we used funds received from the debt and equity offerings to:

our investments.

Short-term Borrowings and Notes Payable

        Total debt at December 31, 20022005 was $1.8$2.1 billion, down $5 million from $2 billion at December 31, 2001. Specifically:

$247 million.

        Contractual maturitiesWe have disclosed future payments of notes payable and operating lease commitments (with initial or remaining non-cancelable lease terms in excess of one year) are disclosed in noteNote 8 to the consolidated financial statements.

        In 2002, we renegotiatedcompleted an offering of $300 million aggregate principal amount of 3.5% convertible senior debentures due 2012. The debentures are unsecured obligations and are convertible into our back-up linescommon stock at an initial conversion price of credit. Anticipatingapproximately $21.475 per common share under certain circumstances, including the previously planned spin-offfollowing:

        Or

        Aon has reserved approximately 14 million shares for the potential conversion of these debentures.



        At December 31, 2005, we renegotiated our short-term back-up lines of credit, reducing the total amount to $775had a $600 million in February 2003. This agreement will expire in 2005.

        To achieve tax-efficient financing, we renegotiated a newunused U.S. committed revolving bank credit facility, which expires in February 2010, to support commercial paper and other short-term borrowings. This facility allows us to issue up to $150 million in letters of credit.

        We also have several foreign credit facilities available. At December 31, 2005, we had available to us:

        The major rating agencies' ratings of our debt securities at December 31, 2002February 28, 2006 appear in the table below.

 
 StandardSenior
And Poor'slong-term debt

 Moody's InvestorCommercial paper
Services


Rating

 Fitch, Inc.Outlook

Rating

Outlook

Senior long-term debtStandard & Poor's A-BBB+PositiveA-2Positive
Moody's Investor Services Baa2 A-
Commercial paperA-2Stable P-2 Stable
Fitch, Inc.BBB+StableF-2Stable

        Aon's principal insurance underwriting subsidiariesDuring 2005:

        A downgrade in the credit ratings of our senior debt and commercial paper would:

Stockholders' Equity

        Stockholders' equity increased $430$200 million during 2002,2005 to $5.3 billion, primarily reflecting:

        Partially offsetting the increaseThese equity increases were partially offset by dividends paid to stockholders of $233 million.$194 million and an increase in our accumulated other comprehensive loss.



        Accumulated other comprehensive loss increased $419$474 million since December 31, 2001. Net2004. Compared to year-end 2004:

        During 2002,In past years, some of our defined benefit pension plans, particularly in the United Kingdom,U.K., incurred significant valuation losses in the investments backing the related pension obligation. These losses were primarily a result of the decline in the international equity markets. Accounting principlesdue to reduced actuarial return assumptions. U.S. generally accepted in the U.S.accounting principles require a company to maintain, at a minimum, a liability on its balance sheet equal to the difference between the present value of benefits incurred to date for pension obligations and the fair value of the assets supporting these obligations. At year-end 2002, this increased2005, the change in pension obligation caused a $552$173 million (after-tax) reductiondecrease to stockholders' equity. We maintain the related pension plan assets in separate trust accounts; they are not part of our consolidated financial statements. This non-cash adjustment to other comprehensive income did not affect 2002 earnings.2005 net income.

        For 2003,2006, we project ourproject:

        Our total debt as a percentage of the principal credit facility which supports our commercial paper program. We expect, however, to amend or replace such credit facilities.

        At December 31, 2002, stockholders' equity per sharetotal capital was $12.56, down from $12.8228.5% at December 31, 2001, due2005. This is compared to our total debt and preferred securities as a percentage of total capital of 29.8% at year-end 2004. In September 2005, we redeemed all of the outstanding shares of our redeemable preferred stock for $50 million plus accrued but unpaid dividends.

Off Balance Sheet Arrangements

        We record various contractual obligations as liabilities in our consolidated financial statements. Other items, such as certain purchase commitments and other executory contracts, are not recognized as liabilities in our consolidated financial statements, but we are required to disclose them.

        Aon and its subsidiaries have issued letters of credit to cover contingent payments of approximately $11 million for taxes and other business obligations to third parties. We accrue amounts in our consolidated financial statements for these letters of credit to the impactextent they are probable and estimable.

        Following the guidance of increased pension obligations.

FASB Statement No. 140,Special Purpose EntitiesAccounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities and

        We other relevant accounting guidance, we use special purpose entities and qualifying special purpose entities (QSPE)("QSPE's"), also known as special purpose vehicles, in some of our operations,operations.

Premium Financing

        Some of our subsidiaries make short-term loans (generally with terms of 12 months or less) to businesses to finance insurance premiums and then sell or "securitize," the finance receivables. Our subsidiaries make these sales through securitization transactions that meet the criteria for sale accounting following the guidance of FASBStatement No. 140. These premium-financing securitizations use special purpose entities which are considered QSPEs, according to Statement No. 140 and other relevant accounting guidance.FIN 46 and commercial



paper multi-seller, non-qualified bank conduit SPEs. Statement No. 140 provides that a QSPE should not be consolidated in the financial statements of a transferor or its affiliates (Aon's subsidiaries).

        CertainPremium financing securitizations performed by our U.S., U.K., Canadian and Australian subsidiaries use multi-seller non-qualified SPEs. By analyzing the qualitative and quantitative factors of the SPEs, we have determined that these subsidiaries are not the sponsors of the SPEs. Additionally, independent third parties:

        We have determined that non-consolidation remains appropriate given that our subsidiaries do not have a significant variable interest in the SPEs.

        Through the premium financing agreements, we or one of our special purpose vehiclesQSPEs sells undivided interests in specified premium finance receivables to the independent SPEs. Under the terms of these agreements, new receivables increase the amounts available to securitize as collections (administered by Aon) and reduce previously sold receivables. The amount advanced from third parties at any one time under the accounts receivable sales agreement is limited to a maximum of $1.9 billion.

        At both December 31, 2005 and 2004, $1.8 billion was advanced under these programs from the SPEs. We record at fair value the retained interest, which is included in insurance brokerage and consulting services receivables in the consolidated statements of financial position.

        We recorded gains associated with the sale of receivables. When we calculate the gain, we include all fees we incurred related to this facility. The gains, which are included in brokerage commissions and fees revenue in the consolidated statements of income, were formed solely to purchase financing$65 million, $81 million and $69 million for the years ended December 31, 2005, 2004 and 2003, respectively.

        We retain servicing rights for sold receivables and sell those balances to conduits owned and managed by third-party financial institutions. Subject to certain limitations, agreements provide for sales to these conduit vehicles continuing through December 2005. As ofearn a servicing fee as income over the servicing period. The servicing fees are included in the gain/loss calculation. At December 31, 2002,2005 and 2004, the maximum commitment contained in these agreements was $1.7 billion.

        Underfair value of the agreements,servicing rights approximates the estimated costs to service the receivables are soldand accordingly, we have not recorded any servicing assets or liabilities related to this servicing activity.

        We estimate fair value by discounting estimated future cash flows from the conduits. Consequently, the conduitsservicing rights and servicing costs using:

        The SPEs bear the credit risks on the receivables, subject to limited recourse in the form of credit loss reserves, provided by our subsidiaries and which we guarantee. Under these recourse provisions, our maximumformerly guaranteed. During 2005, we eliminated the percentage guarantee for all facilities, replacing it with other collateral enhancements. In January 2005, the Canadian facility was amended, reducing the ratings trigger and adding the financial covenants from the credit riskfacility. In December 2005, this facility was approximately $97 millionextended to December 2008. In June 2005, the Australian facility was renewed for three years and the facility was increased by Australian dollar (AUD)$50 million. In July 2005, the U.S. facility was amended, extending the facility to July 2006 and reducing its size by $100 million.

        All but the Australian facility require Aon to maintain consolidated net worth, as defined, of at December 31, 2002.least $2.5 billion, and:


        We intend to renew these conduit facilities when they expire. If there arewere adverse bank, regulatory, tax or accounting rule changes, our access to the conduit facilities and special purpose vehicles would be restricted. These special purpose vehicles are not included in our consolidated financial statements.statements, following the appropriate accounting standards.

44PEPS I


        On December 31,In 2001 we sold the vast majority of our limited partnership (LP)LP portfolio, valued at $450 million, to PEPS I, a QSPE. The common stock interest in PEPS I is held by a limited liability company owned by one of our subsidiaries (49%) and by a charitable trust, which we do not control, established for victims of the September 11th attacks (51%).

        PEPS I:

        TheStandard & Poor's Ratings Services rated the fixed-maturity securities our subsidiaries received from PEPS I are rated as investment grade by Standard & Poor's Ratings Services.grade. As part of this transaction, the insurance companies arehad been required to purchase additional fixed-maturity securities from PEPS I additional fixed-maturity securities in an amount equal to the unfunded LP commitments as they are requested. Approximately $38Beginning in July 2004, Aon Parent assumed this responsibility and funded $12 million of these commitments were funded in 2002.2005. As of December 31, 2002,2005, the unfunded commitments amounted to $100$48 million. Based on the downgrades made by the rating agencies in October 2002, credit support agreements were purchased on January 27, 2003, whereby $100 million of cash of one of our underwriting subsidiaries has been pledged as collateral for these commitments. These commitments have specific expiration dates and the general partners may decide not to draw on these commitments.

        If the insurance companies fail to purchase additional fixed-maturity securities as commitments are drawn down, we have guaranteed their purchase.

Subsequent to the closing of the securitization, one of theour insurance subsidiaries sold PEPS I fixed-maturity securities with a value of $20 million to Aon. TheIn second quarter 2004, CICA paid dividends to Aon Parent of $12 million in fixed-maturities securities. We have not included the assets and liabilities and operations of PEPS I are not included in our consolidated financial statements.

        In second quarter 2002, weprevious years, Aon has recognized a $32 million impairment write-down for this investment. We continue to monitor this investment for other than temporary impairment.

        While this transaction should significantly reduceimpairment writedowns of $59 million, equal to the reported earnings volatility associated with theseoriginal cost of one tranche. The preferred stock interest represents a beneficial interest in securitized limited partnership investments, it will not significantly limit our ability to recoup past losses or realize potential gains.

        As part of CICA's strategy to issue stableinvestments. The fair value investments contracts to institutional investors, Combined Global Funding, LLC (Combined Global), a Cayman Islands-based special purpose entity, was formed solely to issue notes to investors under a European Medium-Term Note Program. The proceeds of the notes are used to purchase Funding Agreement policies issued by CICA. The contract terms of the Funding Agreement mirror the terms of the trust medium-term notes. At the stated maturity of the Funding Agreement, CICA is required to settle with Combined Global, which then redeems the notes issued to investors. Neither CICA nor its affiliates own any shares of Combined Global.

        Outstanding Funding Agreements at December 31, 2002 were $79 million and are included in our consolidated statements of financial position in other policyholder funds. In early 2003, approximately $29 million of these outstanding agreements were settled. As this program has been placed in runoff, there are no new additional issuances of Funding Agreements anticipated, with the remaining liabilities maturing in 2005.


Investments

        We invest in broad asset categories related to our diversified operations. In managing our investments, our objective is to maximize earnings while monitoring asset and liability durations, interest and credit risks and regulatory requirements. We maintain well-capitalized operating companies. The financial strength of these companies permits a diversified investment portfolio including invested cash, fixed-income obligations, public and private equities and limited partnerships.

        The Corporate and Other segment contains invested assets and related investment income not directly required to support the insurance brokerage and consulting businesses, together with the assets in excess of net policyholder liabilities of the underwriting business and related income. These insurance assets, which are publicly traded equities, as well as less liquid private equities and limited partnerships, represent a more aggressive investment strategy that gives us an opportunity for greater returns with longer-term investments. These assets, owned by the insurance underwriting companies, are necessary to support strong claims paying ratings by independent rating agencies and are unavailable for other uses such as debt reduction or share repurchases without considering regulatory requirements (see note 11 to the consolidated financial statements).

        Some of the limited partnerships in which we invest have holdings in publicly traded equities. If the market value of these equities changes, thenpreferred stock interests depends on the value of the limited partnerships also changes. Our ownership share of this partnership valuation is included in our reported Corporate and Other segment revenue. By comparison, we record changesinvestments held by PEPS I. Management assesses other-than-temporary declines in the market fair value below cost using a financial model that considers the:

Contractual Obligations

        The securitization:following table:

RISKS AND OUTLOOK

Risks Related to Our Business and the Insurance Industry

Our results may fluctuate as a result of many factors, including cyclical changes in the insurance and reinsurance industries.

        Our results historically have been subject to significant fluctuations arising from uncertainties in the insurance industry. Changes in premium rates affect not only the potential profitability of our underwriting businesses but also generally affect the commissions and fees payable to our brokerage businesses. In addition, insurance industry developments that can significantly affect our financial performance include factors such as:

46


A further decline        We have provided additional details about these obligations in our notes to the financial statements as noted below.

 
 Payments due by period

(millions)

 Less than
1 year

 1-3
years

 4-5
years

 More than
5 years

 Total


Notes payable and short-term borrowings (Note 8) $593 $257 $2 $1,264 $2,116
Interest expense on notes payable  107  174  173  1,008  1,462
Operating leases (Note 8)  325  556  356  742  1,979
Purchase obligations (1) (2)  216  295  194  40  745
Insurance premiums payable  9,415  12      9,427
Future policy benefits  50  123  153  1,345  1,671
Policy and contract claims  833  351  107  536  1,827
NYAG and other regulatory authorities settlement (3)  76  38      114
Other long-term liabilities reflected on the consolidated balance sheet under GAAP  2  3  2  4  11

Total $11,617 $1,809 $987 $4,939 $19,352

(1)
Included in purchase obligations is a $380 million contract for information technology outsourcing with Computer Sciences Corporation. We are free to terminate this contract at any time for an amount calculated per the contract. However, given the nature of the contract, we have included it in our contractual obligations table.

(2)
Also included in purchase obligations is a $226 million contract for information technology services in the credit ratingsU.K. As of our senior debt and commercial paper may adversely affect our borrowing costs and financial flexibility.

        On several occasions in recent months,December 31, 2005, we can exit this obligation for approximately $35 million. However, given the credit rating agencies have lowered the credit ratings of our senior debt and commercial paper. Most recently, on October 31, 2002, Moody's Investors Service lowered its rating of our senior debt to the current rating of "Baa2" from "Baa1." Moody's also placed the rating of our senior debt and the "P-2" rating of our commercial paper under review for possible future downgrade, which it subsequently removed without change. On October 31, 2002, Standard & Poor's Ratings Services placed its "A-" rating of our senior debt on CreditWatch with negative implications, which it subsequently removed without change. As a resultnature of the actions taken by the rating agencies on October 31, 2002,contract, we have included it in our contractual obligations table.

(3)
The $109 million net present value of this liability has been required,reflected on the December 31, 2005 balance sheet in lieu of our existing guarantees, to fund an aggregate of approximately $43 millionother liabilities.

        We also have obligations with respect to our automobile finance securitizations. A further downgrade in the credit ratings of our senior debtpension and commercial paper will increase our borrowing costs and reduce our financial flexibility.

        Any such further downgrade may trigger a further obligation of our company to fund an aggregate of up to $220 million with respectother benefit plans (see Note 12 to our premium finance and automobile finance securitizations. We no longer securitize automobile finance amounts, and, as a result, we expect this amount will decline over time as the outstanding automobile finance securitizations run down. Moreover, some of our debt instruments, such as our 6.20% notes due January 2007 ($250 million of which are outstanding), expressly provide for interest rate increases in the case of certain ratings downgrades. Similarly, any such downgrade would increase our commercial paper interest rates or may result in our inability to access the commercial paper market altogether. If we cannot access the commercial paper market, although we have committed backup lines in excess of our currently outstanding commercial paper borrowings, we cannot assure you that it would not adversely affect ourconsolidated financial position. A downgrade in the credit ratings of our senior debt may also adversely affect the claims-paying ability or financial strength ratings of our insurance company subsidiaries. See "A decline in the financial strength or claims-paying ability ratings of our insurance underwriting subsidiaries may increase policy cancellations and negatively impact new sales of insurance products" below.

We face significant competitive pressures in each of our businesses.

        We believe that competition in our lines of business is based on service, product features, price, commission structure, financial strength, claims paying ability ratings and name recognition. In particular, we compete with a large number of national, regional and local insurance companies and other financial services providers, brokers and, with respect to our extended warranty business, third-party administrators, manufacturers and distributors.

        Some of our underwriting competitors have penetrated more markets and offer a more extensive portfolio of products and services and have more competitive pricing than we do, which can adversely affect our ability to compete for business. Some underwriters also have higher claims paying ability ratings and greater financial resources with which to compete and are subject to less government regulation than our underwriting operations.

        We encounter strong competition for both business and professional talent in our insurance brokerage and risk management services operations from other insurance brokerage firms which also operate on a nationwide or worldwide basis, from a large number of regional and local firms in the United States, the European Union and in other countries and regions, from insurance and reinsurance companies that market and service their insurance products without the assistance of brokers or agents and from other businesses, including commercial and investment banks, accounting firms and consultants that provide risk-related services and products. Our consulting operations compete with independent consulting firms and consulting organizations affiliated with accounting, information systems, technology and financial services firms around the world.

47



        In addition, the increase in competition due to new legislative or industry developments could adversely affect us. These developments include:

        New competition as a result of these developments could cause the supply of and demand for our products and services to change, which could adversely affect our results of operations and financial condition.

A decline in the financial strength or claims-paying ability ratings of our insurance underwriting subsidiaries may increase policy cancellations and negatively impact new sales of insurance products.

        Financial strength and claims-paying ability ratings have become increasingly important factors in establishing the competitive position of insurance companies. These ratings are based upon criteria established by the rating agencies for the purpose of rendering an opinion as to an insurance company's financial strength, operating performance, strategic position and ability to meet its obligations to policyholders. They are not evaluations directed toward the protection of investors, nor are they recommendations to buy, sell or hold specific securities. Periodically, the rating agencies evaluate our insurance underwriting subsidiaries to confirm that they continue to meet the criteria of the ratings previously assigned to them. A downgrade, or the potential for a downgrade, of these ratings could, among other things, increase the number of policy cancellations, adversely affect relationships with brokers, retailers and other distributors of their products and services, negatively impact new sales and adversely affect their ability to compete.

        Combined Specialty Insurance Company (formerly Virginia Surety Company, Inc.), our principal property and casualty insurance company subsidiary, is currently rated "A" (excellent; third highest of 16 rating levels) by A.M. Best Company. Combined Insurance Company of America, the principal insurance subsidiary that underwrites our specialty accident and health insurance business, is currently rated "A" (excellent; third highest of 16 rating levels) by A.M. Best Company, "BBB+" (good; fourth highest of nine rating levels and highest ranking within the level) for financial strength by Standard and Poor's Ratings Services and "Baa1" (adequate; fourth highest of nine rating levels and highest ranking within the level) for financial strength by Moody's Investors Service. We cannot assure you that one or more of the rating agencies will not downgrade or withdraw their financial strength or claims-paying ability ratings in the future.

Changes in interest rates and investment prices could reduce the value of our investment portfolio and adversely affect our financial condition or results.

        Our insurance underwriting subsidiaries carry a substantial investment portfolio of fixed-maturity and equity and other long-term investments. As of December 31, 2002, our fixed-maturity investments (94% of which were investment grade) had a carrying value of $2.1 billion, our equity investments had a carrying value of $62 millionstatements and our other long-term investments and limited partnerships had a

48



carrying value of $600 million. Accordingly, changes in interest rates and investment prices could reduce the value of our investment portfolio and adversely affect our financial condition or results.

        For example, changes in domestic and international interest rates directly affect our income from, and the market value of, fixed-maturity investments. Similarly, general economic conditions, stock market conditions and other factors beyond our control affect the value of our equity investments. We monitor our portfolio for "other than temporary impairments" in carrying value. For securities judged to have an "other than temporary impairment," we recognize a realized loss through the statement of income to write down the value of those securities.

        For 2002, we recognized impairment losses of $130 million, which includes $51 million to reflect other than temporary impairments existing with respect to prior years. We cannot assure you that we will not have to recognize additional impairment losses in the future, which would negatively affect our financial results.

        On December 31, 2001, our two major insurance companies sold the vast majority of their limited partnership portfolio, valued at $450 million, to Private Equity Partnership Structures I, LLC, a qualifying special purpose entity. We utilized this qualifying special purpose entity following the guidance contained in Financial Accounting Standards Board Statement No. 140 (Statement No. 140) and other relevant accounting guidance. The common stock interest in Private Equity Partnership Structures I is held by a limited liability company which is owned by one of our subsidiaries (49%) and by a charitable trust, which is not controlled by us, established for victims of the September 11 attacks (51%). Approximately $171 million of investment grade fixed-maturity securities were sold by Private Equity Partnership Structures I to unaffiliated third parties. Private Equity Partnership Structures I then paid our insurance underwriting companies the $171 million in cash and issued to them an additional $279 million in fixed-maturity and preferred stock securities. The fixed-maturity securities our insurance underwriting companies received from Private Equity Partnership Structures I are rated as investment grade by Standard & Poor's Ratings Services. As part of this transaction, our insurance underwriting companies are required to purchase from Private Equity Partnership Structures I additional fixed-maturity securities in an amount equal to the unfunded limited partnership commitments, as they are requested. As of December 31, 2002, these unfunded commitments amount to $100 million. Baseddiscussion on the actions taken by the ratings agencies on October 31, 2002, credit support arrangements were purchased on January 27, 2003. If our insurance underwriting companies fail to purchase additional fixed-maturity securities as commitments are drawn down, we have guaranteed their purchase.

        Although the Private Equity Partnership Structures I transaction is expected to reduce the reported earnings volatility historically associated with directly owning limited partnership investments, it will not eliminate our risk of future losses. For instance, we must analyze our preferred stock and fixed-maturity interests in Private Equity Partnership Structures I for other than temporary impairment, based on the valuation of the limited partnership interests held by Private Equity Partnership Structures I and recognize an impairment loss if necessary. We cannot assure you that we will not have to recognize impairment losses with respect to our Private Equity Partnership Structures I interests in the future.

Our pension liabilities may continue to grow, which could adversely affect our stockholders' equity or require us to make additional cash contributions to the pension plans.

        To the extent that the present value of the benefits incurred to date for pension obligations in the major countries in which we operate continue to exceed the market value of the assets supporting these obligations, our financial position and results of operations may be adversely affected. Primarily as a result of the decline in the equity markets, some of our defined benefit pension plans, particularly in the United Kingdom, have suffered significant valuation losses in the assets backing the related pension obligation. On February 12, 2003, we announced that we incurred an after-tax increase to the minimum pension liability and a commensurate reduction in 2002 year-end stockholders' equity of $552 million.

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Current projections indicate that our 2003 pension expense would increase by approximately $130 million compared with 2002 and incremental cash contributions of approximately $40 million would be required in 2003. These estimates are based on certain assumptions, including discount rates, interest rates, fair value of assets for some of our plans and expected return on plan assets. Changes in our pension benefit obligations and the related net periodic costs or credits may occur in the future due to any variance of actual results from our assumptions and changes in the number of participating employees. As a result, there can be no assurance that we will not experience future decreases in stockholders' equity or that we will not be required to make additional cash contributions in the future beyond those which have been announced.

We are subject to a number of contingencies and legal proceedings which, if determined adversely to us, would adversely affect our financial results.

        We are subject to numerous claims, tax assessments and lawsuits that arise in the ordinary course of business. The damages that may be claimed are substantial, including in many instances claims for punitive or extraordinary damages. The litigation naming us as a defendant ordinarily involves our activities as a broker or provider of insurance products or as an employer. It is possible that, if the outcomes of these contingencies and legal proceedings were not favorable to us, it could materially adversely affect our future financial results. In addition, our results of operations, financial condition or liquidity may be adversely affected if in the future our insurance coverage proves to be inadequate or unavailable or there is an increase in liabilities for which we self-insure.above).

Our success depends, in part, on the efforts of our senior management and our ability to attract and retain experienced and qualified personnel.

        We believe that our continued success depends, in part, on the efforts of our senior management. The loss of the services of any of our executive officers for any reason could have a material adverse effect on our business, operating results and financial condition. In addition, our future success depends on our ability to attract and retain experienced underwriters, brokers and other professional personnel. Competition for such experienced professional personnel is intense. If we cannot hire and retain talented personnel, our business, operating results and financial condition could be adversely affected.

We are subject to increasing costs arising from errors and omissions claims against us.

        We have experienced an increase in the frequency and severity of errors and omissions claims against us, which has and will continue to substantially increase our risk management expenses. In our insurance brokerage business, we often assist our clients with matters which include the placement of insurance coverage and the handling of related claims. Errors and omissions claims against us may allege our potential liability for all or part of the amounts in question. Errors and omissions claims could include, for example, the failure of our employees or sub-agents, whether negligently or intentionally, to place coverage correctly or notify claims on behalf of clients or to provide insurance carriers with complete and accurate information relating to the risks being insured. It is not always possible to prevent and detect errors and omissions, and the precautions we take may not be effective in all cases. In addition, errors and omissions claims may harm our reputation or divert management resources away from operating our business.

Our businesses are subject to extensive governmental regulation which could reduce our profitability or limit our growth.

        Our businesses are subject to extensive federal, state and foreign governmental regulation and supervision, which could reduce our profitability or limit our growth by increasing the costs of regulatory compliance, limiting or restricting the products or services we sell or the methods by which we sell our products and services or subjecting our businesses to the possibility of regulatory actions or

50



proceedings. With respect to our insurance brokerage businesses, this supervision generally includes the licensing of insurance brokers and agents and third-party administrators and the regulation of the handling and investment of client funds held in a fiduciary capacity. Our continuing ability to provide insurance brokering and third-party administration in the jurisdictions in which we currently operate depends on our compliance with the rules and regulations promulgated from time to time by the regulatory authorities in each of these jurisdictions. Also, we can be affected indirectly by the governmental regulation and supervision of other insurance companies. For instance, if we are providing managing general underwriting services for an insurer we may have to contend with regulations affecting our client. Further, regulation affecting the insurance companies with whom our brokers place business can affect how we conduct those operations.

        Most insurance regulations are designed to protect the interests of policyholders rather than stockholders and other investors. In the United States, this system of regulation, generally administered by a department of insurance in each state in which we do business, affects the way we can conduct our insurance underwriting business. Furthermore, state insurance departments conduct periodic examinations of the affairs of insurance companies and require the filing of annual and other reports relating to the financial condition of insurance companies, holding company issues and other matters.

        Although the federal government does not directly regulate the insurance business, federal legislation and administrative policies in several areas, including employee benefit plan regulation, age, race, disability and sex discrimination, investment company regulation, financial services regulation, securities laws and federal taxation, do affect the insurance industry generally and our insurance underwriting subsidiaries in particular. For example, recently adopted federal financial services modernization legislation and privacy laws, such as the Health Insurance Portability and Accountability Act of 1996 and the Gramm-Leach-Bliley Act (as it relates to the use of medical and financial information by insurers), may result in additional regulatory compliance costs, limit the ability of our insurance underwriting subsidiaries to market their products or otherwise constrain the nature and scope of our operations. With respect to our international operations, we are subject to various regulations relating to, among other things, licensing, currency, policy language and terms, reserves and the amount of local investment. These various regulations also add to our cost of doing business through increased compliance expenses, the financial impact of use of capital restrictions and increased training and employee expenses. Furthermore, the loss of a license in a particular jurisdiction could restrict or eliminate our ability to conduct business in that jurisdiction.

        In all jurisdictions the applicable laws and regulations are subject to amendment or interpretation by regulatory authorities. Generally, such authorities are vested with relatively broad discretion to grant, renew and revoke licenses and approvals, and to implement regulations. Accordingly, we may be precluded or temporarily suspended from carrying on some or all of our activities or otherwise fined or penalized in a given jurisdiction. No assurances can be given that our businesses can continue to be conducted in any given jurisdiction as they have been in the past.

Our significant global operations expose us to various international risks that could adversely affect our business.

        A significant portion of our operations is conducted outside the United States. Accordingly, we are subject to legal, economic and market risks associated with operating in foreign countries, including:

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        Some of our foreign brokerage subsidiaries receive revenues in currencies that differ from their functional currencies. We must also translate the financial results of our foreign subsidiaries into United States dollars. Although we use various derivative financial instruments to help protect against adverse transaction and translation effects due to exchange rate fluctuations, we cannot eliminate such risks, and significant changes in exchange rates may adversely affect our results.

Our financial results could be adversely affected if our underwriting reserves differ from actual experience.

        We maintain reserves as an estimate of our liability under insurance policies issued by our insurance underwriting subsidiaries. The reserves that we maintain that could cause variability in our financial results consist of (1) unearned premium reserves, (2) policy and contract claim reserves and (3) future policy benefit reserves. Unearned premium reserves generally reflect our liability to return premiums we have collected under policies in the event of the lapse or cancellation of those policies. Under accounting principles generally accepted in the United States, premiums we have collected generally become "earned" over the life of a policy by means of a reduction in the amount of the unearned premium reserve associated with the policy. Unearned premium reserves are particularly significant with respect to our warranty business, given that the premiums we receive for warranty products generally cover an extended period of time. If there are significant lapses or cancellations of these types of policies, or expected losses for existing policies develop adversely and therefore premiums are not earned as expected, it may be necessary to accelerate the amortization of deferred acquisition expenses associated with the policies because these deferred expenses are amortized over the projected life of the policies or establish additional reserves to cover premium deficiencies.

        Policy and contract claim reserves reflect our estimated liability for unpaid claims and claims adjustment expenses, including legal and other fees and general expenses for administering the claims adjustment process, and for reported and unreported losses incurred as of the end of each accounting period. If the reserves originally established for future claims prove inadequate, we would be required to increase our liabilities, which could have an adverse effect on our business, results of operations and financial condition.

        The obligation for policy and contract claims does not represent an exact calculation of liability. Rather, reserves represent our best estimate of what we expect the ultimate settlement and administration of claims will cost. These estimates represent informed judgments based on our assessment of currently available data, as well as estimates of future trends in claims severity, frequency, judicial theories of liability and other factors. Many of these factors are not quantifiable in advance and both internal and external events, such as changes in claims handling procedures, inflation, judicial and legal developments and legislative changes, can cause our estimates to vary. The inherent uncertainty of estimating reserves is greater for certain types of liabilities, where the variables affecting these types of claims are subject to change and long periods of time may elapse before a definitive determination of liability is made. Reserve estimates are periodically refined as experience develops and further losses are reported and settled. Adjustments to reserves are reflected in the results of the periods in which such estimates are changed. Because setting the level of reserves for policy and contract claims is inherently uncertain, we cannot assure you that our current reserves will prove adequate in light of subsequent events.

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        Future policy benefit reserves generally reflect our liability to provide future life insurance benefits and future accident and health insurance benefits on guaranteed renewable and non-cancelable policies. Future policy benefit reserves on accident and health and life products have been provided on the net level premium method. These reserves are calculated based on assumptions as to investment yield, mortality, morbidity and withdrawal rates that were determined at the date of issue and provide for possible adverse deviations.

We may not realize all of the expected benefits from our business transformation plan.

        In the fourth quarter of 2000, we began a comprehensive business transformation plan designed to enhance client service, improve productivity through process redesign and accelerate revenue growth. Outside of U.S. retail brokerage, the plan has been substantially implemented and has delivered the expected benefits, including improved revenue growth and enhanced productivity. Within U.S. retail brokerage, however, we experienced unexpected delays in implementing components of the plan, as well as higher than expected costs. As a result, we cannot assure you that we will realize all of the expected benefits associated with our business transformation plan. In addition, regardless of whether we are able to realize any of the benefits of the business transformation plan, we have incurred significant costs, which have been greater than those planned.

The perceived conflicts associated with our insurance brokerage and underwriting businesses could limit our growth.

        Historically, we have not been able to fully exploit business opportunities due to the perceived conflicts associated with our insurance brokerage and underwriting businesses. For example, we have refrained from offering our extended warranty products and services through competing insurance brokers. Independent brokers have been reluctant to do business with our insurance underwriting business because they believed that any fees or information provided to us would ultimately benefit our competing brokerage business. These brokers also have been concerned that any information gleaned by our underwriting business regarding their clients and their clients' insurance needs would be shared with our competing brokerage business to solicit new business from these clients. Similarly, competing underwriters have feared that our brokers could share information with our underwriting business in an effort to help secure desirable business or, alternatively, seek price quotes from them only for undesirable business. In the future, these perceived conflicts could limit our ability to expand our product and service offerings and seek new business through independent brokerage channels.

Each of our business lines may be adversely affected by an overall decline in economic activity.

        The demand for property and casualty insurance generally rises as the overall level of economic activity increases and generally falls as such activity decreases, affecting both the commissions generated by our brokerage business and the premiums generated by our underwriting businesses. In particular, a growing number of insolvencies associated with an economic downturn, especially insolvencies in the insurance industry, could adversely affect our brokerage business through the loss of clients or by hampering our ability to place insurance and reinsurance business. Moreover, the results of our consulting business are generally affected by the level of business activity of our clients, which in turn is affected by the level of economic activity in the industries and markets these clients serve. As our clients become adversely affected by declining business conditions, they may choose to delay or forgo consulting engagements with us.

Recent and proposed accounting rule changes could negatively affect our financial position and results.

        Recent accounting changes effected and proposals made could negatively affect our financial position or results of operations. Under Financial Accounting Standards Board Statement No. 142 (Statement No. 142), which we adopted on January 1, 2002, goodwill is no longer being amortized, but

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must instead be tested annually for impairment in its value. Goodwill is the excess of cost over net assets purchased relating to business acquisitions. As of December 31, 2002, we had approximately $4.1 billion of goodwill on our balance sheet. If an impairment exists, we must recognize a non-cash charge equal to the impairment, thereby reducing our net worth. Under our principal credit facility that supports our commercial paper program, we are required to maintain a minimum net worth of $2.5 billion. As of December 31, 2002, our net worth calculated for this purpose was $3.9 billion. In connection with our adoption of Statement No. 142 we tested our goodwill and found no impairment as of January 1, 2002. We have finalized our testing for 2002 and found no impairment. However, we cannot assure you that impairment will not exist when we perform testing in future periods, and any impairment charge we would be required to take would have a negative effect on our financial position and results.

We have substantial debt outstanding that could adversely affect our financial flexibility.

        We have substantial debt outstanding. As of December 31, 2002, we had total consolidated debt outstanding (including for this purpose our mandatorily redeemable preferred capital securities) of approximately $2.5 billion. This substantial amount of debt outstanding could adversely affect our financial flexibility.

We are a holding company and, therefore, may not be able to receive dividends in needed amounts.

        Our principal assets are the shares of capital stock of our subsidiaries, including our insurance underwriting companies. We have to rely on dividends from these subsidiaries to meet our obligations for paying principal and interest on outstanding debt obligations and for paying dividends to stockholders and corporate expenses. Payments from our underwriting subsidiaries are limited by governmental regulation and will depend on the surplus and future earnings of these subsidiaries. In some circumstances, specific payments from our insurance underwriting subsidiaries may require prior regulatory approval, and we may not be able to receive dividends from these subsidiaries at times and in the amounts we anticipate or require.

The volume of premiums we write and our profitability are affected by the availability of reinsurance and the size and adequacy of our insurance company subsidiaries' capital base.

        The level of business that our insurance underwriting subsidiaries are able to write depends on the size and adequacy of their capital base. Many state insurance laws to which they are subject impose risk-based capital requirements for purposes of regulating insurer solvency. Insurers having less statutory surplus than that required by the risk-based capital model formula generally are subject to varying degrees of regulatory scrutiny and intervention depending on the level of capital inadequacy. As of December 31, 2002, each of our insurance company subsidiaries met the risk-based statutory surplus requirements of every state in which it conducts business.

        We purchase reinsurance for certain of the risks underwritten by our insurance company subsidiaries. Market conditions beyond our control determine the availability and cost of the reinsurance protection we purchase, which may affect the level of business we are able to write and our profitability. We cannot assure you that we will be able to maintain our current reinsurance facilities or that we can obtain other reinsurance facilities in adequate amounts and at favorable rates. If we are unable to renew our expiring facilities or to obtain new reinsurance facilities, either our net exposures would increase or, if we are unwilling to bear an increase in net exposures, we would have to reduce the level of our underwriting commitments. Either of these potential developments could adversely affect our underwriting business.

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We cannot guarantee that our reinsurers will pay in a timely fashion, if at all.

        To better manage our portfolio of underwriting risk, we may, from time to time, purchase reinsurance by transferring part of the risk that we will assume (known as ceding) to a reinsurance company in exchange for part of the premium that we will receive in connection with the risk. Although reinsurance would make the reinsurer liable to us to the extent the risk were transferred (or ceded) to the reinsurer, it would not relieve us of our liability to our policyholders. Accordingly, we will bear credit risk with respect to our reinsurers, if any. Recently, due to industry and general economic conditions, there is an increasing risk of insolvency among reinsurance companies, resulting in a greater incidence of litigation and affecting the recoverability of claims. We cannot assure you that our reinsurers, if any, will pay the reinsurance recoverables owed to us or that they will pay these recoverables on a timely basis.

Information Concerning Forward-looking Statements

        This report contains certain statements relating to future results, which are forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from either historical or anticipated results, depending on a variety of factors. Potential factors that could impact results include the general economic conditions in different countries around the world, fluctuations in global equity and fixed income markets, exchange rates, rating agency actions, pension funding, changes in commercial property and casualty markets and commercial premium rates, the competitive environment, the actual costs of resolution of contingent liabilities and other loss contingencies, the heightened level of potential errors and omissions liability arising from placements of complex policies and sophisticated reinsurance arrangements in an insurance market in which insurer reserves are under pressure, the ultimate impact of the business transformation plan, and the timing and resolution of related insurance and reinsurance issues relating to the events of September 11, 2001.

RECENT DEVELOPMENTS

Previously Planned Divestiture of Insurance Underwriting Businesses and Discontinuance of Certain Operations

        As previously discussed, in fourth quarter 2002, we announced our plans to sell Sheffield Insurance Corporation, a small property-casualty company. In March 2003, we completed the sale.

Capital Enhancement Actions

        As previously discussed, we received approximately $223 million ($225 million aggregate principal amount) by privately placing 7.375% senior notes in the fourth quarter 2002. In March 2003, we filed a registration statement with the Securities and Exchange Commission to register the offer to exchange these notes for registered notes having identical terms.

