UNITED STATESSECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-K
Commission file number: 001-16503
WILLIS GROUP HOLDINGS LIMITED (Exact name of Registrant as specified in its charter)
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 13 or Section 15(d) of the Act. Yes o No ý
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 Exchange Act of 1934 during the preceding 12 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 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 the Registrant's knowledge, in definite proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definition of "large accelerated filer", "accelerated filer" and "smaller reporting company" in rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No ý
As of February 17, 2009, the aggregate market value of the voting stock held by non-affiliates of the Registrant was approximately $4,344,584,605.
As of February 17, 2009, there were outstanding 166,850,684 shares of common stock, par value $0.000115 per share of the Registrant.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Willis Group Holding Limited's 2009 Notice of Annual Meeting of Stockholders and Proxy Statement are incorporated by reference into Part III of this Form 10-K.
WILLIS GROUP HOLDINGS LIMITED ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2008
Certain Definitions
The following definitions apply throughout this annual report unless the context requires otherwise:
"Company" or "Group" or "Willis"
"Companies Act"
"Shares"
"Willis Group Holdings"
"HRH"
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Table Of Contents
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INFORMATION CONCERNING FORWARD-LOOKING STATEMENTS
We have included in this document "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934, which are intended to be covered by the safe harbors created by those laws. These forward-looking statements include information about possible or assumed future results of our operations. All statements, other than statements of historical facts, included in this document that address activities, events or developments that we expect or anticipate may occur in the future, including such things as the potential benefits of the business combination transaction involving Willis and HRH, expected growth in commissions and fees, business strategies, competitive strengths, goals, the anticipated benefits of new initiatives, growth of our business and operations, plans and references to future successes are forward-looking statements. Also, when we use the words such as "anticipate", "believe", "estimate", "expect", "intend", "plan", "probably", or similar expressions, we are making forward-looking statements.
There are important uncertainties, events and factors that could cause our actual results or performance to differ materially from those in the forward-looking statements contained in this document, including regional, national or global political, economic, business, competitive, market and regulatory conditions and the following:
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The foregoing list of factors is not exhaustive and new factors may emerge from time to time that could also affect actual performance and results.
Although we believe that the assumptions underlying our forward-looking statements are reasonable, any of these assumptions, and therefore also the forward-looking statements
based on these assumptions, could themselves prove to be inaccurate. In light of the significant uncertainties inherent in the forward-looking statements included in this document, our inclusion of this information is not a representation or guarantee by us that our objectives and plans will be achieved.
Our forward-looking statements speak only as of the date made and we will not update these forward-looking statements unless the securities laws require us to do so. In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this document may not occur, and we caution you against unduly relying on these forward-looking statements.
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PART I
Item 1—Business
History and Development of the Company
Willis Group Holdings is the ultimate holding company for the Group. We trace our history to 1828 and are one of the largest insurance brokers in the world.
Willis Group Holdings was incorporated in Bermuda on February 8, 2001 as an exempted company under the Companies Act, for the sole purpose of redomiciling the ultimate parent company of the Willis Group from the United Kingdom to Bermuda.
For administrative convenience, we utilize the offices of a subsidiary company as our principal executive offices. The address is:
Willis Group Holdings Limitedc/o Willis Group LimitedThe Willis Building51 Lime StreetLondon EC3M 7DQEnglandTel: +44 203 124 6000
For several years, we have focused on our core retail and specialist broking operations. Prior to 2008, we made a number of smaller acquisitions around the world and increased our ownership in several of our associates and existing subsidiaries, which were not wholly-owned, where doing so strengthened our retail network and our specialty businesses.
On October 1, 2008, we completed the acquisition of HRH, the eighth largest insurance and risk management intermediary in the United States. The acquisition doubled our North America revenues and the combined Willis HRH operation has critical mass in key markets including California, Florida, Texas, Illinois, New York, Boston, New Jersey and Philadelphia.
