SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001
OR
_ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 1-7933
Aon Corporation
---------------
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 36-3051915
-------- ----------
(State or Other Jurisdiction of (IRS Employer
Incorporation or Organization) Identification No.)
200 E. RANDOLPH ST., CHICAGO, ILLINOIS 60601
- -------------------------------------- -----
(Address of Principal Executive Offices) (Zip Code)
(312) 381-1000
--------------
(Registrant's Telephone Number)
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities and Exchange Act
of 1934 during the preceding 3 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES X NO
- -
Number of shares of common stock outstanding:
No. Outstanding
Class as of 9-30-01
----- -------------
$1.00 par value Common 269,217,702
PART 1
Financial Information
Aon CORPORATION
Condensed Consolidated Statements of Financial Position
(millions) AS OF AS OF
SEPT. 30, 2001 DEC. 31, 2000
--------------------------------
ASSETS (Unaudited)
Investments
Fixed maturities at fair value $ 2,336 $ 2,337
Equity securities at fair value 416 492
Short-term investments 2,899 2,325
Other investments 736 865
--------------- ---------------
TOTAL INVESTMENTS 6,387 6,019
CASH 498 1,118
RECEIVABLES
Insurance brokerage and consulting
services 7,143 6,952
Premiums and other 1,210 1,278
--------------- ---------------
TOTAL RECEIVABLES 8,353 8,230
EXCESS OF COST OVER NET ASSETS PURCHASED 3,626 3,427
OTHER INTANGIBLE ASSETS 469 489
OTHER ASSETS 3,512 2,968
--------------- ---------------
TOTAL ASSETS $ 22,845 $ 22,251
=============== ===============
AS OF AS OF
SEPT. 30, 2001 DEC. 31, 2000
--------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY (Unaudited)
INSURANCE PREMIUMS PAYABLE $ 8,722 $ 8,212
POLICY LIABILITIES
Future policy benefits 1,088 1,054
Policy and contract claims 1,078 801
Unearned and advance premiums 2,041 1,935
Other policyholder funds 827 1,069
--------------- ---------------
TOTAL POLICY LIABILITIES 5,034 4,859
GENERAL LIABILITIES
General expenses 1,685 1,619
Short-term borrowings 193 309
Notes payable 1,660 1,798
Other liabilities 1,075 1,216
--------------- ---------------
TOTAL LIABILITIES 18,369 18,013
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 800 800
STOCKHOLDERS' EQUITY
Common stock - $1 par value 292 264
Paid-in additional capital 1,650 706
Accumulated other comprehensive loss (377) (377)
Retained earnings 3,060 3,127
Less - Treasury stock at cost (807) (118)
Deferred compensation (192) (214)
--------------- ---------------
TOTAL STOCKHOLDERS' EQUITY 3,626 3,388
--------------- ---------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 22,845 $ 22,251
=============== ===============
See the accompanying notes to the condensed consolidated financial statements.
- 1 -
AON CORPORATION
Condensed Consolidated Statements of Income
(Unaudited)
THIRD QUARTER ENDED NINE MONTHS ENDED
---------------------------- ---------------------------
(millions except per share data) SEPT. 30, SEPT. 30, SEPT. 30, SEPT. 30,
2001 2000 2001 2000
------------- ------------- ------------- -------------
REVENUE
Brokerage commissions and fees ................................. $ 1,297 $ 1,176 $ 3,925 $ 3,584
Premiums and other ............................................. 510 476 1,510 1,435
Investment income .............................................. 105 133 205 395
------------- ------------- ------------- -------------
TOTAL REVENUE ............................................... 1,912 1,785 5,640 5,414
------------- ------------- ------------- -------------
EXPENSES
General expenses ............................................... 1,384 1,208 4,303 3,741
Benefits to policyholders ...................................... 271 257 823 766
Interest expense ............................................... 31 38 98 102
Amortization of intangible assets .............................. 40 38 118 115
Unusual expenses - World Trade Center (see note 2) .............. 53 - 53 -
------------- ------------- ------------- -------------
TOTAL EXPENSES. ............................................. 1,779 1,541 5,395 4,724
------------- ------------- ------------- -------------
INCOME BEFORE INCOME TAX, MINORITY INTEREST AND ACCOUNTING CHANGE . 133 244 245 690
Provision for income tax ....................................... 51 95 95 269
------------- ------------- ------------- -------------
INCOME BEFORE MINORITY INTEREST AND ACCOUNTING CHANGE ............. 82 149 150 421
Minority interest - 8.205% trust preferred capital securities .. (10) (10) (30) (30)
------------- ------------- ------------- -------------
INCOME BEFORE ACCOUNTING CHANGE ................................... 72 139 120 391
Cumulative effect of change in accounting principle, net of tax - - - (7)
------------- ------------- ------------- -------------
NET INCOME ........................................................ $ 72 $ 139 $ 120 $ 384
============= ============= ============= =============
Preferred stock dividends ...................................... (1) (1) (2) (2)
------------- ------------- ------------- -------------
NET INCOME AVAILABLE FOR COMMON STOCKHOLDERS ...................... $ 71 $ 138 $ 118 $ 382
============= ============= ============= =============
BASIC NET INCOME PER SHARE:
Before accounting change ....................................... $ 0.26 $ 0.53 $ 0.44 $ 1.50
Cumulative effect of change in accounting principle ............ - - - (0.03)
------------- ------------- ------------- -------------
Basic net income per share ......................... $ 0.26 $ 0.53 $ 0.44 $ 1.47
============= ============= ============= =============
DILUTIVE NET INCOME PER SHARE:
Before accounting change ....................................... $ 0.26 $ 0.53 $ 0.44 $ 1.49
Cumulative effect of change in accounting principle ............ - - - (0.03)
------------- ------------- ------------- -------------
Dilutive net income per share ...................... $ 0.26 $ 0.53 $ 0.44 $ 1.46
============= ============= ============= =============
CASH DIVIDENDS PER SHARE PAID ON COMMON STOCK ..................... $ 0.225 $ 0.22 $ 0.67 $ 0.65
============= ============= ============= =============
Dilutive average common and common equivalent shares outstanding .. 275.4 262.8 271.0 261.7
============= ============= ============= =============
See the accompanying notes to the condensed consolidated financial statements.
- 2 -
AON CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED
--------------------------------------
SEPT. 30, SEPT. 30,
(millions) 2001 2000
----------------- -----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ...................................................................... $ 120 $ 384
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 .............. 90 32
Amortization of intangible assets .......................................... 118 115
Depreciation and amortization of property, equipment and software .......... 134 131
Income taxes ............................................................... (93) 125
Special charge and purchase accounting liabilities ......................... 86 (90)
Valuation changes on investments, income on disposals and impairments ...... 101 (72)
Other receivables and liabilities - net .................................... 122 (98)
----------------- -----------------
CASH PROVIDED BY OPERATING ACTIVITIES .................................. 678 534
----------------- -----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Sale of investments
Fixed maturities
Maturities ............................................................. 93 86
Calls and prepayments .................................................. 73 106
Sales .................................................................. 712 218
Equity securities .......................................................... 257 173
Other investments .......................................................... 93 253
Purchase of investments
Fixed maturities ........................................................... (817) (298)
Equity securities .......................................................... (178) (130)
Other investments .......................................................... (58) (433)
Purchase of short-term investments - net ........................................ (558) (156)
Acquisition of subsidiaries ..................................................... (101) (60)
Property and equipment and other - net .......................................... (166) (104)
----------------- -----------------
CASH USED IN INVESTING ACTIVITIES ...................................... (650) (345)
----------------- -----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Treasury stock transactions - net .............................................. 30 (61)
Issuance (payments) of short-term borrowings - net ............................. (116) 178
Issuance of long-term debt ..................................................... - 250
Repayment of long-term debt .................................................... (136) (26)
Interest sensitive, annuity and investment-type contracts
Deposits ................................................................... 20 65
Withdrawals ................................................................ (265) (275)
Cash dividends to stockholders ................................................. (179) (168)
----------------- -----------------
CASH USED IN FINANCING ACTIVITIES ...................................... (646) (37)
----------------- -----------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH ........................................... (2) (9)
----------------- -----------------
INCREASE (DECREASE) IN CASH ....................................................... (620) 143
CASH AT BEGINNING OF PERIOD ....................................................... 1,118 837
----------------- -----------------
CASH AT END OF PERIOD ............................................................. $ 498 $ 980
================= =================
See the accompanying notes to condensed consolidated financial statements.