BTA Litigation

        On February 27, 2003, oral arguments were held before the Second U.S. Circuit Court of Appeals. In the action filed by reinsurers in the U.K., the court decided that it should wait until at least June 2003 to allow determination of the outcome of the U.S. appeal.

Other Items

        In February 2003, our insurance subsidiaries transferred, for appropriate consideration, shares of Endurance Specialty Insurance, Ltd., to other subsidiaries of Aon of approximately $75 million.

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Item 7A.    Quantitative and Qualitative Disclosures aboutAbout Market Risk.

Market Risk Exposure

        We are subjectexposed to various market risk exposures, includingpotential fluctuations in earnings, cash flows and the fair value of certain of our assets and liabilities due to changes in interest rates, foreign exchange rate, interest raterates and equity price risk.prices. To manage the risk from these exposures, we enter into a variety of derivative instruments. We do not enter into derivatives or financial instruments for trading purposes.

        The following disclosures reflect estimatesdiscussion describes our specific exposures and the strategies we use to manage these risks. See Notes 1 and 14 to the consolidated financial statements for a discussion of future performanceour accounting policies for financial instruments and economic conditions. Actual results may differ.derivatives.

        We are subject to foreign exchange rate risk associated withfrom translating the financial statements of itsour foreign subsidiaries into U.S. dollars. Additionally, some of our foreign brokerage subsidiaries receive revenues in currencies that differ from their functional currencies. Our primary exposures are to the British pound, the Euro, the Canadian dollar and the Australian dollar. We use various derivativeover-the-counter (OTC) options and forward contracts to reduce the impact of foreign currency fluctuations on the translation of our foreign operations' financial instruments (see note 14statements.

        Additionally, some of our foreign brokerage subsidiaries receive revenues in currencies that differ from their functional currencies. Our U.K. subsidiary earns approximately 36% of its revenue in U.S. dollars, but most of its expenses are incurred in pounds sterling. Our policy is to convert into pounds sterling sufficient U.S. dollar revenue to fund the consolidated financial statements) to protect against adversesubsidiary's pound sterling expenses using OTC options and forward exchange contracts. At December 31, 2005, we have hedged 35% and 29% of our U.K. subsidiaries' expected U.S. dollar transaction exposure for the years ending December 31, 2006 and translation effects of exchange rate fluctuations.2007, respectively. We do not generally hedge exposures beyond three years.

        The potential decrease to our consolidated stockholders' equity at December 31, 2002,loss in future earnings from market risk sensitive instruments resulting from a hypothetical 10% adverse change in quoted year-end foreign currency exchange rates, amounts to $207 million and $163 million at December 31, 2002 and 2001, respectively. The impact to 2002 and 2001 pretax income in the event of a hypothetical 10% adverse change in the respective quoted year-end exchange rates would not be material after consideration of derivative positions.in 2005 and 2004.

        The nature of theour businesses' income of our businesses is affected by changes in international and domestic short-term interest rates. We monitor our net exposure to short-term interest rates and, as appropriate, hedge our exposure with various derivative financial instruments. A hypothetical, 1%instantaneous parallel decrease in interest ratesthe period end yield curve of 100 basis points would cause a decrease, net of derivative positions, of $14 million and $10 million to 2002both 2005 and 20012004 pretax income, respectively.income.

        The valuation of our fixed-maturity investment portfolio is subject to interest rate risk. A hypothetical 1% (100 basis point) increase in long-term interest rates would decrease the fair value of the portfolio at December 31, 20022005 and 20012004 by approximately $85$156 million and $89$119 million, respectively. We have notes payable and capital securities outstanding with a fair value of $2.4 billion and $2.5$2.3 billion at December 31, 20022005 and 2001,2004, respectively. SuchThis fair value was greater than the carrying value by $36$337 million and $38$165 million at December 31, 20022005 and 2001,2004, respectively. A hypothetical 1% decrease in interest rates would increase the fair value by approximately 6% at5% for both December 31, 20022005 and 2001.2004.

        The valuation of our marketable equity security portfolio is subject to equity price risk. If market prices were to decrease by 10%, the fair value of the equity portfolio would have a corresponding decrease of $6$4 million at both December 31, 2002 compared to $38 million at December 31, 2001.2005 and 2004. At December 31, 20022005 and 2001,2004, there were no outstanding derivatives hedging the price risk on the equity portfolio.

        PEPS I—In December 2001, we securitized $450 million of limited partnership investments, plus associated limited partnership commitments, via a sale to PEPS I. Aon received $171 million in cash plus $279 million of newly-issued fixed maturity and preferred stock securities of PEPS I. We used the underlying equity in the limited partnerships to determine the fair value of the cash and securities



received in the securitization.    At December 31, 2005, a 10% or 20% decrease in the underlying equity of the limited partnerships would have decreased the value of the preferred stock securities by $27 million and $54 million, respectively.

We have selected the value ranges to representhypothetical changes in foreign currency exchange rates, interest rates and equity market prices only to illustrate the possible impact of these changes; we are not predicting market events. This range ofWe believe these changes reflects changes we believein rates and prices are reasonably possible overwithin a one-year period.

        The translated value of revenue and expense from our international brokerage and underwriting operations are subject to fluctuations in foreign exchange rates. However, the net impact of these fluctuations on Aon's net income or cash flows has not been material.



Item 8.    Financial Statements and Supplementary Data.


Management's Report on Internal Control over Financial Reporting

        Management of Aon Corporation and its subsidiaries is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. The Company's internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles.

        Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

        Management assessed the effectiveness of the Company's internal control over financial reporting as of December 31, 2005. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework.

        Based on our assessment, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2005.

        Our assessment of the effectiveness of our internal control over financial reporting as of December 31, 2005 has been audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in their report on page 70.



/s/  GREGORY C. CASE      
Gregory C. Case
President & Chief Executive
Officer
March 8, 2006
/s/  DAVID P. BOLGER      
David P. Bolger
Executive Vice President,
Chief Financial Officer &
Chief Administrative Officer
March 8, 2006

Report of Independent AuditorsRegistered Public Accounting Firm on
Internal Control Over Financial Reporting

Board of Directors and Stockholders
Aon Corporation

        We have audited management's assessment, included in the accompanying Management's Report on Internal Control Over Financial Reporting, that Aon Corporation maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Aon Corporation's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the Company's internal control over financial reporting based on our audit.

        We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

        A Company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A Company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company's assets that could have a material effect on the financial statements.

        Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

        In our opinion, management's assessment that Aon Corporation maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, Aon Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on the COSO criteria.

        We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statements of financial position of Aon Corporation as of December 31, 2005 and 2004 and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2005 and our report dated March 7, 2006 expressed an unqualified opinion thereon.



Chicago, Illinois
March 7, 2006


Report of Independent Registered Public Accounting Firm on Financial Statements

Board of Directors and Stockholders
Aon Corporation

        We have audited the accompanying consolidated statements of financial position of Aon Corporation as of December 31, 20022005 and 2001,2004 and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2002.2005. Our audits also included the financial statement schedules as listed in the Index at Item 15(a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.

        We conducted our audits in accordance with auditingthe standards generally accepted inof the United States.Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

        In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Aon Corporation atas of December 31, 20022005 and 2001,2004 and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2002,2005, in conformity with accounting principlesU.S. generally accepted in the United States.accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.

        As discussed in Note 1, in 2002as of December 31, 2003 the Company changed its method of accounting for goodwill and in 2000 the Company changed its method of accounting forinvolvement with certain commission and fee revenue and also changed its method of accounting for derivative financial instruments.

Chicago, Illinois
February 12, 2003

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Report By Managementvariable interest entities.

        Management of Aon Corporation is responsible for the fairness of presentation and integrity of the financial statements and other financial information in the annual report. The financial statementsWe also have been prepared in conformity with accounting principles generally accepted in the United States. These statements include informed estimates and judgments for those transactions not yet complete or for which the ultimate effects cannot be measured precisely. Financial information elsewhere in this report is consistent with that in the financial statements. The consolidated financial statements have been audited, by our independent auditors. Their role is to render an independent professional opinion on Aon's financial statements.

        Management maintains a system of internal control designed to meet its responsibilities for reliable financial statements. The system is designed to provide reasonable assurance, at appropriate costs, that assets are safeguarded and that transactions are properly recorded and executed in accordance with management's authorization. Judgments are required to assess and balance the relative costs and expected benefitsstandards of those controls. It is management's opinion that its systemthe Public Company Accounting Oversight Board (United States), the effectiveness of the Company's internal control over financial reporting as of December 31, 2002 was effective2005, based on criteria established in providing reasonable assurance that its financial statements were freeInternal Control—Integrated Framework issued by the Committee of material misstatement. In addition, management supports and maintains a professional staff of internal auditors who coordinate audit coverage with the independent auditors and conduct a program of financial and operational audits.

        The Board of Directors selects an Audit Committee from among its members. All membersSponsoring Organizations of the Audit Committee are independent of the Company. The Audit Committee recommends to the Board of Directors appointment of the independent auditorsTreadway Commission and provides oversight relating to the review of financial information provided to stockholders and others, the systems of internal control which management and the Board of Directors have established and the audit process. The Audit Committee meets periodically with management, internal auditors and independent auditors to review the work of each and satisfy itself that those parties are properly discharging their responsibilities. Both the independent auditors and the internal auditors have free access to the Audit Committee, without the presence of management, to discuss the adequacy of internal control and to review the quality of financial reporting.our report dated March 7, 2006 expressed an unqualified opinion thereon.



Chicago, Illinois
March 7, 2006



Consolidated Statements of Income

 
 Years ended December 31
 
 
 2002
 2001
 2000
 
 
 (millions except per share data)

 
REVENUE          
 Brokerage commissions and fees $6,202 $5,436 $4,946 
 Premiums and other  2,368  2,027  1,921 
 Investment income (note 7)  252  213  508 
  
 
 
 
  Total revenue  8,822  7,676  7,375 
  
 
 
 
EXPENSES          
 General expenses (notes 4, 5 and 15)  6,505  5,813  5,190 
 Benefits to policyholders  1,375  1,111  1,037 
 Interest expense  124  127  140 
 Amortization of intangible assets  54  158  154 
 Unusual charges (credits)—World Trade Center (note 1)  (29) 158   
  
 
 
 
  Total expenses  8,029  7,367  6,521 
  
 
 
 
INCOME BEFORE INCOME TAX, MINORITY INTEREST AND ACCOUNTING CHANGE  793  309  854 
 Provision for income tax (note 9)  293  122  333 
  
 
 
 
INCOME BEFORE MINORITY INTEREST AND ACCOUNTING CHANGE  500  187  521 
 Minority interest, net of tax—Company-obligated mandatorily redeemable preferred capital securities (note 11)  (34) (40) (40)
  
 
 
 
INCOME BEFORE ACCOUNTING CHANGE  466  147  481 
 Cumulative effect of change in accounting principle, net of tax (note 1)      (7)
  
 
 
 
NET INCOME $466 $147 $474 
  
 
 
 
NET INCOME AVAILABLE FOR COMMON STOCKHOLDERS $463 $144 $471 
  
 
 
 
BASIC NET INCOME PER SHARE:          
 Before accounting change $1.65 $0.54 $1.84 
 Cumulative effect of change in accounting principle      (0.03)
  
 
 
 
  Basic net income per share $1.65 $0.54 $1.81 
DILUTIVE NET INCOME PER SHARE:          
 Before accounting change $1.64 $0.53 $1.82 
 Cumulative effect of change in accounting principle      (0.03)
  
 
 
 
  Dilutive net income per share $1.64 $0.53 $1.79 
CASH DIVIDENDS PER SHARE PAID ON COMMON STOCK $0.825 $0.895 $0.87 
  
 
 
 
DILUTIVE AVERAGE COMMON AND COMMON EQUIVALENT SHARES OUTSTANDING  282.6  272.4  263.0 
  
 
 
 
(millions, except per share data)

 Years ended December 31

 2005
 2004
 2003
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
REVENUE          
 Brokerage commissions and fees $6,646 $6,822 $6,545 
 Premiums and other  2,848  2,788  2,609 
 Investment income  343  321  310 
    
 
  Total revenue  9,837  9,931  9,464 

 

EXPENSES

 

 

 

 

 

 

 

 

 

 
 General expenses  6,914  6,969  6,569 
 Benefits to policyholders  1,551  1,516  1,427 
 Depreciation and amortization  277  303  307 
 Interest expense  125  136  101 
 Provision for NewYork and other state settlements  5  180   
 Unusual credit — World Trade Center      (14)
    
 
  Total expenses  8,872  9,104  8,390 

 

INCOME FROM CONTINUING OPERATIONS BEFORE PROVISION FOR INCOME TAX AND MINORITY INTEREST

 

 

965

 

 

827

 

 

1,074

 
 Provision for income tax  323  282  396 
    
 
INCOME FROM CONTINUING OPERATIONS BEFORE MINORITY INTEREST  642  545  678 
 Minority interest, net of tax — Company-obligated mandatorily redeemable preferred capital securities      (36)
    
 
INCOME FROM CONTINUING OPERATIONS  642  545  642 
INCOME (LOSS) FROM DISCONTINUED OPERATIONS, NET OF TAX  95  1  (14)
    
 
NET INCOME $737 $546 $628 

 
NET INCOME AVAILABLE FOR COMMON STOCKHOLDERS $735 $543 $625 

 

BASIC NET INCOME (LOSS) PER SHARE:

 

 

 

 

 

 

 

 

 

 
 Income from continuing operations $1.99 $1.70 $2.01 
 Discontinued operations  0.29    (0.04)
    
 
 Net income $2.28 $1.70 $1.97 
DILUTED NET INCOME (LOSS) PER SHARE:          
 Income from continuing operations $1.89 $1.63 $1.94 
 Discontinued operations  0.28    (0.04)
    
 
 Net income $2.17 $1.63 $1.90 

 
CASH DIVIDENDS PER SHARE PAID ON COMMON STOCK $0.60 $0.60 $0.60 

 
DILUTED AVERAGE COMMON AND COMMON EQUIVALENT SHARES OUTSTANDING  341.5  336.6  331.8 

 

See accompanying notes to consolidated financial statements.

59




Consolidated Statements of Financial Position


 As of December 31
 
(millions)

(millions)

 As of December 31

 2005

 2004



 2002
 2001
 


 (millions)

 

 

 

 

 

 

 

 

 
ASSETSASSETS     ASSETS    
INVESTMENTSINVESTMENTS     
INVESTMENTS

 

 

 

 

 

 
Fixed maturities at fair value $2,089 $2,149 Fixed maturities at fair value $4,218 $3,482
Equity securities at fair value 62 382 Equity securities at fair value 40 40
Short-term investments 3,836 2,975 Short-term investments 4,291 4,448
Other investments 600 640 Other investments 515 483
 
 
     
 Total investments 6,587 6,146  Total investments 9,064 8,453
 
 
 
CASHCASH 506 439 
CASH

 

 

476

 

 

570
RECEIVABLESRECEIVABLES     
RECEIVABLES

 

 

 

 

 

 
Insurance brokerage and consulting services 8,430 7,033 Insurance brokerage and consulting services 8,072 8,235
Other receivables 1,213 863 Other receivables 1,625 1,645
 
 
     
 Total receivables (net of allowance for doubtful accounts: 2002—$177; 2001—$187) 9,643 7,896  Total receivables (net of allowance for doubtful accounts: 2005 — $89;
2004 — $186)
 9,697 9,880
 
 
 
CURRENT INCOME TAXESCURRENT INCOME TAXES 124 46 
CURRENT INCOME TAXES

 

 

148

 

 

175
DEFERRED INCOME TAXESDEFERRED INCOME TAXES 689 582 
DEFERRED INCOME TAXES

 

 

533

 

 

512
DEFERRED POLICY ACQUISITION COSTSDEFERRED POLICY ACQUISITION COSTS 882 704 
DEFERRED POLICY ACQUISITION COSTS

 

 

1,186

 

 

1,137
GOODWILLGOODWILL     
GOODWILL

 

 

4,391

 

 

4,611
(net of accumulated amortization: 2002—$723; 2001—$698) 4,099 3,842 
OTHER INTANGIBLE ASSETSOTHER INTANGIBLE ASSETS     
OTHER INTANGIBLE ASSETS

 

 

115

 

 

133
(net of accumulated amortization: 2002—$238; 2001—$170) 225 242 
PROPERTY AND EQUIPMENT, NETPROPERTY AND EQUIPMENT, NET 865 775 
PROPERTY AND EQUIPMENT, NET

 

 

537

 

 

660
OTHER ASSETSOTHER ASSETS 1,714 1,658 
OTHER ASSETS

 

 

1,671

 

 

2,198
 
 
 
TOTAL ASSETS $25,334 $22,330 
 
 
 
LIABILITIES AND STOCKHOLDERS' EQUITY     
INSURANCE PREMIUMS PAYABLE $9,904 $8,233 
POLICY LIABILITIES     
Future policy benefits 1,310 1,026 TOTAL ASSETS $27,818 $28,329
Policy and contract claims 1,251 937 
Unearned and advance premiums and contract fees 2,610 2,214 
Other policyholder funds 139 813 
 
 
 
 Total policy liabilities 5,310 4,990 
GENERAL LIABILITIES     
General expenses 2,012 1,770 
Short-term borrowings 117 257 
Notes payable 1,671 1,694 
Other liabilities 1,673 1,071 
 
 
 
TOTAL LIABILITIES 20,687 18,015 
 
 
 
COMMITMENTS AND CONTINGENT LIABILITIES     
REDEEMABLE PREFERRED STOCK 50 50 
COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED CAPITAL SECURITIES OF SUBSIDIARY TRUST HOLDING SOLELY THE COMPANY'S JUNIOR SUBORDINATED DEBENTURES 702 800 
STOCKHOLDERS' EQUITY     
Common stock—$1 par value     
 Authorized: 750 shares; issued 333 293 
Paid-in additional capital 2,228 1,654 
Accumulated other comprehensive loss (954) (535)
Retained earnings 3,251 3,021 
Treasury stock at cost (shares: 2002—22.7; 2001—22.5) (794) (786)
Deferred compensation (169) (182)
 
 
 
TOTAL STOCKHOLDERS' EQUITY 3,895 3,465 
 
 
 
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $25,334 $22,330 
 
 
 

See accompanying notes to consolidated financial statements.

60




Consolidated Statements of Cash Flows
Financial Position (Continued)

 
 Years ended December 31
 
 
 2002
 2001
 2000
 
 
 (millions)

 
CASH FLOWS FROM OPERATING ACTIVITIES          
 Net income $466 $147 $474 
 Adjustments to reconcile net income to cash provided by operating activities          
  Cumulative effect of change in accounting principle, net of tax      7 
  Insurance operating assets and liabilities, net of reinsurance  335  (45) 46 
  Amortization of intangible assets  54  158  154 
  Depreciation and amortization of property, equipment and software  209  181  179 
  Income taxes  34  (97) 145 
  Special and unusual charges and purchase accounting liabilities (notes 4, 5 and 15)  (67) 59  (57)
  Valuation changes on investments and income on disposals  87  158  (66)
  Other receivables and liabilities—net  124  (2) (143)
  
 
 
 
   CASH PROVIDED BY OPERATING ACTIVITIES  1,242  559  739 
  
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES          
 Sale of investments          
  Fixed maturities          
   Maturities  162  120  100 
   Calls and prepayments  137  100  129 
   Sales  1,711  1,220  400 
  Equity securities  351  379  253 
  Other investments  61  272  281 
 Purchase of investments          
  Fixed maturities  (1,879) (1,112) (455)
  Equity securities  (46) (227) (148)
  Other investments  (27) (347) (436)
  Short-term investments—net  (678) (633) 3 
 Acquisition of subsidiaries  (111) (107) (85)
 Property and equipment and other—net  (278) (281) (179)
  
 
 
 
CASH USED BY INVESTING ACTIVITIES  (597) (616) (137)
  
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES          
 Issuance of common stock  607     
 Retirement of preferred stock—net  (87)    
 Treasury stock transactions—net  (10) 49  (59)
 Issuance (repayments) of short-term borrowings—net  (163) (395) 11 
 Issuance of long-term debt  519  400  250 
 Repayment of long-term debt  (547) (148) (70)
 Interest sensitive, annuity and investment-type contracts          
  Deposits    20  218 
  Withdrawals  (682) (305) (437)
 Cash dividends to stockholders  (233) (241) (226)
  
 
 
 
   CASH USED BY FINANCING ACTIVITIES  (596) (620) (313)
  
 
 
 
 EFFECT OF EXCHANGE RATE CHANGES ON CASH  18  (2) (8)
  
 
 
 
 INCREASE (DECREASE) IN CASH  67  (679) 281 
 CASH AT BEGINNING OF YEAR  439  1,118  837 
  
 
 
 
CASH AT END OF YEAR $506 $439 $1,118 
  
 
 
 
(millions)

 As of December 31

 2005

 2004

 

 

 

 

 

 

 

 

 

 

 

 
LIABILITIES AND STOCKHOLDERS' EQUITY       

INSURANCE PREMIUMS PAYABLE

 

$

9,427

 

$

9,775

 

POLICY LIABILITIES

 

 

 

 

 

 

 
 Future policy benefits  1,671  1,542 
 Policy and contract claims  1,827  1,854 
 Unearned and advance premiums and contract fees  2,989  2,979 
 Other policyholder funds  21  18 
    
 
  Total policy liabilities  6,508  6,393 

GENERAL LIABILITIES

 

 

 

 

 

 

 
 General expenses  1,661  1,557 
 Short-term borrowings  7  2 
 Notes payable  2,105  2,115 
 Pension, post employment and post retirement liabilities  1,497  1,528 
 Other liabilities  1,310  1,806 
    
 
 TOTAL LIABILITIES  22,515  23,176 

 

REDEEMABLE PREFERRED STOCK

 

 


 

 

50

 

 

 

 

 

 

 

 

 
STOCKHOLDERS' EQUITY         
 Common stock-$1 par value       
  Authorized: 750 shares; issued  344  339 
 Paid-in additional capital  2,349  2,197 
 Accumulated other comprehensive loss  (1,155) (681)
 Retained earnings  4,573  4,031 
 Treasury stock at cost (shares: 2005 — 23.0; 2004 — 22.4)  (808) (783)
    
 
 TOTAL STOCKHOLDERS' EQUITY  5,303  5,103 

 
 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $27,818 $28,329 

 

See accompanying notes to consolidated financial statements.

61




Consolidated Statements of Stockholders' Equity
Cash Flows

 
 Years Ended December 31
 
 
 2002
 2001
 2000
 
 
 (millions)

 
Common Stock        Balance at January 1 $293 $264 $259 
 Issuance of stock (note 11)  37     
 Issued for business combinations  1  28  4 
 Issued for employee benefit plans  2  1  1 
  
 
 
 
   333  293  264 
  
 
 
 
Paid-in Additional Capital        Balance at January 1  1,654  706  525 
 Issuance of stock (note 11)  570     
 Business combinations (notes 4 and 11)  (18) 952  141 
 Employee benefit plans  22  (4) 40 
  
 
 
 
   2,228  1,654  706 
  
 
 
 
Accumulated Other Comprehensive Income (Loss)        Balance at January 1  (535) (377) (309)
 Cumulative effect of change in accounting principle related to derivatives (note 1)      3 
 Net derivative gains (losses)  22  (6) 3 
 Net unrealized investment gains  42  30  49 
 Net foreign exchange gains (losses)  69  (58) (115)
 Net additional minimum pension liability adjustment  (552) (124) (8)
  
 
 
 
 Other comprehensive loss  (419) (158) (68)
  
 
 
 
   (954) (535) (377)
  
 
 
 
Retained Earnings        Balance at January 1  3,021  3,127  2,905 
 Net income  466  147  474 
 Dividends to stockholders  (233) (241) (226)
 Loss on treasury stock reissued  (2) (10) (24)
 Employee benefit plans  (1) (2) (2)
  
 
 
 
   3,251  3,021  3,127 
  
 
 
 
Treasury Stock        Balance at January 1  (786) (118) (90)
 Cost of shares acquired—non-cash exchange (notes 4 and 11)    (783)  
 Cost of shares acquired  (13) (5) (102)
 Shares reissued at average cost  5  120  74 
  
 
 
 
   (794) (786) (118)
  
 
 
 
Deferred Compensation        Balance at January 1  (182) (214) (239)
 Net issuance of stock awards  (13) (3) (7)
 Amortization of deferred compensation  26  35  32 
  
 
 
 
   (169) (182) (214)
  
 
 
 
Stockholders' Equity at December 31 $3,895 $3,465 $3,388 
  
 
 
 
Comprehensive Income (Loss)          
 Net income $466 $147 $474 
 Other comprehensive loss (note 3)  (419) (158) (68)
  
 
 
 
 Comprehensive income (loss) $47 $(11)$406 
  
 
 
 
(millions)

 Years ended December 31

 2005
 2004
 2003
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
CASH FLOWS FROM OPERATING ACTIVITIES          
 Net income $737 $546 $628 
 Adjustments to reconcile net income to cash provided by operating activities          
  (Gain)/loss from disposal of operations  (240) 8  23 
  Insurance operating assets and liabilities, net of reinsurance  160  278  305 
  Depreciation and amortization of property, equipment and software  227  253  251 
  Amortization of stock awards  69  44  49 
  Amortization of intangible assets  50  56  63 
  Income taxes  149  (122) 75 
  Contributions to major defined benefit pension plans (in excess of) less than expense  (221) 45  (30)
  Expense in excess of cash paid for 2005 restructuring plan  118     
  Provision for New York and other state settlements  (71) 180   
  Other receivables and liabilities — net  (92) (104) (52)
    
 
   CASH PROVIDED BY OPERATING ACTIVITIES  886  1,184  1,312 

 

CASH FLOWS FROM INVESTING ACTIVITIES

 

 

 

 

 

 

 

 

 

 
 Sale of investments          
  Fixed maturities          
   Maturities  232  184  153 
   Calls and prepayments  234  131  83 
   Sales  2,053  1,167  1,256 
  Equity securities  11  8  31 
  Other investments  18  454  8 
 Purchase of investments          
  Fixed maturities  (3,408) (2,102) (2,069)
  Equity securities  (14) (4) (1)
  Other investments  (10) (64)  
 Short-term investments — net  (42) (670) 125 
 Acquisition of subsidiaries  (81) (80) (56)
 Proceeds from sale of operations  364  133  48 
 Property and equipment and other — net  (126) (80) (185)
    
 
   CASH USED BY INVESTING ACTIVITIES  (769) (923) (607)

 

CASH FLOWS FROM FINANCING ACTIVITIES

 

 

 

 

 

 

 

 

 

 
 Issuance of common stock  76  23   
 Preferred stock redemption  (50)    
 Treasury stock transactions — net  (25)   (6)
 Issuances (repayments) of short-term borrowings — net  5  (49) (77)
 Issuance of long-term debt  569  323  122 
 Repayment of long-term debt  (586) (320) (430)
 Interest sensitive, annuity and investment-type contracts — withdrawals    (51) (89)
 Cash dividends to stockholders  (193) (192) (190)
    
 
   CASH USED BY FINANCING ACTIVITIES  (204) (266) (670)

 

EFFECT OF EXCHANGE RATE CHANGES ON CASH

 

 

(7

)

 

35

 

 

21

 
    
 
INCREASE (DECREASE) IN CASH  (94) 30  56 
CASH AT BEGINNING OF YEAR  570  540  484 
    
 
CASH AT END OF YEAR $476 $570 $540 

 

See accompanying notes to consolidated financial statements.

62



Consolidated Statements of Stockholders' Equity

(millions)

 Years ended December 31

 2005
 2004
 2003
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
Common Stock            Balance at January 1 $339 $336 $333 
 Issued for employee benefit plans  5  3  3 
    
 
    344  339  336 

 

Paid-in Additional Capital            Balance at January 1

 

 

2,197

 

 

2,128

 

 

2,059

 
 Business combinations  5  4  11 
 Employee benefit plans  147  65  58 
    
 
    2,349  2,197  2,128 

 

Accumulated Other Comprehensive Income (Loss)            Balance at January 1

 

 

(681

)

 

(861

)

 

(954

)
 Net derivative gains (losses)  (51) (10) 28 
 Net unrealized investment gains (losses)  (10) 42  20 
 Net foreign exchange translation  (240) 146  231 
 Net additional minimum pension liability adjustment  (173) 2  (186)
    
 
 Other comprehensive income (loss)  (474) 180  93 
    
 
    (1,155) (681) (861)

 

Retained Earnings            Balance at January 1

 

 

4,031

 

 

3,679

 

 

3,251

 
 Net income  737  546  628 
 Dividends to stockholders  (194) (193) (191)
 Loss on treasury stock reissued    (1) (8)
 Other  (1)   (1)
    
 
    4,573  4,031  3,679 

 

Treasury Stock            Balance at January 1

 

 

(783

)

 

(784

)

 

(794

)
 Cost of shares acquired  (25)   (5)
 Shares reissued at average cost    1  15 
    
 
    (808) (783) (784)

 
Stockholders' Equity at December 31 $5,303 $5,103 $4,498 

 

Comprehensive Income

 

 

 

 

 

 

 

 

 

 
 Net income $737 $546 $628 
 Other comprehensive income (loss)  (474) 180  93 
    
 
 Comprehensive income $263 $726 $721 

 

See accompanying notes to consolidated financial statements.



Notes to Consolidated Financial Statements

1.     Summary of Significant Accounting Principles and Practices

Principles of Consolidation

        The accompanying consolidated financial statements have been prepared in conformityaccordance with accounting principlesU.S. generally accepted in the United States andaccounting principles. The consolidated financial statements include the accounts of Aon Corporation and its majority-owned subsidiaries (Aon). These statements include informed estimates and assumptions that affect("Aon" or the amounts reported. Actual results could differ from"Company"), excluding special-purpose entities ("SPEs") considered variable interest entities ("VIEs") for which Aon is not the amounts reported.primary beneficiary. All material intercompany accounts and transactions have been eliminated.

        The preparation of financial statements requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from the amounts reported.

Segment Reporting

        Aon classifies its businesses into three operating segments: Risk and Insurance Brokerage Services, Consulting and Insurance Underwriting. A fourth segment, Corporate and Other, when combined with the operating segments and after the elimination of intersegment revenues, totals to the amounts included in the consolidated financial statements. Certain amounts in prior years' consolidated financial statements relating to segments have been reclassified to reflect the results of discontinued operations.

Revenue Recognition

        Revenue is recognized when all elements of revenue recognition exist as defined in Staff Accounting Bulleting No. 104. Those elements are (1) persuasive evidence of an agreement with the client; (2) a fixed and determinable price for services; (3) those services have been rendered; and (4) collectibility is reasonably assured.

Brokerage CommissionsCommission and Fees

        Commission incomerevenue is primarily recognized at the later of the billing or the effective date of the policy. However, in circumstances where a binding order has been received before the endrelated insurance policy, net of an allowance for estimated policy cancellations. Where all of the accounting period and coverage is effective,elements of revenue recognition have been met, but processing has not yet occurred in the billing system due to timing, an accrual is recorded. The amounts recorded for these accrualsFor policies that are generally consistent from period to period and the total accrual has not materially impacted the historical trend ofbilled in installments, revenue and earnings in any quarterly or annual period. Aon's policy for estimating allowances for return commissions on policy cancellations is to record an allowance based on a historical evaluation of cancellations as a percentage of related revenue. Certain life insurance commissions, commissions on premiums billed directly by insurance companies and certain other carrier compensation are generally recognized as income when received. Revenues may be recorded in advance of the cash receipts in cases where the amounts due to be received have been confirmed by the insurance company, or when Aon has sufficient information in its records to estimate the amounts. When insurance underwriters directly bill clients, revenue is recognized when the cash is received or amounts for premium based revenue accruals in accordance with agreementsdue to Aon has with insurance carriers.become determinable. Commissions on premium adjustments are recognized as they occur.

        Policy cancellation reserves and revenue accruals are estimates. Policy cancellations are estimated through an historical evaluation of relevant data. Revenue accruals are estimated through an analysis of the specific transactions.

        Fees for claims services, benefit consulting, human capital outsourcing, reinsurance services and other services are recognized when the services are rendered. Aon may enter intohas multiple year outsourcing agreementsarrangements with clients. Revenues received from these agreementsarrangements are recorded on a gross basis, inclusive of amounts ultimately passed through to subcontractors, when Aon maintains the performance obligation and are recorded ratably over the life of the contract.

        The portion of the revenues received on extended warranty contracts that are for the marketing, administration and servicing of those contracts are reported as earned consistent with the method used to earn the premium portion of those revenues and revenues that represent administrative fee-for-service arrangements, for which Aon does not bear the underwriting risk, are earned as those services are performed. These fee-for-service arrangements include the marketing and servicing of



extended warranty contracts on behalf of other companies and brokerage commissions for accident and health products placed with non-Aon insurance carriers. These revenues are reported in the Insurance Underwriting segment.

Premium Revenue

        For accident and health products, premiums are reported as earned in proportion to insurance protection provided over the period covered by the policies. For life products, premiums are recognized as revenue when due. For extended warranty products, premium revenues represent the portion of revenue from these contracts that are submitted to an Aon insurance carrier for coverage and are earned over the period of risk in proportion to the amount of insurance protection provided in accordance with Financial Accounting Standards Board (FASB)FASB Statement No. 60,Accounting and Reporting by Insurance Enterprises.

        For universal life-type and investment products, generally there is no requirement for payment of premium other than to maintain account values at a level sufficient to pay mortality and expense

63



charges. Consequently, premiums for universal life-type policies and investment products are not reported as revenue, but as deposits. Policy fee revenue for universal life-type policies and investment products consists of charges for the cost of insurance, policy administration and surrenders assessed during the period. Expenses include interest credited to policy account balances and benefit claims incurred in excess of policy account balances.

Unusual Charges (Credits)—World Trade Center

        In 2001, Aon recorded pretax unusual charges of $158 million ($97 million after-tax or $0.35 per dilutive share), net of insurance and reinsurance recoveries, related to losses sustained as a result of the destruction of the World Trade Center on September 11, 2001 and the death of 175 employees. Costs incurred included $33 million of destroyed depreciable assets at net book value, $40 million for salaries and benefits for deceased and injured employees and other costs, and a $10 million commitment to the Aon Memorial Education fund to support the educational needs of the children of Aon employees who were victims of the September 11th attacks. Offsetting these expenses were estimated insurance recoveries of $60 million as of fourth quarter 2001. These costs also included $192 million of insurance benefits paid by Aon's Combined Insurance Company of America subsidiary (CICA) under life insurance policies issued for the benefit of deceased employees, which were partially offset by reinsurance recoveries of $147 million, resulting in a net charge of $45 million. Reinsurers have disputed their liability as to approximately $90 million of reinsurance recoveries under a Business Travel Accident (BTA) policy issued by CICA to cover U.S.-based employees of subsidiaries of Aon, and legal actions have been filed by both parties. In fourth quarter 2001, Aon recorded a pretax $90 million allowance for a potentially uncollectible receivable related to this dispute. In September 2002, CICA's action with respect to the BTA policy was dismissed by the Court for the lack of subject matter jurisdiction. Prior to year-end, CICA was granted an expedited appeal.

        During 2002, a settlement was reached with Aon's property insurance carriers pertaining to reimbursement for depreciable assets destroyed. This settlement resulted in a pretax credit of $29 million, which is reported as an Unusual credit—World Trade Center in the consolidated statements of income. Additional claims are in the process of being presented to other insurers for issues related to extra expenses, leasehold interests and business interruption coverage and additional recoveries and gains are expected in future periods when specific claims are settled.

Reinsurance

        Reinsurance premiums, commissions and expense reimbursements on reinsured business are accounted for on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. Premiums and benefits to policyholders ceded to other companies have been reported as a reduction of premium revenue and benefits to policyholders. Expense reimbursements received in connection with reinsurance ceded have been accounted for as a reduction of the related policy acquisition costs. Reinsurance receivables and prepaid reinsurance premium amounts are reported as assets.

Allowance for Doubtful AccountsUnusual Credit — World Trade Center

        Aon's policy for estimating allowances for doubtful accounts with respectIn order to receivables isresume business operations and minimize the loss caused by the World Trade Center disaster, Aon secured temporary office space in Manhattan. Subsequently, permanent space was leased and, during first quarter 2003, Aon assigned this temporary space to record an allowance based onanother company. The costs relating to this assignment were $46 million pretax in 2003. In fourth quarter 2003, Aon reached a historical evaluationfinal settlement of write-offs, aging of balances and other qualitative and quantitative analyses.

Stock Compensation Plans

        Aon applies Accounting Principles Board Opinion (APB) No. 25,Accounting for Stock Issued to Employees, and related Interpretations in accounting$200 million for its stock-based compensation plans.

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Accordingly, no compensationoverall World Trade Center property insurance claim. A cash payment of $92 million was received during fourth quarter 2003, in addition to the $108 million already collected in prior years. This settlement resulted in a pretax gain of $60 million. This gain and the $46 million expense has been recognized for its stock option plandiscussed above, were combined and reported as a $14 million Unusual credit — World Trade Center in the exercise price2003 consolidated statement of the options equaled the market price of the stock at the date of grant. Compensation expense has been recognized for stock awards based on the market price at the date of the award.

        The following table illustrates the effect on net income and earnings per share if Aon had applied the fair value recognition provision of FASB Statement No. 123,Accounting for Stock-Based Compensation, to stock-based employee compensation.

 
 Years ended December 31
 
 2002
 2001
 2000
Net income, as reported $466 $147 $474
Add: Stock based employee compensation
expense included in reported net income, net of related tax effects
  14  19  16
Deduct: Total stock-based compensation expense determined under fair value based method for all awards, net of related tax effects  37  29  32
  
 
 
Pro forma net income $443 $137 $458
  
 
 
Net income per share:         
 Basic         
  As reported $1.65 $0.54 $1.81
  Pro forma  1.57  0.51  1.75
 Dilutive         
  As reported  1.64  0.53  1.79
  Pro forma  1.56  0.50  1.73

        The fair value per share of options and awards granted is estimated as $6.21 and $28.54 in 2002, $8.66 and $29.78 in 2001 and $6.33 and $25.73 in 2000, respectively, on the grant date using the Black-Scholes option pricing model with the following weighted-average assumptions:

 
 2002
 2001
 2000
 
Dividend yield 2.25%2.0%2.0%
Expected volatility 21%28%27%
Risk-free interest rate 4%6%6%
Expected term life beyond vesting date (in years):       
 Stock options 0.96 1.06 0.94 
 Stock awards    

        The compensation cost as generated by the Black-Scholes model may not be indicative of the future benefit, if any, that may be received by the option holder.