Available Information
Willis Group Holdings files annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission (the "SEC"). You may read and copy any documents we file at the SEC's Public Reference Room at 100 F Street, NE
Washington, DC 20549. Please call the SEC at 1-800-SEC-0330 for information on the Public Reference Room. The SEC maintains a website that contains annual, quarterly and current reports, proxy statements and other information that issuers (including Willis Group Holdings) file electronically with the SEC. The SEC's website is www.sec.gov.
The Company makes available, free of charge through our website, www.willis.com, our annual report on Form 10-K, our quarterly reports on Form 10-Q, our proxy statement, current reports on Form 8-K and Forms 3, 4, and 5 filed on behalf of directors and executive officers, as well as any amendments to those reports filed or furnished pursuant to the Securities Exchange Act of 1934 (the "Exchange Act") as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC. Unless specifically incorporated by reference, information on our website is not a part of this Form 10-K.
The Company's Corporate Governance Guidelines, Audit Committee Charter, Compensation Committee Charter and Corporate Governance and Nominating Committee Charter are also available on our website, www.willis.com, in the Corporate Governance section, or upon written or verbal request. Requests for copies of these documents should be directed in writing to the Company Secretary at the above address.
General
We provide a broad range of insurance brokerage, reinsurance and risk management consulting services to our worldwide clients. We have significant market positions in the United States, in the United Kingdom and, directly and through our associates, in many other countries. We are a recognized leader in providing specialized risk management advisory and other services on a global basis to clients in various industries including the aerospace, marine, construction and energy industries.
In our capacity as an advisor and insurance broker, we act as an intermediary between our clients and insurance carriers by advising our
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clients on their risk management requirements, helping clients determine the best means of managing risk, and negotiating and placing insurance risk with insurance carriers through our global distribution network.
We assist clients in the assessment of their risks, advise on the best ways of transferring suitable risk to the global insurance and reinsurance markets and then execute the transactions at the most appropriate available price, terms and conditions for our clients. Our global distribution network enables us to place the risk in the most appropriate insurance or reinsurance market worldwide.
We also offer clients a broad range of services to help them to identify and control their risks. These services range from strategic risk consulting (including providing actuarial analyses), to a variety of due diligence services, to the provision of practical on-site risk control services (such as health and safety or property loss control consulting) as well as analytical and advisory services (such as hazard modeling and reinsurance optimization studies). We assist clients in planning how to manage incidents or crises when they occur. These services include contingency planning, security audits and product tampering plans. We are not an insurance company and therefore we do not underwrite insurable risks for our own account, with the exception of a small legacy HRH operation (which is immaterial to the Group) in Omaha that underwrites for college fraternities.
We and our associates serve a diverse base of clients located in approximately 190 countries. These clients include major multinational and middle-market companies in a variety of industries, as well as public institutions and individual clients. Many of our client relationships span decades. Including our associates, we have approximately 20,000 employees around the world and a network of about 400 offices in some 100 countries.
We believe we are one of only a few insurance brokers in the world possessing the global operating presence, broad product expertise and extensive distribution network necessary to meet effectively the global risk management needs of many of our clients.
Business Strategy—Shaping our Future
Shaping our Future, our strategy introduced in 2006, aims to deliver profitable growth over the next several years.
Our vision is that Willis will:
Our Business
Insurance and reinsurance is a global business, and its participants are affected by global trends in capacity and pricing. Accordingly, we operate as one global business which ensures all clients' interests are handled efficiently and comprehensively, whatever their initial point of contact. We organize our business into three segments: North America and International, which together comprise our principal retail operations, and Global. For information regarding revenues, operating income and total assets per segment, see Note 22 of the Consolidated Financial Statements contained herein.
Global
Our Global business provides specialist brokerage and consulting services to clients worldwide for the risks arising from specific industrial and commercial activities. In these operations, we have extensive specialized
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experience handling diverse lines of coverage, including complex insurance programs, and acting as an intermediary between retail brokers and insurers. We increasingly provide consulting services on risk management with the objective of assisting clients to reduce the overall cost of risk. Our Global business serves clients in around 190 countries, primarily from offices in the United Kingdom, although we also serve clients from offices in the United States, Continental Europe and Asia.