- 3 -
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Statement of Accounting Principles
----------------------------------
The financial results included in this report are stated in conformity
with accounting principles generally accepted in the United States and
are unaudited but include all normal recurring adjustments which the
Registrant ("Aon") considers necessary for a fair presentation of the
results for such periods. These interim figures are not necessarily
indicative of results for a full year as further discussed below.
Refer to the consolidated financial statements and notes in the Annual
Report to Stockholders for the year ended December 31, 2000 for
additional details of Aon's financial position, as well as a
description of the accounting policies which have been continued
without material change. The details included in the notes have not
changed except as a result of normal transactions in the interim and
the events mentioned in the footnotes below.
2. Impact of September 11, 2001 / World Trade Center
-------------------------------------------------
On September 11, 2001, the World Trade Center was destroyed. Aon
occupied space on several floors of one of the towers, where employees
from insurance brokerage, human resource consulting, claims servicing,
other specialty operations, and accident, health and life insurance
underwriting worked and where one of our new client service business
units was located. Most regrettably, 176 of the employees are missing
and presumed dead or have been confirmed as deceased. All of Aon's
normal processing systems are up and running.
Aon has incurred through September 30, 2001, $251 million of expenses
(before insurance recoveries) related to this event. These costs
include $192 million as a result of our Combined Insurance Company
subsidiaries directly underwriting the life insurance coverage for the
benefit of missing employees, and is partially offset by reinsurance
receivables of $147 million. As to approximately $90 million of
reinsurance receivables under a Business Travel and Accident policy
issued by Combined Insurance Company of America to cover Aon's
employees, reinsurers have declined liability via a letter dated
November 12, 2001, to Combined. Legal actions have been taken by both
parties. Other costs incurred were $29 million of depreciable assets at
book value destroyed and $30 million for salaries and benefits for
missing employees and other costs. Offsetting these expenses are
estimated insurance recoveries of $51 million. Further costs and
insurance recoveries including estimated proceeds from our business
interruption policies, are expected to occur over the next few
quarters. In the third quarter 2001, Aon has recorded a pretax charge
of $53 million ($32 million after-tax or $0.12 per diluted share),
which is net of estimated insurance recoveries of $198 million.
3. Accounting and Disclosure Changes
---------------------------------
In December 1999, the Securities and Exchange Commission (SEC) issued
Staff Accounting Bulletin (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 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.
- 4 -
In September 2000, the Financial Accounting Standards Board (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
the consolidated financial statements.
In July 2001, the FASB issued Statement No. 141, Business Combinations,
and Statement No. 142, Goodwill and Other Intangible Assets. Statement
No. 141 supercedes Accounting Principles Board (APB) Opinion No. 16,
and amends or supercedes 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 eliminates the pooling of interests method of accounting for
business combinations. It also changes the criteria to recognize
intangible assets apart from goodwill. The requirements of Statement
No. 141 are effective for any business combination accounted for by the
purchase method that is completed after June 30, 2001. Statement No.
142 supercedes APB No. 17. Under this statement, 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 will be discontinued effective as of
January 1, 2002. The full impact of applying these statements is yet to
be determined. However, reported earnings for Aon are expected to
increase by approximately $120 million pre-tax on an annualized basis
beginning in 2002.
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
supersede the provisions of APB Opinion 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 is
effective January 1, 2002. Aon has not yet determined the effect, if
any, this statement will have on the consolidated financial statements.
4. Spin-Off of Underwriting Business
---------------------------------
On April 20, 2001, Aon's Board of Directors approved, in principle, a
plan to spin-off its current underwriting business to Aon's common
stockholders, creating two independent, publicly-traded companies. The
spin-off would take the form of a tax-free stock dividend to Aon's
common stockholders, pending a favorable Internal Revenue Service (IRS)
ruling. The transaction is subject to final Board approval, a favorable
IRS ruling, and certain insurance regulatory approvals. The spin-off
company will be named Combined Specialty Corporation (CSC). The
spin-off is currently expected to be completed by Spring 2002. In
October 2001, Aon announced that it will
- 5 -
be expanding its insurance underwriting business to include direct
property and casualty insurance and reinsurance through its planned
spin-off of CSC.
5. Comprehensive Income
--------------------
The components of comprehensive income, net of related tax, for the
third quarter and nine months ended September 30, 2001 and 2000 are as
follows:
Third Quarter Ended Nine Months Ended
------------------- -----------------
(millions) Sept. 30, 2001 Sept. 30, 2000 Sept. 30, 2001 Sept. 30, 2000
-------------- -------------- -------------- --------------
Net income $ 72 $ 139 $ 120 $ 384
Net derivative gains (losses) 7 - (5) -
Net unrealized investment gains 13 16 35 11
Net foreign exchange gains
(losses) 16 (31) (30) (111)
-------------- -------------- -------------- --------------
Comprehensive income $ 108 $ 124 $ 120 $ 284
============== ============== ============== ==============
The components of accumulated other comprehensive loss, net of related
tax, at September 30, 2001 and December 31, 2000, are as follows:
(millions) September 30, 2001 December 31, 2000
------------------ -----------------
Net derivative gains $ 1 $ 6
Net unrealized investment losses (37) (72)
Net foreign exchange losses (297) (267)
Net additional minimum pension liability (44) (44)
----------- -----------
Accumulated other comprehensive loss $ (377) $ (377)
============ ===========
6. Business Segments
-----------------
Aon classifies its businesses into three operating segments based on
the types of services and/or products delivered. There is also a fourth
non-operating segment, Corporate and Other. The Insurance Brokerage and
Other Services segment consists primarily of Aon's retail, reinsurance
and wholesale brokerage operations, as well as managing general
underwriting, actuarial, loss control, claims, alternative risk
transfer and premium financing services. Certain service businesses
related to insurance underwriting operations are also reflected in this
segment. The Consulting segment is Aon's human capital consulting
organization which utilizes four practice groups: employee benefits,
compensation, management consulting and employment practices
outsourcing. The Insurance Underwriting segment is comprised of
accident, health and life coverages, and extended warranty and
specialty property and casualty insurance products. Corporate and Other
segment revenues consist primarily of investment income from equity
investments that are assets primarily of the underwriting subsidiaries.
Revenues are derived from valuation changes in limited partnerships,
investment income from certain other investments (which include
non-income producing equities) and income and losses on disposals of
all securities, including those pertaining to assets maintained by the
operating segments. Corporate and Other expenses include general
expenses, administrative and certain information technology costs,
interest expense and goodwill amortization.
- 6 -
Amounts reported in the tables for the four segments, when aggregated,
total to the amounts in the accompanying condensed consolidated
financial statements. Revenues are attributed to geographic areas based
on the location of the resources producing the revenues. There are no
material inter-segment amounts to be eliminated.
Selected information reflecting Aon's operating segments follows.