        The pro forma information reflected above may not be representative of the amounts to be expected in future years as the fair value method of accounting contained in FASB Statement No. 123 has not been applied to options and awards granted prior to January 1995.income.

Income TaxTaxes

        Deferred income tax has beentaxes are provided for the effectseffect of temporary differences between financial reporting and tax bases of assets and liabilities and has beenare measured using the enacted marginal tax rates and laws that are currently in effect. Valuation allowances are recorded to reduce the net deferred tax assets to an amount that is more likely than not realizable.

Income Per Share

        Basic net income per share is computed based onby dividing net income available for common stockholders by the weighted-average number of common shares outstanding, excluding any dilutive effects of options and awards.outstanding. Net income available for common

65



stockholders is net of all preferred stock dividends. DilutiveDiluted net income per share is computed based onby dividing net income available for common stockholders by the weighted-average number of common shares outstanding, plus the dilutive effect of stock options and awards. The dilutive effect of stock options and awards is calculated under the treasury stock method using the average market price for the period. CommonCertain common stock equivalents related to options to purchasewere not included in the computation of diluted income per share because those options' exercise price was greater than the average market



price of the common shares. The number of options excluded from the calculation was 18 million in 2005, 20 million in 2004 and 24 million 4 million and 5in 2003.

        As required by Emerging Issues Task Force (EITF) Issue No. 04-8, The Effect of Contingently Convertible Investments on Diluted Earnings Per Share, Aon includes in its diluted net income per share computation the impact of any contingently convertible instruments regardless of whether the market price trigger has been met. Aon's 3.5% convertible debt securities, issued in November 2002, may be converted into a maximum of 14 million shares of Aon common stock in 2002, 2001 and 2000, respectively, have not been considered because they wouldthese shares have been anti-dilutive.included in the computation of diluted net income per share (see Note 8 for further information).

        Income per share is calculated as follows:

(millions, except per share data)

 2005
 2004
 2003
 

 
Basic net income:          
 Income from continuing operations $642 $545 $642 
 Income (loss) from discontinued operations, net of tax  95  1  (14)
  
 
 Net income  737  546  628 
 Preferred stock dividends  (2) (3) (3)

 
 Net income for basic per share calculation $735 $543 $625 

 
Diluted net income:          
 Income from continuing operations $642 $545 $642 
 Income (loss) from discontinued operations, net of tax  95  1  (14)
  
 
 Net income  737  546  628 
 Interest expense on convertible debt securities, net of tax  7  7  7 
 Preferred stock dividends  (2) (3) (3)

 
 Net income for diluted per share calculation $742 $550 $632 

 
Basic shares outstanding  322  320  317 
Effect of convertible debt securities  14  14  14 
Common stock equivalents  5  3  1 
  
 
Diluted potential common shares  341  337  332 

 
Basic net income (loss) per share:          
 Income from continuing operations $1.99 $1.70 $2.01 
 Discontinued operations  0.29    (0.04)
  
 
 Net income $2.28 $1.70 $1.97 

 
Diluted net income (loss) per share:          
 Income from continuing operations $1.89 $1.63 $1.94 
 Discontinued operations  0.28    (0.04)
  
 
 Net income $2.17 $1.63 $1.90 

 

Stock Compensation Plans

        Aon follows Accounting Principles Board Opinion (APB) No. 25,Accounting for Stock Issued to Employeesand related Interpretations in accounting for its stock-based compensation plans. Under APB No. 25, no compensation expense is recognized for stock options when the exercise price of the options equals the market price of the stock at the date of grant. Compensation expense is recognized on a straight-line basis for stock awards based on the vesting period and market price at the date of the award.

 
 2002
 2001
 2000
 
 
 (millions except per share data)

 
Net income $466 $147 $474 
Redeemable preferred stock dividends  (3) (3) (3)
  
 
 
 
Net income available for common stockholders $463 $144 $471 
  
 
 
 
Basic shares outstanding  281  269  260 
Common stock equivalents  2  3  3 
  
 
 
 
Dilutive potential common shares  283  272  263 
  
 
 
 
Net income per share:          
 Basic $1.65 $0.54 $1.81 
 Dilutive $1.64 $0.53 $1.79 
  
 
 
 


        The following table illustrates pro forma net income and pro forma earnings per share as if Aon had applied the fair value recognition provisions of FASB Statement No. 123,Accounting for Stock-Based Compensation, to stock-based employee compensation.

(millions, except per share data)

 2005
 2004
 2003

Net income, as reported $737 $546 $628
Add: Stock-based compensation expense included in reported net income, net of tax  45  29  31
Deduct: Stock-based compensation expense determined under fair value method for all awards and options, net of tax  57  47  55

Proforma net income $725 $528 $604


Net income per share:

 

 

 

 

 

 

 

 

 
 Basic         
  As reported $2.28 $1.70 $1.97
  Pro forma  2.24  1.64  1.89
 
Diluted

 

 

 

 

 

 

 

 

 
  As reported $2.17 $1.63 $1.90
  Pro forma  2.14  1.58  1.83

        The fair value per share of options and awards granted is estimated as $6.34 and $23.63 in 2005, $6.15 and $25.32 in 2004 and $3.59 and $18.33 in 2003, respectively, on the grant date using the Black-Scholes option pricing model with the following weighted-average assumptions:

 
 2005
 2004
 2003
 

 
Dividend yield 2.3%2.3%2.3%
Expected volatility 30.0%27.0%23.4%
Risk-free interest rate 4.0%3.3%2.9%
Expected term life beyond vesting date (in years):       
 Stock options 1.0 1.0 1.0 
 Stock awards    

 

        The compensation cost as generated by the Black-Scholes model may not be indicative of the future benefit, if any, that may be received by the option holder.

Investments

        Short-term investments include certificates of deposit, money market funds and highly liquid debt instruments purchased with maturities of up to one year (generally three months or less) and money market funds and are carried at cost, which approximates fair value.

        Fixed-maturity securities are available for sale and are carried at fair value. The amortized cost of fixed maturities is adjusted for amortization of premiums and the accretion of discounts to maturity, thatwhich are included in investment income.

Marketable equity securities that are held directly by Aon are carried at fair value. Unrealized gains and temporary unrealized losses on fixed-maturities and directly-held equity securities are excluded from income and are recorded directly to stockholders' equity in accumulated other comprehensive income or loss, net of deferred income taxes.

Mortgage loans and policy loans are generally carried at cost or unpaid principal balance.

Private equity investments are generally carried at cost, which approximates fair value, except where Aon has significant influence, in which case they are carried underusing the equity method. method of accounting.



        Unrealized gains and losses on fixed maturities and marketable equity securities are excluded from income and are recorded directly in stockholders' equity as accumulated other comprehensive income or loss, net of deferred income taxes.

Endurance common stock and warrants —In 2001, Aon announced that it would co-sponsorinvested $227 million in Endurance Specialty Holdings, Ltd. ("Endurance"), a new Bermuda-based insurance and reinsurance company with total initial capitalizationcompany. During 2004, Aon sold virtually all of $1.2 billion to provide additional underwriting capacity to commercial property and casualty insurance and reinsurance clients. Aon'sits common stock investment in Endurance, Specialty Insurance Ltd. (Endurance) was fundedwhich resulted in December 2001 with $227 milliona pretax gain of operating cash. The$48 million. In 2005, Aon sold its remaining common stock investment in Endurance, resulting in a pretax gain of $1 million.

        In conjunction with the initial common stock investment, Aon also received 4.1 million stock purchase warrants, which allow Aon to purchase additional Endurance common stock through December 2011. These warrants meet the definition of a derivative, which requires them to be recorded in the financial statements at fair value, with changes in fair value recognized in earnings on a current basis. Aon has valued the warrants using the Black-Scholes pricing methodology with the assistance of an independent third party. Aon has determined that the warrants had a fair value of $90 million and $80 million at December 31, 2005 and 2004, respectively.

        The assumptions used to value the Endurance stock purchase warrants were as follows:

December 31,

 2005
 2004
 

 
•    Maturity (in years)  5.96  6.96 
•    Spot Price $30.86 $29.31 
•    Risk Free Interest Rate  4.95% 4.40%
���    Dividend Yield  0.00% 0.00%
•    Volatility  32% 17%
•    Exercise Price $12.12 $13.20 

 

        The model assumes: the warrants are "European-style," which means that they are valued as if the exercise can only occur on the expiration date; the spot and exercise prices are reduced by expected future dividends; and the dividend remains unchanged during the period the warrants are outstanding. Although Endurance currently pays a dividend, a zero dividend yield is used in the Endurance warrants valuation because the future dividend payment value has been reflected in the spot and exercise prices.

        The change in value during the period was recognized as investment income in the Corporate and Other segment and was $10 million and $80 million in 2005 and 2003, respectively. There was no net change in value during 2004. The future value of the warrants may vary considerably from the value at December 31, 2005 due to the price movement of the underlying shares, as well as the passage of time and changes in other factors that are employed in the valuation model.

Limited partnership investments are carried underusing the equity method and is included in Other Investments in the consolidated statements of financial position.

        Limited partnership investments are carried under the equity method.accounting. Certain of the limited partnerships in which Aon invests have holdings in publicly traded equities.publicly-traded equity securities. Changes in market value of these indirectly-held equitiesequity securities flow through the limited partnerships' financial statements. Aon's ownershipproportionate share of these valuation changes is included in investment income in Aon's Corporate and Other Segment revenue.segment.


PEPS I — In December 2001, Aon securitized $450 million of limited partnership investments, plus associated limited partnership commitments, via a sale to Private Equity Partnership Structures I, LLC (PEPS I).

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Aon received $171 million in cash, plus $279 million of newly-issued fixed maturity and preferred stock securities of PEPS I. The underlying equity in the limited partnerships was the basis for determining the fair value of the cash and securities received in the securitization. No significant management assumptions were used in determining the fair value of the cash and securities received in the securitization or the value at December 31, 2002. At December 31, 2002, a 10%2005 or 20% decrease in the underlying equity of the limited partnerships would have resulted in a decrease in the value of the preferred stock securities owned by $40 million and $80 million, respectively.2004.

General — Income or loss on disposal of any securities held in the portfolioinvestments is computed using the specific costscost of securitiesthe security sold and is reported as investment income in the consolidated statements of income.

        Declines in the fair value of invested assetsinvestments below cost are evaluated for other than temporaryother-than-temporary impairment losses on a quarterly basis. Impairment losses for declines in the value of fixed-maturity investments and equity securities below cost attributable to issuer-specific events are determined based upon all relevant facts and circumstances for each investment and are recognized when appropriate in accordance with Staff Accounting Bulletin (SAB) 59, FASB Statement No. 115,Accounting for Certain Investments in Debt and Equity Securities and related guidance. For fixed-maturity investments with unrealized losses due to market conditions or industry-related events where Aon has the positive intent and ability to hold the investment for a period of time sufficient to allow a market recovery or to maturity, declines in value below cost are assumed to be temporary.

        Aon's policy for equity securities is to recognize impairment losses on specific securities that have had continuous material unrealized losses for more than three consecutive quarters, or less due to market conditions or industry-related events.

        Reserves for certain other investments are established based on an evaluation of the respective investment portfolio and current economic conditions. Write-downs and changes in reserves are included in investment income in the consolidated statements of income. In general, Aon ceases to accrue investment income when interest or dividend payments are in arrears.

        Accounting policies relating to derivative financial instruments are discussed in noteNote 14.

Cash

        Cash includes cash balances and investments with initial maturities of three months or less.

        Aon maintains premium trust bank accounts for premiums collected from insureds but not yet remitted to insurance companies of $2.9 billion and $3.0 billion at December 31, 2005 and 2004, respectively. These funds and a corresponding liability, are included in short-term investments and insurance premiums payable, respectively, in the accompanying consolidated statements of financial position.

Allowance for Doubtful Accounts

        Aon's policy for estimating allowances for doubtful accounts with respect to receivables is to record an allowance based on a historical evaluation of write-offs, aging of balances and other qualitative and quantitative analyses.

Deferred Policy Acquisition Costs

        Costs of acquiring new and renewal insurance underwriting business, principally the excess of new commissions over renewal commissions, and underwriting and sales expenses that vary with and are primarily related to, the production of new business, are deferred and reported as assets. For long-duration life and health products, amortization of deferred policy acquisition costs is related to and based on, the expected premium revenues of the policies. In general, amortization is adjusted to reflect current withdrawal experience. Expected premium revenues are estimated by using the same assumptions used in estimating future policy benefits. For extended warranty and short-duration health



insurance, costs of acquiring and renewing business are deferred and amortized as the related premiums and contract fees are earned.

Intangible Assets

        In general, prior to January 1, 2002, goodwill relating to business acquisitions had been amortized into income over periods not exceeding 40 years using the straight-line method. Goodwill related to acquisitions made after June 30, 2001 has not been amortized. Beginning January 2002, goodwill was not amortized but instead tested for impairment under new authoritative guidance on business combinations and goodwill. See Accounting and Disclosure Changes (note 1) for further information. The cost of other intangible assets is being amortized over a range of 1 to 10 years with a weighted-average life of 3.8 years.

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        In the unexpected event of a significant deterioration in profitability that is projected to be recurring, Aon would assess the recoverability of its intangible assets through an analysis of expected future cash flows.

Property and Equipment

        Property and equipment areis stated at cost, less accumulated depreciation. Depreciation is generally depreciatedcalculated using the straight-line method over their estimated useful lives. Included in this category is internal use software, which is software that is acquired, internally developed or modified solely to meet internal needs, with no plan to market externally. Costs related to directly obtaining, developing or upgrading internal use software are capitalized. These costs are generally amortized using the straight-line method over a range of 21 to 10 years. The weighted- averageweighted-average original life of Aon's software at December 31, 20022005 is 4.75 years.

        The components of property and equipment, net are as follows:

(millions)    As of December 31,

 2005
 2004

Software $563 $592
Computer equipment  283  305
Land and buildings  132  143
Furniture, fixtures and equipment  368  381
Leasehold improvements  357  360
Automobiles  29  31
  
   1,732  1,812
Less: Accumulated depreciation  1,195  1,152

Property and equipment, net $537 $660

        Depreciation expense for the years ended December 31, 2005, 2004 and 2003 was $227 million, $253 million and $251 million, respectively.

Fair Value of Financial Instruments

        The following methods and assumptions were used to estimate fair values for financial instruments. The carrying amounts in the consolidated statements of financial position for cashinstruments:

        Cash and cash equivalents, including short-term investments,investments:    Carrying amounts approximate their fair value. Fair value for fixed-maturity

        Fixed-maturity and equity securitiessecurities:    Fair value is based on quoted market prices or, if they are not actively traded, on estimated values obtained from independent pricing services.

        Derivative financial instruments:    Fair value of derivative financial instruments is based on quoted prices for exchange-traded instruments or the cost to terminate or offset with other contracts.

        Other investments are comprised of Aon's investment in Endurance warrants, mortgage loans, policy loans, private equity investments and limited partnerships and Aon's investment in Endurance. The fairpartnerships.


        Deposit-type contracts:    Fair value for liabilities for investment-type contracts is estimated using discounted cash flow calculations based on interest rates currently being offered for similar contracts with maturities consistent with those remaining for the contracts being valued. The fair

        Notes payable:    Fair value for notes payable is based on quoted market prices for the publicly-traded portion and on estimates using discounted cash flow analyses based on current borrowing rates for similar types of borrowing arrangements for the nonpublicly-traded portion.

Future Policy Benefits, Policy and Contract Claims, Unearned Premiums and Contract Fees

        Future policy benefit liabilities on non-universal life, and accident and health products have been provided on the net level premium method. The liabilities are calculated based on assumptions as to investment yield, mortality, morbidity and withdrawal rates that were determined at the date of issue and provide for possible adverse deviations. Interest assumptions arehave been graded and range from 4.5%2% to 7.0%6% at December 31, 2002.2005. The interest assumption used on most current issues is a level 4%. Withdrawal assumptions are based principally on insurance subsidiaries' experience and vary by plan, year of issue and duration.

        Policyholder liabilities on universal life and investment products are generally based on policy account values. Interest credit rates for these products range from 2% to 7.3%.

        Policy and contract claim liabilities represent estimates for reported claims, as well as provisions for losses incurred but not yet reported. These claim liabilities are based on historical experience and are estimates of the ultimate amount to be paid when the claims are settled. ChangesThe estimates are subject to the effects of trends in claim severity and frequency. The process of estimating and establishing policy and contract liabilities is inherently uncertain and the actual ultimate cost of a claim may vary materially from the estimated liability are reflected in income as theamount reserved. The estimates are revised.continually reviewed and adjusted as necessary as experience develops or new information becomes known; such adjustments are included in current operations.

        Unearned premiums and contract fees generally are calculated using the pro rata method based on gross premiums. However, in the case of extended warranty, and credit life and disability products, the

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unearned premiums and contract fees are calculated such that the premiums and contract fees are earned over the period of risk in a reasonable relationship to anticipated claims. The Company considers anticipated investment income in determining whether a premium deficiency exists.

Foreign Currency Translation

        In general, foreignForeign revenues and expenses are translated at average exchange rates. Foreign assets and liabilities are translated at year-end exchange rates. Net foreign exchange gains and losses on translation are generally reported in stockholders' equity, in accumulated other comprehensive income or loss ("OCI"), net of applicable deferred income tax.taxes. In 2005, management deemed all undistributed earnings of Aon's foreign subsidiaries to be permanently reinvested. The impact of this decision did not have a material effect on Aon's net income. Because of transaction gainsthe decision to reinvest the undistributed earnings of these foreign subsidiaries, the deferred tax liability of $31 million previously accrued related to the cumulative foreign currency translation adjustment ("CTA") of those subsidiaries was no longer required, resulting in a credit to OCI in 2005. Aon continues to record deferred taxes related to the CTA of its foreign branches of U.S. underwriting subsidiaries.

U.K. Accounting Matters

        In connection with accounting guidance issued by the Institute of Chartered Accountants in the U.K., Aon, like others in the industry, reassessed whether and lossesto what extent its U.K. businesses have legal obligations to provide future claims handling and administrative services for brokerage clients. With the assistance of outside legal counsel, Aon performed a detailed factual and legal review of each different business and each of several classes of clients. This review was completed in October 2005. Where a legal obligation was determined to exist, the Company estimated and accrued the costs of such an obligation. The liability recorded during 2005 was $22 million.



        Also in connection with accounting guidance issued by the Institute of Chartered Accountants in the U.K., Aon refined techniques used to estimate revenue on installment policies in the consolidated statements of income, after consideration of derivative hedging, is insignificant for all periods presented.U.K. This change in estimate resulted in a one-time $23 million increase to Aon's revenue, which was recorded during 2005.

Accounting and Disclosure Changes

        As of October 1, 2000, Aon adopted FASB Statement No. 133,Accounting for Derivative Instruments and Hedging Activities, as amended. The adoption of Statement No. 133 resulted in a $5 million cumulative effect of a change in accounting principle before applicable income taxes of $2 million and was recognized as an decrease to accumulated other comprehensive loss (note 3) in the consolidated statement of stockholders' equity for the year ended December 31, 2000. The adoption of Statement No. 133 did not have a material effect on net income for the year ended December 31, 2000. Refer to note 14 for a description of accounting policies relating to derivative financial instruments.

In December 1999, the Securities and Exchange Commission (SEC) issued SAB No. 101, which provides guidance for applying generally accepted accounting principles relating to the timing of revenue recognition in financial statements filed with the SEC. Effective January 1, 2000, in accordance with the provisions of SAB No. 101, Aon established a provision for estimated returned commissions from policy cancellations. In 1999 and previous years, Aon recognized returned commissions when they occurred. The cumulative effect of this accounting change was an after-tax charge of $7 million or $0.03 per share in the first quarter of 2000. Previously reported results for the remaining quarters of 2000 were not impacted by this accounting change.

        In September 2000, the FASB issued Statement No. 140,Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. Statement No. 140 replaces Statement No. 125 and revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures. Statement No. 140 became effective for all transfers of financial assets occurring after March 31, 2001. Implementation of Statement No. 140 did not have a material impact on Aon's consolidated financial statements.

        In June 2001, the FASB issued Statement No. 141,Business Combinations, and Statement No. 142,Goodwill and Other Intangible Assets. Statement No. 141 superceded APB Opinion No. 16, and amended or superceded a number of interpretations of APB No. 16. Certain purchase accounting guidance in APB No. 16, as well as certain of its amendments and interpretations, have been carried forward. The statement eliminated the pooling of interests method of accounting for business combinations. It also changed the criteria to recognize intangible assets apart from goodwill. The requirements of Statement No. 141 were effective for any business combination accounted for by the purchase method that was completed after June 30, 2001. Statement No. 142 supercedes APB No. 17. Under Statement No. 142, goodwill and indefinite lived intangible assets are no longer amortized but are reviewed annually, or more frequently if impairment indicators arise, for impairment. Separable intangible assets that have finite lives will continue to be amortized over their useful lives. The amortization provisions of Statement No. 142 apply to goodwill and intangible assets acquired after June 30, 2001. With respect to goodwill acquired prior to July 1, 2001, amortization was discontinued effective as of January 1, 2002. Reported goodwill amortization was $118 million and $114 million for the years ended December 2001 and 2000, respectively.

69



        In accordance with Statement No. 141, other intangible assets which resulted from acquisitions made prior to July 1, 2001, that did not meet the criteria for recognition apart from goodwill (as defined by Statement No. 141) were to be classified as goodwill upon adoption of the statement. Accordingly, Aon has reclassified $287 million of these intangibles, net of accumulated amortization, to goodwill as of January 1, 2002. Amounts on the December 31, 2001 consolidated statement of financial position have been reclassified for this item. In addition, Aon re-examined the useful lives of all intangibles in accordance with Statement No. 142. Reported amortization expense for all other intangibles was $54 million, $40 million and $40 million for the years ended December 31, 2002, 2001 and 2000, respectively.

        In August 2001, the FASB issued Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. Statement No. 144 supercedes Statement No. 121,Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, and provides new rules on asset impairment and a single accounting model for long-lived assets to be disposed of. Although retaining many of the fundamental recognition and measurement provisions of Statement No. 121, the new rules significantly change the criteria that would have to be met to classify an asset as held-for-sale. The new rules also supercede the provisions of APB No. 30,Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions, with regard to reporting the effects of a disposal of a segment of a business and require expected future operating losses from discontinued operations to be displayed in discontinued operations in the period(s) in which the losses are incurred. Statement No. 144 was effective January 1, 2002. This statement did not have a material impact on Aon's consolidated financial statements.

        In June 2002, the FASB issued Statement No. 146,Accounting for Costs Associated with Exit or Disposal Activities. Statement No. 146 supercedes Emerging Issues Task Force (EITF) Issue No. 94-3,Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). Statement No. 146 is effective January 1, 2003. The adoption of this statement is not expected to have a material impact on Aon's consolidated financial statements.

        In November 2002, the FASB issued Interpretation No. 45,Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (FIN 45). Guarantees meeting the characteristics described in FIN 45 are required to be initially recorded at fair value, which is different from the general current practice of recording a liability only when a loss is probable and reasonably estimable, as those terms are defined in FASB Statement No. 5,Accounting for Contingencies.

        FIN 45's disclosure requirements are applicable for each guarantee, or each group of similar guarantees, even if the likelihood of the guarantor having to make payments is remote.

        FIN 45's disclosure requirements are effective for financial statements ending after December 15, 2002. Aon's disclosures may be found in note 14. FIN 45's initial recognition and initial measurement provisions are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. Implementation of this Interpretation is not expected to have a material impact on Aon's consolidated financial statements.

        In January 2003, the FASB issued Interpretation No. 46,Consolidation of Variable Interest Entities, an interpretation of ARB No. 51 (FIN 46). This interpretation clarifiesFIN 46 provides a framework for identifying variable interest entities (VIEs) and determining when a company should include the applicationassets, liabilities, non-controlling interests and result of Accounting Research Bulletin No. 51,Consolidated Financial Statements, to certain entities in which equity investors do not have the characteristicsactivities of a controllingVIE in its consolidated financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties.statements. FIN 46 identifies circumstances in which the consolidation decision should be based on voting interests and other circumstances in which the consolidation decision should be based on variable interests. FIN 46's

70



disclosure requirements arewas effective immediately for financial statements issuedVIEs created after January 31, 2003. Aon's disclosures may be found in note 14.

The provisions of FIN 46 are effective immediately for variable interest entities created after Januarywere adopted as of December 31, 2003 for Aon's interests in VIEs that are special purpose entities (SPEs).

        Aon Capital A is a wholly-owned statutory business trust created for the purpose of issuing mandatorily redeemable capital securities (Capital Securities). The sole asset of Aon Capital A is a $726 million aggregate principal amount of Aon's 8.205% Junior Subordinated Deferrable Interest Debentures due January 1, 2027. Aon determined that it is not the primary beneficiary of Aon Capital A, a VIE, and are effectivewas required to deconsolidate the Trust based on the provisions of FIN 46 on December 31, 2003. Prior to the deconsolidation of Aon Capital A, the after-tax interest incurred on the Capital Securities was reported as minority interest in the consolidated statements of income. Beginning in 2004, interest expense on these notes payable was reported as part of interest expense in the consolidated statements of income. There was no effect on net income or consolidated stockholders' equity as a result of this deconsolidation.

        Aon adopted the provisions of FIN 46 for existingits variable interest entities no later than the beginninginterests in all other VIEs as of the first interim reporting period beginning after June 15, 2003. Aon hasMarch 31, 2004, which did not yet determined thehave a material effect if any, this statement will have on the consolidated financial statements. See Note 11 for additional information.

        In 2004, the FASB issued Statement No. 123 (revised 2004)Share-Based Payment ("Statement No. 123(R)"), which is a revision of Statement No. 123. Statement No. 123(R) supersedes APB No. 25 and amends FASB Statement No. 95,Statement of Cash Flows. Generally, the approach in Statement No. 123(R) is similar to the approach described in Statement No. 123. However, Statement No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative.

        Statement No. 123(R) originally required adoption no later than July 1, 2005. In April 2005, the Securities and Exchange Commission ("SEC") issued a release that amended the compliance dates for Statement No. 123(R). Under the SEC's new rule, the Company will be required to apply Statement No. 123(R) as of January 1, 2006. Aon plans to adopt Statement No. 123(R) using the modified-prospective method, in which compensation cost is recognized beginning January 1, 2006 (a) based on the requirements of Statement No. 123(R) for all share-based payments granted after January 1, 2006 and (b) based on the requirements of Statement No. 123 for all awards granted to employees prior to January 1, 2006 that remain unvested as of January 1, 2006.

        The effect of adopting Statement No. 123(R) in 2006 for stock options issued prior to January 1, 2006, is currently estimated to be approximately $0.04 per diluted income per share. In addition, Statement No. 123(R) requires an adjustment to record the cumulative effect of a change in accounting principle, net of any tax effect, to reflect the compensation cost that would not have been recognized in prior periods had forfeitures been estimated during those periods. This adjustment applies only to compensation cost previously recognized in the financial statements for awards that are unvested as of January 1, 2006, and is currently estimated to be approximately $0.02 per diluted income per share.

Previously Planned Divestiture of Underwriting Business

        In April 2001, Aon's Board of Directors approved a preliminary plan to spin off its insurance underwriting businesses to Aon's common stockholders, creating two independent, publicly traded companies. In August 2002, Aon announced it was no longer planning to spin off all the underwriting businesses, but was considering a sale or partial spin-off. At that time, a prompt sale of all or part of the underwriting operations, at an acceptable price, was believed to be achievable within a reasonable timeframe. However, due to adverse market conditions for mergers and acquisitions, Aon announced in October 2002 that it had decided not to sell, or spin off, its major underwriting subsidiaries. In fourth quarter 2002, Aon announced its plans to sell Sheffield Insurance Corporation, a small property-casualty company.

        In 2002, Aon incurred approximately $50 million of pretax expenses associated with its prior spin-off plans and related initiatives that will not be pursued. These expenses, recorded primarily in general expenses in the consolidated statements of income, represent staff build-up and severance costs, corporate overhead and advisory fees and costs tied to an anticipated, but now abandoned, expansion of certain specialty property and casualty underwriting.

ReclassificationReclassifications

        Certain amounts in prior years' consolidated financial statements have been reclassified to conform to the 20022005 presentation.


2.     Goodwill and Other Intangible Assets

        In accordance with FASB Statement No. 142, allGoodwill represents the excess of Aon's goodwill will no longer be amortized.cost over the fair market value of the net assets acquired. Goodwill and other intangible assets areis allocated to various reporting units, which are either at its operating segments or one reporting level below the operating segment. In prior years, goodwill amortization has been systematically expensed in the Corporate and Other segment. Statement No. 142Goodwill is not amortized but is subject to impairment testing at least annually. The impairment testing requires Aon to compare the fair value of theits reporting unitunits to itstheir carrying value on an annual basis to determine if there is potential impairment of goodwill. If the fair value of thea reporting unit is less than its carrying value at the valuation date, an impairment loss would be recorded to the extent that the implied fair value of the goodwill within the reporting unit is less than the recorded amount of goodwill. Fair value is estimated based on various valuation metrics.

approaches. In first quarter 2002, Aon completed its initial impairment review that indicated that there was no impairment as of January 1, 2002. Inthe fourth quarter 2002,2005 and 2004, Aon completed its annual impairment review that affirmed that there was no impairment as of October 1 2002 (the annual evaluation date).

        A reconciliationWhen a business entity is sold, goodwill is allocated to the disposed entity based on the fair value of net income forthat entity compared to the years ended December 31, 2001 and 2000 to adjusted net income had Statement No. 142 andfair value of the reclassification provisions of Statement No. 141 been applicable for all periods presented follows:reporting unit in which it is included.

 
 Year Ended December 31, 2001
 Year Ended December 31, 2000
 
 
 Amount
 Basic Net
Income
Per Share

 Dilutive Net
Income Per
Share

 Amount
 Basic Net
Income
Per Share

 Dilutive Net
Income Per
Share

 
 
 (millions, except per share data)

 
Reported net income $147 $0.54 $0.53 $474 $1.81 $1.79 
Add back amortization (net of tax):                   
 Goodwill  104  0.38  0.38  98  0.37  0.37 
 Intangible assets reclassified to goodwill  10  0.04  0.04  10  0.04  0.04 
Less amortization (net of tax):                   
 Other intangible assets—change in amortization periods  (5) (0.02) (0.02) (5) (0.02) (0.02)
  
 
 
 
 
 
 
  $256 $0.94 $0.93 $577 $2.20 $2.18 
  
 
 
 
 
 
 

        The changes in the net carrying amount of goodwill by operating segment for the yearyears ended December 31, 20022005 and 2004, respectively, are as follows:

 
 Insurance
Brokerage
and Other
Services

 Consulting
 Insurance
Underwriting

 Total
 
 (millions)

Balance as of December 31, 2001 $3,239 $366 $237 $3,842
Goodwill acquired during the period  58  5    63
Foreign currency revaluation  190  1  3  194
  
 
 
 
Balance as of December 31, 2002 $3,487 $372 $240 $4,099
  
 
 
 
(millions)

 Risk and
Insurance
Brokerage
Services

 Consulting
 Insurance
Underwriting

 Total
 

 
Balance as of January 1, 2005 $3,991 $375 $245 $4,611 
Goodwill acquired  69    6  75 
Income tax adjustments related to previous acquisitions  (14)     (14)
Goodwill related to disposals  (1)     (1)
Foreign currency revaluation  (281) 3  (2) (280)

 
Balance as of December 31, 2005 $3,764 $378 $249 $4,391 

 
Balance as of January 1, 2004 $3,770 $381 $242 $4,393 
Goodwill acquired  69  1    70 
Goodwill related to disposals  (48) (5)   (53)
Intersegment transfers  4  (4)    
Foreign currency revaluation  196  2  3  201 

 
Balance as of December 31, 2004 $3,991 $375 $245 $4,611 

 

72        Other intangible assets are classified into three categories:



        AmortizableOther intangible assets by asset class follow:are as follows:

 
 Customer
Related and
Contract Based

 Present Value
of Future
Profits

 Marketing,
Technology
and Other

 Total
 
 (millions)

As of December 31, 2002            
 Gross carrying amount $225 $76 $162 $463
 Accumulated amortization  148  24  66  238
  
 
 
 
 Net carrying amount $77 $52 $96 $225
  
 
 
 
As of December 31, 2001            
 Gross carrying amount $237 $83 $92 $412
 Accumulated amortization  151  3  16  170
  
 
 
 
 Net carrying amount $86 $80 $76 $242
  
 
 
 
(millions)

 Customer
Related and
Contract Based

 Present Value
of Future
Profits

 Marketing,
Technology
and Other

 Total

As of December 31, 2005            
 Gross carrying amount $212 $86 $175 $473
 Accumulated amortization  178  79  101  358

 Net carrying amount $34 $7 $74 $115

As of December 31, 2004            
 Gross carrying amount $218 $87 $158 $463
 Accumulated amortization  176  67  87  330

 Net carrying amount $42 $20 $71 $133

        The cost of other intangible assets is being amortized over a range of 2 to 10 years, with a weighted average original life of 7.6 years. Amortization expense for amortizable intangible assets for the years ending December 31, 2003, 2004, 2005, 2006, 2007, 2008, 2009 and 20072010 is estimated to be $50$40 million, $43$21 million, $37$17 million, $26$15 million and $11$12 million, respectively.

        When impairment indicators arise, Aon assesses the recoverability of its intangible assets through an analysis of expected future cash flows.


3.     Other Comprehensive LossIncome (Loss)

        The components of other comprehensive lossincome (loss) and the related tax effects are as follows:

 
 Year ended December 31, 2002
 
 
 Amount
Before
Taxes

 Income Tax
(Expense)
Benefit

 Amount
Net
of Taxes

 
 
 (millions)

 
Cumulative effect of change in accounting principle related to derivatives $ $ $ 
Net derivative gains (losses) arising during the year  33  (13) 20 
Net derivative gains arising during fourth quarter 2000       
Reclassification adjustment  3  (1) 2 
  
 
 
 
Net derivative gains (losses)  36  (14) 22 
Unrealized holding gains (losses) arising during the year  31  (12) 19 
Reclassification adjustment  38  (15) 23 
Net unrealized investment gains  69  (27) 42 
Net foreign exchange gains (losses)  113  (44) 69 
Net additional minimum pension liability adjustment  (876) 324  (552)
  
 
 
 
Total other comprehensive loss $(658)$239 $(419)
  
 
 
 

73


(millions)    Year ended December 31, 2005

 Pretax
 Income Tax
(Expense)
Benefit

 Net
of Tax

 

 
Net derivative losses arising during the year $(20)$8 $(12)
Reclassification adjustment  (64) 25  (39)

 
Net derivative losses  (84) 33  (51)

Unrealized holding losses arising during the year

 

 

(8

)

 

3

 

 

(5

)
Reclassification adjustment  (8) 3  (5)

 
Net unrealized investment losses  (16) 6  (10)

Net foreign exchange translation

 

 

(248

)

 

8

 

 

(240

)
Net additional minimum pension liability adjustment  (253) 80  (173)

 
Total other comprehensive loss $(601)$127 $(474)

 

        TheIn 2005, the pretax amount of $876 million for net additional minimum pension liability adjustment of $253 million includes $30$19 million related to the defined benefit pension plans in Canada recognized forand $4 million related to defined benefit plans in Germany.

(millions)    Year ended December 31, 2004

 Pretax
 Income Tax
(Expense)
Benefit

 Net
of Tax

 

 
Net derivative gains arising during the year $33 $(14)$19 
Reclassification adjustment  (48) 19  (29)

 
Net derivative losses  (15) 5  (10)

Unrealized holding gains arising during the year

 

 

70

 

 

(27

)

 

43

 
Reclassification adjustment  (2) 1  (1)

 
Net unrealized investment gains  68  (26) 42 

Net foreign exchange translation

 

 

197

 

 

(51

)

 

146

 
Net additional minimum pension liability adjustment  (18) 20  2 

 
Total other comprehensive income $232 $(52)$180 

 

        In 2004, the first timepretax net additional minimum pension liability adjustment of $18 million included $17 million related to defined benefit pension plans in 2002.Canada and $38 million related to defined benefit plans in Germany.

 
 Year ended December 31, 2001
 
 
 Amount
Before
Taxes

 Income Tax
(Expense)
Benefit

 Amount
Net
of Taxes

 
 
 (millions)

 
Cumulative effect of change in accounting principle related to derivatives $ $ $ 
Net derivative gains (losses) arising during the year  (6) 2  (4)
Net derivative gains arising during fourth quarter 2000       
Reclassification adjustment  (4) 2  (2)
  
 
 
 
Net derivative gains (losses)  (10) 4  (6)
Unrealized holding gains (losses) arising during the year  (9) 3  (6)
Reclassification adjustment  59  (23) 36 
  
 
 
 
Net unrealized investment gains  50  (20) 30 
Net foreign exchange gains (losses)  (95) 37  (58)
Net additional minimum pension liability adjustment  (203) 79  (124)
  
 
 
 
Total other comprehensive loss $(258)$100 $(158)
  
 
 
 
 
 Year ended December 31, 2000
 
 
 Amount
Before
Taxes

 Income Tax
(Expense)
Benefit

 Amount
Net
of Taxes

 
 
 (millions)

 
Cumulative effect of change in accounting principle related to derivatives $5 $(2)$3 
Net derivative gains (losses) arising during the year       
Net derivative gains arising during fourth quarter 2000  4  (1) 3 
  
 
 
 
Net derivative gains (losses)  9  (3) 6 
Unrealized holding gains (losses) arising during the year  45  (14) 31 
Reclassification adjustment  26  (8) 18 
  
 
 
 
Net unrealized investment gains  71  (22) 49 
Net foreign exchange gains (losses)  (188) 73  (115)
Net additional minimum pension liability adjustment  (13) 5  (8)
  
 
 
 
Total other comprehensive loss $(121)$53 $(68)
  
 
 
 
(millions)    Year ended December 31, 2003

 Pretax
 Income Tax
(Expense)
Benefit

 Net
of Tax

 

 
Net derivative gains arising during the year $68 $(27)$41 
Reclassification adjustment  (22) 9  (13)

 
Net derivative gains  46  (18) 28 

Unrealized holding gains arising during the year

 

 

31

 

 

(11

)

 

20

 
Reclassification adjustment       

 
Net unrealized investment gains  31  (11) 20 

Net foreign exchange translation

 

 

379

 

 

(148

)

 

231

 
Net additional minimum pension liability adjustment  (225) 39  (186)

 
Total other comprehensive income $231 $(138)$93 

 

        In 2003, the pretax net additional minimum pension liability adjustment of $225 million included $(4) million related to defined benefit pension plans in Canada.