The Global business is divided into:
Faber & Dumas, our new wholesale brokerage division, was launched in October 2008 on completion of Willis' acquisition of HRH. Faber & Dumas comprises HRH's London-based operation Glencairn, together with our Fine Art, Jewelry and Specie; Special Contingency Risk and Hughes-Gibb units.
Global Specialties
Global Specialties has strong global positions in Aerospace, Energy, Marine, Construction, Financial and Executive Risks and several niche businesses.
We are highly experienced in the provision of insurance and reinsurance brokerage and risk management services to Aerospace clients, including aircraft manufacturers, air cargo handlers and shippers, airport managers and other general aviation companies. Advisory services provided by aerospace include claims recovery, contract and leasing risk management, safety services and market information. Aerospace's clients are spread throughout the world and include approximately 350 airlines and in excess of 30 percent of the top 30 of the world's leading insured non-American airports by passenger movement. Aerospace is also prominent in supplying the space industry through providing insurance and risk management services to approximately 40 companies.
Our Energy practice provides insurance brokerage services including property damage, offshore construction, liability and control of well and pollution insurance to the energy industry. The Energy practice clients are worldwide. We are highly experienced in providing insurance brokerage for all aspects of the energy industry including exploration and production, refining and marketing, offshore construction and pipelines.
Our marine unit provides marine insurance and reinsurance brokerage services, including hull, cargo and general marine liabilities. Marine's clients include ship owners, ship builders, logistics operators, port authorities, traders and shippers, other insurance intermediaries and insurance companies. Marine insurance brokerage is our oldest line of business dating back to our establishment in 1828.
Our Construction practice provides risk management advice and brokerage services for a wide range of UK and international construction activities. The clients of the construction practice include contractors, project owners, project managers, project financiers, professional consultants and insurers. We are the broker for many of the leading global construction firms.
Our Financial and Executive Risks unit specializes in broking directors' and officers' insurance as well as professional indemnity insurance for corporations and professional firms. It incorporates our political risk unit, as well as structured finance and credit teams. It also places structured crime and specialist liability insurance for clients across the broad spectrum of financial institutions as well as specializing in strategic risk assessment and transactional risk transfer solutions.
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Willis Re
We are one of the world's largest intermediaries for reinsurance and have a significant market share in the world's major markets, particularly marine and aviation. We operate this business on a global basis and our clients are both insurance and reinsurance companies.
We provide a complete range of transactional capabilities, including risk transfer via the capital markets, as well as analytical and advisory services including enterprise risk management, hazard modeling, financial and balance sheet analysis and reinsurance optimization studies.
Faber & Dumas
Faber & Dumas is our wholesale brokerage division and comprises Glencairn; Fine Art, Jewelry and Specie; Special Contingency Risk and Hughes-Gibb units.
Retail operations
Our North America and International retail operations provide services to small, medium and major corporate clients, accessing Global's specialist expertise when required.
North America
In October 2008, we completed the acquisition of HRH, a leading middle market US-based insurance broker with a large account portfolio. HRH generated $800 million of revenues in 2007, with $57 million from its international operations, which are based in London. The acquisition substantially improves our position in important areas in North America including California, Florida, Texas, Illinois, New York, Massachusetts, New Jersey and Pennsylvania, and in key business lines. In particular, it will more than double our North America revenues in Employee Benefits, an already strong area of expertise that we have targeted for further growth. In addition, it will further strengthen key practice areas including personal lines, real estate, health care, environmental, construction, complex property and executive risk.
Our North America business provides risk management, insurance brokerage, related risk services, and employee benefits brokerage and consulting to a wide array of industry and client segments in the United States and Canada. With around 95 retail locations, organized into 8 regions including Canada, Willis North America locally delivers our global and national resources and specialist expertise through this retail distribution network.
In addition to being organized geographically and by specialty, our North America business focuses on four client segments: global, large national/middle-market, small commercial, and private client, with service, marketing and sales platform support for each segment. Further, our North America Marketing Practice provides clients with efficient access to worldwide insurance capital.
The largest industry practice group in North America is Construction which specializes in providing risk management, insurance brokerage, and surety bonding services to the construction industry. Willis Construction provides these services to around 25 percent of the Engineering News Record Top 400 contractors (a listing of the largest 400 North American contractors based on revenue). In addition, this practice group has expertise in
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owner controlled insurance programs for large projects and insurance for national homebuilders.