Third Quarter ended Sept.30: Insurance Brokerage Insurance
(millions) and Other Services Consulting Underwriting
------------------ ---------- ------------
2001 2000 2001 2000 2001 2000
---- ---- ---- ---- ---- ----
Revenue
United States $ 597 $ 549 $ 161 $ 118 $ 409 $ 384
United Kingdom 227 231 37 35 75 74
Continent of Europe 149 134 15 13 30 25
Rest of World 139 128 19 16 51 53
---------------------------------------------------------------------------------------------------------------------------------
Total revenue $ 1,112 $ 1,042 $ 232 $ 182 $ 565 $ 536
---------------------------------------------------------------------------------------------------------------------------------
Income before income taxes
excluding unusual charges $ 153 $ 183 $ 29 $ 26 $ 80 $ 81
Unusual charges - World Trade
Center 8 - - - 45 -
---------------------------------------------------------------------------------------------------------------------------------
Income before income taxes $ 145 $ 183 $ 29 $ 26 $ 35 $ 81
---------------------------------------------------------------------------------------------------------------------------------
Nine Months ended Sept. 30: Insurance Brokerage Insurance
(millions) and Other Services Consulting Underwriting
------------------ ---------- ------------
2001 2000 2001 2000 2001 2000
---- ---- ---- ---- ---- ----
Revenue
United States $ 1,740 $ 1,618 $ 453 $ 326 $ 1,208 $ 1,154
United Kingdom 670 673 110 114 225 233
Continent of Europe 550 503 53 49 91 79
Rest of World 423 387 57 49 156 152
- ----------------------------------------------------------------------------------------------------------------------------------
Total revenue $ 3,383 $ 3,181 $ 673 $ 538 $ 1,680 $ 1,618
- ----------------------------------------------------------------------------------------------------------------------------------
Income before taxes excluding
unusual and special charges $ 544 $ 545 $ 84 $ 68 $ 227 $ 227
Unusual charges - World Trade
Center 8 - - - 45 -
Special charges 187 - 7 - 24 -
- ----------------------------------------------------------------------------------------------------------------------------------
Income before income taxes $ 349 $ 545 $ 77 $ 68 $ 158 $ 227
- ----------------------------------------------------------------------------------------------------------------------------------
- 7 -
Selected information for Aon's non-operating segment follows:
Corporate and Other Third Quarter ended Sept. 30, Nine Months ended Sept. 30,
------------------------------------- -----------------------------------
(millions) 2001 2000 2001 2000
- ----------------------------------------------------------------------------------------------------------------------------------
Corporate and other revenue:
Change in valuation on private limited
partnership investments $ 7 $ 15 $ (56) $ 75
Income from marketable equity securities
and other investments 2 2 6 6
------------------ ------------------ ---------------- ------------------
Corporate and other revenue before gain
(loss ) on disposals and related expenses 9 17 (50) 81
Gain (loss) on disposals and related
expenses* (6) 8 (46) (4)
- ----------------------------------------------------------------------------------------------------------------------------------
Corporate and other revenue $ 3 $ 25 $ (96) $ 77
- ----------------------------------------------------------------------------------------------------------------------------------
Non-operating expenses:
Amortization of goodwill $ 30 $ 29 $ 88 $ 85
Interest expense 31 38 98 102
General expenses 18 4 57 40
- ----------------------------------------------------------------------------------------------------------------------------------
Loss before income taxes $ (76) $ (46) $ (339) $ (150)
- ----------------------------------------------------------------------------------------------------------------------------------
<FN>
* Nine months 2001 includes impairment write-downs of $29 million.
</FN>
7. Capital Stock
-------------
During the first nine months of 2001, Aon reissued 2,629,000 shares of
common stock from treasury for employee benefit plans and 519,300
shares in connection with the employee stock purchase plan. During the
first nine months of 2001, Aon acquired 137,000 shares of its common
stock at a total value of $4.7 million and obtained approximately 22.4
million shares of stock in connection with the acquisition of two
entities controlled by Aon's Chairman and Chief Executive Officer (see
footnote 14). The acquisition was financed by the issuance of 22.4
million new shares of Aon common stock. The additional 22.4 million
shares of treasury stock are restricted as to their reissuance. There
were 23.1 million shares of common stock held in treasury at September
30, 2001.
8. Capital Securities
------------------
In 1997, Aon Capital A, a subsidiary trust of Aon, issued $800 million
of 8.205% mandatorily redeemable preferred capital securities (capital
securities). The sole asset of Aon Capital A is $824 million aggregate
principal amount of Aon's 8.205% Junior Subordinated Deferrable
Interest Debentures due January 1, 2027.
- 8 -
9. Business Combinations
---------------------
For the third quarter and nine months of 2001, Aon made payments of $4
million and $12 million, respectively, on restructuring charges and
purchase accounting liabilities relating to business combinations.
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 operations 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 and Bain Hogg brokerage operations, Aon recorded
$264 million in costs to restructure those acquisitions. These charges
primarily related to termination benefits of $152 million, lease
abandonments and other exit costs of $280 million, and asset
impairments of $37 million. As of December 31, 2000, all termination
benefits have been paid. The remaining liability of $68 million is for
lease abandonments and other exit costs.
The following table demonstrates recent activity regarding the lease
abandonments and other exit costs associated with the A&A and Bain Hogg
acquisitions:
(millions) Lease Abandonments and Other
Exit Costs
----------------------------------
Balance at December 31, 1998 $ 155
Cash payments in 1999 and 2000 (77)
Charge to expense in 1999 and 2000 6
Cash payments in 2001 (10)
Foreign currency revaluation (6)
-------------
Balance at September 30, 2001 $ 68
=============
The combination of 1998 acquisitions and the finalization of purchase
accounting for the 1997 Jauch & Hubener acquisition resulted in $70
million of purchase accounting liabilities. In 1999, a charge of $120
million was recorded for a plan to restructure Aon's operations as a
result of business combination activity. These charges primarily
related to termination benefits of $107 million, the related pension
expense of $32 million, lease abandonments and other exit costs of $41
million, and asset impairments of $10 million. As of September 30, 2001
these liabilities have been reduced to termination benefits of $3
million and lease abandonments of $3 million.
All of Aon's unpaid liabilities relating to acquisitions are reflected
in general expense liabilities in the condensed consolidated statements
of financial position.
10. Business Transformation Plan
----------------------------
In fourth quarter 2000, Aon commenced a business transformation plan.
This plan has been implemented during the fourth quarter of 2000 and
the first nine months of 2001 and will continue throughout the
remainder of 2001 and into 2002. Pretax special charges of $82 million,
$72 million and $146 million were recorded in fourth quarter 2000, and
the first and second quarters of 2001, respectively, and are recorded
in general expenses in the condensed consolidated statements of income.
For the first nine months of 2001, charges included costs related to
termination benefits of $109 million, other costs to exit an activity
of $21 million and other charges of $89 million primarily
- 9 -
relating to costs for the abandonment of systems and equipment as well
as to end Aon's involvement in certain joint ventures and service
partner relationships that did not meet profitability hurdles.
Approximately 4,000 employees have been notified that their positions
have been or will be eliminated under the plan. Most have already
departed Aon. Most of these positions were related to the Insurance
Brokerage and Other Services segment in the U.S. and the U.K.
For the third quarter and first nine months of 2001, Aon made payments
of $31 million and $80 million, respectively, related to the business
transformation plan.
The following demonstrates the activity related to the liability for
termination benefits and other costs to exit an activity for the
business transformation plan.
Other Costs
Termination to Exit an
(millions) Benefits Activity Total
--------------------------------------------------------------------------------------------------------------------
Expense charged in 2000 $ 54 $ 6 $ 60
Cash payments in 2000 (13) (3) (16)
Expense charged in 2001 109 21 130
Cash payments in 2001 (58) (22) (80)
--------------------------------------------------------------------------------------------------------------------
Balance at September 30, 2001 $ 92 $ 2 $ 94
--------------------------------------------------------------------------------------------------------------------
All of Aon's unpaid liabilities relating to the business transformation
plan are reflected in general expense liabilities in the condensed
consolidated statements of financial position.
11. Income Per Share
----------------
Income per share is calculated as follows:
Third Quarter ended Sept. 30, Nine Months ended Sept. 30,
----------------------------- ---------------------------
(millions) 2001 2000 2001 2000
------------------------------------------------ ------------ ------------- ------------- ------------
Net income $ 72 $ 139 $ 120 $ 384
Redeemable preferred stock dividends (1) (1) (2) (2)
------------ ------------- ------------ -------------
Net income for dilutive and basic $ 71 $ 138 $ 118 $ 382
============ ============= ============ =============
Basic shares outstanding 272 260 268 259
Common stock equivalents 3 3 3 3
------------ ------------- ------------ -------------
Dilutive potential common shares 275 263 271 262
--------------------------------------- ------------ ------------- ------------ -------------
Basic net income per share $ 0.26 $ 0.53 $ 0.44 $ 1.47
Dilutive net income per share $ 0.26 $ 0.53 $ 0.44 $ 1.46
--------------------------------------- ------------ ------------- ------------ -------------
- 10 -
12. Alexander & Alexander Services Inc. (A&A) Discontinued Operations
-----------------------------------------------------------------
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 purchasers 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. As of September 30, 2001, the
liabilities associated with the foregoing indemnities and liabilities
of insurance underwriting subsidiaries that are currently in run-off
were included in other liabilities in the accompanying condensed
consolidated statements of financial position. Such liabilities
amounted to $117 million, net of reinsurance recoverables and other
assets of $152 million, and would be substantially reduced if a
February, 2000 ruling from the Court of Appeal in England favorable to
A&A, in respect of which right to appeal has been granted, were upheld
in a decision expected in or around 2002.