        The components of accumulated other comprehensive loss, net of related tax, are as follows:

(millions)    As of December 31,

 2005
 2004
 2003
 

 
Net derivative gains (losses) $(11)$40 $50 
Net unrealized investment gains  52  62  20 
Net foreign exchange translation  (119) 121  (25)
Net additional minimum pension liability  (1,077) (904) (906)

 
Accumulated other comprehensive loss $(1,155)$(681)$(861)

 
 
 As of December 31
 
 
 2002
 2001
 2000
 
 
 (millions)

 
Net derivative gains $22 $ $6 
Net unrealized investment gains (losses)    (42) (72)
Net foreign exchange losses  (256) (325) (267)
Net additional minimum pension liability  (720) (168) (44)
  
 
 
 
 Accumulated other comprehensive loss $(954)$(535)$(377)
  
 
 
 

74


4.     Business Combinations

Acquisitions

        In 2002,2005, 2004 and 2003, Aon completed several immaterialsmall acquisitions, mostprimarily related to theits insurance brokerage operations. In these transactions, AonThe following table includes the aggregate amounts paid an aggregateand intangible assets recorded as a result of approximately $111 million in cash and $3 million in common stock.the acquisitions.

(millions)            Years ended December 31,

 2005
 2004
 2003

Amounts paid:         
 Cash $81 $80 $56
 Common stock  5    8

  Total $86 $80 $64


Intangible assets:

 

 

 

 

 

 

 

 

 
 Goodwill $75 $70 $45
 Other intangible assets  39  30  11

  Total $114 $100 $56

        Internal funds, short-term borrowings and common stock financed the acquisitions. Goodwill of approximately $51 million and other intangible assets of approximately $48 million, accounted for on a preliminary basis, resulted from these acquisitions.

        With respect to certain acquisitions, Aon is contingently liable to issue additional shares based on the occurrence of future events which would increase the purchase price of certain acquisitions. Approximately 230,000 shares were contingently issuable at December 31, 2002 related to current and prior year acquisitions. In January 2003, approximately 173,000 shares were issued in relation to a prior year acquisition.

        In 2001, Aon acquired ASI Solutions Incorporated (ASI), a worldwide provider of human resource outsourcing and compensation consulting services, and First Extended, Inc. (FEI), an underwriter and administrator of automotive extended warranty products, and certain other insurance brokerage and consulting operations. In these transactions, Aon paid an aggregate of approximately $107 million in cash and $197 million in common stock. Internal funds, short-term borrowings and common stock financed the acquisitions. Goodwill of approximately $282 million and other intangible assets of approximately $72 million, resulted from these acquisitions.

        In July 2001, Aon acquired the common stock of two entities controlled by Aon's Chairman and Chief Executive Officer. The acquisition was financed by the issuance of approximately 22.4 million shares of Aon common stock. The two acquired entities owned, in the aggregate, approximately 22.4 million shares of Aon common stock, which are included in treasury stock, and had additional net assets, net of expenses, totaling $5 million. This transaction did not have a material effect on Aon's total assets, liabilities or stockholders' equity.

        In 2000, Aon acquired Actuarial Sciences Associates, Inc., Horizon Consulting Group, Inc., and certain other insurance brokerage and consulting operations for approximately $85 million in cash and $145 million in common stock. Internal funds, short-term borrowings and common stock financed the acquisitions. Goodwill of approximately $225 million resulted from these acquisitions.

        The results of operations of these acquisitions all of which were accounted for by the purchase method, are included in the consolidated financial statements from the dates they were acquired. Pro forma results of these acquisitions are not materially different from reported results. In accordance with a 1992 purchase agreement, securities with a value of $41 million, previously held under an escrow agreement (as amended), were released. All current balances with Aon were settled.


5.     Restructuring Charges

2005 Restructuring chargesPlan

        In 2002, Aon made payments2005, the Company announced that it was reviewing the revenue potential and cost structure of $12each of its businesses. As a result of this review, the Company has adopted restructuring initiatives that are expected to be completed in 2007 and result in cumulative pretax charges totaling approximately $262 million, onincluding workforce reductions and lease consolidation costs, asset impairments and other expenses necessary to implement the restructuring charges and purchase accounting liabilitiesinitiative. Costs related to business combinations.the restructuring are included in general expenses and depreciation and amortization in the accompanying consolidated statements of income.

        The following is a summary of 2005 restructuring and related expenses by type incurred and estimated to be incurred through the end of the restructuring initiative:

(millions)

 Actual
2005

 Estimated
Total


Workforce reduction $116 $157
Lease consolidation  20  57
Asset impairments  17  23
Other related expenses  5  25

Total restructuring and related expenses $158 $262

        The following is a summary of our restructuring and related costs by segment incurred and estimated to be incurred through the end of the restructuring initiative:

(millions)

 Actual
2005

 Estimated
Total


Risk & Insurance Brokerage Services $143 $233
Consulting  8  18
Insurance Underwriting  3  4
Corporate & Other  4  7

Total restructuring and related expenses $158 $262

        As of December 31, 2005, the Company's restructuring liabilities are as follows:

(millions)

  
 

 
Balance at January 1, 2005 $ 
Expensed in 2005  141 
Cash payments in 2005  (23)
Foreign currency revaluation  (2)

 
Balance at December 31, 2005 $116 

 

Restructuring charges—prior years

        In 1996 and 1997, Aon recorded pretax special charges of $60 million and $145 million, respectively, related to management's commitment to a formal plan of restructuring Aon's brokerage operationsliabilities as a result of the acquisition of Alexander & Alexander Services, Inc. (A&A). Also in 1997, following management's commitment to a formal plan of restructuring the ("A&A&A") and Bain Hogg brokerage operations, Aon recorded $264 million in costs to restructure those acquisitions. Together, these costs were primarily related to termination benefits of $152 million, lease abandonments and other exit costs of $280 million, and asset impairments of $37 million relating to the abandonment of systems and real estate space. All termination benefits have been paid.Hogg. The remaining liability of

75



$51 $26 million is primarily for lease abandonments and other exit costs, and is being paid out over severala number of years, as planned.



        The following table sets forth the activity related to these liabilities:

 
 (millions)

 
Balance at December 31, 1999 $105 
Cash payments in 2000  (25)
Charge to expense in 2000  4 
Foreign currency revaluation  (6)
  
 
Balance at December 31, 2000  78 
Cash payments in 2001  (19)
Foreign currency revaluation  (1)
  
 
Balance at December 31, 2001  58 
Cash payments in 2002  (11)
Foreign currency revaluation  4 
  
 
Balance at December 31, 2002 $51 
  
 
(millions)

  
 

 
Balance at January 1, 2003 $51 
Cash payments in 2003  (14)
Foreign currency revaluation  3 
  
 
Balance at December 31, 2003  40 
Cash payments in 2004  (9)
Foreign currency revaluation  2 
  
 
Balance at December 31, 2004 $33 
Cash payments in 2005  (5)
Foreign currency revaluation  (2)
  
 
Balance at December 31, 2005 $26 

 

6.     Disposal of Operations

        AllIn 2004, Aon sold Cambridge Integrated Services Group ("Cambridge"), its U.S. claims services business, which was included in the Risk and Insurance Brokerage Services segment, to Scandent Holdings Mauritius Limited ("SHM"), for $90 million in cash plus convertible preferred stock in SHM valued at $15 million.

        Because of Aon's unpaid liabilities relatingconvertible preferred stock holding and other factors, the results of Cambridge prior to acquisitions are reflectedthe sale date and the pretax gain of $15 million on the sale of this business remained in general expense liabilities inincome from continuing operations. Due to a book-tax basis difference resulting primarily from goodwill, a tax benefit of $26 million was recorded on the consolidated statements of financial position.sale.

5.    Business Transformation PlanDiscontinued Operations

        In fourth quarter 2000, after final approval by2005, Aon completed the sale of Swett & Crawford ("Swett"), its BoardU.S.-based wholesale insurance brokerage unit. Previously, Swett was included in the Risk and Insurance Brokerage Services segment. The sale resulted in a pretax gain of Directors,$239 million.

        In fourth quarter 2005, Aon begancommitted to sell a comprehensivenon-core Australian brokerage unit, which was previously included in the Risk and Insurance Brokerage Services segment. This operation was sold in early first quarter 2006 for a nominal pretax gain, which will be recognized in first quarter 2006.

        In 2004, Aon sold the following businesses:

        In connection with the overall plan and strategic initiatives,2003, Aon recorded total net expenses of $294 million, ofsold its automotive finance servicing business, which $6 million of income, $218 million of expenses and $82 million of expenses were recordedhad been in 2002,run-off since first quarter 2001 and 2000, respectively, and are reflected in general expenseswas included in the consolidated statements of income.

        In 2000, expenses included costs related to termination benefits of $54 million, covering notification to 750 employees.Corporate and Other costs to exit an activity of $6 million were incurred, which included $2 million for abandoned leases and $4 million for direct costs necessary to complete portionssegment. A pretax loss on the revaluation of the business transformation plan and cash settlement necessary to exit contractual obligations. Other expenses of $22$23 million were alsowas recorded in 2000, including fixed asset impairments of $20 million (of which $16 million related to information systems assets), as well as $2 million of other costs.2003.

        For 2001, expenses included costs related to termination benefits of $109 million, covering notification to 3,150 employees. Other costs to exit an activity of $21 million were incurred, which included $10 million for abandoned leases and $11 million for direct costs necessary to complete portions of the business transformation plan and cash settlements necessary to exit contractual obligations.

        Other expenses of $88 million were recorded in 2001. A subsidiary of Aon has acted as a servicing agent for a limited partnership affiliated with automobile dealerships to provide auto financing to dealerships on a cooperative basis through various financing conduit facilities. This subsidiary also has a general partnership interest in the limited partnership. Continued competition from financing provided by the financing arms of automobile manufacturers caused Aon to evaluate whether it wished to continue in this servicing partner relationship. In first quarter 2001, Aon elected to cease servicing new business and run off its existing service obligation. The limited partnership affiliated with automobile dealerships established allowances for uncollectible loan balances. In conjunction with the decision to discontinue new auto financing receivables, the limited partners are not obligated to contribute

76



additional capital beyond what they have already provided for any shortfall in the reserves for their individual book of business. Aon is required to fund any shortfalls in accordance with Aon's limited recourse to the funding facility arranged by the servicing agent. The servicing agent estimated the liability that Aon would have for the existing shortfall at the time Aon decided to discontinue new auto loan financing under the facility. Aon recorded a charge to establish this obligation in accordance with FASB Statement No. 5, which amounted to an expense of $44 million. For the year 2000, the last full year of operation, these servicing operations, which were part of Aon's Insurance Brokerage and Other Services segment, generated revenue of $42 million and pretax income of $3 million.

        During 2001 Aon exited four other joint venture operations as a part of its business transformation process. For the year 2000, the last full year of operation, these joint ventures, which were part of Aon's Insurance Brokerage and Other Services segment, generated less than $1 million of revenue and incurred nearly $3 million of pretax losses. The total cost to exit these four joint ventures was $12 million. Additional expenses in 2001 included a provision of $14 million for discontinuing supplemental accident and health insurance business operations in Mississippi. The expense included severance costs and expenses associated with the reassignment of agents, as well as estimated costs for resolving asserted and unasserted claims and suits. A $5 million expense was recorded relating to the write-down of certain agent receivables in conjunction with the restructuring of a worksite marketing agent commission pay structure and operations.

        Further fixed asset impairments of $10 million (of which $9 million related to information systems assets) were taken in 2001, as well as $3 million of other costs.

        In the second quarter 2002, $6 million of pretax costs previously incurred in connection with the business transformation plan in the U.S. were reversed and included as a credit to general expenses.

        Approximately 3,700 employees have either departed voluntarily or have positions that have been eliminated. Most of the terminations have occurred and are related to the Insurance Brokerage and Other Services segment in the U.S. and the U.K.

        The following table sets forth the activity related to the liability for termination benefits and other costs to exit an activity:

 
 Termination
Benefits

 Other Costs
to Exit an
Activity

 Total
 
 
 (millions)

 
Expense charged in 2000 $54 $6 $60 
Cash payments in 2000  (13) (3) (16)
  
 
 
 
Balance at December 31, 2000  41  3  44 
  
 
 
 
Expense charged in 2001  109  21  130 
Cash payments in 2001  (73) (20) (93)
Foreign currency revaluation  (2)   (2)
  
 
 
 
Balance at December 31, 2001  75  4  79 
  
 
 
 
Credit to expense in 2002  (6)   (6)
Cash payments in 2002  (46) (3) (49)
Foreign currency revaluation  4    4 
  
 
 
 
Balance at December 31, 2002 $27 $1 $28 
  
 
 
 

        All of Aon's unpaid liabilities relating to business transformation plan are reflected in general expense liabilities in the consolidated statements of financial position. Termination benefits of $15 million and $2 million are expected to be paid in 2003 and 2004, respectively, with the remainder payable thereafter.

77



6.&A Discontinued Operations

        Prior to its acquisition by Aon, A&A discontinued its property and casualty insurance underwriting operations in 1985, some of which were then placed into run-off, with the remainder sold in 1987. In connection with those sales, A&A provided indemnities to the purchaser for various estimated and potential liabilities, including provisions to cover future losses attributable to insurance pooling arrangements, a stop-loss reinsurance agreement and actions or omissions by various underwriting agencies previously managed by an A&A subsidiary.

        In January 2002, Aon settled certain of these liabilities. The settlement had no material effect on the consolidated financial statements. As of December 31, 2002,2005 and 2004, the liabilities associated with the foregoing indemnities were included in other liabilities in the consolidated statements of financial position. Such liabilities amounted to $48$5 million and $16 million, respectively, net of reinsurance recoverables and other assets of $101 million.

$83 million and $82 million, respectively. In 2005, a pretax expense of $11 million was recorded for consulting and legal costs related to completed and contemplated settlements and actuarial refinements to claims reserves and reinsurance recoverables. The insurance liabilities represent estimates of known and future claims expected to be settled over the next 20 to 30 years, principally with regards to asbestos, pollution and other health hazard exposures.

Although these insurance liabilities represent a best estimate of the probable liabilities, adverse developments may occur given the nature of the information available and the variables inherent in the estimation processes. Based on current estimates, management believes that the established liabilities


        The operating results of all these businesses are classified as discontinued operations are sufficient.and prior years' operating results have been reclassified to discontinued operations, as follows.

78


(millions)            Years ended December 31,

 2005
 2004
 2003
 

 
Revenues:          
 Swett $183 $228 $242 
 U.K. brokerage units    29  79 
 Automotive finance servicing business      13 
 Other  10  17  25 
  
 
  Total revenues $193 $274 $359 

 
Pretax gain (loss):          
 Operations:          
  Swett $2 $49 $53 
  U.K. brokerage units    (16) (16)
  Automotive finance servicing business    (1) (32)
  Other  (8) 1  (1)
  
 
   (6) 33  4 
Gain (loss) on sale:          
 Swett  239     
 U.K. brokerage units  (3) (23)  
 Automotive finance servicing business      (23)
  
 
   236  (23) (23)

 
Total pretax gain (loss) $230 $10 $(19)

 
After-tax gain (loss):          
 Operations $(6)$19 $ 
 Sale  101  (18) (14)

 
  Total $95 $1 $(14)

 


7.     Investments

        The components of investment income are as follows:

 
 Years ended December 31
 
 
 2002
 2001
 2000
 
 
 (millions)

 
Short-term investments $131 $191 $214 
  
 
 
 
Fixed maturities:          
 Interest income  118  137  172 
 Income on disposals  51  37  13 
 Losses on disposals(1)  (33) (21) (12)
  
 
 
 
  Total  136  153  173 
  
 
 
 
Equity securities:          
 Dividend income  15  25  31 
 Income on disposals  3  13  28 
 Losses on disposals(1)  (63) (37) (9)
  
 
 
 
  Total  (45) 1  50 
  
 
 
 
Limited partnerships—equity earnings  14  (94) 73 
  
 
 
 
Other investments:          
 Interest, dividend and other income  40  10  11 
 Endurance Specialty—equity earnings  21     
 Losses on disposals(1)  (39) (41) (5)
  
 
 
 
  Total  22  (31) 6 
  
 
 
 
Gross investment income  258  220  516 
Less: investment expenses  6  7  8 
  
 
 
 
Investment income $252 $213 $508 
  
 
 
 

(millions)            Years ended December 31,

 2005
 2004
 2003
 

 
Short-term investments $162 $94 $92 

 
Fixed maturities:          
 Interest income  164  120  93 
 Income on disposals  16  8  21 
 Losses (1)  (6) (7) (19)
  
 
Total  174  121  95 

 
Equity securities:          
 Dividend income  2  3  4 
 Income on disposals    4  9 
 Losses (1)    (3) (2)

 
  Total  2  4  11 

 
Limited partnerships — equity earnings  1  6  1 

 
Other investments:          
 Interest, dividend and other income  13  8  11 
 Endurance — warrants  10    80 
 Endurance — equity earnings    38  46 
 Net gains (losses) (1)  (13) 56  (19)
  
 
Total  10  102  118 

 
Gross investment income  349  327  317 
Less: investment expenses  6  6  7 
  
 
Investment income $343 $321 $310 

 
(1)
IncludesIn addition to losses on disposals, includes other-than-temporary impairment write-downs of $130$11 million, $57$3 million and $10$36 million in 2002, 20012005, 2004 and 2000,2003, respectively.

        The components of net unrealized investment gains (losses) are as follows:

 
 As of December 31
 
 
 2002
 2001
 2000
 
 
 (millions)

 
Fixed maturities $(4)$(28)$(45)
Equity securities  3  (43) (72)
Other investments  3  4   
Deferred tax credit (charge)  (2) 25  45 
  
 
 
 
Net unrealized investment gains (losses) $ $(42)$(72)
  
 
 
 

79


(millions)            As of December 31,

 2005
 2004
 2003
 

 
Fixed maturities $(39)$12 $(4)
Equity securities  (1) 1  5 
Other investments  125  88  32 
Deferred taxes  (33) (39) (13)

 
Net unrealized investment gains $52 $62 $20 

 

        The pretax changes in net unrealized investment gains (losses) are as follows:

(millions)            Years ended December 31,

 2005
 2004
 2003

Fixed maturities $(51)$16 $
Equity securities  (2) (4) 2
Other investments  37  56  29

Total $(16)$68 $31

 
 Years ended December 31
 
 2002
 2001
 2000
 
 (millions)

Fixed maturities $24 $17 $55
Equity securities  46  29  16
Other investments  (1) 4  
  
 
 
Total $69 $50 $71
  
 
 

        The amortized cost and fair value of investments in fixed maturities by type and equity securities are as follows:

 
 As of December 31, 2002
 
 Amortized
Cost

 Gross
Unrealized
Gains

 Gross
Unrealized
Losses

 Fair
Value

 
 (millions)

U.S. government and agencies $378 $7 $ $385
States and political subdivisions  4  1    5
Foreign governments  564  9    573
Corporate securities  1,140  16  (36) 1,120
Mortgage-backed securities  7    (1) 6
  
 
 
 
Total fixed maturities  2,093  33  (37) 2,089
Total equity securities  59  5  (2) 62
  
 
 
 
Total $2,152 $38 $(39)$2,151
  
 
 
 
 
 As of December 31, 2001
 
 Amortized
Cost

 Gross
Unrealized
Gains

 Gross
Unrealized
Losses

 Fair
Value

 
 (millions)

U.S. government and agencies $355 $8 $(2)$361
States and political subdivisions  3      3
Foreign governments  515  8  (2) 521
Corporate securities  1,243  14  (54) 1,203
Mortgage-backed securities  42      42
Other fixed maturities  19      19
  
 
 
 
Total fixed maturities  2,177  30  (58) 2,149
Total equity securities  425  6  (49) 382
  
 
 
 
Total $2,602 $36 $(107)$2,531
  
 
 
 

80


(millions)            As of December 31, 2005

 Amortized
Cost

 Gross
Unrealized
Gains

 Gross
Unrealized
Losses

 Fair
Value


Government:            
 U.S. government and agencies $439 $2 $(8)$433
 U.S. state and political subdivisions  111    (1) 110
 Foreign governments:            
  Canada  662  3  (7) 658
  U.K.  221  1    222
  Other  959  6  (13) 952
  
   Total foreign governments  1,842  10  (20) 1,832
Corporate securities:            
 Basic materials  68    (1) 67
 Consumer cyclical  46    (1) 45
 Consumer staples  58    (1) 57
 Diversified  107      107
 Energy  129  1  (2) 128
 Financial  748  1  (11) 738
 Technology  147  1  (3) 145
 Transport & services  27      27
 Utilities  87  1  (2) 86
 Other  25      25
  
 Total  1,442  4  (21) 1,425
Mortgage-and asset-backed securities  423  1  (6) 418
  
Total fixed maturities  4,257  17  (56) 4,218
Total equity securities  41    (1) 40

Total $4,298 $17 $(57)$4,258


(millions)            As of December 31, 2004

 Amortized
Cost

 Gross
Unrealized
Gains

 Gross
Unrealized
Losses

 Fair
Value


Government:            
 U.S. government and agencies $408 $3 $(4)$407
 U.S. state and political subdivisions  66  1    67
 Foreign governments:            
  Canada  625  9  (1) 633
  U.K.  359    (2) 357
  Other  699  7  (5) 701
  
  Total foreign governments  1,683  16  (8) 1,691
Corporate securities:            
 Basic materials  53  1    54
 Consumer cyclical  46  2  (1) 47
 Consumer staples  59  1    60
 Diversified  197      197
 Energy  131  4    135
 Financial  518  4  (7) 515
 Technology  55    (1) 54
 Utilities  98  1    99
 Other  16      16
  
  Total  1,173  13  (9) 1,177
Mortgage-and asset-backed securities  140  1  (1) 140
  
Total fixed maturities  3,470  34  (22) 3,482
Total equity securities  39  1  ��  40

  Total $3,509 $35 $(22)$3,522

        The amortized cost and fair value of fixed maturities by contractual maturity as of December 31, 2005, are as follows:


 As of December 31, 2002

 Amortized
Cost

 Fair
Value

(millions)

 Amortized
Cost

 Fair
Value


 (millions)


Due in one year or less $96 $98 $291 $289
Due after one year through five years 1,135 1,143 1,953  1,933
Due after five years through ten years 359 362 1,222  1,212
Due after ten years 496 480 368  366
Mortgage-backed securities 7 6
Mortgage-and asset-backed securities 423  418
 
 

Total fixed maturities $2,093 $2,089 $4,257 $4,218
 
 

        Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.



        Securities on deposit for regulatory authoritiesThe following table analyzes our investment positions with unrealized losses segmented by type and period of continuous unrealized loss as requiredof December 31, 2005.

 
 Investment Grade
 
($ in millions)

 0-6
Months

 6-12
Months

 >12
Months

 Total
 

 
FIXED MATURITIES             
 U.S. government and agencies             
  # of positions  31  15  18  64 
  Fair Value $122 $63 $176 $361 
  Amortized Cost  123  64  182  369 
  Unrealized Loss  (1) (1) (6) (8)
 
States and political subdivisions

 

 

 

 

 

 

 

 

 

 

 

 

 
  # of positions  20  8  2  30 
  Fair Value $69 $7 $6 $82 
  Amortized Cost  70  7  6  83 
  Unrealized Loss  (1)     (1)
 
Foreign government

 

 

 

 

 

 

 

 

 

 

 

 

 
  # of positions  72  45  28  145 
  Fair Value $605 $289 $248 $1,142 
  Amortized Cost  611  295  256  1,162 
  Unrealized Loss  (6) (6) (8) (20)
 
Corporate securities

 

 

 

 

 

 

 

 

 

 

 

 

 
  # of positions  293  141  57  491 
  Fair Value $556 $256 $172 $984 
  Amortized Cost  564  262  179  1,005 
  Unrealized Loss  (8) (6) (7) (21)
 
Mortgage and asset backed securities

 

 

 

 

 

 

 

 

 

 

 

 

 
  # of positions  194  170  18  382 
  Fair Value $177 $116 $20 $313 
  Amortized Cost  179  119  21  319 
  Unrealized Loss  (2) (3) (1) (6)
 
TOTAL FIXED MATURITIES

 

 

 

 

 

 

 

 

 

 

 

 

 
  # of positions  610  379  123  1,112 
  Fair Value $1,529 $731 $622 $2,882 
  Amortized Cost  1,547  747  644  2,938 
  Unrealized Loss  (18) (16) (22) (56)
  
% of Total Unrealized Loss

 

 

31

%

 

28

%

 

39

%

 

98

%
 
 Not Rated
 
($ in millions)

 0-6
Months

 6-12
Months

 >12
Months

 Total
 

 
TOTAL EQUITY SECURITIES             
 # of positions  3  1    4 
 Fair Value $32 $1 $ $33 
 Amortized Cost  33  1    34 
 Unrealized Loss  (1)     (1)
 
% of Total Unrealized Loss

 

 

2%

 

 

0%

 

 

0%

 

 

2%

 

        For categorization purposes, Aon considers any rating of Baa or higher by law, all relatingMoody's Investor Services or equivalent rating agency to the insurance underwriting subsidiaries, amounted to $343be investment grade. Aon had no fixed maturities below investment grade with an unrealized loss.

        Aon's fixed-maturity portfolio in total had a $56 million gross unrealized loss at December 31, 20022005 and $290 million at December 31, 2001. Aon maintains premium trust bank accounts for premiums collected from insureds but not yet remittedis subject to insurance companiesinterest rate, market and credit risks. No single position had an unrealized loss greater than $2 million. With a carrying value of $2.8 billion and $2.3approximately $4.2 billion at December 31, 20022005, Aon's total fixed-maturity portfolio is approximately 98% investment grade based on market value. Fixed-maturity securities with an unrealized loss are all investment grade and 2001, respectively.have a weighted average rating of "Aa" based on amortized cost. Aon's non publicly-traded fixed maturity portfolio had a carrying value of $366 million, including $81 million in notes issued by PEPS I to Aon since December 2001. In February 2006, Aon, via its U.K. subsidiary, contributed $33 million of these notes to one of the U.K. pension plans. Valuations of these securities primarily reflect the fundamental analysis of the issuer and current market price of comparable securities.

        AtAon's equity portfolio is comprised of non-redeemable preferred stocks, publicly traded common stocks and other common and preferred stocks not publicly traded. This portfolio had $1 million of gross unrealized losses at December 31, 20022005 and 2001, Aon had $129 millionis subject to interest rate, market, credit, illiquidity, concentration and $25 million, respectively, of non-income producing investments, which excludes private equity investments carried on the equity method, held for at least twelve months, that have not declared dividends during 2002 and 2001.operational performance risks.

        Limited Partnership Securitization.    On December 31,In 2001, Aon sold the vast majority of its limited partnership (LP) portfolio, valued at $450 million, to PEPS I, a Qualified Special Purpose Entity (QSPE).QSPE. The common stock interest in PEPS I is held by a limited liability company which is owned by one of Aon's subsidiaries (49%) and by a charitable trust, which is not controlled by Aon, established for victims of the September 11th attacks (51%). Approximately $171 million of investment grade fixed-maturity securities were sold by PEPS I to unaffiliated third parties. PEPS I then paid Aon's insurance underwriting subsidiaries the $171 million in cash and issued to them an additional $279 million in fixed-maturity and preferred stock securities. The fixed-maturity securities Aon subsidiaries received from PEPS I are rated as investment grade by Standard & Poor's Ratings Services. In second quarter 2002, Aon recognized a $32 million impairment write-downwritedowns on a portion of the preferred stock securities.securities of $27 million in 2003.

        As part of this transaction, the insurance underwriting subsidiaries arewere required to purchase from PEPS I additional fixed-maturity securities in an amount equal to the unfunded limited partnership commitments, as they are requested. In 2002,2004, Aon's insurance underwriting subsidiaries funded $38$13 million of commitments. Beginning in July 2004, Aon Parent is funding all future commitments. Aon Parent funded $12 million and $7 million of commitments in 2005 and 2004, respectively. As of December 31, 2002,2005, these unfunded commitments amountamounted to $100$48 million. Based on the downgrades to Aon and the underwriting subsidiaries made by the ratings agencies in October 2002, credit support arrangements were put in place on January 27, 2003, whereby $100 million of cash of one of Aon's underwriting subsidiaries has been pledged as collateral for these commitments. If the insurance underwriting subsidiaries fail to purchase additional fixed-maturity securities as commitments are drawn down, Aon has guaranteed their purchase. These commitments have specific expiration dates and the general partners may decide not to draw on these commitments.

        To achieve the benefits of the securitization, Aon gave up all future voting interests in and control over the limited partnership interests sold to PEPS I and has no voting interest, control or significant influence over the business activities of PEPS I.


Aon has obtained a true sale/non-consolidation opinion from qualified external legal counsel.


        PEPS I holds limited partnership investments. The legal documents that established PEPS I specify the actions that PEPS I and the servicer will undertake when PEPS I is required to make a voting decision (due to the general partner of a limited partnership calling for the vote of limited partners or proxy voting on a money market fund that PEPS I is invested in). Additionally, the legal documents contain specific instructions regarding actions to be taken if PEPS I receives (or has the ability to receive) distributions of investments held by limited partnerships in which it is invested. In instances where the general partner of a given investment may distribute underlying invested company shares to the limited partners (such as PEPS I), the legal documents that establish PEPS I outline very specific disposal instructions.

        Throughout the life of PEPS I, at least 10% of the beneficial interests will be held by parties other than the transferor,Aon, its affiliates, or its agents. This 10% threshold is accomplished through the first tranche notes outstanding to unaffiliated third party investors.

        PEPS I will investinvests cash collected from the limited partnerships pending distribution to holders of beneficial interests. PEPS I invests only in relatively risk free investments with maturities no later than an expected distribution date.

        All holders of each of the above beneficial interests have the right to pledge or exchange (sell), without any constraints, the beneficial interests that they hold. As such, there are no conditions that constrain the beneficial interest holders from pledging or exchanging their beneficial interest(s) and provide the transferor with more than a trivial benefit.

Other

        Securities on deposit for regulatory authorities as required by law, all relating to the insurance underwriting subsidiaries, amounted to $739 million at December 31, 2005 and $606 million at December 31, 2004.

        At December 31, 2005 and 2004, Aon had $195 million and $173 million, respectively, of non-income producing investments, which excludes derivatives that are marked to market through the income statement, as well as private equity investments carried on the equity method, held for at least twelve months, that have not declared dividends during 2005 and 2004.


8.     Debt and Lease Commitments

Notes Payable

        The following is a summary of outstanding notes payable:

 
 As of December 31
 
 2002
 2001
 
 (millions)

Commercial paper $ $254
3.5% convertible debt securities, due November 2012  296  
6.2% debt securities, due January 2007(1)  250  250
8.65% debt securities, due May 2005  250  250
7.375% debt securities, due December 2012  223  
6.9% debt securities, due July 2004  216  250
6.7% debt securities, due June 2003  150  150
LIBOR +1% debt securities, (3.025% at December 31, 2002) due January 2003  150  150
6.3% debt securities, due January 2004  89  100
7.4% debt securities, due October 2002    100
Euro credit facility(2)    87
Notes payable, due in varying installments, with interest at 3.7% to 8.1%  47  103
  
 
Total notes payable $1,671 $1,694
  
 

(millions)            As of December 31,

 2005

 2004


8.205% junior subordinated deferrable interest debentures, due January 2027 $726 $726
3.5% convertible debt securities, due November 2012  297  297
6.2% debt securities, due January 2007 (1)  250  250
7.375% debt securities, due December 2012  224  223
8.65% debt securities, due May 2005    250
Euro credit facility  581  334
Notes payable, due in varying installments, with interest at 0.9% to 15.9%  27  35

Total notes payable $2,105 $2,115

(1)
Rate increased to 6.7% in January 2003.

(2)
Excludes $76 million2003 and $152 million classified as short-term borrowings at6.95% in January 2005.

        Aon created Aon Capital A, a wholly-owned statutory business trust, for the purpose of issuing mandatorily redeemable preferred capital securities. Aon received cash and an investment in 100% of the common equity of Aon Capital A by issuing 8.205% Junior Subordinated Deferrable Interest Debentures (subordinated debt) to Aon Capital A. Aon determined that it is not the primary beneficiary of Aon Capital A, a VIE and was required to deconsolidate Aon Capital A upon the adoption of FIN 46 on December 31, 2002 and 2001, respectively.

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        Commercial paper borrowings2003. As a result of $254 million at December 31, 2001 were included inthe deconsolidation, Aon increased its notes payable basedfor the subordinated debt by $726 million. See Note 11, "Redeemable Preferred Stock, Capital Securities and Stockholders' Equity" for further information on Aon's intent and ability to maintain or refinance these obligations on a long-term basis through 2005.Aon Capital A.

        In November 2002, Aon completed a private offering of $300 million aggregate principal amount of 3.5% convertible senior debentures due in 2012. NetThe net proceeds from this offering were $296 million. The debentures are unsecured obligations and are convertible into Aon common stock at an initial conversion price of approximately $21.475 per common share under certain circumstances including (1) during any fiscal quarter, beginning after December 31, 2002, if the closing price of Aon's common stock exceeds 120% of the conversion price (i.e. $25.77) for at least 20 trading days in the 30 consecutive trading day period ending on the last trading day of the previous fiscal quarter, or (2) subject to certain exceptions, during the five business day period after any ten consecutive trading day period in which the trading price per $1,000 principal amount of the debentures for each day of the ten trading day period was less than 95% of the product of the closing sale price of Aon's common stock and the number of shares issuable upon conversion of $1,000 principal amount of the debentures. Aon will be required to pay additional contingent interest, beginning November 15, 2007, if the trading price of the debentures for each of the five trading days immediately preceding the first day of the six month interest period equals or exceeds 120% of the par value of the debentures. Aon has reserved approximately 14 million shares for the potential conversion of these debentures. Beginning November 19, 2007, Aon may redeem any of the debentures at an initial redemption price of 101% of the principal amount, plus accrued interest. The debentures were sold to qualified institutional buyers. We have reserved approximately 14 million shares for the potential conversion of these debentures. In January 2003, Aon filed a registration statement with the SEC to register the resale of the debentures.

        In December 2002, Aon completed a private offering of $225 million aggregate principal amount of 7.375% senior notes due 2012. Net proceeds from this offering were $223 million. The debentures were sold to qualified institutional buyers.

        Aon has used the net proceeds of both offerings to repay outstanding commercial paper, other short-term debt and certain other notes payable. In addition, some of the funds were used to repurchase a portion of Aon's 8.205% Mandatorily Redeemable Preferred Capital Securities (see note 11). A portion of the funds were invested and utilized to repay $150 million of LIBOR + 1% debt securities that matured in January 2003.

        In December 2001, Aon issued $150 million of debt securities with a floating interest rate of LIBOR +1% due January 2003 and $250 million of 6.2% debt securities due January 2007. ThisThe interest rate on these debt was initially soldsecurities is subject to qualified institutional buyers under Rule 144A ofadjustment in the Securities Act and the net proceeds were usedevent that Aon's credit ratings change. Due to reduce short-term borrowings. In December 2002, Aon consummated an offer to exchange the 6.2% notes for registered notes having identical terms. Because of the ratings downgrades during 2002 and 2004, the interest rate on the 6.2% debt securities was increased to 6.7%, effective January 2003.2003 and 6.95% effective January 2005.

        Interest isIn 2001, certain of Aon's European subsidiaries entered into a committed bank credit facility. At December 31, 2004, Aon had borrowed €250 million ($334 million) under the facility, which was classified as notes payable semi-annually on most debt securities.in the consolidated statements of financial position. In February 2005, Aon replaced this facility with a new €650 million multi-currency revolving loan credit facility. The new



facility included a €325 million three-year and a €325 million five-year revolving loan facility. In October 2005, Aon amended this facility. The amendment extends the term of each revolving loan facility to five years from the date of the amendment, with an option to extend each facility for two additional one-year periods. Thus, this facility will mature in October 2010, unless Aon opts to extend the facility. In addition, the amendment eliminates the requirement that a representation regarding material adverse change be made at the time of each borrowing request and on the first day of each interest period, deletes certain covenants related to acquisitions and investments and revises certain covenants related to mergers and dispositions. Commitment fees of 8.75 basis points are payable on the unused portion of the facility. At December 31, 2005, Aon has borrowed €490 million ($581 million) under this facility, which is classified as notes payable in the consolidated statements of financial position. Aon has guaranteed the obligations of its subsidiaries with respect to this facility.

        At December 31, 2004, Aon had a $775 million U.S. committed bank credit facility to support commercial paper and other short-term borrowings. No amounts were outstanding under this facility at December 31, 2004. In February 2005, Aon replaced this facility with a new $600 million three-year revolving credit facility. This facility permits the issuance of up to $150 million in letters of credit. In September 2005, Aon amended the facility. The three-year term of the facility was extended to a five-year term with a maturity date of February 2010, certain covenants related to guarantors and acquisitions were deleted and certain covenants related to mergers, acquisitions and indebtedness were revised. At December 31, 2005, Aon had $20 million in letters of credit outstanding. Based on Aon's current credit ratings, commitment fees of 10 basis points are payable on the unused portion of the facility.

        For both the U.S. and Euro facilities, Aon is required to maintain consolidated net worth, as defined, of at least $2.5 billion, a ratio of consolidated EBITDA (earnings before interest, taxes, depreciation and amortization) to consolidated interest expense of 4 to 1 and a ratio of consolidated debt to EBITDA of not greater than 3 to 1.

        Aon also has other foreign facilities available, which include a 364-day £37.5 million ($65 million) facility and a 10 million Canadian dollar ($9 million) facility, both of which expire in September 2006 and a €20 million ($24 million) facility, which has no set expiration date.