Other industry practice groups include Healthcare, serving the professional liability and other insurance and risk management needs of private and not-for-profit health systems, hospitals and physicians groups; Financial Institutions, serving the needs of large banks, insurers and other financial services firms; Mergers & Acquisitions, providing due diligence, and risk management and insurance brokerage services to private equity and merchant banking firms and their portfolio companies.
Willis Employee Benefits, fully integrated into the North America platform, is our largest product-based practice group and provides health, welfare and human resources consulting, and brokerage services to all of our commercial client segments. This practice group's value lies in helping clients control employee benefit plan costs, reducing the amount of time human resources professionals spend administering their companies' benefit plans and educating and training employees on benefit plan issues.
Another industry-leading North America practice group is Willis Executive Risks, a national team of technical professionals who specialize in meeting the directors & officers, employment practices, fiduciary liability insurance risk management, and claims advocacy needs of public and private corporations and organizations. This practice group also has expertise in professional liability, especially internet risks.
The Excess and Surplus segment, based in Redondo Beach, California with offices operating in California, Texas, Florida and Illinois, is a wholesale broker providing access to excess and surplus lines markets for the domestic network of retail brokers.
The Captive, Actuarial, and Pooling Solutions (CAPS) practice has a national team of actuaries, certified public accountants, financial analysts and pooled insurance program experts who help large clients develop, implement and manage alternative risks financing vehicles.
Willis HRH Programs, based in Portsmouth, New Hampshire with operations in Florida, Michigan, Utah, Colorado, Connecticut and Vermont, is a managing general agent/managing general underwriter and a leader in providing national insurance programs to niche industries including ski resorts, auto dealers, recycling, environmental, and specialty workers' compensation.
International
Our International unit consists of our retail operations in Eastern and Western Europe, the United Kingdom and Ireland, Asia/Pacific, Russia, the Middle East, South Africa and Latin America, with a presence in over 100 countries worldwide.
Our offices are there to grow our business locally around the world, making use of skills, industry knowledge and expertise available elsewhere in the Group.
The services provided are focused according to the characteristics of each market and are not identical in every office, but generally include direct risk management and insurance brokerage, specialist and reinsurance brokerage and employee benefits consulting.
We target both large accounts and middle market clients. Recent global market conditions have resulted in excellent opportunities to recruit talented teams and individuals from the competition with new and complementary skills and relationships. We have a dedicated team within International working on the implementation of our Shaping our Future strategy and initiatives, identifying opportunities for increased efficiency and growth.
We believe the combined total revenues of our International subsidiaries and associates provide
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an indication of the spread and capability of our International network. Our International segment generated close to 40 percent of total consolidated commissions and fees in 2008.
We have separately identified high growth markets across all International retail operations. This encompasses the fast-developing, high growth regions of Eastern Europe, Russia, Asia (excluding Japan), the Middle East and South Africa. We bring particular capabilities and scale in energy, construction, marine and aerospace to these regions.
Global Markets International works closely with Global to further develop access for our retail clients to global markets, and provide structuring and placing skills in the relevant areas of property, casualty, terrorism, accident & health, facultative and captives.
As part of our on-going strategy, we are continually strengthening our International market share through acquisitions and strategic investments. We have acquired a controlling interest in a broad geographic spread of other brokers—a list of the significant International subsidiaries is included in Exhibit 21.1 to this document.
We have also invested in associate companies; our significant associates at December 31, 2008 were Gras Savoye & Cie ("Gras Savoye"), France (48 percent voting rights) and Al-Futtaim Willis Co. LLC, Dubai (49 percent holding). In connection with many of our investments, we retain the rights to increase our ownership percentage over time, typically to a majority or 100 percent ownership position. In addition, in certain instances our co-shareholders have a right, typically based on some price formula of revenues or earnings, to put some or all of their shares to us (see "Item 1a—Risk Factors—Put and Call Arrangements"). On January 2, 2008, we acquired an additional 4 percent of Gras Savoye and a further 5 percent on December 31, 2008, bringing our total current voting rights to 48 percent.