13. Contingencies
-------------
Aon and its subsidiaries 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. Accruals for
these items have been provided to the extent that losses are deemed
probable and are estimable.
In 1998, the Internal Revenue Service (IRS) proposed adjustments to the
tax of certain Aon subsidiaries for the period of 1990 through 1993.
Most of these adjustments should be resolved through factual
substantiation of certain accounting matters. However, the IRS has
contended that retro-rated extended warranty contracts do not
constitute insurance for tax purposes. Accordingly, the IRS has
proposed a deferral of deductions for obligations under those
contracts. The effect of such deferral would be to increase the current
tax obligations of certain Aon subsidiaries by approximately $74
million, $3 million, $5 million and $12 million (plus interest) in
years 1990, 1991, 1992, and 1993, respectively. Aon believes that the
IRS's position is without merit and inconsistent with numerous previous
IRS private letter rulings. Aon has commenced an administrative appeal
and intends to contest vigorously such treatment. Aon believes that if
the contracts are deemed not to be insurance for tax purposes, they
would be recharacterized in such a way that the increased taxes for the
years in question would be far less than the proposed assessments.
In the second 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. Aon
believes that the Aon subsidiary has meritorious defenses and the Aon
subsidiary intends to vigorously defend this claim.
- 11 -
Except for an action filed to compel Aon to produce documents, which
has been settled, the Allianz lawsuit is the only lawsuit or
arbitration relating to Unicover in which any Aon-related entity is
currently a party.
Certain U.K. 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.
As to approximately $90 million of reinsurance receivables under a
Business Travel and Accident policy issued by Combined Insurance
Company of America to cover Aon's employees, reinsurers have declined
liability via a letter dated November 12, 2001, to Combined. Legal
actions have been filed by both parties.
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.
14. Acquisitions
------------
Acquisitions which closed in July 2001 were disclosed in Part I,
Footnote 13 and 14 of Aon's Quarterly Report on Form 10Q for the
quarter ended June 30, 2001 and are incorporated herein by reference.
15. Subsequent Event
----------------
On November 7, 2001, Aon announced that, together with Zurich Financial
Services, Aon will be sponsoring a new Bermuda-based insurance and
reinsurance company to provide much needed underwriting capacity to
commercial property and casualty insurance and reinsurance clients. The
new company will be named Endurance Specialty Insurance Ltd. Plans for
the new company include capitalization of approximately $1.2 billion
with investments from several parties, including approximately $200
million by Aon. Funding of this investment is intended to come from
Aon's underwriting subsidiaries and is available from operating cash.
It is anticipated that, after the planned spin-off of CSC from Aon
Corporation (see footnote 4), CSC will be a minority owner in Endurance
Specialty.
As to approximately $90 million of reinsurance receivables under a
Business Travel and Accident policy issued by Combined Insurance
Company of America to cover Aon's employees, reinsurers have declined
liability via a letter dated November 12, 2001, to Combined. Legal
actions have been filed by both parties.
- 12 -
AON CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THIRD QUARTER ENDED SEPTEMBER 30, 2001
GENERAL
- -------
Aon has three operating segments: Insurance Brokerage and Other Services,
Consulting and Insurance Underwriting. These segments are based on the type of
client and the services or products delivered. Aon has a fourth, non-operating
segment, Corporate and Other.
References to organic revenue growth exclude the impact of acquisitions,
dispositions, transfers, investment income, foreign exchange and other unusual
items. Within the Insurance Underwriting segment, written premiums are the basis
for the measurement of organic growth. References to income before income tax
are before minority interest related to the issuance of 8.205% mandatorily
redeemable preferred capital securities and the cumulative effect of a change in
accounting principle. For purposes of operating segment discussions, comparisons
against 2000 results exclude unusual and special charges.
INFORMATION CONCERNING FORWARD-LOOKING STATEMENTS
- -------------------------------------------------
This quarterly report may contain 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, changes in commercial
property and casualty premium rates, the competitive environment, the actual
cost of resolution of contingent liabilities, the final form of the business
transformation plan, the ultimate cost and timing of the implementation thereof,
the actual cost savings and other benefits resulting therefrom, whether the
Company ultimately implements the proposed spin-off of its underwriting
operations, and the timing and terms associated therewith, and events
surrounding terrorist attacks of September 11, 2001, including the timing and
resolution of related insurance and reinsurance issues.
SPIN-OFF OF UNDERWRITING BUSINESS
- ---------------------------------
As previously disclosed, on April 20, 2001, Aon's Board of Directors approved,
in principle, a plan to spin-off its underwriting business to Aon's common
stockholders, creating two independent, publicly traded companies. The spin-off
would take the form of a tax-free stock dividend to Aon's common stockholders.
The transaction is subject to final Board approval, a favorable Internal Revenue
Service ruling, and certain insurance regulatory approvals. In October 2001, Aon
announced plans to expand its underwriting operations to include direct property
and casualty insurance and reinsurance policies to meet clients' growing demand
for insurance coverage. These expanded operations are intended to be part of the
spin-off and may require the raising of additional capital. In November 2001,
Aon announced that it would sponsor a new, Bermuda-based insurance and
reinsurance company to provide underwriting capacity to commercial property and
casualty insurance and reinsurance clients. It is anticipated that after the
spin-off of CSC, CSC will be a minority owner of this company. The transaction
is subject to final Board approval, a favorable Internal Revenue Service ruling,
and certain insurance regulatory approvals.
- 13 -
WORLD TRADE CENTER
- ------------------
On September 11, 2001, the World Trade Center was destroyed. Aon occupied space
on several floors of one of the towers, where employees from insurance
brokerage, human resource consulting, claims servicing, other specialty
operations, and accident, health and life insurance underwriting worked. Most
regrettably, 176 of the employees are missing and either presumed dead or have
been confirmed as deceased.
The events of September 11 are expected to have an unfavorable impact on
near-term financial results due in part to the loss of many highly talented
employees. Other factors include delayed billings resulting from policy
extensions arranged for clients, building closures, business interruption
issues, and benefits to families of deceased employees. The exact impact that
Aon will experience from these events is not currently determinable and future
insurance claims may act to offset some of these costs.
World Trade Center costs identified thus far for inclusion in the third quarter
results total $53 million on a pre-tax basis. These expenses are principally
composed of life insurance benefits of $45 million, net of approximately $147
million of reinsurance recoveries, provided under life insurance policies issued
by Aon's Combined Insurance Company subsidiaries for Aon employees. As to
approximately $90 million of reinsurance receivables under a Business Travel and
Accident policy issued by Combined Insurance Company of America to cover Aon's
employees, reinsurers have declined liability via a letter dated November 12,
2001, to Combined. Legal actions have been filed by both parties. Expenses also
included $30 million for salaries and benefits for missing employees and other
costs and $29 million of depreciable assets at book value which were destroyed,
offset by estimated insurance recoveries of $51 million.
Additional costs are expected to be incurred in the fourth quarter, and
potentially into 2002. Currently, some known costs have been incurred and offset
by insurance claims and many costs and recoveries remain to be identified and
quantified, including business interruption issues, current replacement value of
lost assets and other related issues. As our analysis of the issues continues
into the fourth quarter and additional insurance claims are presented, an
accounting gain could potentially be recognized in the fourth quarter 2001 or in
2002.
BUSINESS TRANSFORMATION PLAN
- ----------------------------
In November 2000, Aon's Board of Directors approved a comprehensive business
transformation plan designed to enhance client service, significantly improve
the way Aon conducts business, improve profitability through utilization of
technology and process redesign, and accelerate organic revenue growth.
Implementation of the business transformation plan began in fourth quarter 2000
and will continue throughout 2001 and into 2002. Total plan costs, which include
transition expenses, were originally expected to be less than $325 million on a
pretax basis. The majority of the plan costs and savings are related to the
Insurance Brokerage and Other Services segment, principally in the U.S. and the
United Kingdom, where most of Aon's offices and employees are located. Slightly
more than half of the total charges involve cash outlays for severance payments
related to job eliminations. The net reductions of approximately 3,000 positions
are in line with previous announcements after considering new hires resulting
from Aon's evaluation of work processes, changing job functions and service
center locations.