        Outstanding debt securities, including Aon Capital A's, are not redeemable by Aon prior to maturity except for the 3.5% convertible debt securities, which are redeemable by Aon beginning in 2007. There are no sinking fund provisions. MaturitiesInterest is payable semi-annually on most debt securities. Repayments of notes payable are $309 million, $312$593 million, $255 million, $4$2 million, $1 million and $265$1 million in 2003, 2004, 2005, 2006, 2007, 2008, 2009 and 2007,2010, respectively.

        In September 2001, Aon entered into a new committed bank credit facility under which certain European subsidiaries can borrow up to EUR 500 million. At December 31, 2002, Aon had borrowed EUR 74 million ($76 million) under this facility which is classified as short-term borrowings in the consolidated statements of financial position. Aon has guaranteed the obligations of its subsidiaries with respect to this facility.

83



        Aon had $875 million of other unused committed bank credit facilities at December 31, 2002 to support $1 million of commercial paper and other short-term borrowings. Aon has recently renegotiated the size of the short-term portion of the bank credit facilities, reducing the total amount to $775 million in February 2003. Commitment fees of 10 basis points are payable on the unused short-term portion and 12.5 basis points on the unused long-term portion. The facility requires Aon to maintain consolidated net worth of at least $2.5 billion, a ratio of consolidated EBITDA (earnings before interest, taxes, depreciation and amortization) to consolidated interest expense of 4 to 1 and contains certain other restrictions relating to mergers and the sale or pledging of assets. No amounts were outstanding under this facility at December 31, 2002.

        Information related to notes payable and short-term borrowings is as follows:


 Years ended December 31
 
Years ended December 31,

 2005

 2004

 2003

 

 2002
 2001
 2000
 
 
Interest paid (millions) $123 $127 $140  $130 $147 $103 
Weighted-average interest rates—short-term borrowings 3.3% 4.5% 6.4%
Weighted-average interest rates — short-term borrowings 3.5% 3.5% 2.6%


 

Lease Commitments

        Aon has noncancelable operating leases for certain office space, equipment and automobiles. These leases expire at various dates and may contain renewal and expansion options. In addition to base rental costs, occupancy lease agreements generally provide for rent escalations resulting from increased assessments for real estate taxes and other charges. Approximately 82% of Aon's lease obligations are for the use of office space. Rental expensesexpense for all operating leases amounted to $289$345 million, in 2002, $242$387 million in 2001 and $217$381 million in 2000. Futurefor 2005, 2004 and 2003, respectively, after deducting rentals from subleases ($29 million, $34 million and $31 million for 2005, 2004 and 2003, respectively).



        At December 31, 2005, future minimum rental payments required under operating leases that have initial or remaining noncancelable lease terms in excess of one year, at December 31, 2002 are:net of sub-lease rental income, most of which pertain to real estate leases, are as follows:

(millions)

  

 (millions)

2003 $311
2004 282
2005 258
2006 230 $325
2007 197 305
2008 251
2009 200
2010 156
Later years 904 742
 

Total minimum payments required $2,182 $1,979
 


9.     Income TaxTaxes

        Aon and its principal domestic subsidiaries are included in a consolidated life-nonlife federal income tax return. Aon's foreigninternational subsidiaries file various income tax returns in their foreign jurisdictions.

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        Income (loss)from continuing operations before income tax and the cumulative effect of a change in accounting principleminority interest and the provision for income tax consist of the following:

 
 Years ended December 31
 
 2002
 2001
 2000(1)
 
 (millions)

Income (loss) before income tax:         
 U.S. $166 $(66)$454
 Foreign  627  375  400
  
 
 
Total $793 $309 $854
  
 
 
Provision for income tax:         
Current:         
 Federal $34 $15 $115
 Foreign  191  122  124
 State  13  6  28
  
 
 
Total current  238  143  267
  
 
 
Deferred (credit):         
 Federal  28  (28) 46
 Foreign  21  9  16
 State  6  (2) 4
  
 
 
Total deferred  55  (21) 66
  
 
 
Provision for income tax $293 $122 $333
  
 
 

(1)
Before cumulative effect
(millions)            Years ended December 31,

 2005
 2004
 2003

Income from continuing operations before income tax and minority interest:         
 U.S. $306 $66 $313
 International  659  761  761
  
Total $965 $827 $1,074

Provision for income tax:         
Current:         
 Federal $12 $105 $70
 International  194  277  213
 State  17  32  41
  
Total current  223  414  324

Deferred (credit):         
 Federal  51  (140) 45
 International  39  14  18
 State  10  (6) 9
  
Total deferred  100  (132) 72

Provision for income tax $323 $282 $396

        Income from continuing operations before income tax and minority interest shown above is based on the location of changethe corporate unit to which such earnings are attributable. However, because such earnings in accounting principle.

some cases may be subject to taxation in more than one country, the income tax provision shown above as U.S. or International may not correspond to the geographic attribution of the earnings.

        During 2002, 2001 and 2000,In 2003, Aon's consolidated statementsstatement of income reflectreflected a tax benefit of $24$22 million $26 million and $26 million, respectively, on the 8.205% Capital Securities issued(see Note 11). As a result of the adoption of FIN 46 on December 31, 2003, Aon was required to deconsolidate the Capital Securities, which was completely offset by an increase in January 1997 (see note 11).notes payable. In 2005 and 2004, interest expense on these notes payable was reported as a part of interest expense in the consolidated statements of income and the related tax benefit is included in the provision for income tax.


        A reconciliation of the income tax provisions based on the U.S. statutory corporate tax rate to the provisions reflected in the consolidated financial statements is as follows:

 
 Years ended December 31
 
 
 2002
 2001
 2000
 
Statutory tax rate 35.0%35.0%35.0%
Tax-exempt investment income (0.3)(0.7)(0.5)
Amortization of intangible assets relating to acquired businesses 0.3 4.3 2.1 
State income taxes 1.6 1.4 2.5 
Other—net 0.4 (0.5)(0.1)
  
 
 
 
Effective tax rate 37.0%39.5%39.0%
  
 
 
 

85


Years ended December 31,

 2005

 2004

 2003

 

 
Statutory tax rate 35.0%35.0%35.0%
State income taxes, net of federal benefit 1.8 2.0 3.0 
Taxes on international operations (0.7)(0.7)(2.4)
Adjustments to prior year taxes (5.4)(1.9)0.6 
Deferred tax adjustments 1.9 1.3  
Basis difference in businesses sold  (3.9) 
Other — net 0.9 2.3 0.7 

 
Effective tax rate 33.5%34.1%36.9%

 

        Significant components of Aon's deferred tax assets and liabilities are as follows:


 As of December 31
 

 2002
 2001
 
(millions) As of December 31,

(millions) As of December 31,

 2005
 2004
 


 (millions)

 
 
Deferred tax assets:Deferred tax assets:     Deferred tax assets:      
Employee benefit plans $400 $141 Employee benefit plans $501 $548 
Unrealized foreign exchange losses 171 210 Unearned and advanced premiums and contract fees 211  168 
Unearned and advanced premiums and contract fees 150 110 Net operating loss and tax credit carryforwards 52  66 
Net operating loss and tax credit carryforwards 82 81 Certain purchase accounting and special charges 69  90 
Certain purchase accounting and special charges 32 81 Other 19  43 
Unrealized investment losses  26   
 
Other 141 146    852  915 
Valuation allowance on deferred tax assetsValuation allowance on deferred tax assets (26) (41)
 
 
   
 
Total 976 795 Total 826  874 
 
 
 
 
Deferred tax liabilities:Deferred tax liabilities:     Deferred tax liabilities:      
Policy acquisition costs (167) (91)Policy acquisition costs (191) (210)
Unrealized investment gains (16)  Unrealized investment gains (26) (65)
Other (71) (101)Unrealized foreign exchange gains (22) (59)
 
 
 Other (54) (28)
Total (254) (192)  
 
 
 
  Total (293) (362)
Valuation allowance on deferred tax assets (33) (21)
 
 
 
 
Net deferred tax assets $689 $582 
Net deferred tax assetNet deferred tax asset $533 $512 
 
 
 
 

        There are limitations onValuation allowances have been established primarily with regard to the utilizationtax benefits of certain net operating loss and tax credit carryforwards. Valuation allowances were reduced to $26 million in 2005 from $41 million in 2004, attributable largely to the assessment of the potential future utilization of U.S. Federal tax net operating loss carryforwards after a change of control, consequently, there will be annual limitations onand the realization of theseU.S. federal alternative minimum tax assets. Accordingly,credit carryforwards. To the extent valuation allowances were established for various acquisitions. Subsequently, recognizedprovided originally through acquisition accounting, the tax benefits recognized for thesesuch items would reducehave been recorded as a reduction in goodwill. The valuation allowance changed to $33 million in 2002 from $21 million in 2001, corresponding to increases in related deferred tax assets, with no effect on net income. Although future earnings cannot be predicted with certainty, management currently believes that the realization of the net deferred tax asset after consideration of the valuation allowance is more likely than not.

        Aon recognized, as an adjustment to additional paid-in-capital, income tax benefits attributable to employee stock compensation as follows: 2005, $11 million; 2004, $0 million; and 2003, $2 million.

        U.S. deferred income taxes are not provided on unremitted foreign earnings that are considered permanently reinvested, which at December 31, 2005 amounted to approximately $1.8 billion. It is not practicable to determine the income tax liability that might be incurred if all such earnings were remitted to the U.S. The American Jobs Creation Act of 2004 introduced a temporary incentive for U.S. multinationals to repatriate, in 2004 or 2005, certain foreign earnings at an effective tax rate of



5.25%. In 2005, Aon repatriated $101 million pursuant to this legislation and incurred a current tax expense of $5 million.

At December 31, 2002,2005, Aon had domestic federal operating loss carryforwards of $55$27 million whichthat will expire at various dates from 20032006 to 2021. At December 31, 2002, Aon had2021, state operating loss carryforwards of $349 million that will expire at various dates from 2006 to 2024 and foreign operating loss carryforwards of $113$89 million, which expire at various dates.

        Prior to 1984, life insurance companies were required to accumulate certain untaxed amounts in a memorandum "policyholders'policyholders' surplus account."account ("PSA"). Under the Tax Reform Act of 1984, the "policyholders' surplus account"PSA balances were "capped" at December 31, 1983 and the balances willwere to be taxed only to the extent distributed to stockholders or when they exceed certain prescribed limits. The American Jobs Creation Act of 2004 suspended for 2005 and 2006 the application of the rules imposing income tax on distributions from the PSA. As of December 31, 2002,2005, the combined "policyholders' surplus account"PSA of Aon's life insurance subsidiaries approximates $363is approximately $262 million. Aon's life insurance subsidiaries do not intend to make any taxable distributions or exceed the prescribed limits in the foreseeable future; therefore, no income tax provision has been made. However, if such taxes were assessed, the amount of taxes payable would be approximately $127$92 million.

        The amount of income taxes paid in 2002, 20012005, 2004 and 20002003 was $238$309 million, $193$413 million and $158$296 million, respectively.


10.   Reinsurance and Claim Reserves

        Aon's insurance subsidiaries are involved in both the cession and assumption of reinsurance with other companies. Aon's reinsurance consists primarily of short-duration contracts that are entered into with the captive insurance operations of numerous automobile dealerships and insurers, certain newer accident and health initiatives, as well as certain property casualty lines. Aon's insurance subsidiaries remain liable to the extent that the reinsuring companiesreinsurers are unable to meet their obligations.

        A summary of reinsurance activity is as follows:


 Years ended December 31

 2002
 2001
 2000
(millions) Years ended December 31,

 2005
 2004
 2003

 (millions)


Ceded premiums earned $1,190 $921 $845 $1,106 $1,379 $1,261
Ceded premiums written 1,371 1,020 888 1,039  1,226  1,307
Assumed premiums earned 493 391 379 208  336  366
Assumed premiums written 533 384 304 206  336  382
Ceded benefits to policyholders 703 630 552 548  804  796
 
 
 

        Activity in the liability for policy and contract claims is summarized as follows:

(millions)            Years ended December 31,

 2005
 2004
 2003

Liabilities at beginning of year $825 $751 $529
Incurred losses:         
 Current year  1,389  1,435  1,319
 Prior years (1)  20  (1)  87
  
Total  1,409  1,434  1,406

Payment of claims:         
 Current year  (942)  (915)  (798)
 Prior years  (467)  (445)  (386)
  
Total  (1,409)  (1,360)  (1,184)

Liabilities at end of year         
 (net of reinsurance recoverables:         
  2005 — $1,002; 2004 — $1,029; 2003 — $858) $825 $825 $751

(1)
For 2003, prior years' incurred losses primarily represent losses from business produced by NPS. NPS stopped initiating any new business in mid-2002.
 
 Years ended December 31
 
 
 2002
 2001
 2000
 
 
 (millions)

 
Liabilities at beginning of year $455 $377 $448 
Incurred losses:          
 Current year  1,235  1,110  840 
 Prior years  25  (11) 16 
  
 
 
 
Total  1,260  1,099  856 
  
 
 
 
Payment of claims:          
 Current year  (930) (769) (633)
 Prior years  (256) (252) (294)
  
 
 
 
Total  (1,186) (1,021) (927)
  
 
 
 
Liabilities at end of year (net of reinsurance recoverables:          
  2002—$722; 2001—$482; 2000—$424) $529 $455 $377 
  
 
 
 

11.   Redeemable Preferred Stock, Capital Securities and Stockholders' Equity

Redeemable Preferred Stock

        At December 31, 2002, one2004, 1 million shares of redeemable preferred stock were outstanding. Dividends arewere cumulative at an annual rate of $2.55 per share. TheThese shares of redeemable preferred stock will bewere redeemable at the option of Aon or the holders, in whole or in part, at $50.00 per share plus accrued but unpaid dividends, beginning one year after the occurrencedeath of a certain future event.the last of the original two owners, which occurred in September 2004. In September 2005, Aon redeemed all of the outstanding shares of redeemable preferred stock.

Capital Securities

        In January 1997, Aon created Aon Capital A is a wholly-owned statutory business trust created for the purpose of issuing mandatorily redeemable preferred capital securities (Capital Securities)("Capital Securities"). The sole asset of Aon Capital A is athe $726 million aggregate principal amount of Aon's 8.205% Junior Subordinated Deferrable Interest Debentures (subordinated debt) due January 1, 2027. The back-up guarantees, in the

87



aggregate, provide a full and unconditional guarantee of the trust'sAon Capital A's obligations under the Capital Securities.

        Aon Capital A issued $800 million of 8.205% capital securities in January 1997. The proceeds from the issuance of the Capital Securities were used to finance a portion of the A&A acquisition. Aon received $800 million in cash and a $24 million investment in 100% of the common equity of Aon Capital A by issuing $824 million of subordinated debt. During 2002, approximately $98 million (face value) of the Capital Securities were repurchased on the open market and were used to retire $98 million of the debt to Aon Capital A. The Capital Securities are subject to mandatory redemption on January 1, 2027 (upon the maturity of the subordinated debt) or are redeemable in whole, but not in part, at the option of Aon (through its prepayment of the subordinated debt) upon the occurrence of certain events. During 2002, approximately $98 million of the Capital Securities were repurchased on the open market for $87 million excluding accrued interest. An after-tax gain on the repurchases of $7 million is included in minority interest in the consolidated statements of income.

Interest is payable semi-annually on the Capital Securities. The

        Aon has determined that it is not the primary beneficiary of Aon Capital Securities are categorizedA, a VIE and was required to deconsolidate the Trust upon the adoption of FIN 46 on December 31, 2003, which was completely offset by an increase in notes payable. Prior to the consolidated statementsdeconsolidation of financial position as "Company-Obligated Mandatorily Redeemable PreferredAon Capital Securities of Subsidiary Trust Holding Solely Aon's Junior Subordinated Debentures." TheA, the after-tax interest incurred on the Capital Securities iswas reported as minority interest in the consolidated statements of income. Beginning in 2004, interest expense on these notes payable was reported as part of interest expense in the consolidated statements of income. There was no effect on net income or consolidated stockholders' equity as a result of this deconsolidation.

Common Stock

        In December 2001,November 2005, Aon filed a universal shelf registrationannounced that its Board of Directors had authorized the repurchase of up to $1 billion of Aon's common stock. Shares may be repurchased through the open market or in privately negotiated transactions from time to time, based on Form S-3prevailing market conditions and will be funded from available capital. Any repurchased shares will be available for the issuance of $750 million of debtuse in connection with employee stock plans and equity securities. In November 2002, Aon completed a public offering of 36.8for other corporate purposes. The Company repurchased 0.7 million shares at a cost of its common stock at $17.18 per share, raising net proceeds of $607 million.$25 million in 2005. In 2004, Aon has used the net proceeds to repay commercial paper and other short-term debt. A portion of the funds were invested and were utilized to repay debt maturing in 2003.

        Aon repurchased 0.4 million, 0.1 million and 3.5 million shares in 2002, 2001 and 2000, respectively,did not repurchase any of its common stock. Share repurchases in 2000 were made primarily to provideIn 2003, Aon repurchased 0.1 million shares. In 2006, through March 6, the Company has repurchased 3.2 million shares for stock compensation plans. In addition, Aon issued 3.5 million new sharesat a cost of common stock in 2002 for employee benefit plans and for acquisitions.$126 million.

        In connection with the acquisition of two entities controlled by Aon's Chairmanthen-Chairman and Chief Executive Officer in 2001, (note 4), Aon obtained approximately 22.4 million shares of its common stock. These treasury shares are restricted as to their reissuance. The acquisition was financed by the issuance of approximately 22.4



        In 2005, Aon issued 4.1 million new shares of Aon stock.common stock for employee benefit plans, 0.7 million shares in connection with employee stock purchase plans and 0.2 million shares in connection with acquisitions.

Dividends

        A summary of dividends declaredpaid is as follows:


 Years ended December 31

 2002
 2001
 2000
(millions) Years ended December 31,

 2005
 2004
 2003

 (millions)


Redeemable preferred stock $3 $3 $3 $2 $3 $3
Common stock 230 238 223 191  189  187
 
 
 

Total dividends declared $233 $241 $226
Total dividends paid $193 $192 $190
 
 
 

        Dividends paid per common share were $0.60 for the years ended December 31, 2005, 2004 and 2003.

Statutory Capital and Surplus

        Generally, the capital and surplus of Aon's insurance subsidiaries available for transfer to the parent company areis limited to the amountsamount that the insurance subsidiaries' statutory capital and surplus exceedexceeds minimum statutory capital requirements; however, payments of the amounts as dividends in excess of $105$197 million may be subject to approval by regulatory authorities. See noteNote 9 for possible tax effects of distributions made out of untaxed earnings.

88



        Net statutory income (loss) of the insurance subsidiaries is summarized as follows:

 
 Years ended December 31
 
 2002
 2001
 2000
 
 (millions)

Life insurance $(13)$(61)$133
Property casualty  (64) 60  49
  
 
 
(millions)            Years ended December 31,

 2005
 2004
 2003
 

 
Accident & Health and Life $157 $193 $95 
Warranty, Credit and Property & Casualty  78  123  (21)

 

        Statutory capital and surplus of the insurance subsidiaries isare summarized as follows:

(millions)            As of December 31,

 2005
 2004
 2003

Accident & Health and Life $901 $840 $700
Warranty, Credit and Property & Casualty  702  676  611

 
 As of December 31
 
 2002
 2001
 2000
 
 (millions)

Life insurance $537 $421 $492
Property casualty  448  484  491
  
 
 

        The National Association of Insurance Commissioners revised the Accounting Practices and Procedures Manual in a process referred to as Codification. The revised manual was effective January 1, 2001. The domiciliary states of Aon's major insurance subsidiaries have adopted the provisions of the revised manual. The revised manual changed, to some extent, prescribed statutory accounting practices and resulted in changes to the accounting practices that Aon's major insurance subsidiaries use to prepare their statutory-basis financial statements. The impact of these changes was to increase Aon's major insurance subsidiaries' statutory capital and surplus by approximately 6% as of January 1, 2001.

12.   Employee Benefits

Savings and Profit Sharing Plans

        Aon subsidiaries maintain contributory savings plans with both contributory and non-contributory accounts for the benefit of United StatesU.S. salaried and commissioned employees. The non-contributory accounts were established in lieu of a defined pension benefit in 2004 for certain U.S. employees. Provisions made for these plans were $48$47 million, $43 million and $39$54 million in 2002, 20012005, 2004 and 2000,2003, respectively.

Pension and Other Postretirement Benefits

        Aon sponsors defined benefit pension and postretirement health and welfare plans that provide retirement, medical and life insurance benefits. The postretirement healthcare plans are contributory, with retiree contributions adjusted annually; the life insurance and pension plans are noncontributory.

        Effective January 1, 2004, the U.S. pension plans were closed to new employees.

        In 1999, Aon's U.K. pension plans were closed to new employees. All new employees became participants in a defined contribution plan. The provisions for the defined contribution plan were $20 million, $20 million and $19 million in 2005, 2004 and 2003, respectively.

U.S. Pension and Other Benefit Plans

        The following tables provide a reconciliation of the changes in obligations and fair value of assets for the years ended December 31, 20022005 and 20012004 and a statement of the funded status as of

89




December 31, 20022005 and 2001,2004, for both qualified and non-qualifiednonqualified plans. The measurement date for the U.S. plans is November 30.


 Pension Benefits
 Other Benefits
  Pension Benefits
 Other Benefits
 

 2002
 2001
 2002
 2001
 
(millions)

 2005
 2004
 2005
 2004
 

 (millions)

 
 
Reconciliation of benefit obligation                    
Obligation at beginning of period $961 $792 $73 $69 
Projected benefit obligation at beginning of period $1,546 $1,340 $79 $74 
Service cost 46 33 3 2  62  67 3  3 
Interest cost 72 65 5 5  93  85 4  4 
Participant contributions   7 6     8  8 
Plan amendments (9)    
Curtailment (8) (8)    
Plan amendment 20      
Actuarial loss (gain) 35 12 1 (1) 43  68 (8) 1 
Benefit payments (53) (49) (13) (13) (61) (57) (12) (13)
Curtailments  (10)   
Acquisitions  21   
Change in interest rate 55 97 4 5 
Change in discount rate 63  51 1  2 
 
 
 
 
 
 
Obligation at end of period $1,107 $961 $80 $73 
Projected benefit obligation at end of period $1,758 $1,546 $75 $79 


 
Accumulated benefit obligation at end of period $1,614 $1,421 $75 $79 
 
 
 
 
 
 

Reconciliation of fair value of plan assets

 

 

 

 

 

 

 

 

 

 

 

 

 
           
Fair value at beginning of period $931 $932 $8 $8  $969 $929 $8 $8 
Actual return on plan assets (91) 21    114  94    
Participant contributions   7 6     8  8 
Employer contributions 2 2 6 7  304  3 4  5 
Benefit payments (53) (49) (13) (13) (61) (57) (12) (13)
Acquisitions  25   
 
 
 
 
 
 
Fair value at end of period $789 $931 $8 $8  $1,326 $969 $8 $8 
 
 
 
 
 
 
Market related value at end of period $1,395 $1,111 $8 $8 


 
Funded status                    
Funded status at end of period $(318)$(30)$(72)$(65) $(432)$(577)$(67)$(71)
Unrecognized prior-service (11) (3)   
Unrecognized prior-service cost 14  (7) (10) (11)
Unrecognized loss (gain) 363 76 (6) (12) 623  584 (4) 3 
 
 
 
 
 
 
Net amount recognized $34 $43 $(78)$(77) $205 $ $(81)$(79)
 
 
 
 
 
 
Prepaid benefit cost $ $93 $ $ 
Accrued benefit liability (213) (60) (78) (77)
Amounts recognized in the statements of financial position consist of:           
Accrued benefit liability (included in pension, post employment and post retirement liabilities) $(288)$(452)$(81)$(79)
Intangible pension asset (included in other assets) 14      
Other comprehensive income 247 10    479  452    
 
 
 
 
 
 
Net amount recognized $34 $43 $(78)$(77) $205 $ $(81)$(79)
 
 
 
 
 
 

        The increase in amounts recognized in other comprehensive income related to the minimum pension liability for U.S. pension plans was $27 million and $108 million in 2005 and 2004, respectively.

        In 2002,2005, plans with a projected benefit obligation (PBO)("PBO") and an accumulated benefit obligation ("ABO") in excess of the fair value of plan assets had a PBO of $1.1$1.8 billion, an ABO of $1.6 billion and plan assets with a fair value of $1.3 billion.

        In 2004, plans with an accumulated benefit obligation (ABO)a PBO and ABO in excess of the fair value of plan assets had a PBO of $1.5 billion, an ABO of $1 billion. In 2001, plans$1.4 billion and plan assets with a PBO in excess of the fair value of plan assets were unfunded plans with a PBO of $71 million, and plans with an ABO in excess of the fair value of plan assets were unfunded plans with an ABO of $60 million.$1.0 billion.

        In both 2002 and 2001, pension plan assets include 3.7 million shares of common stock issued by Aon on which dividends of $3.1 million and $3.3 million were received in 2002 and 2001, respectively.

90




        The following table provides the components of net periodic benefit cost (credit) for the plans for the years ended December 31, 2002, 2001 and 2000:plans:

 
 Pension Benefits
 
 
 2002
 2001
 2000
 
 
 (millions)

 
Service cost $46 $33 $32 
Interest cost  72  65  60 
Expected return on plan assets  (108) (104) (95)
Amortization of prior-service  (2) (1) (1)
Amortization of net (gain) loss  2  (8) (7)
  
 
 
 
Net periodic benefit cost (credit) $10 $(15)$(11)
  
 
 
 
 
   
Other Benefits

 
 
 2002
 2001
 2000
 
 
 (millions)

 
Service cost $3 $2 $2 
Interest cost  5  5  5 
Amortization of prior-service      (5)
Amortization of net gain  (1) (1) (1)
  
 
 
 
Net periodic benefit cost $7 $6 $1 
  
 
 
 
(millions)            Pension Benefits

 2005
 2004
 2003
 

 
Service cost $62 $67 $52 
Interest cost  93  85  77 
Expected return on plan assets  (93) (92) (78)
Amortization of prior-service cost  (2) (2) (2)
Amortization of net loss  39  22  11 

 
Net periodic benefit cost $99 $80 $60 

 
(millions)            Other Benefits

 2005
 2004
 2003

Service cost $3 $3 $3
Interest cost  4  4  5
Amortization of prior-service cost  (1) (1) 

Net periodic benefit cost $6 $6 $8

        The weighted-average assumptions for the measurement period forused to determine future U.S. benefit obligations are shownas follows:

 
 Pension Benefits
 Other Benefits
 
 
 2005
 2004
 2005
 2004
 

 
Discount rate 5.75%6.0%5.75%6.0%
Rate of compensation increase 3.5 3.5   

 

        The weighted-average assumptions used to determine the U.S. net periodic benefit cost are as follows:

 
 Pension Benefits
 Other Benefits
 
 
 2005
 2004
 2003
 2005
 2004
 2003
 

 
Discount rate 6.0%6.25%7.0%6.0%6.25%7.0%
Expected return on plan assets 8.5 8.5 8.5    
Rate of compensation increase 3.5 3.5 3.5   3.5 

 

Expected Return on Plan Assets

        To determine the expected long-term rate of return on plan assets, the historical performance, investment community forecasts and current market conditions are analyzed to develop expected returns for each asset class used by the plans. The expected returns for each asset class are weighted by the target allocations of the plans.



Plan Assets

        Aon's U.S. pension plan asset allocation as of December 31, 2005 and 2004 is as follows:

 
  
 Fair Value of Plan Assets
 
 
 Target
Allocation

 
Asset Class

 2005
 2004
 

 
Equities 80%61%74%

 
 Domestic equities 45 38 45 
 International equities 15 8 11 
 Limited partnerships and other 15 11 11 
 Real estate and REITs 5 4 4 
 Aon common stock   3 

 
Debt securities 20 39 26 

 
 Fixed maturities 20 22 23 
 Invested cash No target 17 3 

 
Total   100%100%

 

        Pension plan assets did not include any Aon common stock at December 31, 2005. At December 31, 2004, pension plan assets included $30 million of Aon common stock. Dividends from Aon stock received by the plan in 2005 and 2004 were $0.4 million and $0.9 million, respectively. In November 2005, Aon contributed $200 million to its U.S. pension plan. As of the following table:plan measurement date, these funds were invested in invested cash.

 
 Pension Benefits
 Other Benefits
 
 
 2002
 2001
 2002
 2001
 
Discount rate 7.0%7.5%7.0%7.5%
Expected return on plan assets 8.5 10.3   
Rate of compensation increase 3.5 4.0 3.5 4.0 
  
 
 
 
 

Investment Policy and Strategy

        The investment policy, as established by the Aon Pension Plan Investment Committee, seeks reasonable asset growth at prudent risk levels within target allocations. Aon believes that plan assets are well-diversified and are of appropriate quality. The investment portfolio asset allocation is reviewed quarterly and re-balanced to within policy target allocations. The investment policy is reviewed at least annually and revised, as deemed appropriate by the Aon Pension Plan Investment Committee.

        Aon's U.S. other benefit plan assets of $8 million at both December 31, 2005 and 2004 were invested in money market instruments.

Cash Flows

Contributions

        Based on current assumptions, Aon expects to contribute $6 million to U.S. pension plans during 2006 to satisfy minimum funding requirements and $4 million to fund other postretirement benefit plans during 2006.



Estimated Future Benefit Payments

        Estimated future benefit payments for U.S. plans are as follows at December 31, 2005:

(millions)

 Pension Benefits
 Other Benefits

2006 $63 $4
2007  66  4
2008  70  4
2009  75  4
2010  81  4
2011—2015  527  24

Assumptions for Other Postretirement Benefits

        The employer'sAssumed health care cost trend rates at December 31:

 
 2005
 2004
 

 
Assumed healthcare cost trend rate 12%10.5%
Ultimate trend rate 5%5.5%
Year that the ultimate trend rate is reached 2012 2014 

 

        Aon's liability for future plan cost increase for pre-65 and Medical Supplement plan coverage is limited in any year to 5% per annum. For measurement purposes in 2002, 2001 and 2000, the annual rateBecause of increase in the per capita cost of covered health care benefits (trend rate) adjusted for actual current year cost experience was assumed to be 11.5%, 12.0% and 7.5%, respectively, decreasing gradually to 5.5% in year 2014 and remaining the same thereafter. However, with the employer funding increasethis cap, limited to 5% per year, net employer trend rates for these plans are effectively limited to 5% per year in the future.

The $50 per month subsidy for future post-65 retirees is assumed not to increase in future years. Therefore, there is no employer trend for future post-65 retirees. As a result, a 1% change in assumed healthcare cost trend rates has no effect on the service and interest cost components of net periodic postretirement healthcare benefit cost andor on the accumulated postretirement benefit obligation for the measurement period ended in 2002.2005.

International Pension Plans

        The following tables provide a reconciliation of the changes in the benefit obligations and fair value of assets for the years ended December 31, 20022005 and 20012004 and a statement of the funded status as of

91



December 31, 20022005 and 2001,2004, for material international pension plans, which are located in the United Kingdom U.K.



and theThe Netherlands. The measurement datedates for these plans isare September 30.30 and December 31, respectively.


 International Pension
  International Pension Plans
 

 2002
 2001
 
(millions)

 2005
 2004
 

 (millions)

 
 
Reconciliation of benefit obligation          
Obligation at beginning of period $2,011 $2,036 
Projected benefit obligation at beginning of period $3,847 $3,324 
Service cost 45 51  60 64 
Interest cost 133 124  197 185 
Participant contributions 3 4  4 3 
Actuarial loss 285 139 
Benefit payments (80) (69) (106) (103)
Change in interest rate 300 (81)
Change in discount rate 345 (63)
Foreign exchange translation 242 (54) (430) 298 
 
 
 
 
Obligation at end of period $2,654 $2,011 
Projected benefit obligation at end of period $4,202 $3,847 


 
Accumulated benefit obligation at end of period $3,720 $3,385 
 
 
 
 
Reconciliation of fair value of plan assets          
Fair value at beginning of period $1,693 $2,000  $2,718 $2,239 
Actual return on plan assets (98) (243) 463 188 
Employer contributions 74 53  168 181 
Participant contributions 3 4  4 3 
Benefit payments (80) (69) (106) (103)
Foreign exchange translation 185 (52) (305) 210 
 
 
 
 
Fair value at end of period $1,777 $1,693  $2,942 $2,718 
 
 
 
 
Funded status          
Funded status at end of period $(877)$(318) $(1,260)$(1,129)
Unrecognized prior service 1 2 
Unrecognized loss 1,286 660  1,737 1,635 
 
 
 
 
Net amount recognized $409 $342  $478 $508 
 
 
 
 
Prepaid benefit cost $64 $221 
Accrued benefit liability (555) (144)
Amounts recognized in the statement of financial position consist of:Amounts recognized in the statement of financial position consist of: 
Prepaid benefit cost and intangible pension asset (included in other assets) $116 $123 
Accrued benefit liability (included in pension, post employment and post retirement liabilities) (815) (694)
Other comprehensive income 900 265  1,177 1,079 
 
 
 
 
Net amount recognized $409 $342  $478 $508 
 
 
 
 

        The change in amounts recognized in other comprehensive income related to the minimum pension liability was an increase of $98 million and a decrease of $46 million in 2005 and 2004, respectively.

        In 2002,2005, plans with a PBO in excess of the fair value of plan assets had a PBO of $2.7$4.2 billion and plan assets with a fair value of $1.8$2.9 billion and plans with an ABO in excess of the fair value of plan assets had an ABO of $2.1$3.4 billion and plan assets with a fair value of $1.6$2.6 billion.

        In 2001,2004, plans with a PBO in excess of the fair value of plan assets had a PBO of $1.9$3.8 billion and plan assets with a fair value of $1.5$2.7 billion and plans with an ABO in excess of the fair value of plan assets had an ABO of $1.0$3.0 billion and plan assets with a fair value of $0.9$2.4 billion.


        The following table provides the components of net periodic benefit cost for the international plans for the measurement period ended in 2002, 2001 and 2000:plans:


 2002
 2001
 2000
 
(millions) Years ended December 31,

 2005
 2004
 2003
 

 (millions)

 
 
Service cost $45 $51 $65  $60 $64 $51 
Interest cost 133 124 123  197  185  152 
Expected return on plan assets (163) (182) (193) (184) (165) (134)
Amortization of prior service cost 1     
Amortization of net loss 31 11 10  69  70  58 
 
 
 
 
 
Net periodic benefit cost $46 $4 $5  $143 $154 $127 
 
 
 
 
 

        The range of weighted-average assumptions forused to determine the measurement period for the international pension benefit obligations are shown in the following table:as follows:

Pension Benefits

 20022005

 20012004

 
2000
 
Discount rate 5.5   - 5.754.0 – 5.1%6.25 - 7.0  4.5 – 5.6%
Rate of compensation increase3.25 – 3.53.25 – 3.5

        The range of weighted-average assumptions used to determine the international net periodic benefit costs are as follows:

Pension Benefits

2005
2004
2003

Discount rate4.5 – 5.6%5.25 – 5.5%6.0 -   7.05.5 – 5.75%
Expected return on plan assets 6.0 - 7.5  – 7.25 6.0 - 9.5  – 7.25 7.0 - 10.06.0 – 7.5 
Rate of compensation increase 3.75 - 4.0  3.25 – 3.5 3.5 – 4.0 3.75 – 4.0 -   4.5 



 

Expected Return on Plan Assets

        To determine the expected long-term rate of return on plan assets, the historical performance, investment community forecasts and current market conditions are analyzed to develop expected returns for each asset class used by the plans. The expected returns for each asset class are weighted by the target allocations of the plans.

Plan Assets

        Aon's international pension plan asset allocation at December 31, 2005 and 2004 is as follows:

 
  
  
 Fair Value of Plan Assets
 
 
 Allocation Range
 Target Allocation
 
Asset Class

 2005
 2004
 

 
Equities 43 – 71%61% 63%61%

 
 Equities     58 57 
 Real estate     5 4 

 
Debt securities 29 – 57 39 37 39 

 
 Fixed maturities     37 37 
 Invested cash      2 

 
Total     100%100%

 

Investment Policy and Strategy

        The investment policies for international plans are established by the local pension plan trustees and seek to maintain the plans' ability to meet liabilities and to comply with local minimum funding requirements. Plan assets are invested, within asset allocation ranges as shown above, in diversified portfolios that provide adequate levels of return at an acceptable level of risk. The investment policies are reviewed at least annually and revised, as deemed appropriate to ensure that the objectives are being met.

Cash Flows

Contributions

        Based on current assumptions, Aon expects to contribute $180 million to its international pension plans during 2006 to satisfy minimum funding requirements.

Estimated Future Benefit Payments

        Estimated future pension benefit payments for international plans are as follows at December 31, 2005:

(millions)

  

2006 $93
2007  97
2008  110
2009  116
2010  123
2011—2015  769


13.   Stock Compensation Plans

        In 2001, Aon stockholders approved the AonAon's Stock Incentive Plan which replaced all existing incentive compensation plans, includingprovides for the Aon Stock Award Plan and the Aon Stock Option Plan. Under the new plan,grant of non-qualified and incentive stock options, stock appreciation rights, restricted stock and restricted stock awards may be granted.units. The annual rate ofat which awards are granted each year is based upon financial and competitive business conditions. The number of shares authorized to be issued under the new plan is equal to 18% of the number of common shares outstanding of Aon.outstanding.

Stock Awards

        Stock awards, in the form of restricted stock units, are granted to certain officers and employees of Aon. Generally, employees are required to complete three continuous years of service before the award beginsstock awards begin to vest in increments until the completion of a 10-year period of continuous employment. In 2003 and 2002, a significantlarge number of stock awards were granted that vest annually over five years, with the initial vesting occurring after one year of continuous service. In 2005 and 2004, a large number of stock awards were granted that will not vest until five years after the date of grant. For most employees, beginning in 2005, individual incentive compensation over $50,000 will partially be paid in restricted stock units, which will vest ratably over three years. In general, most awarded sharesstock awards are issued as they become vested. In certain circumstances, an employee can elect to defer the receipt of vested shares to a later date. With certain limited exceptions, any break in continuous employment will cause forfeiture of all unvested awards. The compensation cost associated with each stock award is deferred and amortized over the period of continuous employment using the straight-line method. At December 31, 20022005, 2004 and 2001,2003, the number of shares available for awardstock awards is included with options available for grant.