Customers
Our clients operate on a global and local scale in a multitude of businesses and industries throughout the world and generally range in size from major multinational corporations to middle-market companies. Further, many of our client relationships span decades, for instance our relationship with The Tokio Marine and Fire Insurance Company Limited dates back over 100 years. No one client accounted for more than 10 percent of revenues for fiscal year 2008. Additionally, we place insurance with over 5,000 insurance carriers, none of which individually accounted for more than 10 percent of the total premiums we placed on behalf of our clients in 2008.
Competition
We face competition in all fields in which we operate based on global capability, product breadth, innovation, quality of service and price. According to the Directory of Agents and Brokers published by Business Insurance in July 2008, the 140 largest commercial insurance brokers globally reported brokerage revenues totaling $37 billion in 2007, of which Marsh & McLennan Companies Inc. had approximately 31 percent, Aon Corporation had approximately 19 percent and Willis had approximately 7 percent.
We compete with Marsh & McLennan and Aon as well as with numerous specialist, regional and local firms. Although Marsh & McLennan and Aon, along with us, have agreed to implement certain business reforms, many specialist, regional and local firms have not agreed to those business reforms. These firms are continuing to accept contingent compensation and are not disclosing the compensation received in connection with providing policy placement services to the customer.
Insurance companies also compete with brokers by directly soliciting insureds without the assistance of an independent broker or agent.
Competition for business is intense in all our business lines and in every insurance market. Competition on premium rates has also exacerbated the pressures caused by a continuing reduction in demand in some classes of business.
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For example, insurers are currently retaining a greater proportion of their risk portfolios than previously. Industrial and commercial companies are increasingly relying upon captive insurance companies, self-insurance pools, risk retention groups, mutual insurance companies and other mechanisms for funding their risks, rather than buying insurance.
Additional competitive pressures arise from the entry of new market participants, such as banks, accounting firms and insurance carriers themselves, offering risk management or transfer services.
Regulation
Our business activities are subject to legal requirements and governmental and quasi-governmental regulatory supervision in virtually all countries in which we operate. Also, such regulations may require individual or company licensing to conduct our business activities. While these requirements may vary from location to location they are generally designed to protect our clients by establishing minimum standards of conduct and practice, particularly regarding the provision of advice and product information as well as financial criteria.
Our activities in connection with insurance brokerage services within the United States are subject to regulation and supervision by state authorities. Although the scope of regulation and form of supervision may vary from jurisdiction to jurisdiction, insurance laws in the United States are often complex and generally grant broad discretion to supervisory authorities in adopting regulations and supervising regulated activities. That supervision generally includes the licensing of insurance brokers and agents and the regulation of the handling and investment of client funds held in a fiduciary capacity. Our continuing ability to provide insurance brokerage in the jurisdictions in which we currently operate is dependent upon our compliance with the rules and regulations promulgated from time to time by the regulatory authorities in each of these jurisdictions.
The European Union Insurance Mediation Directive introduced rules to enable insurance
and reinsurance intermediaries to operate and provide services within each member state of the EU on a basis consistent with the EU single market and customer protection aims. Each EU member state, in which we operate, is required to ensure that the insurance and reinsurance intermediaries resident in their country are registered with a statutory body in that country and that each intermediary meets professional requirements in relation to their competence, good repute, professional indemnity cover and financial capacity. In the United Kingdom the statutory body is the Financial Services Authority.
The Financial Services Authority has prescribed the methods by which our insurance and reinsurance operations are to conduct business, and they generally conduct their regulatory functions through the establishment of net worth and other financial criteria. They also require the submission of reports and have investigative and disciplinary powers. Monitoring visits are carried out to assess our compliance with regulatory requirements.
Our failure, or that of our employees, to satisfy the regulators that we are in compliance with their requirements or the legal requirements governing our activities, can result in disciplinary action, fines, reputational damage and financial harm.
All companies carrying on similar activities in a given jurisdiction are subject to regulations which are not dissimilar to the requirements for our operations in the United States and United Kingdom. We do not consider that these regulatory requirements adversely affect our competitive position.