- 14 -
In the U.S. retail brokerage unit, the business transformation plan entailed
process redesign following the rollout of a new policy management and accounting
system, job redesign based on functional expertise and the creation of four new
client service business units (CSBUs). During the second quarter, implementation
steps taken included notifications of job eliminations, hiring of new employees
at new job grades and locations, the creation of specialized syndication groups
to handle the placement of insurance coverage with insurance carriers, the
establishment of new business development and relationship management groups,
and the building of the four CSBUs.
However, conversions of client account servicing into the CSBUs fell behind
schedule due to unexpected challenges in handling higher volumes of transfers
between field operations and the CSBUs and steps were taken to improve the
conversion process. These delays not only increased costs in the short-term, but
also put pressure on regional offices that had to maintain parallel systems to
ensure quality client services. This also adversely affected new business
production in the U.S. in the quarter as attention was diverted from generating
new accounts to completing client conversions.
Aon's largest and most advanced CSBU was located in the World Trade Center,
which was destroyed on September 11, 2001. This CSBU has been relocated to
mid-town Manhattan in New York City, along with a majority of the World Trade
Center retail brokerage employees. A concerted effort is currently being made to
fully convert client servicing for U.S. retail brokerage accounts to the CSBU's
by second quarter 2002, which will involve unplanned, one-time costs in the
fourth quarter 2001 and the first half of 2002. Total costs including both
special charges and transition costs related to the business transformation plan
will therefore exceed the $325 million upper range originally projected. Some of
these costs, however, may be recoverable as part of our insurance claims.
In connection with the plan, Aon recorded pretax special charges of $218 million
($133 million after tax or $0.49 per share) for the first nine months 2001. Aon
does not anticipate any additional special charges from the business
transformation plan. Year-to-date, charges of $108 million were taken which
related to termination benefits and involved about 3,200 employees. As part of
the business transformation, Aon examined its marginal return non-core business
alliances and took a pretax charge of $50 million to end Aon's involvement in
certain joint ventures and service partner relationships that did not meet
profitability hurdles. It also allowed Aon to further reduce headcounts. Charges
of $60 million were incurred for asset impairments, primarily relating to the
abandonment of systems and equipment, and other charges. Transition costs,
primarily related to our core operating businesses, were approximately $13
million in the third quarter and $18 million for the first nine months 2001 and
consisted of system conversion costs, consulting fees and employee compensation
and benefits.
Annualized pretax savings from the plan are estimated to be approximately $150
million to $200 million and are expected to be achieved in 2002 as transition
and other one-time costs related to the business transformation plan are
eliminated. Savings generated to date in 2001 were offset by transition costs
and lower revenues. As Aon progresses through the next several quarters, more
business process change and additional position eliminations will drive cost
savings. Temporary revenue growth rate declines, particularly in Aon's U.S.
retail brokerage operation, occurred related to the transformation and may
continue to occur during the remainder of the plan's implementation.
- 15 -
CONSOLIDATED RESULTS
- --------------------
Total revenue increased $127 million or 7% when compared to third quarter 2000.
Excluding the effect of foreign exchange rates, revenues rose 9% over third
quarter 2000, attributable to growth in brokerage commissions and fees, which
was partially offset by a decline in investment income. Consolidated revenue for
the operating segments grew approximately 7% on an organic basis over last year.
For the first nine months, revenue rose $226 million or 4% over last year.
Excluding the effects of foreign exchange rates, revenues increased 7% over the
comparable nine-month period. Improvements in brokerage commissions and fees as
well as premiums earned were partially offset by a decline in investment income
resulting from lower interest rates and higher losses on disposals.
Brokerage commissions and fees increased $121 million or 10% in third quarter
2001 and $341 million or 10% on a year-to-date basis. This improvement was
primarily from organic growth, business combination activity, especially
Actuarial Sciences Associates, Inc. (ASA) and ASI Solutions Incorporated (ASI),
increased new business and the impact of increased property and casualty premium
rates, offset somewhat by unfavorable results in U.S. retail brokerage related
to the business transformation.
Premiums and other is primarily related to insurance underwriting operations.
Premiums and other improved $34 million over third quarter 2000, and increased
$75 million or 5% in the first nine months of 2001, compared with the same
period last year. In the third quarter, growth in the accident and health lines
as well as the impact of acquisitions, including First Extended, Inc., acquired
in July 2001, was somewhat offset by the loss of some accounts in the warranty
business, in addition to a general slowdown of the market. The increase in
premiums earned for the first nine months primarily reflects strong growth in
low margin new business initiatives, continued organic growth, and the impact of
acquisitions.
Investment income, which includes related expenses and income or loss on
disposals and impairments, decreased significantly in both the third quarter and
the first nine months of 2001 when compared to prior year, primarily reflecting
reduced valuations on equity investments in limited partnerships and reductions
in short-term interest rates for both the quarter and year-to-date. The
nine-month comparison is also negatively impacted by the impairment recorded for
certain directly owned equity investments in the first quarter 2001. Revenues
from private equity investments tend to fluctuate due to the inherent volatility
of equity investments. Investment income from Insurance Brokerage and Other
Services and Consulting segments, primarily relating to fiduciary funds,
decreased $2 million and $5 million in third quarter and nine months 2001,
respectively, compared to similar periods in 2000, primarily as a result of
declines in rates.
Total expenses increased $238 million or 15% over third quarter 2000 due
partially to acquisitions, the inclusion of charges related to the World Trade
Center tragedy in the quarter and additional unanticipated costs to run parallel
systems. Total expenses, excluding the World Trade Center charges, rose 12%.
General expenses increased $176 million or 15% in the quarter reflecting growth
of our businesses, higher costs in the U.S. retail brokerage business and
increased business transformation implementation costs. Benefits to
policyholders rose $14 million or 5%. Interest expense declined $7 million or
18%, driven by lower short-term interest rates and lower average debt levels.
For nine months, total expenses increased $671 million or 14% over 2000,
partially driven by the inclusion of unusual and special charges this year.
Excluding these charges, total expenses rose $400 million or 9%. General
expenses grew $562 million or 15%, reflecting special charges of $218 million,
along with expenditures to grow the brokerage business and higher business
transformation costs. Benefits to policyholders rose $57 million or 7% as a
result of new underwriting initiatives and an unusual increase in warranty
claims during the first quarter 2001 related to an isolated program that will
- 16 -
not affect future quarters. Interest expense declined $4 million or 4% compared
to prior year attributed to decreases in short-term interest rates and lower
average debt balances.
For the quarter, income before income tax declined significantly from $244
million in 2000 to $133 million in 2001, due partially to the inclusion in 2001
of expenses related to the events of September 11 ($53 million) with no
comparable amount in the third quarter of 2000. In addition, slower revenue
growth in the U.S. retail brokerage business due to the implementation of the
business transformation plan and slower organic revenue growth in the
consulting segment negatively impacted results. Similarly, nine month 2001
results declined from 2000 by 64% to $245 million from $690 million due to 2001
business transformation special charges of $218 million, World Trade Center
charges of $53 million and a decline in consolidated investment income of $190
million.
As a result of these factors, third quarter 2001 net income declined to $72
million ($0.26 per dilutive share) compared to $139 million ($0.53 per dilutive
share) in 2000. Basic net income per share was $0.26 and $0.53 in third quarter
2001 and 2000, respectively. For the first nine months 2001 net income declined
to $120 million ($0.44 per dilutive share) compared to $384 million ($1.46 per
dilutive share) in 2000. In 2000, the company adopted the Securities and
Exchange Commission's Staff Accounting Bulletin 101, which resulted in a
one-time cumulative non-cash charge of $7 million after-tax ($0.03 per share).
Basic net income per share was $0.44 and $1.47 for the first nine months of 2001
and 2000, respectively. Dividends on the redeemable preferred stock have been
deducted from net income to compute income per share. The effective tax rate was
39% for both third quarter and nine months 2001 and 2000, respectively.