        Aon commonCommon stock awards outstanding consist of the following:

 
 Years ended December 31
 
 
 2002
 2001
 2000
 
 
 (shares in thousands)

 
Shares outstanding at beginning of year 7,424 8,881 9,865 
Granted 1,024 258 586 
Vested (1,432)(1,488)(1,216)
Canceled (533)(227)(354)
  
 
 
 
Shares outstanding at end of year 6,483 7,424 8,881 
  
 
 
 

93


(shares in thousands)        Years ended December 31,

 2005
 2004
 2003
 

 
Shares outstanding at beginning of year 8,784 7,061 6,483 
Granted 4,842 3,439 2,529 
Vested (1,164)(1,330)(1,413)
Canceled (677)(386)(538)

 
Shares outstanding at end of year 11,785 8,784 7,061 

 

Stock Options

        Options to purchase common stock are granted to certain officers and employees of Aon and its subsidiaries at 100% of market value on the date of grant. Generally, employees are required to complete two continuous years of service before the options begin to vest in increments until the completion of a 4-year period of continuous employment. For all grants made prior to an amendment to the former stock option plan in 2000, employees were required to complete three continuous years of service before the options began to vest in increments until the completion of a 6-year period of continuous employment.



        A summary of Aon's stock option activity (including options granted pursuant to the former Aon Stock Award Plan) and related information consists of the following:is as follows:

 
 Years ended December 31
 
 2002
 2001
 2000
 
 Shares
 Weighted-
Average
Exercise
Price

 Shares
 Weighted-
Average
Exercise
Price

 Shares
 Weighted-
Average
Exercise
Price

 
 (shares in thousands)

Beginning outstanding 21,298 $32 16,156 $29 11,223 $31
Granted 5,552  34 7,647  34 6,812  25
Exercised (877) 20 (1,751) 18 (1,174) 17
Canceled (1,495) 33 (754) 32 (705) 33
  
 
 
 
 
 
Ending outstanding 24,478 $32 21,298 $32 16,156 $29
  
 
 
 
 
 
Exercisable at end of year 5,308 $30 2,538 $29 2,607 $21
  
 
 
 
 
 
Options available for grant 22,771    14,444    2,368   
  
 
 
 
 
 

94


(shares in thousands)
Years ended December 31,

 2005
 2004
 2003

 
 Shares

 Weighted-
Average
Exercise
Price

 Shares

 Weighted-
Average
Exercise
Price

 Shares

 Weighted-
Average
Exercise
Price


Beginning outstanding 34,188 $29 31,627 $29 24,478 $32
Granted 6,295  24 5,233  27 9,226  20
Exercised (2,671) 24 (475) 23 (13) 24
Canceled (2,100) 29 (2,197) 29 (2,064) 27

Ending outstanding 35,712 $29 34,188 $29 31,627 $29

Exercisable at end of year 18,178 $32 15,060 $32 9,574 $32

Options available for grant 10,322    11,885    15,742   

        A summary of options outstanding and exercisable is as follows:

 
 As of December 31, 2002
 
 Options Outstanding
  
 Options Exercisable
Range of Exercise Prices

 Shares Outstanding
 Weighted-Average Remaining Contractual Life (years)
 Weighted-Average Exercise Price
 Shares Exercisable
 Weighted-Average Exercise Price
 
 (Shares in thousands)

$14.92 - $22.89 1,565 4.6 $20.02 942 $22.40
  23.56 -   23.94 4,986 7.0  23.93 1,524  23.93
  26.53 -   31.22 2,140 5.1  29.31 1,211  29.03
  31.53 -   32.53 3,589 8.3  32.51 17  31.53
  32.64 -   35.35 3,692 8.1  34.87 177  35.28
  35.36 -   36.74 439 8.2  36.00 42  35.92
  36.88 -   49.29 8,067 7.8  39.64 1,395  43.33
  
 
 
 
 
$14.92 - $49.29 24,478 7.3 $32.45 5,308 $30.42
  
 
 
 
 

 


 

As of December 31, 2001

 
 Options Outstanding
  
 Options Exercisable
Range of Exercise Prices

 Shares Outstanding
 Weighted-Average Remaining Contractual Life (years)
 Weighted-Average Exercise Price
 Shares Exercisable
 Weighted-Average Exercise Price
 
 (Shares in thousands)

$14.69 - $22.89 1,471 1.0 $20.95 1,022 $20.09
  23.41 -   23.94 5,735 8.1  23.93 40  23.69
  26.53 -   31.22 2,304 6.1  29.35 734  28.71
  31.53 -   32.53 3,804 9.3  32.51   
  32.64 -   35.18 2,330 9.4  34.74 4  35.06
  35.20 -   43.33 3,803 7.4  39.44 712  41.57
  43.44 -   49.29 1,851 7.2  43.57 26  46.26
  
 
 
 
 
$14.69 - $49.29 21,298 7.5 $31.50 2,538 $28.96
  
 
 
 
 
(Shares in thousands)
As of December 31, 2005

 Options Outstanding
  
 Options Exercisable

Range of Exercise Prices

 Shares
Outstanding

 Weighted-
Average
Remaining
Contractual
Life (years)

 Weighted-
Average
Exercise
Price

 Shares
Exercisable

 Weighted-
Average
Exercise
Price


$14.92 — $19.70 5,135 7.17 $19.43 1,398 $19.15
  19.76 — 23.94 8,013 6.81  22.91 3,526  23.54
  23.95 — 27.03 6,455 8.99  26.12 60  25.50
  27.16 — 32.53 5,988 5.38  30.28 4,365  31.38
  32.64 — 36.88 7,181 5.72  35.99 5,890  35.83
  37.13 — 49.29 2,940 2.77  43.28 2,939  43.28

$14.92 — $49.29 35,712 6.47 $28.53 18,178 $32.26

Employee Stock Purchase PlansPlan

United States

        Effective July 1, 1998,        Aon adoptedhas 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 original plan, shares of Aon's common stock couldmay be purchased at 6-month3-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 6-month3-month period. Effective July 1, 2000, the plan was amended by changing the purchase period to 3-month intervals. In 2002, 20012005, 2004 and 2000, 312,0002003, 697,000 shares, 680,000754,000 shares and 940,000734,000 shares, respectively, were issued to employees under the plan. In the first quarter 2002, the plan was suspended in anticipation of the planned divestiture of the insurance underwriting businesses (note 1). The plan was reactivated as of January 1, 2003. There was no compensation expense associated with this plan.


United Kingdom

        In 1999, Aon adopted an employee stock purchase plan that provides for the purchase of approximately 720,000 shares of Aon common stock by eligible U.K. employees after a 3-year period

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and is similar to the U.S. plan described above. In 2002, 4,000 shares were issued to employees under the plan. No shares were issued under the plan in 2001 or 2000. There was no compensation expense associated with this plan.

14.   Financial Instruments

Financial Risk Management

        Aon is exposed to market risk from changes in foreign currency exchange rates, interest rates and equity securitiessecurity prices. To manage the risk related to these exposures, Aon enters into various derivative transactions thattransactions. The derivatives have the effect of reducing theseAon's market risks by creating offsetting market exposures. If Aon diddoes not useenter into derivative contracts, its exposure to market risk would be higher.transactions for trading purposes.

        Derivative transactions are governed by a uniform set of policies and procedures covering areas such as authorization, counterparty exposure and hedging practices. Positions are monitored using techniques such as market value and sensitivity analyses.

        Certain derivatives also give rise to credit risks from the possible non-performance by counterparties. The credit risk is generally limited to the fair value of those contracts that are favorable to Aon. Aon has limited its credit risk by restricting investments in derivative contracts to a diverse group ofusing master netting agreements, entering into non-exchange-traded derivatives with highly rated major financial institutions and by using exchange-traded instruments. Aon closely monitors the creditworthinesscredit-worthiness of, and exposure to, its counterparties and considers its credit risk to be minimal. At December 31, 20022005 and 2001,2004, Aon placed cash and securities relating to these derivative contracts in escrow amounting to $11$6 million and $5 million, respectively.

        Foreign currency forward contracts (forwards) and interest rate swaps entered into require no up-front premium. Forwards settle at the expiration of the related contract. The net effect of swap payments is settled periodically and reported in income. The premium and commission paid for purchased options, including interest rate caps and floors, and premium received, net of commission paid, for written options represent the cost basis of the position until it expires or is closed. The commission paid for futures contracts represents the cost basis of the position, until it expires or is closed. Exchange-traded futures are valued and settled daily. Unless otherwise noted, derivative instruments are generally reported in other receivables and liabilities in the consolidated statements of financial position.

Accounting Policy for Derivative Instruments

        Effective October 1, 2000, Aon adopted FASB Statement No. 133. FASB Statement No. 133 requires allAll derivative instruments to beare recognized in the consolidated statements of financial position at fair value. Unless otherwise noted, derivative instruments with a positive fair value are reported in other receivables and derivative instruments with a negative fair value are reported in other liabilities in the consolidated statements of financial position. Where Aon has entered into master netting agreements with counterparties, the derivative positions are netted by program and are reported accordingly in other receivables or other liabilities. Changes in the fair value of derivative instruments are recognized immediately in earnings, unless the derivative is designated as a hedge and qualifies for hedge accounting.

        FASB Statement No. 133,Accounting for Derivative Instruments and Hedging Activities, identifies three hedging relationships where a derivative (hedging instrument) may qualify for hedge accounting: (i) a hedge of the change in fair value of a recognized asset or liability or firm commitment (fair("fair value hedge)hedge"), (ii) a hedge of the variability in cash flows from a recognized variable-rate asset or liability or forecasted transaction (cash("cash flow hedge)hedge"), and (iii) a hedge of the net investment in a foreign subsidiary.subsidiary ("net investment hedge"). Under hedge accounting, recognition of derivative gains and losses can be matched in the same period with that of the hedged exposure and thereby minimize earnings volatility.

        In order for a derivative to qualify for hedge accounting, the derivative must be formally documented and designated as a fair value, cash flow, or a net investment hedge at inceptionby documenting the relationship between the derivative and be consistent withthe hedged item. The documentation will include a description of the hedging instrument, the hedge item, the risk being hedged, Aon's overall risk management policy. Theobjective and strategy for undertaking the hedge, and the method for assessing the effectiveness of the hedge. Additionally, the hedge relationship must be expected to be highly effective at offsetting changes in either the fair value or cash flows of the hedged item at both inception of the hedge and on an ongoing basis. Aon assesses the ongoing effectiveness of its hedges at the end of each quarter.

For a highly effectivefair value hedge, changesthe change in the fair value of the hedging instrument must be expected to substantially offset changes in the fair value of the hedged item. Aon performs frequent analyses to measure hedge effectiveness.

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        The change in fair value of a hedging instrument designated and qualified as a fair value hedge and the change in fair value of the hedged item attributable to the risk being hedged are both recognized currently in earnings. TheFor a cash flow hedge, the effective portion of the change in fair value of a hedging instrument designated and qualified as a cash flow hedge is recognized in other comprehensive income (OCI)OCI and subsequently reclassified to income when the hedged item affects earnings. The ineffective portion of the change in fair value of a cash flow hedge is recognized



immediately in earnings. For a derivative designated and qualified as a hedge of a net investment in a foreign subsidiary,hedge, the effective portion of the change in fair value of the hedging instrument is reported in OCI as part of the cumulative translation adjustment. Theadjustment while the ineffective portion of the change in fair value of a hedge of a net investment in a foreign subsidiary is recognized immediately in earnings.

        Prior toChanges in the adoption of FASB Statement No. 133, the ineffective portion of the change in fair value of a hedging instrumentderivative that is not designated and qualifiedas an accounting hedge (known as an "economic hedge") are recorded in either investment income or general expenses (depending on the hedged exposure) in the current period's consolidated statements of income.

        Aon discontinues hedge accounting prospectively when (1) the derivative expires or is sold, terminated, or exercised, (2) it determines that the derivative is no longer effective in offsetting changes in the hedged item's fair value or cash flows, (3) a hedged forecasted transaction is no longer probable of occurring in the time period described in the hedge documentation, (4) the hedged item matures or is sold, or (5) management elects to discontinue hedge accounting voluntarily.

        When hedge accounting is discontinued because the derivative no longer qualifies as a fair value hedge, wasAon will continue to carry the derivative in the consolidated statements of financial position at its fair value, recognize subsequent changes in the fair value of the derivative in current-period earnings, cease to adjust the hedged asset or liability for changes in its fair value, and begin to amortize the hedged item's cumulative basis adjustment into earnings over the remaining life of the hedged item using a method that approximates the level-yield method.

        When hedge accounting is discontinued because the derivative no longer qualifies as a cash flow hedge, Aon will continue to carry the derivative in the consolidated statements of financial position at its fair value, recognize subsequent changes in the fair value of the derivative in current-period earnings, and continue to defer the derivative gain or loss in accumulated OCI until the hedged forecasted transaction affects earnings. If the hedged forecasted transaction is probable of not recognizedoccurring in the time period described in the hedge documentation or within a two month period of time thereafter, the deferred derivative gain or loss would be reclassified immediately into earnings.

Foreign Exchange Risk Management

        Certain of Aon's foreign brokerage subsidiaries, primarily in the United Kingdom,U.K., receive revenues in currencies (primarily in U.S. dollars) that differ from their functional currencies. The foreign subsidiary's functional currency revenue will fluctuate as the currency exchange rates change. To reduce thethis variability, of cash flows from these transactions, Aon has entered intouses foreign exchange forwards and options with settlement dates prior to December 2004. Upon adoptionhedge the foreign exchange risk of FASB Statement No. 133,the forecasted revenue for up to a maximum of three years in the future. Aon has designated and qualified forwards are accounted forthese derivatives as cash flow hedges of its forecasted transactions.foreign currency denominated revenue. As of December 31, 2002,2005, a $32$13 million pretax gainloss has been deferred to OCI, $21$9 million of which is expected to impact pretaxbe reclassified to earnings as an adjustment to general expenses in 2003. There was2006. Deferred gains or losses will be reclassified from OCI to general expenses when the hedged revenue is recognized. This hedge had no material ineffectiveness recorded.

        Priorin 2005. Aon also uses over-the-counter options and forward contracts, which have not been designated as hedges for accounting purposes, to hedge economic risks that arise from fluctuations in the adoption of FASB Statement No. 133, these transactions did not qualify for hedge accounting and changescurrency exchange rates. Changes in the fair value related toof these derivatives were recorded in general expenses in the consolidated statements of income. Certain other forward and option contracts did not meet the hedging requirements of FASB Statement No. 133. Changes in fair value related to these contracts wereare recorded in general expenses in the consolidated statements of income.

        Aon uses exchange-traded foreign currency futures and options on futures, as well as over-the-counter options and forward contracts to reduce the impact of foreign currency fluctuations on the translation of the financial statements of Aon's foreign operations. These derivatives are not affordedeligible for hedge accounting as defined by FASB Statement No. 133treatment and prior guidance. Changeschanges in the fair value of these derivatives are recorded in general expenses in the consolidated statements of income.

        Aon also uses foreign currency forward contracts to offset foreign exchange risk associated with foreign denominated (primarily British pounds) inter-company notes. These derivatives were not designated as a hedge because changes in their fair value were largely offset in earnings by remeasuring



the notes for changes in spot exchange rates. Changes in the fair value of these derivatives were recorded in general expenses in the consolidated statements of income.

        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 2002, there were2005, this hedge had no designatedineffectiveness, and qualifying hedges of this exposure.a $15 million pretax loss has been included in OCI.

        In 2000,2005, Aon subsidiaries entered into a cross currency swapcross-currency swaps to hedge the foreign currency and interest rate risks associated with a foreign denominated fixed-rate policyholder liability. This swap hasterm intercompany borrowings. These swaps have been designated as cash flow hedges. As of December 31, 2005, a fair value hedge$1 million pretax loss has been deferred to OCI, which is expected to be reclassified to earnings in 2006 as an adjustment to interest income. The reclassification from OCI will offset the related Statement No. 52 transaction gain or loss arising from the remeasurement of the combined exposure. There wasborrowing 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 related to this hedge.in 2005.

Interest Rate Risk Management

        Aon uses futures contracts and purchasespurchased options on futures contracts to reduce the price volatility of its fixed-maturity portfolio. Upon adoptionDerivatives designated as hedging the aggregate interest rate exposure of FASB Statement No. 133, derivativesthe fixed-maturity portfolio do not qualify as hedges. Changes in their fair value were recorded in investment income. Derivatives designated and qualified as hedging specific fixed-income securities are accounted for as fair value hedges. There were no designated and qualified hedges at December 31, 2002. Prior toChanges in the adoption of FASB Statement No. 133, realized gains and losses on derivatives that qualified as hedges were deferred and reported as

97



an adjustmentfair value of the cost basis ofhedge and the hedged item and are being amortized into earnings over the remaining life of the hedged item.recorded in investment income.

        Aon occasionally enters into receive-fixed-pay-floating interest rate swaps to hedge changes in the fair value of its fixed-rate notes. The interest rate swaps qualify as fair value hedges and there washave no ineffectiveness recorded. Realizedbecause their critical terms (e.g., amount, maturity date) match those of the hedged debt. Upon the termination of this type of hedge, the swap realized gains and losses on swaps qualifiedthat have been deferred as hedges are deferred and reported as adjustments ofan adjustment to the cost basis of the hedged items anditem are being amortized into earningsinterest expense over the remaining life of the hedged items. Prior to the adoption of FASB Statement No. 133, Aon purchased futures contracts to hedge the fair value of its fixed-rate notes from changes in interest rates. Aon deferred the gains from the termination of the contracts and is amortizing these gains over the remaining life of the fixed-rate notes.

        Aon issued fixed-rate notes in May 2000. Aon purchased options on interest rate swaps to hedge against the change in interest rates prior to the issuance. These options qualified as a hedge of an anticipated transaction under prior accounting guidance and related gains were deferred and are being amortized as an offset to interest expense over the remaining life of the notes. Upon the adoption of FASB Statement No. 133, pretax deferred gains of $5 million were reclassified to OCI. At December 31, 2002, $3 million remains in OCI, $1 million of which is expected to offset interest expense in 2003.

        Aon enters into interest rate swap and floor agreements and uses exchange-traded futures and options to limit its net exposure to decreasing short-term interest rates, primarily relating to U.S. dollar denominated brokerage fiduciary funds held on behalf of clients in the U.S. and the U.K. Aon also sells exchange-traded futures to limit its exposure to increasing long-term interest rates. Since the adoption of FASB Statement No. 133, thereThese derivatives were nonot designated as a hedge and qualified cash flow hedges of these exposures. Changeschanges in their fair value related to these contracts were recorded in investment income in the consolidated statements of income. Under prior accounting guidance, realized gains

        In 2005 and losses were deferred and recognized in earnings as the hedged item affected earnings.

        Aon uses2004, receive-fixed-pay-floating interest rate swaps and caps to limit its exposure to changes in interest rates related towere designated as cash flow hedges of the interest rate guarantees provided byrisk of a subsidiaryportion of Aon to certain unaffiliated entities. Under prior accounting guidance, these derivatives qualified for hedge accounting treatment,Aon's U.S. dollar denominated brokerage funds held on behalf of U.K. clients and realized gainsother U.S. and losses were deferred and recognized in earnings as the hedged item affected earnings. In August 2000, these guarantees were replaced with new offsettingU.K. operating funds. These interest rate swaps between Aon and an unaffiliated entity, with Aon essentially retainingdo not have maturities greater than one year. Changes in the same exposure. Following the replacementfair value of the original hedged item,swaps were recorded in OCI and will be reclassified to earnings as an adjustment to investment income over the term of the swap. As of December 31, 2005, a $2 million pretax loss related to this hedge accounting was terminated and previously deferred realized gains and losses as well as previously unrecognized changesrecorded in fair value were recognizedOCI, which is expected to be reclassified to investment income in earnings. The termination of this hedging relationship did not have a2006. This hedge had no material effect on pretax earnings. The adoption of FASB Statement No. 133 did not affect the accounting for these derivative instruments.ineffectiveness in 2005.

Equity Price Risk Management

        Aon sells futures contracts and purchases options to reduce the price volatility of its equity securities portfolio and equity securities it owns indirectly through limited partnership investments. Since the adoption of FASB Statement No. 133, thereThese derivatives were nonot designated as a hedge and qualified hedges of this exposure. Prior to the adoption of FASB Statement No. 133, realized gains and losses on derivatives that qualified as hedgeschanges in their fair value were deferred and reported as an adjustment of the cost basis of the hedged item and are being amortized into earnings over the remaining life of the hedged item. Realized gains and losses on derivatives that did not qualify for hedge accounting treatment were recognized immediatelyrecorded in investment income in the consolidated statements of income.

98




Other Financial InstrumentsUnconsolidated SPEs Excluding PEPS I

        Prior to 2002, an Aon subsidiary issued fixed- and floating-rate Guaranteed Investment Contracts (GICS) and floating-rate funding agreements and invested the proceeds primarily in the U.S. fixed income markets. The assets backing the GICS are subject to varying elements of credit and market risk. This program is currently in run-off.

        Unconsolidated Special Purpose Entities (SPEs) Excluding PEPS I.        Certain of Aon's subsidiaries make short-term loans (generally with terms of 12 months or less) to businesses for the financing ofto finance insurance premiums and then securitizesell ("securitize") the finance receivables through securitization transactions that meet the criteria for sale accounting in accordance with FASB Statement No. 140.140,Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. These premium financing securitizations are accomplished through the use ofby using special purpose entities which are considered QSPEsqualifying SPEs ("QSPEs") pursuant to FASB Statement No. 140 and FIN 46 and commercial paper multi-seller, non-qualified bank conduits (multi-seller non-qualified SPEs)(SPEs). FASB Statement No. 140 provides that a QSPE should not be consolidated in the financial statements of a transferor or its affiliates (Aon's subsidiaries).

        Premium financing securitizations performed by Aon's U.S., U.K., Canadian and Australian subsidiaries utilizeuse multi-seller non-qualified SPEs. Based on an analysis ofBy analyzing the qualitative and quantitative factors of the SPEs, Aon has determined that it isthese subsidiaries are not the sponsor of the SPEs. Additionally, independent third parties (i) have made substantial equity investments in the SPEs, (ii) have voting control of the SPEs and (iii) generally have the risks and rewards of ownership of the assets of the SPEs. Based on these factors and the fact that these subsidiaries do not have a significant variable interest in the multi-seller SPEs, Aon has determined that non-consolidation to be the appropriate accounting treatment in accordance with current accounting guidance.is appropriate.

        AsAon or one of its QSPEs sells undivided interests in specified premium financing receivables to the independent SPEs. Under the terms of these agreements, new receivables increase the amounts available to securitize as collections (administered by Aon) reduce previously sold receivables. The amount advanced from third parties at any one time under the accounts receivable sales agreement was limited to a maximum of $1.9 billion and $2 billion at December 31, 20022005 and 2001,2004, respectively.

        At both December 31, 2005 and 2004, $1.8 billion was advanced under these programs from the maximum commitment containedSPEs. Aon records at fair value the retained interest, which is included in these agreements was $1.7 billioninsurance brokerage and $1.4 billion, respectively,consulting services receivables in the consolidated balance sheets.

        Aon recorded gains associated with the sale of receivables. When Aon calculated the gains, all fees related to this facility were included. The gains included in revenue in the consolidated statements of income, were $65 million, $81 million and $69 million for the maximum credit risk under recourse provisions was approximately $97years ended December 31, 2005, 2004 and $82 million, respectively, which represents2003, respectively.

        Aon retains servicing rights for sold receivables and a servicing fee is earned as income over the extentservicing period. The servicing fees are included in the gain/loss calculation. At December 31, 2005 and 2004, the fair value of the servicing rights approximates the estimated costs to service the receivables and accordingly, Aon has not recorded any servicing assets or liabilities related to this servicing activity.

        Aon estimates fair value by discounting estimated future cash flows from the servicing rights and servicing costs using discount rates that approximate current market rates and expected future prepayment rates.

        The SPEs bear the credit risks on the receivables, subject to limited recourse. These recourse obligations arein the form of credit loss reserves, which were formerly guaranteed by Aon. As of December 31, 2002During 2005, Aon eliminated the percentage guarantee for all facilities, replacing it with other collateral enhancements. Also in 2005, the Canadian facility was amended, reducing the ratings trigger and 2001,adding the unpaid principal amount of securitized receivables outstandingfinancial covenants from the credit facility. The Australian facility was $1.6 billionrenewed, increasing the facility by AUD50 million. The U.S. facility was amended in 2005, extending the facility to July 2006 and $1.3 billion, respectively.reducing its size by $100 million.

        A subsidiary of Aon is also a general partner in a limited partnership ("LP") that purchased automobile installment contracts from automobile dealers and subsequently securitizedintends to renew these contracts through securitization transactions in accordance withconduit facilities when they expire. If there are adverse bank, regulatory, tax or accounting rule changes, the requirements of FASB Statement No. 140. Effective April 1, 2001, the LP ceased purchasing and securitizing new automobile installment contracts. A subsidiary of Aon services the existing portfolio for the LP. Aon acts as a performance guarantor with respect to its subsidiary's servicing duties under the securitization agreement. Aon uses the equity method of accounting to record its share of the net income or loss of the LP. As of December 31, 2002 and 2001, the remaining unpaid principal amount of securitized installment contracts outstanding was $466 million and $1 billion, respectively. As of December 31, 2002 and 2001, as the general partner of the LP, Aon had approximately $121 million and $143 million, respectively, of recourse with respect to a limited guarantee relatingCompany's access to the LP's securitization agreement. In February 2003, an agreement was reached with the beneficial interest holders, reducing the amount of recourse to Aon to $66 million.conduit facilities and SPEs would be restricted.


Fair Value of Financial Instruments

        Accounting standards require the disclosure of fair values for certain financial instruments. The fair value disclosures are not intended to encompass the majority of policy liabilities, various other non-financial instruments or other intangible assets related to Aon's business. Accordingly, care should

99



be exercised in deriving conclusions about Aon's business or financial condition based on the fair value disclosures. The basis for determining the fair value of financial instruments is discussed in Note 1. The carrying value and fair value of certain of Aon's financial instruments are as follows:

 
 As of December 31
 
 2002
 2001
 
 Carrying Value
 Fair Value
 Carrying Value
 Fair Value
 
 (millions)

Assets:            
 Fixed maturities and equity securities $2,151 $2,151 $2,531 $2,531
 Other investments  600  599  640  639
 Cash, receivables and short-term investments*  13,906  13,906  11,264  11,264
 Derivatives  79  79  46  46
Liabilities:            
 Investment-type insurance contracts  139  136  813  782
 Short-term borrowings, premium payables and general expenses  12,033  12,033  10,260  10,260
 Notes payable  1,671  1,754  1,694  1,750
 Capital securities  702  632  800  782
 Derivatives  45  45  55  55

*
Excludes derivatives.
(millions)            As of December 31,

 2005

 2004


 
 Carrying
Value

 Fair
Value

 Carrying
Value

 Fair
Value


Assets:            
 Fixed maturities and equity securities $$4,258 $4,258 $3,522 $3,522
 Other investments  515  514  483  482
 Cash, receivables and short-term investments  14,376  14,376  14,749  14,749
 Derivatives  88  88  149  149
Liabilities:            
 Deposit-type insurance contracts  21  21  18  18
 Short-term borrowings, premium payables and general expenses  11,095  11,095  11,334  11,334
Notes payable  2,105  2,442  2,115  2,280
Derivatives  91  91  86  86

Guarantees and Indemnifications

        Aon provides a variety of guarantees and indemnifications to its customers and others to allow Aon or others to complete a wide variety of business transactions.others. The maximum potential amount of future payments representrepresents the notional amounts that could become payable under the guarantees and indemnifications if there were a total default by the guaranteed parties, without consideration of possible recoveries under recourse provisions or other methods. These amounts may bear no relationship to the expected future payments, if any, for these guarantees and indemnifications. Any anticipated amounts payable which are deemed to be probable and estimable are properly reflectedaccrued in Aon's consolidated financial statements.

        Refer to Other Financial Instruments, above, for guarantees associated with Aon's premium and auto loan financing securitizations.        Guarantees associated with Aon's limited partnership securitization are disclosed in noteNote 7. Indemnities related to discontinued operations are disclosed in noteNote 6. Contingent shares issuable related to prior acquisitions are disclosed in note 4.

        Aon and its subsidiaries have issued letters of credit to cover contingent payments of approximately $60$11 million for taxes and other business obligations to third parties. Amounts have beenare accrued in the consolidated financial statements for these letters of credit to the extent they are probable and estimable.

        Aon has certain contractual contingent guarantees for premium payments owed by clients to certain insurance companies. Costs associated with these guarantees, to the extent estimable and probable, are provided in Aon's allowance for doubtful accounts. The maximum exposure with respect to such contractual contingent guarantees was approximately $30$17 million at December 31, 2002.2005.

        Aon expects that as prudent business interests dictate, additional guarantees and indemnifications may be issued from time to time.

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15.   Contingencies

        Aon and its subsidiaries are subject to numerous claims, tax assessments, lawsuits and lawsuitsproceedings that arise in the ordinary course of business. The damages thatclaimed in these matters are or may be claimed are substantial, including, in many instances, claims for punitive, treble or extraordinary damages. Aon has purchased errors and omissions ("E&O") insurance and other appropriate insurance to provide protection against losses that arise in such matters. Accruals for these items, net of insurance receivables, when applicable, have been provided to the extent that losses are deemed probable and are reasonably estimable. These accruals and receivables are adjusted from time to time as developments warrant.

        In 2004, Aon, other insurance brokers, insurers and numerous other industry participants received subpoenas and other requests for information from the secondoffice of the Attorney General of the State of New York and from other states relating to certain practices in the insurance industry.

        On March 4, 2005, Aon entered into an agreement (the "Settlement Agreement") with the Attorney General of the State of New York, the Superintendent of Insurance of the State of New York, the Attorney General of the State of Connecticut, the Illinois Attorney General and the Director of the Division of Insurance, Illinois Department of Financial and Professional Regulation (collectively, the "State Agencies") to resolve all the issues related to investigations conducted by the State Agencies.

        As has been described in detail in Aon's previous financial filings, the Settlement Agreement requires Aon to pay between 2005-2007 a total of $190 million into a fund (the "Fund") to be distributed to certain Eligible Policyholder clients. The Settlement Agreement set forth the procedures under which Aon mailed notices to its Eligible Policyholder clients and distributes the Fund to Participating Policyholder clients. In order to obtain a payment from the Fund, Participating Policyholders were required to tender a release of claims against the Company arising from acts, omissions, transactions or conduct that are the subject of the lawsuits.

        As required by the Settlement Agreement, within 60 days of the effective date of that agreement, the Company commenced the implementation of certain business reforms, including agreeing not to accept contingent compensation as defined in the Settlement Agreement.

        In accordance with APB Opinion No. 21,Interest on Receivables and Payables, the Company discounted the payment stream associated with the Settlement Agreement and recorded the present value of the liability and corresponding expense of $180 million in the financial statements as of December 31, 2004. The discount was determined using Aon's incremental borrowing rate. The Company did not discount the payment made on September 1, 2005. The settlement was considered fully tax deductible and is not treated as a permanent difference in the Company's tax calculation.

        Purported clients have also filed civil litigation against Aon and other companies under a variety of laws and legal theories relating to broker compensation practices and other issues under investigation by New York and other states. As previously reported, a putative class action styledDaniel v. Aon (Affinity) has been pending in the Circuit Court of Cook County, Illinois since August 1999. On March 9, 2005, the Court gave preliminary approval to a nationwide class action settlement within the $40 million reserve established in the fourth quarter of 1999, Allianz Life Insurance Company of North America, Inc. ("Allianz") filed an amended complaint in Minnesota adding a brokerage subsidiary of Aon as a defendant in an action which Allianz brought against three insurance carriers reinsured by Allianz. These three carriers provided certain types of workers' compensation reinsurance to a pool of insurers and to certain facilities managed by Unicover Managers, Inc. ("Unicover"), a New Jersey corporation not affiliated with Aon. Allianz alleges that the Aon subsidiary acted as an agent of the three carriers when placing reinsurance coverage on their behalf. Allianz claims that the reinsurance it issued should be rescinded or that it should be awarded damages, based on alleged fraudulent, negligent and innocent misrepresentations by the carriers, through their agents, including the Aon subsidiary defendant.

        On August 30, 2002, two of the three carriers referred to above filed a complaint2004. The Court held hearings in the United States District Court forfourth quarter of 2005 to consider whether to grant final approval to the Districtsettlement, and is expected to issue a decision in first quarter 2006.

        Beginning in June 2004, a number of Connecticutother putative class actions have been filed against the Aon brokerage subsidiary. The two carriersand other companies by purported clients under a variety of legal theories, including state tort, contract, fiduciary duty, antitrust and statutory theories and federal antitrust and Racketeer Influenced and Corrupt Organizations Act theories. These actions are currently involvedpending at early stages in an arbitration proceeding with Allianz, related to the original litigation,state court in which Allianz seeks the recission of the reinsurance placements. These carriers also seek to recover from the Aon brokerage subsidiary any damages, costsCalifornia and expenses, including legal fees, suffered by such carriers as a result of an adverse arbitration award.Illinois and in federal court in New Jersey. Aon believes that the Aon subsidiaryit has meritorious defenses in



all of these cases and the Aon subsidiary intends to vigorously defend this claim. On January 8, 2003, the two carriers dismissed their lawsuit without prejudice, meaning it could be refiled at a later time.itself against these claims. The remaining Unicover issues are complex, and therefore, the timing and amountoutcome of resolution cannot be determined at this time. In early October 2002, there was reportedly an award made by arbitrators in an arbitration held in New York among Unicover Managers, Inc., Unicover pool members and the three carriers referred to above. Aon has not received a copy of the arbitration award and therefore cannot make an informed statement as to its content.

        Certain United Kingdom subsidiaries of Aon have been required by their regulatory body, the Personal Investment Authority (PIA), to review advice given by those subsidiaries to individuals who bought pension plans during the period from April 1988 to June 1994. These reviews have resulted in a requirement to pay compensation to clients based on guidelines issued by the PIA. Aon's ultimate exposure from the private pension plan review, as presently calculated, is subject to a number of variable factors including, among others, general level of pricing in the equity markets, the interest rate established quarterly for calculating compensation, and the precise scope, duration and methodology of the review, including whether recent regulatory guidance will have to be applied to previously settled claims. These variable factors are ones that the U.K. Financial Services Authority, the current governing body in the U.K., has used as a basis in the past for establishing the calculation tables to determine redress or compensatory amounts. Because Aon is unable to predict if, or how, regulators may change these tables or if, or how, they may apply future regulatory guidance to previous claims, Aon has been, and will continue to be, unable to determine a range or estimate of additional possible exposure.

        One of Aon's insurance subsidiaries is a defendant in more than twenty lawsuits in Mississippi. The lawsuits generally allege misconduct by the subsidiary in the solicitation and sale of insurance policies. Attorneys representing the plaintiffs in these lawsuits have advised the subsidiary that approximately 2,700 other current or former policyholders may file similar claims. Each lawsuit includes, and each threatened claim could include, a request for punitive damages. Aon's insurance subsidiary has been litigating the pending suits and investigating the claims. In the second quarter 2002, Aon negotiated a compromise of several of the lawsuits and approximately 2,000 of the claims. In the third quarter of

101



2002, the settlement of approximately 1,000 of these claims has been concluded. The remainder of the settlements is of uncertain status. Aon's insurance subsidiary has filed a lawsuit against the claimaints' attorney asserting that the settlements were not appropriately completed. If these settlements are concluded, there will still be at least 2,700 threatened claims outstanding. Each of the remaining lawsuits, and any threatened claim is being investigated and vigorously defended.losses or other payments that may occur as a result, cannot be predicted at this time.

        On August 8, 2002, Daniel & Raizel Taubenfeld, a purportedBeginning in late October 2004, several putative securities class actions have been filed against Aon stockholder, filed a putative class action lawsuit in the United StatesU.S. District Court for the Northern District of Illinois, Eastern Division, on behalf of purchasers of Aon Common Stock between May 4, 1999 and August 6, 2002. The complaint names Aon, Patrick G. Ryan, Chairman and Chief Executive Officer, and Harvey N. Medvin, Executive Vice President and Chief Financial Officer, as defendants, and contains allegations of violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated under such Act relating to Aon's press release issued on August 7, 2002. The plaintiff seeks, among other things,Illinois. Also beginning in late October 2004, several putative ERISA class action certification, compensatory damages in an unspecified amount and an award of costs and expenses, including counsel fees. On January 17, 2003, the lead plaintiff filed a "Consolidated Amended Complaint" against the same defendants which alleges violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated under such Act. Aon intends to defend this action vigorously.

        There have been nine other putative class action lawsuitsactions were filed against Aon and certain of its officers and directors in the United StatesU.S. District Court for the Northern District of IllinoisIllinois. Aon believes it has meritorious defenses in all of these cases and intends to vigorously defend itself against these claims. The outcome of these lawsuits, and any losses or other payments that eachmay occur as a result, cannot be predicted at this time.

        In May 2005, the Office of the U.S. Attorney for the Southern District of New York and the Securities and Exchange Commission sent to Aon subpoenas seeking information relevant to these agencies' industry-wide investigations of finite risk insurance. Aon is substantially similarfully cooperating with these investigations.

        In July 2004, several subsidiaries of Aon were joined as defendants in an action in a U.K. court between British Petroleum ("BP") and underwriters who subscribed to policies of insurance covering various offshore energy projects on which BP and its co-venturers have incurred losses. BP settled on confidential terms with underwriters, but asserted a claim against Aon for approximately $96 million, which BP claims is a shortfall between its total losses and what it recovered in the settlements with underwriters, plus interest and costs. The trial in this matter concluded in December 2005, and judgment is expected to be issued sometime in the first half of 2006. Aon believes it has meritorious defenses and has vigorously defended itself against these claims. The ultimate outcome of this matter, and any losses or other payments that may occur as a result, cannot be predicted at this time.

        In February 2006, Lloyds announced that it had brought suit in London against Benfield and a subsidiary of Aon to recover alleged losses relating to these brokers' placement of insurance for Lloyds's New Central Fund. Lloyds alleges that its brokers did not fairly present the risk to reinsurers and thus that the brokers should be held liable for reinsurers' failure to pay approximately £325 million ($563 million based on December 31, 2005 exchange rate) in claims. Aon disputes Lloyds's allegations, believes that it has meritorious defenses and intends to vigorously defend itself against Lloyd's claims.