Employees
As of December 31, 2008 we had approximately 17,000 employees worldwide of whom approximately 3,500 were employed in the United Kingdom and 7,400 in the United States, with the balance being employed across the rest of the world. In addition, our associates had approximately 3,300 employees, all of whom were located outside the United Kingdom and the United States.
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Item 1A—Risk Factors
Risks Relating to our Business and the Insurance Industry
This section describes material risks affecting the Group's business. These risks could materially affect the Group's business, its revenues, operating income, net income, net assets, liquidity and capital resources and ability to achieve its financial targets and, accordingly should be read in conjunction with any forward-looking statements in this Annual Report on Form 10-K.
Competitive Risks
Our business may be adversely affected by an overall decline in economic activity.
Our business and operating results are materially affected by worldwide economic conditions. Current global economic conditions including the current credit crisis coupled with declining customer and business confidence, increasing energy prices, and other challenges, may have a significant negative impact on the buying behavior of some of our clients as their businesses suffer from these conditions. In particular, financial institutions, construction, aviation, and logistics businesses such as marine cargo are most likely to be affected. Further, the global economic downturn is also negatively affecting some of the international economies that have supported the strong growth in our International operations. Our employee benefits practice may also be adversely affected as businesses continue to downsize during this period of economic turmoil. In addition, 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. While it is difficult to predict consequences of any further deterioration in global economic conditions on our business, any significant reduction or delay by our clients in purchasing insurance or making payment of premiums could have a material adverse impact on our financial condition and results of operations.
We do not control the premiums on which our commissions are based, and volatility or declines in premiums may seriously undermine our profitability.
We derive most of our revenues from commissions and fees for brokerage and consulting services. We do not determine insurance premiums on which our commissions are generally based. Premiums are cyclical in nature and may vary widely based on market conditions. From the late 1980s through late 2000, insurance premium rates generally declined as a result of a number of factors, including the expanded underwriting capacity of insurance carriers; consolidation of both insurance intermediaries and insurance carriers; and increased competition among insurance carriers. During 2004, we saw a rapid transition from a "hard" market, with premium rates stable or increasing, to a "soft" market, with premium rates falling in most markets. Rates continued to decline in most sectors through 2005 and 2006, with the exception of catastrophe-exposed markets. In 2007, the market softened further with decreases in many of the market sectors in which we operated and this has continued into 2008 with further declines of between 5 and 15 percent in many territories.
In addition, as traditional risk-bearing insurance carriers continue to outsource the production of premium revenue to non-affiliated agents or brokers such as ourselves, those insurance carriers may seek to reduce further their expenses by reducing the commission rates payable to those insurance agents or brokers. The reduction of these commission rates, along with general volatility and/or declines in premiums, may significantly undermine our profitability.
Competition in our industry is intense, and if we are unable to compete effectively, we may lose market share and our business may be materially adversely affected.
We face competition in all fields in which we operate, based on global capability, product breadth, innovation, quality of service and price. We compete with Marsh & McLennan and Aon, the two other providers of global risk
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management services, as well as with numerous specialist, regional and local firms. Although Marsh & McLennan and Aon, along with us, have agreed to implement certain business reforms, many specialist, regional and local firms have not agreed to these business reforms. These firms are continuing to accept contingent compensation and are not disclosing the compensation received in connection with providing policy placement services to the customer. If we are unable to compete effectively against these competitors, we will suffer lower revenue, reduced operating margins and loss of market share. As a result of our acquisition of HRH, we must phase out the contingent compensation payable to HRH over 3 years. We are currently seeking to increase revenue through higher commissions and fees that we disclose to our clients, and to generate profitable revenue growth by focusing on the provision of value-added risk advisory services beyond traditional brokerage activities. We cannot be certain that such steps will generate the profitable revenue growth we are targeting.