OPERATING SEGMENTS
- ------------------
INSURANCE BROKERAGE AND OTHER SERVICES
- --------------------------------------
The Insurance Brokerage and Other Services segment consists principally of Aon's
retail, reinsurance and wholesale brokerage operations as well as managing
underwriting, actuarial, loss control, claims, alternative risk transfer and
premium financing services. This segment represented 58% and 60% of Aon's total
revenues for the third quarter and first nine months of 2001, respectively.
Third quarter 2001 Insurance Brokerage and Other Services revenue was $1.1
billion, up 7% over last year. Excluding foreign exchange, revenues rose 8%.
Year-to-date, revenues of $3.4 billion improved 6% over the previous year.
Eliminating the effect of foreign exchange, revenues increased by 9%. Organic
revenue growth was 6% in the quarter, principally reflecting slower new business
growth in U.S. retail brokerage due in part to unexpected complications and
delays in the implementation of the business transformation plan and the events
of September 11. Claims services and international and wholesale brokerage
posted solid revenue growth for both the quarter and year-to-date periods.
U.S. revenue of $597 million for the quarter was up 9% from 2000. For the first
nine months, revenues climbed 8% to $1.7 billion. For both periods, the increase
reflects growth in U.S. specialty operations, improved pricing and acquisitions,
all of which more than offset the direct and indirect impact of the business
transformation plan on the U.S. retail operation and the World Trade Center
tragedy. U.S. retail new account generation during 2001 grew at a slower rate
than anticipated in certain U.S. retail brokerage units as operational changes
were implemented to achieve long-term benefits of the business transformation
plan. Commercial property and casualty premium rate increases were evident for
most lines of coverage and client demand for risk retention programs and
services has risen along with the upward trend in premium rates. U. K. and
Continent of Europe revenues of $376 million for the third quarter and $1.2
billion for the first nine
- 17 -
months of 2001 increased 3% and 4%, respectively, from 2000, primarily due to
organic growth and acquisitions. The reported revenue growth was unfavorably
impacted by the effect of foreign exchange rates. Rest of world revenue
increased $11 million or 9% over third quarter 2000 and $36 million or 9% over
the first nine months 2000 reflecting solid organic growth resulting from new
business and good renewal rates and the positive impact of hardening insurance
markets, in addition to new business and the impact of acquisitions.
Pretax income, including unusual charges related to the World Trade Center, was
$145 million for the third quarter 2001. Excluding these charges, pretax income
of $153 million declined 16% over 2000. Pretax margins, excluding the charges,
were 13.8% in the quarter compared to 17.6% in 2000. Year-to-date, pretax income
was $349 million. Excluding unusual and special charges, nine months 2001 pretax
income was essentially flat at $544 million. Pretax margins excluding the
charges were 16.1% for 2001 versus 17.1% last year. For both periods, the margin
decline was principally driven by slower new business growth and higher lost
business in the U.S. retail brokerage operations. In addition, higher costs in
certain parts of the U.S. retail business, due to the business transformation
process, including expense to run parallel systems longer than expected, along
with significant growth in our claims service business, which has lower margins
also contributed to the margin decline. These items more than offset business
transformation savings.
CONSULTING
- ----------
The consulting segment provides a full range of services related to the
management of human capital, benefits and business processes. These services are
delivered to a predominately corporate clientele utilizing four practice groups:
employee benefits, compensation, management consulting and outsourcing. The
acquisition of ASI further strengthened Aon's outsourcing and compensation
consulting services. This segment accounted for 12% of Aon's total revenues for
both the quarter and first nine months of 2001.
Third quarter 2001 revenue increased 27% to $232 million. Excluding the foreign
exchange impact, revenues grew 29%. For the first nine months, revenues of $673
million represent a 25% increase over 2000. Excluding the impact of foreign
exchange rates, the growth rate was 28%. For the third quarter 2001, revenue
grew 4% on an organic basis reflecting a slowdown on hiring by some of our
clients and the impact of September 11. On a global basis, the improvement in
revenue for both periods was influenced by acquisition activity, especially the
inclusion of ASA acquired in fourth quarter 2000, and to a lesser extent, ASI,
acquired in the second quarter 2001, as well as organic growth. Client demand
for solutions that enhance workforce productivity continued. However, the
worsening economy has put some pressure on organic revenue growth.
For the quarter, U.S. revenue of $161 million was up 36% from 2000, while
year-to-date revenue of $453 million represents a 39% increase. In both periods,
the improvement reflects the impacts of acquisitions and for the nine months
strong fundamental operating performance, particularly in the employee benefits
area. U.S. organic growth was flat for the quarter due to the slowing economy
and the World Trade Center disaster. U.K. revenue increased by 6% for the third
quarter over the prior year. U.K. revenue for the nine-month period declined 4%
compared with 2000, reflecting the sale of the financial planning consulting
business last year, along with unfavorable foreign exchange rates. Continent of
Europe revenue rose $2 million for the quarter and $4 million for nine months
compared to 2000.
Pretax income was $29 million for the quarter, a 12% increase over last year.
Year-to-date, pretax income was $77 million. Excluding special charges, pretax
income of $84 million was 24% better than 2000. Pretax margins in this segment
were 12.5% in the quarter compared to 14.3% in 2000. For nine months, pretax
- 18 -
margins before special charges were 12.5% in 2001 compared to 12.6% in 2000.
Margin deterioration in the quarter is primarily due to lower levels of employee
hiring on the part of Aon/ASI outsourcing clients and the impact of the World
Trade Center disaster.
INSURANCE UNDERWRITING
- ----------------------
The Insurance Underwriting segment provides accident and health and life
insurance coverage through distribution networks, most of which are directly
owned by Aon's subsidiaries, and extended warranty and property and casualty
insurance products. This segment represented 30% of Aon's total revenues for
both the third quarter and first nine months of 2001.
Revenue was $565 million in the third quarter 2001, an increase of 5% from 2000.
Year-to-date, revenues of $1.7 billion in 2001 represented an increase of 4%
over 2000. Excluding the impact of exchange rates, revenues rose 7% for both the
quarter and nine months. For both periods, improvement over last year was driven
by the development of new product initiatives and a higher volume of business in
accident and health products, which continued to expand distribution through
worksite marketing programs.
U.S. revenue increased $25 million in the third quarter 2001 to $409 million.
For nine months 2001, revenues rose 5% from 2000 to $1.2 billion. For both
periods, higher revenues reflect new product initiatives and increased revenues
for accident and health products, due in part to acquired business, which more
than offset a decline in electronic warranty products. United Kingdom and
Continent of Europe revenue of $105 million increased 6% during the quarter,
while year-to-date, revenues increased 1% to $316 million. Unfavorable foreign
exchange rates and the slowdown of business in the warranty area offset organic
growth in the accident and health sector. Rest of world revenue was $51 million
for the third quarter, down $2 million from 2000. For the first nine months of
2001, revenue was up 3% to $156 million, due principally to growth in Latin
America.
Pretax income was $35 million for the quarter. Excluding this year's charge
related to the World Trade Center, pretax income was relatively flat to last
year at $80 million. Year-to-date, pretax income was $158 million. Excluding
both unusual and special charges, pretax income of $227 million was flat
compared to 2000. Pretax margins in this segment were 14.2% in the quarter
before unusual charges compared to 15.1% in 2000. A decline in investment
income, due in part to lower interest rates, affected margin comparisons in the
quarter. For nine months, pretax margins before unusual and special charges fell
from 14.0% in 2000 to 13.5% in 2001. For both periods in 2001, new underwriting
initiatives drove premium growth but also resulted in increased benefits to
policyholders. For the year-to-date comparison, an unusual increase in warranty
claims occurred during the first quarter 2001 related to an isolated program
that will not affect subsequent quarters.
NON-OPERATING SEGMENT
- ---------------------
CORPORATE AND OTHER
- -------------------
Revenue in this category consists primarily of investment income (including
income or loss on disposals, along with impairment losses) which is not
otherwise reflected in the results of the operating segments. 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 businesses and related income, are
allocated to the Corporate and Other segment. Corporate and Other expenses
include general expenses, administrative and certain information technology
costs, interest expense and goodwill amortization.