        Fiduciary Counselors, Inc., a former Aon subsidiary, has asked Aon Consulting, Inc. of New Jersey to defend and indemnify it with regard to claims that may be asserted in an arbitration relating to the lawsuit describedformer subsidiary's service from November 1999 to November 2000 as an independent fiduciary for the development and construction of the Diplomat Resort and Country Club in the immediately preceding paragraph. All of these actions have been consolidated with the Taubenfeld actionHollywood and a lead plaintiffHallendale, Florida (the "Project"). Aon has been appointed by the court. Aon intendsconditionally agreed to defend each of these actions vigorously.

        Aon has also received a complaint which purports to be a shareholder's derivative action against Aon and each of Aon's directors. This complaint, which is styledBernard Stern v. Patrick Ryan, et al. was filed in the United States District Court for the Northern District of Illinois on September 13, 2002. This lawsuit makes allegations which are substantially similarindemnify Fiduciary Counselors with respect to the original Taubenfeld lawsuit.potential arbitration demand. The prospective claimants, a labor union pension fund that owns the Project and its current independent fiduciary, allege that Fiduciary Counselors breached fiduciary duties and other obligations under ERISA. The prospective claimants have asserted that their claims are valued at over $100 million. Aon intendsbelieves that there are meritorious defenses both as to defend this action vigorously.liability and damages and continues to evaluate whether the matter may be resolved without formal arbitration.

        Although the ultimate outcome of all matters referred to above cannot be ascertained, and liabilities in indeterminate amounts may be imposed on Aon or its subsidiaries, on the basis of present information, amounts already provided, availability of insurance coverages and legal advice received, it is the opinion of management that the disposition or ultimate determination of such claims will not have a material adverse effect on the consolidated financial position of Aon. However, it is possible that future results of operations or cash flows for any particular quarterly or annual period could be materially affected by an unfavorable resolution of these matters.


16.   Segment Information

        Aon classifies its businesses into three operating segments: Risk and Insurance Brokerage and Other Services, Consulting and Insurance Underwriting. A fourth non-operating segment, Corporate and Other, when aggregatedcombined with the operating segments and after the elimination of intersegment revenues, totals to the amounts in the accompanying consolidated financial statements. Certain segment information in prior periods' consolidated financial statements has been reclassified to reflect sold business reported as discontinued operations.

        The accounting policies of the operating segments are the same as those described in Note 1, except that the disaggregated financial results have been prepared using a management approach, which is consistent with the basis and manner in which Aon senior management internally disaggregates financial information for the purposes of assisting in making internal operating decisions. Aon evaluates performance based on stand-alone operating segment income before income taxes and generally accounts for intersegment revenue as if the revenue were from third parties, that is, considered by management to be at current market prices.

Revenues are generally attributed to geographic areas based on the location of the resources producing the revenues. Intercompany revenues and expenses are eliminated in computing consolidated revenues and income before tax. There are no material inter-segment amounts to be eliminated. Long-lived assets and related depreciation and amortization are not material.

102



Consolidated revenue by geographic area is as follows:

 
 Total
 United
States

 United
Kingdom

 Continent
of Europe

 Rest of
World

 
 (millions)

Revenue for the years ended December 31:               
 2002 $8,822 $5,034 $1,621 $1,117 $1,050
 2001  7,676  4,463  1,390  938  885
 2000  7,375  4,350  1,363  833  829
(millions)

 Total

 United States

 United Kingdom

 Continent of Europe

 Rest of World


Years ended December 31:               
 2005 $9,837 $4,859 $1,567 $1,802 $1,609
 2004  9,931  5,020  1,732  1,719  1,460
 2003  9,464  4,956  1,756  1,469  1,283

        The Risk and Insurance Brokerage and Other Services segment consists principally of Aon's retail and reinsurance and wholesale brokerage operations, as well as related insurance services, including claims services, underwriting management, captive insurance company management services, claims services and premium financing. Aon's retail brokerage area provides a broad spectrumDuring 2004, Aon sold essentially all of advisory and outsourcingits claim services including risk identification and assessment, alternative risk financing, safety engineering, loss management and program administration for clients. This area also designs, places and implements customized insurance solutions. Aon's reinsurance brokerage activities offer sophisticated advisory services in program design that enhance the risk/return characteristics of insurance policy portfolios and improve capital utilization, along with the evaluation of catastrophic loss exposures. Aon also actively participates in placement and captive management services, designing programs that enable clients to effectively retain a portion of certain risks that are cost prohibitive or unavailable in the traditional insurance markets. Aon offers claims administration and loss cost management services to insurance companies, firms with self-insurance programs and to agents and brokers for the benefits of their customers.businesses.

        The wholesale operations, serving thousands of independent insurance brokers and agents nationwide, provide brokering expertise and underwriting solutions, with custom-designed products and services in several specialty areas, including entertainment, public entities, directors' and officers' and professional liability, workers' compensation, media, financial institutions, marine, aviation, construction, healthcare and energy.

        Our Consulting segment is one of the world's largest integrated human capital consulting organizations.        The operations of thisthe Consulting segment provide a full range of human capital management services. These services are delivered predominantly to corporate clientele utilizing fivesix major practices: employee benefits, human resource outsourcing, compensation, management consulting, outsourcingcommunications and communications.strategic human resource consulting.

        The Insurance Underwriting segment provides specialty insurance products including supplemental accident, health and life insurance coverage through several distribution networks, most of which are directly owned by Aon's subsidiaries. Extended warranty and select property and casualty insurance products are sold through automobile dealership retailers, independent agents and brokers, Aon brokers and other channels.



Operating segment revenue by productsub-segment is as follows:

 
 Total
Operating

 Retail
 Reinsurance,
Wholesale,
Claims and Other Services

 Consulting
 Accident,
Health
and Life

 Extended
Warranty
and Casualty

 
 (millions)

Revenue for the years ended December 31:                  
 2002 $8,843 $3,333 $1,930 $1,054 $1,733 $793
 2001  7,847  3,009  1,650  938  1,507  743
 2000  7,304  2,947  1,420  770  1,424  743
(millions)            Years ended December 31,

 2005
 2004
 2003
 

 
Risk management and insurance brokerage — Americas $2,172 $2,067 $2,040 
Risk management and insurance brokerage — International  2,383  2,357  2,074 
Reinsurance brokerage and related services  845  861  873 
Claims services    212  352 
  
 
Total Risk and Insurance Brokerage Services  5,400  5,497  5,339 

Consulting services

 

 

981

 

 

949

 

 

898

 
Outsourcing  274  298  287 
  
 
Total Consulting  1,255  1,247  1,185 

Accident & health and life

 

 

1,805

 

 

1,721

 

 

1,594

 
Warranty, credit and property & casualty  1,383  1,429  1,289 
  
 
Total Insurance Underwriting  3,188  3,150  2,883 

Intersegment revenues

 

 

(62

)

 

(72

)

 

(68

)
  
 
Total operating segments $9,781 $9,822 $9,339 
  
 

103


Selected information reflectingfor Aon's operating segments is as follows:

 
 Insurance Brokerage and
Other Services

 Consulting
 Insurance Underwriting
 
 Years ended December 31
 
 2002
 2001
 2000
 2002
 2001
 2000
 2002
 2001
 2000
 
 (millions)

Revenue by geographic area:                           
 United States $2,604 $2,425 $2,277 $703 $628 $486 $1,784 $1,615 $1,545
 United Kingdom  1,087  918  889  160  157  151  363  302  308
 Continent of Europe  857  733  654  105  77  67  151  125  111
 Rest of World  715  583  547  86  76  66  228  208  203
  
 
 
 
 
 
 
 
 
  Total revenues  5,263  4,659  4,367  1,054  938  770  2,526  2,250  2,167
General expenses(1)  4,479  4,074  3,640  932  810  661  997  854  830
Benefits to policyholders              1,375  1,111  1,037
Amortization of intangible assets  50  38  37  2  2  3  2    
Unusual charges/(credits)—World                           
  Trade Center  (29) 23            135  
  
 
 
 
 
 
 
 
 
  Total expenses  4,500  4,135  3,677  934  812  664  2,374  2,100  1,867
  
 
 
 
 
 
 
 
 
  Income before income tax $763 $524 $690 $120 $126 $106 $152 $150 $300
  
 
 
 
 
 
 
 
 
Identifiable assets at December 31 $12,528 $10,393 $10,035 $313 $232 $232 $5,999 $5,526 $5,594
  
 
 
 
 
 
 
 
 


 
 Risk and Insurance Brokerage Services
  
  
  
  
  
  
(millions)            Years ended December 31,

 Consulting
 Insurance Underwriting
 2005
 2004
 2003
 2005
 2004
 2003
 2005
 2004
 2003

Revenue by geographic area:                           
 United States $2,007 $2,151 $2,224 $730 $754 $762 $2,175 $2,108 $1,953
 United Kingdom  1,014  1,056  1,093  206  213  182  340  456  460
 Continent of Europe  1,279  1,265  1,112  186  162  139  330  284  211
 Rest of World  1,100  1,025  910  133  118  102  343  302  259

  Total revenues (1)  5,400  5,497  5,339  1,255  1,247  1,185  3,188  3,150  2,883

General expenses (1) (2) (3)

 

 

4,677

 

 

4,768

 

 

4,548

 

 

1,144

 

 

1,115

 

 

1,075

 

 

1,323

 

 

1,380

 

 

1,260
Benefits to policyholders              1,551  1,516  1,427
Provision for New York and other state settlements  4  153    1  27        

  Total expenses  4,681  4,921  4,548  1,145  1,142  1,075  2,874  2,896  2,687

  Income before income tax $719 $576 $791 $110 $105 $110 $314 $254 $196

Identifiable assets at December 31 $12,566 $13,235 $13,174 $319 $333 $296 $7,233 $7,122 $6,598

(1)
Excludes the elimination of intersegment revenues and expenses of $62 million, $72 million and $68 million for 2005, 2004 and 2003, respectively.

(2)
Insurance underwriting general expenses include amortization of deferred acquisition costs of $275$433 million, $231$437 million and $218$399 million in 2002, 20012005, 2004 and 2000,2003, respectively.

(3)
Includes depreciation and amortization expense.

        Corporate and Other segment revenue consists of investment income from equity, fixed-maturity and short-term investments that are assets primarily of valuation changes of investments in limited partnerships and certain other investments (whichthe insurance underwriting subsidiaries that exceed policyholders liabilities. These assets may include non-income producing equities),equities, valuation changes in limited partnership investments and income and losses on disposals of all securities, including those pertaining to assets maintained by the operating segments. Corporate and Other segment general expenses include administrative and certain information technology costs.



Selected information reflectingfor Aon's Corporate and Other segment is as follows:

 
 Corporate and Other
 
 
 Years ended December 31
 
 
 2002
 2001
 2000
 
 
 (millions)

 
Revenue $(21)$(171)$71 
  
 
 
 
General expenses  97  75  59 
Interest expense  124  127  140 
Amortization of goodwill    118  114 
 Total expenses  221  320  313 
  
 
 
 
Loss before income tax $(242)$(491)$(242)
  
 
 
 
Identifiable assets at December 31* $6,494 $6,179 $6,390 
  
 
 
 

 
 Corporate and Other
 
(millions)            Years ended December 31,

 2005
 2004
 2003
 

 
Revenue $56 $109 $125 

 
General expenses (1)  109  81  61 
Interest expense  125  136  101 
Unusual credit —World Trade Center      (14)
  
 
 Total expenses  234  217  148 

 
Loss before income tax $(178)$(108)$(23)

 
Identifiable assets at December 31 $7,700 $7,639 $6,959 

 
*(1)
Limited partnerships were $25 million, $42 million and $602 million as of December 31, 2002, 2001 and 2000, respectively.Includes depreciation expense.

104


Selected information reflectingfor Aon's investment income is as follows:

(millions) Years ended December 31,

(millions) Years ended December 31,

 2005
 2004
 2003

 Years ended December 31

Risk and Insurance Brokerage ServicesRisk and Insurance Brokerage Services        

 2002
 2001
 2000
(primarily short-term investments) $129 $80 $68

 (millions)

Insurance Brokerage and Other Services (primarily short-term investments) $113 $156 $186
Consulting (primarily short-term investments) 2 5 6Consulting (primarily short-term investments) 4  3  2
Insurance Underwriting (primarily fixed maturities) 158 223 245Insurance Underwriting (primarily fixed maturities) 154  129  115
Corporate and Other (primarily equity investments and limited partnerships) (21) (171) 71
Corporate and Other (primarily equity and other investments and limited partnerships)Corporate and Other (primarily equity and other investments and limited partnerships) 56  109  125
 
 
 

Total investment income $252 $213 $508Total investment income $343 $321 $310
 
 
 


105


Quarterly Financial Data

 
 1Q
 2Q
 3Q
 4Q
 2002
 
 (millions except common stock and per share data)

INCOME STATEMENT DATA(1)               
 Brokerage commissions and fees $1,444 $1,510 $1,551 $1,697 $6,202
 Premiums and other  535  638  607  588  2,368
 Investment income (loss)  109  (26) 88  81  252
  
 
 
 
 
  Total revenue $2,088 $2,122 $2,246 $2,366 $8,822
  
 
 
 
 
 Net Income $160 $ $128 $178 $466
  
 
 
 
 
DILUTIVE PER SHARE DATA(1) $0.57 $ $0.46 $0.59 $1.64

BASIC NET INCOME PER SHARE(1)

 

$

0.58

 

$


 

$

0.46

 

$

0.59

 

$

1.65
  
 
 
 
 
COMMON STOCK DATA               
 Dividends paid per share $0.225 $0.225 $0.225 $0.15 $0.825
 Stockholders' equity per share  12.97  13.53  13.60  12.56  12.56
 Price range  36.23-31.76  39.63-28.00  29.83-13.50  21.95-15.59  39.63-13.50
 Shares outstanding (in millions)  272.0  272.8  273.0  310.2  310.2
 Average monthly trading volume (in millions)  16.4  19.6  41.7  39.1  29.2
  
 
 
 
 

(millions except per share data)

 1Q
 2Q
 3Q
 4Q
 2005

INCOME STATEMENT DATA               
 Brokerage commissions and fees $1,675 $1,664 $1,582 $1,725 $6,646
 Premiums and other  698  718  732  700  2,848
 Investment income  91  74  73  105  343
  
  Total revenue $2,464 $2,456 $2,387 $2,530 $9,837
  
 Income from continuing operations $198 $180 $120 $144 $642
 Discontinued operations  2  11  2  80  95
  
 Net Income $200 $191 $122 $224 $737

PER SHARE DATA               
 Diluted:               
  Income from continuing operations $0.58 $0.54 $0.35 $0.42 $1.89
  Discontinued operations  0.01  0.03  0.01  0.23  0.28
  
  Net income $0.59 $0.57 $0.36 $0.65 $2.17
  
 Basic:               
  Income from continuing operations $0.61 $0.56 $0.36 $0.44 $1.99
  Discontinued operations  0.01  0.03  0.01  0.25  0.29
  
  Net income $0.62 $0.59 $0.37 $0.69 $2.28

COMMON STOCK DATA               
 Dividends paid per share $0.15 $0.15 $0.15 $0.15 $0.60
 Stockholders' equity per share  16.19  16.49  16.65  16.51  16.51
 Price range  25.44-21.35  26.10-20.65  32.87-24.90  37.14-30.62  37.14-20.65
 Shares outstanding  317.8  318.5  320.0  321.2  321.2
 Average monthly trading volume  24.5  25.6  25.7  27.7  25.9

(millions except per share data)
 1Q
 2Q
 3Q
 4Q(1)
 2004

INCOME STATEMENT DATA               
 Brokerage commissions and fees $1,739 $1,691 $1,601 $1,791 $6,822
 Premiums and other  692  716  693  687  2,788
 Investment income  80  69  50  122  321
  
  Total revenue $2,511 $2,476 $2,344 $2,600 $9,931
  
 Income from continuing operations $193 $167 $112 $73 $545
 Discontinued operations  (23) 6  10  8  1
  
 Net Income $170 $173 $122 $81 $546

PER SHARE DATA               
 Diluted:               
  Income from continuing operations $0.58 $0.50 $0.33 $0.22 $1.63
  Discontinued operations  (0.07) 0.02  0.03  0.02  
  
  Net income $0.51 $0.52 $0.36 $0.24 $1.63

 Basic:               
  Income from continuing operations $0.60 $0.52 $0.35 $0.23 $1.70
  Discontinued operations  (0.07) 0.02  0.03  0.02  
  
  Net income $0.53 $0.54 $0.38 $0.25 $1.70
  

COMMON STOCK DATA               
 Dividends paid per share $0.15 $0.15 $0.15 $0.15 $0.60
 Stockholders' equity per share  14.77  14.94  15.38  16.11  16.11
 Price range  29.10-23.47  29.04-25.15  29.40-24.46  29.05-18.17  29.40-18.17
 Shares outstanding  315.1  315.8  316.5  316.8  316.8
 Average monthly trading volume  18.6  21.9  17.0  46.0  25.9

(1)
InIncludes $140 million after-tax charge for settlements with the first quarter of 2002, Aon adopted FASB Statement No. 142, GoodwillNew York Attorney General and Other Intangible Assets, effective January 1, 2002. Beginning in 2002, amortization of goodwill is no longer included in net income. (See note 2other regulatory authorities and for costs to settle the consolidated financial statements)Daniel class action lawsuit.

 
 1Q
 2Q
 3Q
 4Q
 2001
 
 (millions except common stock and per share data)

INCOME STATEMENT DATA               
 Brokerage commissions and fees $1,281 $1,347 $1,297 $1,511 $5,436
 Premiums and other  508  492  510  517  2,027
 Investment income  22  78  105  8  213
  
 
 
 
 
  Total revenue $1,811 $1,917 $1,912 $2,036 $7,676
  
 
 
 
 
 Net Income $19 $29 $72 $27 $147
  
 
 
 
 
DILUTIVE PER SHARE DATA $0.07 $0.11 $0.26 $0.10 $0.53

BASIC NET INCOME PER SHARE

 

$

0.07

 

$

0.11

 

$

0.26

 

$

0.10

 

$

0.54
  
 
 
 
 
COMMON STOCK DATA               
 Dividends paid per share $0.22 $0.225 $0.225 $0.225 $0.895
 Stockholders' equity per share  12.84  13.02  13.47  12.82  12.82
 Price range  38.18-30.81  36.50-29.75  42-33.26  44.80-32.50  44.80-29.75
 Shares outstanding (in millions)  261.9  266.5  269.2  270.2  270.2
 Average monthly trading volume (in millions)  17.6  21.4  20.4  24.4  21.0

106



SCHEDULE I


Aon Corporation
(Parent Company)
CONDENSED STATEMENTS OF FINANCIAL POSITION



 December 31
 
 As of December 31
 

 2002
 2001
 
(millions)

(millions)

 2005
 2004
 


 (millions)

 

 

 

 

 

 
ASSETSASSETS     ASSETS     
Investments in subsidiaries $6,499 $6,552 Investments in subsidiaries $6,742 $7,304 
Other investments 20 20 Other investments 135 111 
Notes receivable—subsidiaries 223 58 Notes receivable — subsidiaries 23 59 
Cash and cash equivalents 130 4 Cash and cash equivalents 837 248 
Other assets 123 39 Other assets 192 220 
 
 
   
 
 
 Total Assets $6,995 $6,673  Total Assets $7,929 $7,942 
 
 
   
 
 

LIABILITIES AND STOCKHOLDERS' EQUITY

LIABILITIES AND STOCKHOLDERS' EQUITY

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS' EQUITY

 

 

 

 

 
LIABILITIES     
LIABILITIES

 

 

 

 

 
Short-term borrowings $1 $254 Subordinated debt $726 $726 
6.3% long-term debt securities 89 100 Notes payable — subsidiaries 703 721 
7.4% long-term debt securities  100 3.5% long-term debt securities 297 297 
8.65% long-term debt securities 250 250 6.2% long-term debt securities 250 250 
6.9% long-term debt securities 216 250 7.375% long-term debt securities 224 223 
6.7% long-term debt securities 150 150 8.65% long-term debt securities  250 
6.2% long-term debt securities 250 250 Accrued expenses and other liabilities 426 322 
3.5% long-term debt securities 296    
 
 
7.375% long-term debt securities 223   Total Liabilities 2,626 2,789 
Floating rate long-term debt securities 150 150   
 
 

Redeemable Preferred Stock

Redeemable Preferred Stock

 


 

50

 

STOCKHOLDERS' EQUITY

STOCKHOLDERS' EQUITY

 

 

 

 

 
Common stockCommon stock 344 339 
Subordinated debt 702 800 Paid-in additional capital 2,349 2,197 
Notes payable—subsidiaries 526 595 Accumulated other comprehensive loss (1,155) (681)
Notes payable—other  70 Retained earnings 4,573 4,031 
Accrued expenses and other liabilities 197 189 Less treasury stock at cost (808) (783)
 
 
   
 
 
 Total Liabilities 3,050 3,158  Total Stockholders' Equity 5,303 5,103 
 
 
   
 
 

Redeemable Preferred Stock

 

50

 

50

 
 Total Liabilities and Stockholders' Equity $7,929 $7,942 

STOCKHOLDERS' EQUITY

 

 

 

 

 
 
 
 
Common stock 333 293 
Paid-in additional capital 2,228 1,654 
Accumulated other comprehensive loss (954) (535)
Retained earnings 3,251 3,021 
Less treasury stock at cost (794) (786)
Less deferred compensation (169) (182)
 
 
 
 Total Stockholders' Equity 3,895 3,465 
 
 
 
 Total Liabilities and Stockholders' Equity $6,995 $6,673 
 
 
 

See notes to condensed financial statements.

107



SCHEDULE I
(Continued)

Aon Corporation
(Parent Company)
CONDENSED STATEMENTS OF INCOME



 Years Ended December 31

 Years Ended December 31

 2002
 2001
 2000

 (millions)

(millions)

(millions)

 2005
 2004
 2003
REVENUEREVENUE      REVENUE      
Dividends from subsidiaries $288 $333 $379Dividends from subsidiaries $915 $320 $278
Other investment income 68 1 9Other investment income 21 20 18
 
 
 
 
 
 
 Total Revenue 356 334 388 Total Revenue 936 340 296
 
 
 
 
 
 

EXPENSES

EXPENSES

 

 

 

 

 

 

EXPENSES

 

 

 

 

 

 
Operating and administrative 14 14 22Operating and administrative 12 1 3
Interest—subsidiaries 81 93 103Interest — subsidiaries 26 19 71
Interest—other 99 107 122Interest — other 111 130 90
 
 
 
 
 
 
 Total Expenses 194 214 247 Total Expenses 149 150 164
 
 
 
 
 
 

INCOME BEFORE INCOME TAXES AND EQUITY (DEFICIT) IN UNDISTRIBUTED INCOME OF SUBSIDIARIES

 

162

 

120

 

141

INCOME BEFORE INCOME TAXES AND EQUITY IN

INCOME BEFORE INCOME TAXES AND EQUITY IN

 

 

 

 

 

 

 
Income tax benefit 50 85 95UNDISTRIBUTED INCOME OF SUBSIDIARIES 787 190 132
 
 
 
 Income tax benefit 51 52 58
 212 205 236  
 
 

EQUITY (DEFICIT) IN UNDISTRIBUTED INCOME OF SUBSIDIARIES

 

254

 

(58

)

 

238
 838 242 190

EQUITY IN UNDISTRIBUTED INCOME OF SUBSIDIARIES

EQUITY IN UNDISTRIBUTED INCOME OF SUBSIDIARIES

 

(101

)

 

304

 

438
 
 
 
 
 
 
NET INCOME $466 $147 $474 NET INCOME $737 $546 $628
 
 
 
 
 
 

See notes to condensed financial statements.

108



SCHEDULE I
(Continued)


Aon Corporation
(Parent Company)
CONDENSED STATEMENTS OF CASH FLOWS



 Years Ended December 31
 
 Years Ended December 31
 

 2002
 2001
 2000
 

 (millions)

 
(millions)

(millions)

 2005
 2004
 2003
 
Cash Flows From Operating ActivitiesCash Flows From Operating Activities $193 $170 $137 
Cash Flows From Operating Activities

 

$

929

 

$

185

 

$

220

 

Cash Flows From Investing Activities:

Cash Flows From Investing Activities:

 

 

 

 

 

 

 

Cash Flows From Investing Activities:

 

 

 

 

 

 

 
Investments in subsidiaries (17) (24) (124)Investments in subsidiaries 93 151 208 
Other investments  (20)  Other investments (5) (6) 32 
Notes receivables from subsidiaries (200) 60 (40)Notes receivables from subsidiaries 39 306 (97)
 
 
 
   
 
 
 
 Cash Provided (Used) by Investing Activities (217) 16 (164) Cash Provided by Investing Activities 127 451 143 
 
 
 
   
 
 
 

Cash Flows From Financing Activities:

Cash Flows From Financing Activities:

 

 

 

 

 

 

 

Cash Flows From Financing Activities:

 

 

 

 

 

 

 
Treasury stock transactions—net (10) 49 (59)Treasury stock transactions — net (25)  (6)
Issuance of common stock 607   Issuance of common stock 76 23  
Retirement of preferred stock—net (87)   Redemption of preferred stock (50)   
Issuance (repayment) of short-term borrowings—net (253) (599) 30 Repayment of notes payable and long-term debt (250) (305) (299)
Repayment of notes payable and long-term debt (393)   Notes payable to subsidiaries (25) (42) 130 
Issuance of notes payable and long-term debt 519 608 266 Cash dividends to stockholders (193) (192) (190)
Cash dividends to stockholders (233) (241) (226)  
 
 
 
 
 
 
  Cash Used by Financing Activities (467) (516) (365)
 Cash Provided (Used) by Financing Activities 150 (183) 11   
 
 
 
 
 
 
 

Increase (Decrease) in Cash and Cash Equivalents

Increase (Decrease) in Cash and Cash Equivalents

 

126

 

3

 

(16

)

Increase (Decrease) in Cash and Cash Equivalents

 

589

 

120

 

(2

)
Cash and Cash Equivalents at Beginning of YearCash and Cash Equivalents at Beginning of Year 4 1 17 Cash and Cash Equivalents at Beginning of Year 248 128 130 
 
 
 
   
 
 
 
Cash and Cash Equivalents at End of YearCash and Cash Equivalents at End of Year $130 $4 $1 Cash and Cash Equivalents at End of Year $837 $248 $128 
 
 
 
   
 
 
 

See notes to condensed financial statements.

109



SCHEDULE I
(Continued)

Aon Corporation
(Parent Company)
NOTES TO CONDENSED FINANCIAL STATEMENTS

(1)
See notes to consolidated financial statements included in Item 15(a).

(2)
In 2001, the Condensed Statements of Cash Flows exclude the impact of certain non-cash transfers primarily related to notes receivable from subsidiaries and notes payable to subsidiaries.
(3)
During 2001, Aon reclassified $520 million of notes receivable—subsidiaries to investments in subsidiaries related to its shared services operations.
(4)
Investments in subsidiaries include approximately $2.6$2.7 billion invested in countries outside of the United States,U.S., primarily denominated in the British Pound, the Euro, the Canadian dollar and the Australian dollar.

(5)(3)
Guarantees and Indemnifications

    Aon provides a variety of guarantees and indemnifications to its customers and others to allow Aon or others to complete a wide variety of business transactions. The maximum potential amount of future payments representrepresents the notional amounts that could become payable under the guarantees and indemnifications if there were a total default by the guaranteed parties, without consideration of possible recoveries under recourse provisions or other methods. These amounts may bear no relationship to the expected future payments, if any, for these guarantees and indemnifications. Aon does not currently anticipate making future payments to any of its subsidiaries, or third parties on behalf of its subsidiaries, for these guarantees and indemnifications.

            One of Aon's insurance underwriting subsidiaries holds a $95 million demand note receivable from another Aon subsidiary as of December 31, 2002. Aon has guaranteed the repayment of this note in the event that the obligated subsidiary is unable to make the principal payment, in whole or in part, when contractually due.

            Aon has unconditionally guaranteed the obligations of certain of its operating subsidiaries with respect to specific noncancelable operating leases. At December 31, 2002, future minimum payments (excluding sublease income) under these leases were approximately $95 million. These amounts are included in lease commitments, which are reflected in note 8 to the consolidated financial statements.

            Aon has provided indemnification under surety bonds issued by third parties of approximately $170 million as of December 31, 2002. These license, performance and other types of surety bonds are issued to permit operating subsidiaries of Aon to conduct business in various jurisdictions and to indemnify third parties for nonperformance by these subsidiaries.

    A bank provides overdraft facilities for certain of Aon's foreign subsidiaries. Aon has guaranteed repayment of this facilitythese facilities in the unlikely event that the foreign subsidiaries are unable to repay. Aon has also issued guarantees and/or other letters of support for various bank lines and various other credit facilities for certain of its foreign operations (including the Euro credit facility discussed in noteNote 8 to the consolidated financial statements). Aon's maximum potential liability with regard to these exposures was $160$581 million at December 31, 2002.2005.

    Aon has guaranteeda liability for its commitment to contribute $6 million to the contractual performanceAon Memorial Education Fund to support the educational needs of certain subsidiaries for third-party outsourcing agreements, which extend through 2009. However, in no case can the cumulative amountchildren of these guarantees exceed $50 million.Aon employees who were victims of the September 11, 2001 attacks.

            Aon has guaranteed the contractual performance of certain subsidiaries for other agreements, which extend no later than June 30, 2003. Aon does not expect to incur any additional expenses or liabilities as a result of these guarantees. The notional amounts involved are $130 million.

    Aon has guaranteed the obligations of one of its major Netherlands' subsidiaries through 2007. Management believes there is sufficient operating cash flow, liquidity and equity at this subsidiary to cover current obligations and future obligations as they come due.

    Aon has issued various other guarantees for miscellaneous purposes at its international subsidiaries for $4 million.

    Aon expects that as prudent business interests dictate, additional guarantees and indemnifications may be issued from time to time.

    110




SCHEDULE II


Aon CORPORATIONCorporation and Subsidiaries
VALUATION AND QUALIFYING ACCOUNTS
Years Ended December 31, 2002, 2001,2005, 2004, and 2000
2003

 
  
 Additions
  
  
Description

 Balance at beginning of year
 Charged to cost and expenses
 Charged/(credited) to other accounts
 Deductions(1)
 Balance at end of year
 
 (millions)

Year ended December 31, 2002               
 Allowance for doubtful accounts(2) (deducted from insurance brokerage and consulting receivables) $93 $23 $2 $(39)$79
 Allowance for doubtful accounts (deducted from premiums and other)  94  7    (3) 98

Year ended December 31, 2001

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
 Allowance for doubtful accounts(2) (deducted from insurance brokerage and consulting receivables) $88 $30 $(2)$(23)$93
 Allowance for doubtful accounts (deducted from premiums and other)  4  90      94

Year ended December 31, 2000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
 Allowance for doubtful accounts(2) (deducted from insurance brokerage and consulting receivables) $88 $19 $(2)$(17)$88
 Allowance for doubtful accounts (deducted from premiums and other)  6      (2) 4
 
  
 Additions
  
  
Description

 Balance at
beginning
of year

 Charged to
cost and
expenses

 Charged/
(credited)
to other
accounts (2)

 Deductions
(1)

 Balance
at end
of year

 
 (millions)

Year ended December 31, 2005               

Allowance for doubtful accounts
(deducted from insurance brokerage
and consulting receivables) (3)

 

$

92

 

$

17

 

$

(8

)

$

(16

)

$

85

Allowance for doubtful accounts
(deducted from premiums and other)(4)

 

 

94

 

 

2

 

 


 

 

(92

)

 

4

Year ended December 31, 2004

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for doubtful accounts
(deducted from insurance brokerage and consulting receivables) (3)

 

$

83

 

$

29

 

$

1

 

$

(21

)

$

92

Allowance for doubtful accounts
(deducted from premiums and other)

 

 

99

 

 

1

 

 


 

 

(6

)

 

94

Year ended December 31, 2003

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for doubtful accounts
(deducted from insurance brokerage and consulting receivables) (3)

 

$

74

 

$

42

 

$

8

 

$

(41

)

$

83

Allowance for doubtful accounts
(deducted from premiums and other)

 

 

98

 

 

2

 

 


 

 

(1

)

 

99

(1)
Amounts deemed to be uncollectible.

(2)
Amounts shown in additions charged/(credited) to other accounts primarily represent reserveschanges due to foreign exchange.

(3)
Amounts for all years have been restated to reflect the transfer of the assets of Swett & Crawford to assets held-for-sale.

(4)
Deduction principally represents write-off of uncollectible reinsurance receivable related to acquired business and foreign exchange.the World Trade Center, which was previously fully reserved.

111




SCHEDULE II.1


Aon Corporation and Subsidiaries
CONSOLIDATED SUMMARY OF INVESTMENTS—
OTHER THAN INVESTMENTS IN RELATED PARTIES
AS OF DECEMBER 31, 2002
2005



 Amortized
Cost or Cost

 Fair
Value

 Amount Shown
in Statement
of Financial
Position

 
 Amortized
Cost or Cost

 Fair
Value

 Amount Shown
in Statement
of Financial
Position


 (millions)

 
Fixed maturities—available for sale:       
(millions)

(millions)

  
Fixed maturities — available for sale:Fixed maturities — available for sale:      
U.S. government and agencies $378 $385 $385 U.S. government and agencies $439 $433 $433
States and political subdivisions 4 5 5 States and political subdivisions 111 110 110
Debt securities of foreign governments not classified as loans 564 573 573 Debt securities of foreign governments not classified as loans 1,842 1,832 1,832
Corporate securities 1,082 1,064 1,064 Corporate securities 1,355 1,339 1,339
Public utilities 58 56 56 Public utilities 87 86 86
Mortgage-backed securities 7 6 6 Mortgage-backed and asset-backed securities 423 418 418
 
 
 
   
 
 
 Total fixed maturities 2,093 2,089 2,089  Total fixed maturities 4,257 4,218 4,218
 
 
 
   
 
 
Equity securities—available for sale:       
Equity securities — available for sale:Equity securities — available for sale:      
Common stocks:       Common stocks:      
 Banks, trusts and insurance companies 3 3 3  Public utilities 1 1 1
 Industrial, miscellaneous and all other 37 42 42  Industrial, miscellaneous and all other 39 38 38
Non-redeemable preferred stocks 19 17 17 Non-redeemable preferred stocks 1 1 1
 
 
 
   
 
 
 Total equity securities 59 62 62  Total equity securities 41 40 40
 
 
 
   
 
 
Mortgage loans on real estate 2*   2*
Other Investments:Other Investments:      
Policy loansPolicy loans 50*   50*Policy loans 59   59
Other long-term investments(1)Other long-term investments(1) 548*   548*Other long-term investments(1)      
Endurance warrants    90
PEPS I preferred stock 61   187
Other 178   179
 
   
 Total other long-term investments 239   456
 
   
 Total other investments 298   515
Short-term investmentsShort-term investments 3,836   3,836 Short-term investments 4,292   4,291
 
   
   
   
 TOTAL INVESTMENTS $6,588   $6,587  TOTAL INVESTMENTS $8,888   $9,064
 
   
   
   

*(1)
These investment categories are combinedCost for investments accounted for on the equity method represents original cost adjusted for equity method earnings and are shown as other investments in the Statement of Financial Position.other-than-temporary impairment losses, if any.