Competition for business is intense in all our business lines and in every insurance market, and the other two providers of global risk management services have substantially greater market share than we do. Competition on premium rates has also exacerbated the pressures caused by a continuing reduction in demand in some classes of business. For example, rather than purchase additional insurance through brokers, many insureds have been retaining a greater proportion of their risk portfolios than previously. Industrial and commercial companies have been increasingly relying upon their own subsidiary insurance companies, known as captive insurance companies, self-insurance pools, risk retention groups, mutual insurance companies and other mechanisms for funding their risks, rather than buying insurance. Additional competitive pressures arise from the entry of new market participants, such as banks, accounting firms and insurance carriers themselves, offering risk management or transfer services.
Dependence on Key Personnel—The loss of our Chairman and Chief Executive Officer or a number of our senior management or a significant number of our brokers could significantly impede our financial plans, growth, marketing and other objectives.
The loss of our Chairman and Chief Executive Officer or a number of our senior management or a significant number of our brokers could significantly impede our financial plans, growth, marketing and other objectives. Our success depends to a substantial extent not only on the ability and experience of our Chairman and Chief Executive Officer, Joseph J. Plumeri and other members of our senior management, but also on the individual brokers and teams that service our clients and maintain client relationships. The insurance and reinsurance brokerage industry has in the past experienced intense competition for the services of leading individual brokers and brokerage teams, and we have lost key individuals and teams to competitors. We believe that our future success will depend in part on our ability to attract and retain additional highly skilled and qualified personnel and to expand, train and manage our employee base. We may not continue to be successful in doing so because the competition for qualified personnel in our industry is intense.
Legal and Regulatory Risks
We are subject to insurance industry regulation worldwide. If we fail to comply with regulatory requirements, we may not be able to conduct our business.
Many of our activities are subject to regulatory supervision in virtually all the countries in which we are based or our activities are undertaken. Failure to comply with some of these regulations could lead to disciplinary action, including requiring clients to be compensated for loss, the imposition of penalties and the revocation of our authorization to operate. In addition, changes in legislation or regulations and actions by regulators, including changes in administration and enforcement policies, could from time to time require operational improvements or modifications at various locations which could result in higher costs or hinder our ability to operate our business.
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We are subject to a number of legal proceedings concerning contingent compensation, other industry practices and certain conduct, which, if determined unfavorably to us, could adversely affect our financial results.
We have been subject to investigations by the departments of insurance or attorneys general of over 20 states, the District of Columbia, one US city, Canada and Australia concerning, among other things, arrangements pursuant to which insurers compensated insurance brokers for distribution and other services provided to insurers known as contingent compensation, bid rigging, tying and other possible violations of law, including violations of fiduciary duty, securities laws and antitrust laws. As more fully described in Note 17 to our consolidated financial statements included under Part II, Item 8 of this report, we are subject to a number of legal proceedings and other contingencies related to the subject of these investigations. If one or more of these matters is determined unfavorably to us it could have a material adverse effect on our business, results of operations or financial condition in any given quarterly or annual period. We intend to vigorously defend ourselves against these claims. The outcomes of these lawsuits, however, including any losses or other payments that may occur as a result, cannot be predicted at this time.
Our business, results of operations, financial condition or liquidity may be materially adversely affected by errors and omissions and the outcome of certain actual and potential claims, lawsuits and proceedings.
We are subject to various actual and potential claims, lawsuits and other proceedings relating principally to alleged errors and omissions in connection with the placement of insurance and reinsurance in the ordinary course of business. Because we often assist our clients with matters, including the placement of insurance coverage and the handling of related claims, involving substantial amounts of money, errors and omissions claims against us may arise which allege our potential liability for all or part of the amounts in question. Claimants can seek large damage awards and these claims can involve potentially significant defense costs. Such claims,
lawsuits and other proceedings could, for example, include allegations of damages for our employees or sub-agents improperly failing to place coverage or notify claims on behalf of clients, to provide insurance carriers with complete and accurate information relating to the risks being insured or to appropriately apply funds that we hold for our clients on a fiduciary basis. Errors and omissions claims, lawsuits and other proceedings arising in the ordinary course of business are covered in part by professional indemnity or other appropriate insurance. The terms of this insurance vary by policy year and self-insured risks have increased significantly in recent years. In respect of self-insured risks, we have established provisions against these items which we believe to be adequate in the light of current information and legal advice, and we adjust such provisions from time to time according to developments. Our business, results of operations, financial condition and 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. Our ability to obtain professional indemnity insurance in the amounts and with the deductibles we desire in the future may be adversely impacted by general developments in the market for such insurance or our own claims experience. In addition, claims, lawsuits and other proceedings may harm our reputation or divert management resources away from operating our business.