- 19 -
Corporate and Other revenue for the third quarter 2001 was $3 million, versus
$25 million in the third quarter 2000. For nine months 2001, revenue was a
negative $96 million, versus positive revenue of $77 million last year. The
falloff in revenue in both periods primarily reflects reduced valuations for
equity investments in limited partnerships. The year-to-date comparison is also
affected by the write-down of certain directly owned equity investments in the
first quarter 2001. Revenues from private equity investments fluctuate due to
the inherent volatility of equity investments. Limited partnership investments
often require longer time horizons to generate income.
Corporate and Other expenses for the quarter were $79 million, up $8 million
from the same period last year. For the first nine months of 2001, expenses were
$243 million, an increase of $16 million from the comparable period in 2000.
Interest expense declined $7 million for the quarter and $4 million for the
first nine months compared to prior year, reflecting lower interest rates as
well as lower debt levels. General expenses, which were at levels similar to the
first two quarters of 2001, rose $14 million and $17 million over what was
reported for the quarter and nine months of 2000, respectively, due in part to
duplicate occupancy costs involving major moves to new office space. General
expenses in 2000 benefited from the gain on sale of a non-core business in the
U.K. Goodwill amortization increased as a result of new acquisitions made prior
to July 1, 2001.
The revenue and expense comparisons discussed above contributed to the overall
Corporate and Other pretax loss of $76 million in the quarter versus a loss of
$46 million last year. The year-to-date loss of $339 million is compared to a
$150 million loss in 2000.
- 20 -
CASH FLOW AND FINANCIAL POSITION
AT THE END OF NINE MONTHS 2001
Cash flows from operating activities represent the net income earned by Aon in
the reported periods adjusted for non-cash charges as well as changes in assets
and liabilities. Cash flows provided by operating activities for the first nine
months 2001 were $678 million, a $144 million increase over the same period in
2000. Other receivables and liabilities increased $122 million during the year,
driven by higher deferred compensation and other accruals of $61 million and a
$29 million impairment write-off of fixed assets lost in the World Trade Center
tragedy. This was partially offset by the timing of income tax payments and
refunds. The non-cash effect of lower valuations on the company's limited
partnership portfolio, coupled with impairments on investments and loss on
disposals, was partially offset by lower net income.
Investing activities used cash of $650 million. The net sale of investments
provided cash of $175 million during the first nine months of 2001. This was
offset by the net purchase of short-term investments of $558 million. Cash used
for acquisition activity during the first nine months 2001 was $101 million,
reflecting both brokerage and consulting acquisitions.
Cash of $646 million was used during the first nine months 2001 for financing
activities, which was $609 million more than was utilized in 2000. The higher
usage of cash from last year is primarily due to a reduction of both short- and
long-term borrowings in 2001 compared to short-term debt increases during last
year. In addition, $250 million of long-term debt was issued in the second
quarter 2000 with no corresponding amount issued in 2001. Cash was used to pay
dividends of $177 million on common stock and $2 million on redeemable preferred
stock during the first nine months of 2001.
Aon's operating subsidiaries anticipate that there will be adequate liquidity to
meet their needs in the foreseeable future. Aon's liquidity needs are primarily
for servicing its debt and for the payment of dividends on stock issues and
capital securities. The businesses of Aon's operating subsidiaries continue to
provide substantial positive cash flow. Brokerage cash flow has been used
primarily for business reinvestment, acquisition financing and payments of
special charge and purchase accounting liabilities. Aon anticipates continuation
of the company's positive cash flow and the ability of the parent company to
access adequate short-term lines of credit. In November 2001, Aon announced
that, along with Zurich Financial Services, it will sponsor a new Bermuda-based
insurance and reinsurance company and will invest $200 million in the new
company. Aon has adequate operating cash to fund this commitment.
Due to the contractual nature of its insurance policyholder liabilities, which
are primarily intermediate to long-term in nature, Aon has invested primarily in
fixed maturities. With a carrying value of $2.3 billion, Aon's total fixed
maturity portfolio is invested primarily in investment grade holdings (95%) and
has a fair value that is 100% of amortized cost at September 30, 2001.
Total assets increased $594 million to $22.8 billion since year-end 2000.
Invested assets at September 30, 2001 increased $368 million from year-end
levels as higher levels of short-term investments more than offset lower equity
securities as well as lower valuations and impairment charges in other
investments. The amortized cost and fair value of less than investment grade
fixed maturity investments at September 30, 2001 were $131 million and $119
million, respectively. The carrying value of non-income producing investments in
Aon's portfolio at September 30, 2001 was $48 million, or 0.8% of total invested
assets.
Short-term borrowings decreased at the end of third quarter 2001 by $116 million
when compared to year-end 2000. At the end of third quarter 2001 notes payable
decreased by $138 million when compared to year-end 2000, primarily reflecting
the repayment of foreign debt.
- 21 -
Stockholders' equity increased $238 million during the first nine months of
2001, reflecting an increase in paid-in additional capital of $944 million, of
which $782 million was a result of shares issued to acquire two entities
controlled by Aon's Chairman and Chief Executive Officer. This increase is
offset with a corresponding increase in Treasury Stock. Paid-in-capital also
rose as a result of shares issued for the ASI acquisition in May 2001 and the
First Extended, Inc. acquisition in July 2001. Net income before preferred
dividends for the first nine months of 2001 was $120 million. Partially
offsetting the equity increase were dividends paid to stockholders of $179
million. Unrealized investment gains and losses and foreign exchange gains and
losses fluctuations from period to period are largely based on market
conditions.
At September 30, 2001 stockholders' equity per share was $13.47, up from $13.02
at December 31, 2000 as the higher equity balance more than offset the increased
number of shares outstanding since year-end.
REVIEW BY INDEPENDENT AUDITORS
- ------------------------------
The condensed consolidated financial statements at September 30, 2001, and for
the nine months then ended have been reviewed, prior to filing, by Ernst & Young
LLP, Aon's independent auditors, and their report is included herein.
- 22 -
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
Board of Directors and Stockholders
Aon Corporation
We have reviewed the accompanying condensed consolidated statement of financial
position of Aon Corporation as of September 30, 2001, and the related condensed
consolidated statements of income for the three-month and nine-month periods
ended September 30, 2001 and 2000, and the condensed consolidated statements of
cash flows for the nine-month periods ended September 30, 2001 and 2000. These
financial statements are the responsibility of the Company's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data, and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with auditing standards generally accepted in the United States,
which will be performed for the full year with the objective of expressing an
opinion regarding the financial statements taken as a whole. Accordingly, we do
not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to the accompanying condensed consolidated financial statements referred
to above for them to be in conformity with accounting principles generally
accepted in the United States.
We have previously audited, in accordance with auditing standards generally
accepted in the United States, the consolidated statement of financial position
of Aon Corporation as of December 31, 2000, and the related consolidated
statements of income, stockholders' equity, and cash flows for the year then
ended, not presented herein, and in our report dated February 8, 2001, we
expressed an unqualified opinion on those consolidated financial statements. In
our opinion, the information set forth in the accompanying condensed
consolidated statement of financial position as of December 31, 2000, is fairly
stated, in all material respects, in relation to the consolidated statement of
financial position from which it has been derived.
ERNST & YOUNG LLP
Chicago, Illinois
November 13, 2001
- 23 -
PART II
-------
OTHER INFORMATION
-----------------
ITEM 2. CHANGED IN SECURITIES AND USE OF PROCEEDS
(a) Pursuant to a Plan and Agreement of Merger dated May 3, 2001 by and
among Aon, Merger Acquisition Company, a Delaware corporation (a
wholly owned subsidiary of Aon) ("Merger Sub"), First Extended,
Inc., a Delaware corporation, and the stockholders of First
Extended, Inc. ("Sellers"), Merger Sub merged with and into the
Company on July 24, 2001 with the result that the surviving
corporation became a wholly owned subsidiary of Aon and the stock of
First Extended, Inc. outstanding immediately prior to the merger was
converted into an aggregate 2,000,000 shares of Aon Common Stock.
The merger did not involve any underwriters, underwriting discounts
or commissions, and Aon believes that the transaction was exempt
from the registration requirements of the Securities Act of 1933 by
virtue of Section 4(2) thereof regarding transactions not involving
a public offering and Rule 506 of Regulation D promulgated
thereunder. Aon filed a Registration Statement on Form S-3 in
connection with the resale of the 2,000,000 shares of Aon Common
Stock by the Sellers of First Extended. The Sellers of First
Extended, Inc. will receive all of the proceeds from any sale of the
Aon Common Stock offered under the Registration Statement on Form
S-3, and Aon will not receive any proceeds from the sale of the Aon
Common Stock offered thereunder.