112




SCHEDULE II.2

Aon Corporation and Subsidiaries
REINSURANCE

 
 Year Ended December 31, 2005
 
(millions)

 Gross
amount

 Ceded to
other
companies

 Assumed
from other
companies

 Net
amount

 Percentage of
amount
assumed to net

 
Life insurance in force $17,182 $14,149 $4,929 $7,962 62%
  
 
 
 
 
 
Premiums               
 Life Insurance $221 $66 $14 $169 8%
 A&H Insurance  1,870  265  72  1,677 4%
 Specialty Property & Casualty Insurance, including Warranty  1,655  775  122  1,002 12%
  
 
 
 
 
 
  Total premiums $3,746 $1,106 $208 $2,848 7%
  
 
 
 
 
 

 


 

Year Ended December 31, 2004


 
(millions)

 Gross
amount

 Ceded to
other
companies

 Assumed
from other
companies

 Net amount
 Percentage of
amount
assumed to net

 
Life insurance in force $20,529 $15,873 $5,208 $9,864 53%
  
 
 
 
 
 
Premiums               
 Life Insurance $219 $114 $45 $150 30%
 A&H Insurance  1,873  376  154  1,651 9%
 Specialty Property & Casualty Insurance, including Warranty  1,739  889  137  987 14%
  
 
 
 
 
 
  Total premiums $3,831 $1,379 $336 $2,788 12%
  
 
 
 
 
 

 


 

Year Ended December 31, 2003


 
(millions)

 Gross
amount

 Ceded to
other
companies

 Assumed
from other
companies

 Net amount
 Percentage of
amount
assumed to net

 
Life insurance in force $19,310 $17,861 $7,474 $8,923 84%
  
 
 
 
 
 
Premiums               
 Life Insurance $219 $87 $26 $158 16%
 A&H Insurance  1,754  394  162  1,522 11%
 Specialty Property & Casualty Insurance, including Warranty  1,471  780  178  869 20%
  
 
 
 
 
 
  Total premiums $3,444 $1,261 $366 $2,549 14%
  
 
 
 
 
 

SCHEDULE II.3

Aon Corporation and Subsidiaries

REINSURANCE

 
 Year Ended December 31, 2002
 
 
 Gross amount
 Ceded to
other
companies

 Assumed
from other
companies

 Net amount
 Percentage of
amount
assumed to net

 
 
 (millions)

 
Life insurance in force $19,401 $20,803 $8,735 $7,333 119%
  
 
 
 
 
 
Premiums               
 Life Insurance $257 $133 $48 $172 28%
 A&H Insurance  1,574  377  259  1,456 18%
 Specialty Property & Casualty, including Warranty  1,226  680  186  732 25%
  
 
 
 
 
 
  Total premiums $3,057 $1,190 $493 $2,360 21%
  
 
 
 
 
 

 


 

Year Ended December 31, 2001


 
 
 Gross amount
 Ceded to
other
companies

 Assumed
from other
companies

 Net amount
 Percentage of
amount
assumed to net

 
 
 (millions)

 
Life insurance in force $20,265 $13,660 $11,189 $17,794 63%
  
 
 
 
 
 
Premiums               
 Life Insurance $198 $110 $76 $164 46%
 A&H Insurance  1,293  329  222  1,186 19%
 Specialty Property & Casualty, including Warranty  1,061  482  93  672 14%
  
 
 
 
 
 
  Total premiums $2,552 $921 $391 $2,022 19%
  
 
 
 
 
 

 


 

Year Ended December 31, 2000


 
 
 Gross amount
 Ceded to
other
companies

 Assumed
from other
companies

 Net amount
 Percentage of
amount
assumed to net

 
 
 (millions)

 
Life insurance in force $18,803 $9,442 $9,367 $18,728 50%
  
 
 
 
 
 
Premiums               
 Life Insurance $198 $156 $102 $144 71%
 A&H Insurance  1,209  309  189  1,089 17%
 Specialty Property & Casualty, including Warranty  965  380  88  673 13%
  
 
 
 
 
 
  Total premiums $2,372 $845 $379 $1,906 20%
  
 
 
 
 
 

113


SCHEDULE II.3

Aon Corporation and Subsidiaries

SUPPLEMENTARY INSURANCE INFORMATION

 
 Deferred
policy
acquisition
costs

 Future policy
benefits,
losses, claims
and loss
expenses

 Unearned
premiums
and other
policyholders'
funds

 Premium
revenue

 Net
investment
income(1)

 Commissions,
fees and other

 Benefits,
claims, losses
and
settlement
expenses

 Amortization
of deferred
policy
acquisition
costs(2)

 Other
operating
expenses(2)

 Premiums
written(3)

 
 (millions)

Year ended December 31, 2002                              
 Insurance brokerage and other services $ $ $ $ $113 $5,150 $ $31 $4,469 $
 Consulting          2  1,052      934  
 Insurance underwriting  882  2,561  2,749  2,360  158  8  1,375  275  724  2,511
 Corporate and other          (21)       221  
  
 
 
 
 
 
 
 
 
 
  Total $882 $2,561 $2,749 $2,360 $252 $6,210 $1,375 $306 $6,348 $2,511
  
 
 
 
 
 
 
 
 
 
Year ended December 31, 2001                              
 Insurance brokerage and other services $ $ $ $ $156 $4,503 $ $38 $4,097 $
 Consulting          5  933      812  
 Insurance underwriting  704  1,963  3,027  2,022  223  5  1,111  231  758  1,966
 Corporate and other          (171)       320  
  
 
 
 
 
 
 
 
 
 
  Total $704 $1,963 $3,027 $2,022 $213 $5,441 $1,111 $269 $5,987 $1,966
  
 
 
 
 
 
 
 
 
 
Year ended December 31, 2000                              
 Insurance brokerage and other services $ $ $ $ $186 $4,181 $ $40 $3,637 $
 Consulting          6  764      664  
 Insurance underwriting  656  1,855  3,122  1,906  245  16  1,037  218  612  1,887
 Corporate and other          71        313  
  
 
 
 
 
 
 
 
 
 
  Total $656 $1,855 $3,122 $1,906 $508 $4,961 $1,037 $258 $5,226 $1,887
  
 
 
 
 
 
 
 
 
 
(millions)

 Deferred
policy
acquisition
costs

 Future policy
benefits,
losses, claims
and loss
expenses

 Unearned
premiums and
other
policyholders'
funds

 Premium
revenue

 Net
investment
income
(1)(2)

 Commissions,
fees and other
(2)

 Benefits,
claims, losses
and settlement
expenses

 Amortization
of deferred
policy
acquisition
costs (2)

 Other
operating
expenses
(2)

 Premiums
written (3)

 
 
Year ended December 31, 2005                              
 
Risk and insurance brokerage services

 

$


 

$


 

$


 

$


 

$

129

 

$

5,271

 

$


 

$


 

$

4,681

 

$

 Consulting          4  1,251      1,145  
 Insurance underwriting  1,186  3,498  3,009  2,848  154  186  1,551  433  890  2,764
 Corporate and other          56        234  
 Intersegment elimination            (62)     (62) 
  
 
 
 
 
 
 
 
 
 
   Total $1,186 $3,498 $3,009 $2,848 $343 $6,646 $1,551 $433 $6,888 $2,764
  
 
 
 
 
 
 
 
 
 

Year ended December 31, 2004

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
 
Risk and insurance brokerage services

 

$


 

$


 

$


 

$


 

$

80

 

$

5,417

 

$


 

$


 

$

4,921

 

$

 Consulting          3  1,244      1,142  
 Insurance underwriting  1,137  3,396  2,997  2,788  129  233  1,516  437  943  2,806
 Corporate and other          109        217  
 Intersegment elimination            (72)     (72) 
  
 
 
 
 
 
 
 
 
 
   Total $1,137 $3,396 $2,997 $2,788 $321 $6,822 $1,516 $437 $7,151 $2,806
  
 
 
 
 
 
 
 
 
 

Year ended December 31, 2003

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
 
Risk and insurance brokerage services

 

$


 

$


 

$


 

$


 

$

68

 

$

5,271

 

$


 

$


 

$

4,548

 

$

 Consulting          2  1,183      1,075  
 Insurance underwriting  1,021  3,005  2,927  2,549  115  219  1,427  399  861  2,667
 Corporate and other          125        148  
 Intersegment elimination            (68)     (68) 
  
 
 
 
 
 
 
 
 
 
   Total $1,021 $3,005 $2,927 $2,549 $310 $6,605 $1,427 $399 $6,564 $2,667
  
 
 
 
 
 
 
 
 
 

(1)
The above results reflect allocations of investment income and certain expense elements considered reasonable under the circumstances. Results include income (loss) on disposals of investments and other than temporaryother-than-temporary impairments.

(2)
Certain amounts in prior years' amortization of deferred policy acquisition costs and other operating expensesamounts have been reclassified to conform to the 20022005 presentation.

(3)
Net of reinsurance ceded.

114




Item 9.    Changes in and Disagreements withWith Accountants on Accounting and Financial Disclosure.

        Not Applicable.


PART III

Item 10. Directors and Executive Officers of the Registrant.

        The Registrant hereby incorporates by reference the information under the heading "Election of Directors" of the Registrant's Proxy Statement for the Annual Meeting of Stockholders on May 16, 2003 ("Proxy Statement") and 2002 Report of Financial and General Information. Information concerning additional executive officers of the Registrant is contained in Part I hereof, pursuant to General Instruction G(3) and Instruction 3 to Item 401(b) of Regulation S-K. The Registrant also hereby incorporates by reference the information under the heading "Compensation of the Board of Directors" of the Proxy Statement.


Item 11. Executive Compensation.

        The Registrant hereby incorporates by reference the information under the headings "Executive Compensation," "Aggregated Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values," "Option Grants in 2002 Fiscal Year" and "Pension Plan Table" of the Proxy Statement.


Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

        Our shareholders approved the Aon Stock Incentive Plan in 2001. This plan is designed to further align our directors', management's and key employees' interests with the company's long-term performance and the long-term interests of our shareholders.

        The following table summarizes the number of shares of our common stock that may be issued under our equity compensation plans as of December 31, 2002.

Plan Category

 Number of Securities
to be Issued Upon
Exercise of
Outstanding Options,
Options, Warrants,
and Rights

 Weighted Average
Exercise Price of
Outstanding
Options, Warrants,
and Rights

 Number of Securities
Remaining Available
for Future Issuance
(Excluding Securities
Reflected in the First
Column)

Equity compensation plans approved by security holders(1) 34,767,035 $32.45(2)27,615,210
Equity compensation plans not approved by security holders(3,5,6) 1,762,505 £23.10(4)
Total 36,529,540    27,615,210

(1)
Aon Stock Incentive Plan
The total number of shares of stock authorized for issuance in connection with awards under the Aon Stock Incentive Plan and any pre-existing plans is 18% of total outstanding common shares; securities remaining available for future issuance includes other equity plans.

(2)
Indicates weighted average exercise price of 24,478,100 outstanding options under the Aon Stock Incentive Plan.

(3)
Aon UK Sharesave Scheme
The Aon UK Sharesave Scheme (the "UK Scheme") is available solely to employees in the United Kingdom. Under the UK Scheme, employees authorize Aon to deduct a specified amount from compensation each pay period for deposit into a savings account for a three-year term. If a

115


(4)
As of December 31, 2002, 36 individuals held options granted under the UK Scheme for a total of 6,360 shares of Aon common stock at an option price of £23.10.

(5)
Aon Supplemental Savings Plan
The Aon Supplemental Savings Plan (the "ASSP") was adopted by the board of directors in 1998. It is a nonqualified supplemental retirement plan that provides benefits to participants in the Aon Savings Plan whose employer matching contributions are limited because of IRS-imposed restrictions. Under the ASSP, participants are credited with the additional matching contributions they would have received under the Aon Savings Plan—100% of the first 1% to 3% of compensation (the First Tier Match) and 75% of the next 4% to 6% of compensation (the Second Tier Match)—had compensation up to $500,000 been considered. Participants in the ASSP may elect to have Tier I allocations credited to their accounts as if invested in a money market account or as if invested in Aon common stock. Tier II allocations are maintained in an Aon common stock account unless the participant is age 55 or more. If so, the participant may elect to direct his or her allocation to the money market account. Amounts maintained in the Aon common stock account may not be moved to the money market account, regardless of the participant's age. Before the beginning of each plan year, an election may be made by any participant to transfer some or all of a participant's money market account to the Aon common stock account. All amounts credited to the Aon common stock account are credited with dividends.
(6)
Aon Supplemental Employee Stock Ownership Plan
The Aon Supplemental Employee Stock Ownership Plan was a plan established in 1989 as a nonqualified supplemental retirement plan that provided benefits to participants in the Aon Employee Stock Ownership Plan whose employer contributions were limited because of IRS-imposed restrictions. As of 1998, no additional amounts have been credited to participant accounts, although account balances are maintained for participants, and credited with dividends, until distribution is required under the plan. Distributions are made solely in Aon common stock.

        No specific authorization of shares of Aon common stock for the plan has been made.

        The Registrant hereby incorporates by reference the share ownership data contained under the headings "Voting Securities and Principal Holders Thereof" and "Ownership of Common Shares" of the Proxy Statement.

116




Item 13. Certain Relationships and Related Transactions.

        The Registrant hereby incorporates by reference the information under the heading "Certain Relationships and Related Transactions" of the Proxy Statement.


Item 14.9A.    Controls and Procedures.

Disclosure Controls and Procedures

        The Registrant has established disclosure controls and procedures to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to the officers who certify the Registrant's financial reports and to other members of senior management and the Board of Directors.

        Based on their evaluation as of a date within 90 days of the filing date of this Annual Report on Form 10-K,December 31, 2005, the principal executive officer and principal financial officer of the Registrant have concluded that the Registrant's disclosure controls and procedures (as defined in Rules 13a-14(c)13a-15(e) and 15d-14(c)15d-15(e) under the Securities Exchange Act of 1934) are effective to ensure that the information required to be disclosed by the Registrant in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the SecuritiesSEC rules and Exchange Commission.forms.

        There were no significant changes in the Registrant's internal controls or in other factors that could significantly affect those controls subsequent to the date of their most recent evaluation.

Internal Control Over Financial Reporting

        Information regarding the Registrant's Internal Control Over Financial Reporting is set forth in Part II, Item 8 of this Report and is incorporated by reference herein.


Item 9B.    Other Information.

        Not applicable.



PART III

Item 10.    Directors and Executive Officers of the Registrant.

        Information relating to Aon's directors, including members of the audit committee and Aon's audit committee financial expert, is set forth under the heading "Election of Directors" in our Proxy Statement for the 2006 Annual Meeting of Stockholders to be held on May 19, 2006 (the "Proxy Statement") and is incorporated herein by reference from the Proxy Statement. Information concerning Aon's executive officers is contained in Part I hereof, pursuant to General Instruction G(3) and Instruction 3 to Item 401(b) of Regulation S-K. Also incorporated herein by reference is the information under the heading "Board of Directors — Corporate Governance — Audit Committee Financial Expert," the information under the heading "Board of Directors — Committees and Meetings — Audit Committee" and the information under the heading "Board of Directors — Corporate Governance — Code of Ethics" in the Proxy Statement. Information relating to compliance with Section 16(a) of the Securities Exchange Act of 1934, as amended, is incorporated by reference from the discussion under the heading "Section 16(a) Beneficial Ownership Reporting Compliance" in the Proxy Statement.


Item 11.    Executive Compensation.

        Information relating to director and executive officer compensation is set forth under the headings "Compensation of the Board of Directors," "Executive Compensation," "Summary Compensation Table," "Option Grants in 2005 Fiscal Year," "Aggregated Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values," "Pension Plan Tables," and "Employment and Severance Agreements" of the Proxy Statement and all such information is incorporated herein by reference from the Proxy Statement.


Item 12.    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

        Information relating to securities authorized for issuance under equity compensation plans is set forth under the heading "Equity Compensation Plan Information" in the Proxy Statement and is hereby incorporated by reference.

        Information relating to the security ownership of certain beneficial owners of Aon's common stock is set forth under the headings "Principal Holders of Voting Securities" and "Security Ownership of Certain Beneficial Owners and Management" in the Proxy Statement and all such information is incorporated herein by reference.


Item 13.    Certain Relationships and Related Transactions.

        Aon hereby incorporates by reference the information under the heading "Certain Relationships and Related Transactions" in the Proxy Statement.


Item 14.    Principal Accountant Fees and Services.

        Information required by this Item is included under the caption "Agenda Item No. 2 — Ratification of Appointment of Independent Registered Public Accounting Firm" in the Proxy Statement and is hereby incorporated by reference.



PART IV

Item 15.    Exhibits and Financial Statement Schedules and Reports on Form 8-K.Schedules.

(a)(1) and (2).The following documents have been included in Part II, Item 8.

Report of Ernst & Young LLP, Independent Auditors
Report by Management
Consolidated Statements of Financial Position—As of December 31, 2002 and 2001
Consolidated Statements of Income—Years Ended December 31, 2002, 2001 and 2000
Consolidated Statements of Cash Flows—Years Ended December 31, 2002, 2001 and 2000
Consolidated Statements of Stockholders' Equity—Years Ended December 31, 2002, 2001 and 2000
Notes to Consolidated Financial Statements
Quarterly Financial Data

        Financial statement schedules of the Registrant and consolidated subsidiaries filed herewith:

 
 Schedule
Condensed Financial Information of Registrant I
Valuation and Qualifying Accounts II

        All other schedules for the Registrant and consolidated subsidiaries have been omitted because the required information is not present in amounts sufficient to require submission of the schedules or because the information required is included in the respective financial statements or notes thereto.

        The following supplementary schedules have been provided for the Registrant and consolidated subsidiaries as they relate to the insurance underwriting operations:

 
 Schedule
Summary of Investments Other than Investments in Related Parties II.1
Reinsurance II.2
Supplementary Insurance Information II.3

(a)(3).    List of Exhibits (numbered in accordance with Item 601 of Regulation S-K)

 3(a)* Second Restated Certificate of Incorporation of the Registrant—incorporated by reference to Exhibit 3(a) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991 (the "1991 Form 10-K").

 

3(b)*

 

Certificate of Amendment of the Registrant's Second Restated Certificate of Incorporation—incorporated by reference to Exhibit 3 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1994 (the "First Quarter 1994 Form 10-Q").

 

3(c)*

 

Certificate of Amendment of the Registrant's Second Restated Certificate of Incorporation—incorporated by reference to Exhibit 3 to the Registrant's Current Report on Form 8-K dated May 9, 2000.

 

3(d)*

 

Amended Bylaws of the Registrant—incorporated by reference to Exhibit 3.2 to the Registrant's Current Report on Form 8-K dated September 20, 2002.November 18, 2005.



 


118



4(a)*

 

Indenture dated as of September 15, 1992 between the Registrant and Continental Bank Corporation (now known as Bank of America Illinois), as Trustee—incorporated by reference to Exhibit 4(a) to the Registrant's Current Report on Form 8-K dated September 23, 1992.

 4(b)*


Resolutions establishing the terms of 6.70% Notes due 2003 and 6.30% Notes due 2004—incorporated by reference to Exhibits 4(c) and 4(d) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993 (the "1993 Form 10-K").

  4(c)*


Resolutions establishing the terms of the 6.90% Notes due 2004—incorporated by reference to Exhibit 4(e) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1999 (the "1999 Form 10-K").

  4(d)*


Resolutions establishing the terms of the 8.65% Notes due 2005—incorporated by reference to Exhibit 4(f) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2000.

  4(e)4(b)*

 

Junior Subordinated Indenture dated as of January 13, 1997 between the Registrant and The Bank of New York, as Trustee—incorporated by reference to Exhibit 4.1 to the Registrant's Amendment No. 1 to Registration Statement on Form S-4 (File No. 333-21237) (the "Capital Securities Registration") filed on March 27, 1997.

 4(f)

4(c)*

 

Indenture dated as of December 13, 2001, between the Registrant and The Bank of New York, as Trustee, for the Floating Rate Notes due 2003 and 6.2% Notes due 2007—incorporated by reference to Exhibits 4(g) and 4(h) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2001 (the "2001 Form 10-K").

 4(g)

4(d)*

 

Indenture dated as of December 31, 2001 between Private Equity Partnership Structures I, LLC, as issuer and The Bank of New York, as Trustee, Custodian, Calculation Agent, Note Registrar, Transfer Agent and Paying Agent—incorporated by reference to Exhibit 4(i) to the 2001 Form 10-K.

 4(h)

4(e)*

 

First Supplemental Indenture dated as of January 13, 1997 between the Registrant and The Bank of New York, as Trustee—incorporated by reference to Exhibit 4.2 to the Capital Securities Registration.

 4(i)

4(f)*

 

Certificate of Trust of Aon Capital A—incorporated by reference to Exhibit 4.3 to the Capital Securities Registration.

 4(j)

4(g)*

 

Amended and Restated Trust Agreement of Aon Capital A dated as of January 13, 1997 among the Registrant, as Depositor, The Bank of New York, as Property Trustee, The Bank of New York (Delaware), as Delaware Trustee, the Administrative Trustees named therein and the holders, from time to time, of the Capital Securities—incorporated by reference to Exhibit 4.5 to the Capital Securities Registration.

 4(k)

4(h)*

 

Capital Securities Guarantee Agreement dated as of January 13, 1997 between the Registrant and The Bank of New York, as Guarantee Trustee—incorporated by reference to Exhibit 4.8 to the Capital Securities Registration.

 4(l)

4(i)*

 

Capital Securities Exchange and Registration Rights Agreement dated as of January 13, 1997 among the Registrant, Aon Capital A, Morgan Stanley & Co. Incorporated and Goldman, Sachs & Co.—incorporated by reference to Exhibit 4.10 to the Capital Securities Registration.

 


119



  4(m)4(j)*

 

Debenture Exchange and Registration Rights Agreement dated as of January 13, 1997 among the Registrant, Aon Capital A, Morgan Stanley & Co. Incorporated and Goldman, Sachs & Co.—incorporated by reference to Exhibit 4.11 to the Capital Securities Registration.

 4(n)

4(k)*

 

Guarantee Exchange and Registration Rights Agreement dated as of January 13, 1997 among the Registrant, Aon Capital A, Morgan Stanley & Co. Incorporated and Goldman, Sachs & Co.—incorporated by reference to Exhibit 4.12 to the Capital Securities Registration.

  4(o)*


 

Certificate of Designation for the Registrant's Series C Cumulative Preferred Stock—incorporated by reference to Exhibit 4.1 to the Registrant's Current Report on Form 8-K dated February 9, 1994.

  4(p)4(l)*

 

Registration Rights Agreement dated as of November 2, 1992 by and between the Registrant and Frank B. Hall & Co., Inc.—incorporated by reference to Exhibit 4(c) to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1992.

 4(q)

4(m)*

 

Registration rights agreementRights Agreement dated as of July 15, 1982 by and among the Registrant and certain affiliates of Ryan Insurance Group, Inc. (including Patrick G. Ryan and Andrew J. McKenna)—incorporated by reference to Exhibit (f) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1982.

 4(r)

4(n)*

 

Indenture dated as of November 7, 2002 between the Registrant and The Bank of New York, as Trustee (including form of note)—incorporated by reference to Exhibit 4(a) to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2002 (the "Third Quarter 2002 Form 10-Q").

 4(s)

4(o)*

 

Registration Rights Agreement dated as of November 7, 2002 between the Registrant and Morgan Stanley & Co. Incorporated—incorporated by reference to Exhibit 4(b) to the Third Quarter 2002 Form 10-Q.

 4(t)

4(p)*

 

Indenture dated as of December 16, 2002 between the Registrant and The Bank of New York, as Trustee (including form of note)—incorporated by reference to Exhibit 4(a) to the Registrant's Registration Statement on Form S-4 (File No. 333-103704) filed on March 10, 2003 (the "2003 Form S-4").

 4(u)

4(q)*

 

Registration Rights Agreement dated as of December 16, 2002 between the Registrant and Salomon Smith Barney Inc., Credit Suisse First Boston Corporation, BNY Capital Markets, Inc. and Wachovia Securities, Inc.—incorporated by reference to Exhibit 4(b) to the 2003 Form S-4.


Material contracts:

 

10(a)*#

 

Aon Corporation Outside Director Deferred Compensation Agreement by and among the Registrant and Registrant's directors who are not salaried employees of the Registrant or Registrant's affiliates—incorporated by reference to Exhibit 10(d) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1999.

 

10(b)*#

 

Amendment and Waiver Agreement dated as of November 4, 1991 among the Registrant and each of Patrick G. Ryan, Shirley Ryan, Ryan Enterprises Corporation and Harvey N. Medvin—incorporated by reference to Exhibit 10(j) to the 1991 Form 10-K.

 

10(c)*#

 

Aon Corporation 1994 Amended and Restated Outside Director Stock Award Plan—incorporated by reference to Exhibit 10(b) to the First Quarter 1994 Form 10-Q.

 


120



10(d)*#

 

Aon Stock Award Plan (as amended and restated through February 2000)—incorporated by reference to Exhibit 10(a) to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2000 (the "Second Quarter 2000 Form 10-Q").

 

10(e)*#

 

Aon Stock Option Plan (as amended and restated through 1997)—incorporated by reference to Exhibit 10(a) to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997 (the "First Quarter 1997 Form 10-Q").



 

10(f)*#

 

First Amendment to the Aon Stock Option Plan (as amended and restated through 1997)—incorporated by reference to Exhibit 10(a) to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1999 (the "First Quarter 1999 Form 10-Q").

 

10(g)*#

 

Aon Stock Award Plan (as amended and restated through 1997)—incorporated by reference to Exhibit 10(b) to the First Quarter 1997 Form 10-Q.

 

10(h)*#

 

First Amendment to the Aon Stock Award Plan (as amended and restated through 1997)—incorporated by reference to Exhibit 10(b) to the First Quarter 1999 Form 10-Q.

 

10(i)*#

 

Aon Corporation 1995 Senior Officer Incentive Compensation Plan—incorporated by reference to Exhibit 10(p) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1995 (the "1995 Form 10-K").

 

10(j)*#

 

Aon Deferred Compensation Plan and First Amendment to the Aon Deferred Compensation Plan—incorporated by reference to Exhibit 10(q) to the 1995 Form 10-K.

 

10(k)*#

 

1999 Aon Deferred Compensation Plan—incorporated by reference to Exhibit 10(1) to the 1999 Form 10-K.

 

10(l)*#

 

Employment Agreement dated JuneJanuary 1, 1993 by and among2001, as amended September 29, 2004, between the Registrant Aon Risk Services, Inc. and Michael D. O'Halleran, O'Halleran—incorporated by reference to Exhibit 10(p)10(l) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1998.2004 (the "2004 Form 10-K").

 

10(m)*#

 

Aon Severance Plan—incorporated by reference to Exhibit 10 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997.

 

10(n)*

 

Asset Purchase Agreement dated as of July 24, 1992 between the Registrant and Frank B. Hall & Co. Inc.—incorporated by reference to Exhibit 10(c) to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1992.

 

10(o)*

 

Stock Purchase Agreement dated as of November 11, 1995 by and among the Registrant, Combined Insurance Company of America, Union Fidelity Life Insurance Company and General Electric Capital Corporation—incorporated by reference to Exhibit 10(s) to the 1995 Form 10-K.

 

10(p)*

 

Stock Purchase Agreement dated as of December 22, 29951995 by and among the Registrant; Combined Insurance Company of America; The Life Insurance Company of Virginia; Forth Financial Resources, Ltd.; Newco Properties, Inc.; and General Electric Capital Corporation—incorporated by reference to Exhibit 10(t) to the 1995 Form 10-K.

 

10(q)*

 

Agreement and Plan of Merger dated as of December 11, 1996 among the Registrant, Subsidiary Corporation, Inc. ("Purchaser"), and Alexander & Alexander Services Inc. ("A&A")—incorporated by reference to Exhibit (c)(1) to the Registrant's Tender Offer Statement on Schedule 14D-1 filed on December 16, 1996 (the "Schedule 14D-1").

 

10(r)*

 

First Amendment to Agreement and Plan of Merger, dated as of January 7, 1997, among the Registrant, Purchaser and A&A—incorporated by reference to Exhibit (c)(3) to Amendment No. 2 to the Schedule 14D-1 filed on January 9, 1997.

 


 

121



10(s)*

 

Agreement and Plan of Merger dated as of July 16, 2001 among the Registrant, Ryan Holding Corporation of Illinois, Ryan Enterprises Corporation of Illinois, Holdco #1, Inc., Holdco #2, Inc., Patrick G. Ryan, Shirley W. Ryan and the stockholders of Ryan Holding Corporation of Illinois and of Ryan Enterprises Corporation of Illinois set forth on the signature pages thereto—incorporated by reference to Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2001 (the "Second Quarter 2001 Form 10-Q").

 

10(t)*

 

Stock Restriction Agreement dated as of July 16, 2001 among the Registrant, Patrick G. Ryan, Shirley W. Ryan, Patrick G. Ryan Jr., Robert J.W. Ryan, the Corbett M.W. Ryan Living Trust dated July 13, 2001, the Patrick G. Ryan Living Trust dated July 10, 2001, the Shirley W. Ryan Living Trust dated July 10, 2001, the 2001 Ryan Annuity Trust dated April 20, 2001 and the Family GST Trust under the PGR 2000 Trust dated November 22, 2000—incorporated by reference to Exhibit 10.2 to the Second Quarter 2001 Form 10-Q.

 

10(u)*

 

Escrow Agreement dated as of July 16, 2001 among the Registrant, Patrick G. Ryan, Shirley W. Ryan, Patrick G. Ryan, Jr., Robert J.W. Ryan, the Corbett M. W. Ryan Living Trust dated July 13, 2001, the Patrick G. Ryan Living Trust dated July 10, 2001, the Shirley W. Ryan Living Trust dated July 10, 2001, the 2001 Ryan Annuity Trust dated April 20, 2001 and the Family GST Trust under the PGR 2000 Trust dated November 22, 2000 and American National Bank and Trust Company of Chicago, as Escrow Agent—incorporated by reference to Exhibit 10.3 to the Second Quarter 2001 Form 10-Q.

 10(v)*


Three Year Credit Agreement dated as of February 8, 2002 among the Registrant, the Lenders named therein, Bank One, NA, as Agent, and Citibank N.A., ABN AMRO Bank N.V. and First Union National Bank, as Syndication Agents—incorporated by reference to Exhibit 10(x) to the Third Quarter 2002 Form 10-Q.

 10(w)10(v)*


364-Day Credit Agreement dated as of February 8, 2002 among Aon Corporation, the Lenders named therein, Bank One, NA, as Agent and Citibank N.A., ABN AMRO Bank N.V. and First Union National Bank, as Syndication Agents—incorporated by reference to Exhibit 10(y) to the Third Quarter 2002 Form 10-Q.

 10(x)*


Credit Agreement dated as of September 24, 2001 among the Registrant, as Guarantor, Aon Finance Limited, Aon France S.A., Aon Group Nederland B.V., Aon Holdings, B.V. and Aon Jauch & Hübener Holdings GmbH, as Borrowers, the Lenders named therein, Citibank International plc, as Agent, and Salomon Brothers International Limited as Arranger—incorporated by reference to Exhibit 10(z) to the Third Quarter 2002 Form 10-Q.

 10(y)#

 

Employment Agreement dated January 1, 2003 between the Registrant and David P. Bolger.Bolger—incorporated by reference to Exhibit 10(y) to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2002 (the "2002 Form 10-K").

 10(z)

10(w)*#

 

364-DayEmployment Agreement dated May 2, 2003 between the Registrant and D. Cameron Findlay—incorporated by reference to Exhibit 10(ab) to the Second Quarter 2003 Form 10-Q.


10(x)*


$600 million three-year Credit Agreement dated as of February 3, 2005 among the Registrant, Citibank, N.A., as Administrative Agent and the lenders listed therein—incorporated by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K dated February 3, 2005 (the "February 3, 2005 Form 8-K").


10(y)*


€650 million Facility Agreement dated February 7, 20032005 among Aon Corporation, the Lenders named therein, Bank One, NA,Registrant, Citibank International plc, as Agent and ABN AMRO Bank N.V. and Citibank, N.A., as Syndication Agents.the lenders listed therein—incorporated by reference to Exhibit 10.2 to the February 3, 2005 Form 8-K.

 

10(z)*#


Form of Severance Agreement—incorporated by reference to Exhibit 10(z) to the 2004 Form 10-K.


10(aa)*#


Aon Corporation Executive Special Severance Plan—incorporated by reference to Exhibit 10(aa) to the 2004 Form 10-K.


10(ab)*


Agreement between the Attorney General of the State of New York, the Superintendent of Insurance of the State of New York, the Attorney General of the State of Connecticut, the Illinois Attorney General, the Director of the Division of Insurance, Illinois Department of Financial and Professional Regulation and Aon Corporation and its subsidiaries and affiliates dated March 4, 2005—incorporated by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K dated March 7, 2005.




10(ac)*#


Employment Agreement dated April 4, 2005 between the Registrant and Gregory C. Case—incorporated by reference to Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2005 (the "First Quarter 2005 Form 10-Q").


10(ad)*#


Employment Agreement dated May 2, 2005—between the Registrant and Ted T. Devine—incorporated by reference to Exhibit 10.2 to the First Quarter 2005 Form 10-Q.


10(ae)*#


Employment Agreement dated November 30, 1998 between Aon Group, Inc., Aon Group Limited and Dennis L. Mahoney—incorporated by reference to Exhibit 10.3 to the First Quarter 2005 Form 10-Q.


10(af)*#


Employment Agreement dated October 31, 1998 between Aon Holdings b.v. and Dirk P.M. Verbeek—incorporated by reference to Exhibit 10.4 to the First Quarter 2005 Form 10-Q.


10(ag)*#


Employment Agreement dated as of July 15, 2005 between Aon Corporation and Andrew M. Appel—incorporated by reference to Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2005.


10(ah)*

 

Amendment No. 21 dated as of September 30, 2005 to Three Year$600 million Three-Year Credit Agreement, dated as of February 3, 2005, among the Registrant, Citibank, N.A., as Administrative Agent and the lenders listed therein — incorporated by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K dated September 30, 2005.


10(ai)*


Transfer and Amendment Agreement dated October 24, 2005 to €650 million Facility Agreement dated February 7, 20032005 among the Registrant, Citibank International plc, as Agent and the Lenders named therein and Bank One, NA, as Agent.lenders listen therein—incorporated by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K dated October 24, 2005.

 

10(aj)*#


Letter Agreement dated as of December 9, 2005 between Aon Corporation and Patrick G. Ryan—incorporated by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K dated December 9, 2005.


10(ak)#


Employment Agreement dated August 1, 2005 between Combined Insurance Company of America and Richard M. Ravin.


10(al)#


Sixth Amendment to the Aon Corporation Excess Benefit Plan


12(a)

 

Statement regarding Computation of Ratio of Earnings to Fixed Charges.

 

12(b)

 

Statement regarding Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends.

 

21

 

List of Subsidiaries of the Registrant.

 


122



23

 

Consent of Ernst & Young LLPLLP.

(99)

31.1


Rule 13a-14(a) Certification of Chief Executive Officer of the Registrant in accordance with Section 302 of the Sarbanes-Oxley Act of 2002.


31.2


Rule 13a-14(a) Certification of Chief Financial Officer of the Registrant in accordance with Section 302 of the Sarbanes-Oxley Act of 2002.


32.1


Section 1350 Certification of Chief Executive Officer of the Registrant in accordance with Section 906 of the Sarbanes-Oxley Act of 2002.



32.2


Section 1350 Certification of Chief Financial Officer of the Registrant in accordance with Section 906 of the Sarbanes-Oxley Act of 2002.


99

 

Annual Report on Form 11-K for the Aon Savings Plan for the year ended December 31, 2002—2005—to be filed by amendment as provided in Rule 15d-21(b).

(99.1)


Certification of CEO Pursuant to Section 1350 of Chapter 63 of Title 18 of the United States Code.

(99.2)


Certification of CFO Pursuant to Section 1350 of Chapter 63 of Title 18 of the United States Code.

*
Document has heretofore been filed with the Securities and Exchange Commission and is incorporated by reference and made a part hereof.

#
Indicates a management contract or compensatory plan or arrangement.

(b)    Reports on Form 8-K.

        During the quarter ended December 31, 2002, the Registrant filed five Current Reports on Form 8-K and two additional Current Reports on Form 8-K thereafter.

123



SIGNATURES

        Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrantregistrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 Aon Corporation


By:


/s/  
GREGORY C. CASE      
Gregory C. Case, President
and Chief Executive Officer

Date: March 8, 2006

 

 

By:

/s/  
PATRICK G. RYAN      
Patrick G. Ryan,Chairman
and Chief Executive Officer

Date: March 21, 2003

        Pursuant to the requirements of the Securities Exchange Act of 1934, this Reportreport has been signed below by the following persons on behalf of the Registrantregistrant and in the capacities and on the dates indicated.

Signature
 Title
 Date

 

 

 

 

 
/s/  GREGORY C. CASE      
Gregory C. Case
President, Chief Executive Officer and Director (Principal Executive Officer)March 8, 2006

/s/  
PATRICK G. RYAN      
Patrick G. Ryan

 

Executive Chairman Chief Executive
Officer and Director
(Principal Executive Officer)

 

March 21, 20038, 2006


/s/  
EDGAR D. JANNOTTA      
Edgar D. Jannotta




Director




March 8, 2006

/s/  
JAN KALFF      
Jan Kalff

 

Director

 

March 21, 20038, 2006

/s/  
LESTER B. KNIGHT      
Lester B. Knight

 

Director

 

March 21, 20038, 2006

/s/  
PERRY J. LEWISMICHAEL LOSH      
Perry J. LewisMichael Losh

 

Director

 

March 21, 20038, 2006

/s/  
R. EDEN MARTIN      
R. Eden Martin

 

Director

 

March 21, 20038, 2006


/s/  
ANDREW J. MCKENNA      
Andrew J. McKenna

 

Director

 

March 21, 20038, 2006

/s/  
ROBERT S. MORRISON      
Robert S. Morrison

 

Director

 

March 21, 20038, 2006





124



/s/  
RICHARD C. NOTEBAERT      
Richard C. Notebaert

 

Director

 

March 21, 2003

/s/  
MICHAEL D. O'HALLERAN      
Michael D. O'Halleran


Director


March 21, 20038, 2006

/s/  
JOHN W. ROGERS, JR.      
John W. Rogers, Jr.

 

Director

 

March 21, 20038, 2006

/s/  
PATRICK G. RYAN, JR.GLORIA SANTONA      
Patrick G. Ryan, Jr.Gloria Santona

 

Director

 

March 21, 2003

/s/  
GEORGE A. SCHAEFER      
George A. Schaefer


Director


March 21, 2003

/s/  
RAYMOND I. SKILLING      
Raymond I. Skilling


Director


March 21, 20038, 2006

/s/  
CAROLYN Y. WOO      
Carolyn Y. Woo

 

Director

 

March 21, 20038, 2006

/s/  
HARVEY N. MEDVINDAVID P. BOLGER      
Harvey N. MedvinDavid P. Bolger

 

Executive Vice President,
and Chief Financial Officer and
Chief Administrative Officer
(Principal Financial and Accounting Officer)

 

March 21, 2003

125



CERTIFICATIONS

I, Patrick G. Ryan, the Chief Executive Officer of Aon Corporation, certify that:

        1.    I have reviewed this annual report on Form 10-K of Aon Corporation;

        2.    Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report.

        3.    Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report.

        4.    The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

        5.    The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):

        6.    The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: March 26, 2003/s/  PATRICK G. RYAN      
Patrick G. Ryan
Chief Executive Officer

126



CERTIFICATIONS

I, Harvey N. Medvin, the Chief Financial Officer of Aon Corporation, certify that:

        1.    I have reviewed this annual report on Form 10-K of Aon Corporation;

        2.    Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report.

        3.    Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report.

        4.    The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

        5.    The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):

        6.    The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: March 26, 2003/s/  HARVEY N. MEDVIN      
Harvey N. Medvin
Chief Financial Officer8, 2006



QuickLinks

Documents From Which Information is Incorporated By Reference
PART I
PART II
Consolidated Statements of Income
Consolidated Statements of Financial Position
Consolidated Statements of Cash Flows
Consolidated Statements of Stockholders' Equity
Notes to Consolidated Financial Statements
Aon Corporation (Parent Company) CONDENSED STATEMENTS OF FINANCIAL POSITION
Aon Corporation (Parent Company) CONDENSED STATEMENTS OF INCOME
Aon Corporation (Parent Company) CONDENSED STATEMENTS OF CASH FLOWS
Aon Corporation (Parent Company) NOTES TO CONDENSED FINANCIAL STATEMENTS
Aon CORPORATION and Subsidiaries VALUATION AND QUALIFYING ACCOUNTS Years Ended December 31, 2002, 2001, and 2000
Aon Corporation and Subsidiaries CONSOLIDATED SUMMARY OF INVESTMENTS— OTHER THAN INVESTMENTS IN RELATED PARTIES AS OF DECEMBER 31, 2002
Aon Corporation and Subsidiaries REINSURANCE
PART III
PART IV
SIGNATURES
CERTIFICATIONS
CERTIFICATIONS