(b) Securities issued pursuant to an acquisition were disclosed in Part
II, Item 2 of Aon's Quarterly Report on Form 10Q for the quarter
ended June 30, 2001, which is incorporated herein by reference.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits - The exhibits filed with this report are listed on the
--------
attached Exhibit Index.
(b) Reports on Form 8-K -
-------------------
(i) No Current Reports on Form 8-K were filed for the quarter
ended September 30, 2001.
(ii) The Registrant filed one Current Report on Form 8-K dated
November 8, 2001. The following exhibit was included in the
report: Exhibit 99 - Earnings Press Release issued on November
7, 2001.
- 24 -
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Aon Corporation
---------------
(Registrant)
November 14, 2001 /s/ Harvey N. Medvin
--------------------------
HARVEY N. MEDVIN
EXECUTIVE VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER
(Principal Financial and Accounting Officer and
authorized signatory on behalf of Registrant)
- 25 -
Aon CORPORATION
- ---------------
Exhibit Number
In Regulation S-K
Item 601 Exhibit Table
- ----------------------
(12) Statements regarding Computation of Ratios.
(a) Statement regarding Computation of Ratio of Earnings to Fixed
Charges.
(b) Statement regarding Computation of Ratio of Earnings to
Combined Fixed Charges and Preferred Stock Dividends.
(15) Letter re: Unaudited Interim Financial Information
- 26 -
EXHIBIT 12(a)
AON CORPORATION AND CONSOLIDATED SUBSIDIARIES
COMBINED WITH UNCONSOLIDATED SUBSIDIARIES
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
NINE MONTHS ENDED
SEPTEMBER 30, YEARS ENDED DECEMBER 31,
--------------------- --------------------------------------------------------
(millions except ratios) 2001 2000 2000 1999 1998 1997 1996
--------- ---------- ---------- --------- ---------- --------- ----------
Income from continuing operations
before provision for income taxes
and minority interest (1) $ 245 $ 690 $ 854 $ 635 $ 931 $ 542 $ 446
ADD BACK FIXED CHARGES:
Interest on indebtedness 98 102 140 105 87 70 45
Interest on ESOP - - - 1 2 3 4
Portion of rents representative of
interest factor 39 37 54 49 51 44 29
--------- ---------- ---------- --------- ---------- --------- ----------
INCOME AS ADJUSTED $ 382 $ 829 $ 1,048 $ 790 $ 1,071 $ 659 $ 524
========= ========== ========== ========= ========== ========= ==========
FIXED CHARGES:
Interest on indebtedness $ 98 $ 102 $ 140 $ 105 $ 87 $ 70 $ 45
Interest on ESOP - - - 1 2 3 4
Portion of rents representative of
interest factor 39 37 54 49 51 44 29
--------- ---------- ---------- --------- ---------- --------- ----------
TOTAL FIXED CHARGES $ 137 $ 139 $ 194 $ 155 $ 140 $ 117 $ 78
========= ========== ========== ========= ========== ========= ==========
RATIO OF EARNINGS TO FIXED CHARGES 2.8 6.0 5.4 5.1 7.6 5.6 6.7
========= ========== ========== ========= ========== ========= ==========
<FN>
(1) Income from continuing operations before provision for income taxes and
minority interest includes unusual charges of $53 million related to
the World Trade Center tragedy and special charges of $218 million for
the nine months ended September 30, 2001. Income from continuing
operations before provision for income taxes and minority interest
includes special charges of $82 million, $313 million, $172 million and
$90 million for the years ended December 31, 2000, 1999, 1997 and 1996,
respectively.
</FN>
EXHIBIT 12(b)
AON CORPORATION AND CONSOLIDATED SUBSIDIARIES
COMBINED WITH UNCONSOLIDATED SUBSIDIARIES
COMPUTATION OF RATIO OF EARNINGS TO COMBINED FIXED CHARGES
AND PREFERRED STOCK DIVIDENDS
NINE MONTHS ENDED
SEPTEMBER 30, YEARS ENDED DECEMBER 31,
---------------------- ----------------------------------------------------------
(millions except ratios) 2001 2000 2000 1999 1998 1997 1996
---------- ---------- ----------- ---------- ---------- ---------- -----------
Income from continuing operations
before provision for income taxes
and minority interest (1) $ 245 $ 690 $ 854 $ 635 $ 931 $ 542 $ 446
ADD BACK FIXED CHARGES:
Interest on indebtedness 98 102 140 105 87 70 45
Interest on ESOP - - - 1 2 3 4
Portion of rents representative of
interest factor 39 37 54 49 51 44 29
---------- ---------- ----------- ---------- ---------- ---------- -----------
INCOME AS ADJUSTED $ 382 $ 829 $ 1,048 $ 790 $ 1,071 $ 659 $ 524
========== ========== =========== ========== ========== ========== ===========
FIXED CHARGES AND PREFERRED STOCK DIVIDENDS:
Interest on indebtedness $ 98 $ 102 $ 140 $ 105 $ 87 $ 70 $ 45
Preferred stock dividends 52 52 70 70 70 82 29
---------- ---------- ----------- ---------- ---------- ---------- -----------
INTEREST AND DIVIDENDS 150 154 210 175 157 152 74
Interest on ESOP - - - 1 2 3 4
Portion of rents representative of
interest factor 39 37 54 49 51 44 29
---------- ---------- ----------- ---------- ---------- ---------- -----------
TOTAL FIXED CHARGES AND PREFERRED
STOCK DIVIDENDS $ 189 $ 191 $ 264 $ 225 $ 210 $ 199 $ 107
========== ========== =========== ========== ========== ========== ===========
RATIO OF EARNINGS TO COMBINED FIXED
CHARGES AND PREFERRED STOCK DIVIDENDS (2) 2.0 4.3 4.0 3.5 5.1 3.3 4.9
========== ========== =========== ========== ========== ========== ===========
<FN>
(1) Income from continuing operations before provision for income taxes and
minority interest includes unusual charges of $53 million related to
the World Trade Center tragedy and special charges of $218 million for
the nine months ended September 30, 2001. Income from continuing
operations before provision for income taxes and minority interest
includes special charges of $82 million, $313 million, $172 million and
$90 million for the years ended December 31, 2000, 1999, 1997 and 1996,
respectively.
(2) Included in total fixed charges and preferred stock dividends are $49
million for the nine months ended September 30, 2001 and 2000, $66
million for the years ended December 31, 2000, 1999 and 1998, and $64
million for the year ended December 31, 1997, of pretax distributions
on the 8.205% mandatorily redeemable preferred capital securities which
are classified as "minority interest" on the condensed consolidated
statements of income.
</FN>
Exhibit 15
Board of Directors and Stockholders
Aon Corporation
We are aware of the incorporation by reference in the Registration Statements of
Aon Corporation ("Aon") described in the following table of our report dated
November 8, 2001 relating to the unaudited condensed consolidated interim
financial statements of Aon Corporation that are included in its Form 10-Q for
the quarter ended September 30, 2001:
Registration Statement
Form Number Purpose
S-8 33-27984 Pertaining to Aon's savings plan
S-8 33-42575 Pertaining to Aon's stock award plan and stock
option plan
S-8 33-59037 Pertaining to Aon's stock award plan and stock
option plan
S-4 333-21237 Offer to exchange Capital Securities of Aon
Capital A
S-3 333-50607 Pertaining to the registration of 369,000 shares
of common stock
S-8 333-55773 Pertaining to Aon's stock award plan, stock
option plan and employee stock purchase plan
S-3 333-78723 Pertaining to the registration of debt
securities, preferred stock and common stock
S-3 333-49300 Pertaining to the registration of 3,864,
824 shares of common stock
S-4 333-57706 Pertaining to the registration of up to
3,852,184 shares of common stock
S-3 333-65624 Pertaining to the registration of 2,000,000
shares of common stock
Pursuant to Rule 436(c) of the Securities Act of 1933, our report is not a part
of the registration statements prepared or certified by accountants within the
meaning of Section 7 or 11 of the Securities Act of 1933.
ERNST & YOUNG LLP
Chicago, Illinois
November 13, 2001