The principal actual or potential claims, lawsuits and proceedings to which we are currently subject, including but not limited to errors and omissions claims, are: (1) the regulatory and other proceedings relating to contingent compensation arrangements referred to above; (2) potential claims arising out of various legal proceedings between reinsurers, reinsureds and their reinsurance brokers relating to personal accident excess of loss reinsurance placements for the years 1993 to 1998; (3) potential damages arising out of a court action, on behalf of a purported class of present and former female officer and officer equivalent employees for alleged discrimination against them on the basis of their gender; and (4) claims with respect to our placement of property and casualty insurance for a number of entities which were
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directly impacted by the September 11, 2001 destruction of New York's World Trade Center complex.
The ultimate outcome of all matters referred to above cannot be ascertained and liabilities in indeterminate amounts may be imposed on us. It is thus 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. In addition, even if we do not experience significant monetary costs, there may be adverse publicity associated with these matters that will result in reputational harm to the insurance brokerage industry in general or to us in particular that may adversely affect our business.
Interruption or loss of our information processing systems or failure to maintain secure information systems could have a material adverse effect on our business.
Our business depends on highly available systems, secure information and the ability of our employees to process transactions. Our capacity to service our clients relies on storing, retrieving, processing and managing information. Interruption or loss of our information processing capabilities through loss of stored data, the failure of computer equipment or software systems, telecommunications failure or other disruption could have a material adverse effect on our business, financial condition and results of operations. Despite the business contingency plans we have in place, our ability to conduct business may be adversely affected by a disruption in the infrastructure that supports our business and the communities where we are located. This may include a disruption involving physical site access, terrorist activities, disease pandemics, electrical, communications or other services used by our company, our employees or third parties with whom we conduct business. Although we have certain disaster recovery procedures in place and insurance to protect against such contingencies, such procedures may not be effective and any insurance or recovery procedures may not continue to be available at reasonable prices and may not address all such losses or compensate us for the possible loss of clients occurring during any period that we are unable to provide services.
Furthermore, we depend on computer systems to store information about our clients, some of which is private. Database privacy, identity theft, and related computer and internet issues are matters of growing public concern and are subject to frequently changing rules and regulations. Our failure to adhere to or successfully implement processes in response to changing regulatory requirements in this area could result in legal liability or harm to our reputation. We have taken reasonable and appropriate security measures to prevent unauthorized access to information in our database. However, our technology may fail to adequately secure the private information we maintain in our databases and protect it from theft or inadvertent loss. In such circumstances, we may be held liable to our clients, which could result in litigation or adverse publicity that could have a material adverse effect on our business.
Financial Risks
The integration of the businesses and operations of HRH into our company involves risks and we may fail to realize all of the anticipated benefits of the acquisition of HRH.
The success of the acquisition of HRH completed in October 2008 will depend, in part, on our ability to achieve the anticipated cost synergies and other strategic benefits from combining the businesses of our company and HRH. We expect to benefit from operational synergies resulting from the consolidation of capabilities and elimination of redundancies as well as greater efficiencies from increased scale. We may face significant challenges in consolidating the functions of our company and HRH and their subsidiaries, integrating their technologies, organizations, procedures, policies and operations, addressing differences in the business cultures of the two companies, retaining key personnel and maintaining relationships with certain third parties. The integration process and other disruptions resulting from the acquisition may disrupt our ongoing businesses or cause inconsistencies in standards, controls, procedures and policies that adversely affect our relationships with clients and customers and with other market participants, employees, regulators and others with whom we have business or other dealings. If we are not able to successfully
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integrate the businesses, the anticipated cost synergies and other strategic benefits of the acquisition may not be realized fully or at all or may take longer to realize than expected.
Our incurrence of additional debt to pay a portion of the consideration related to the HRH acquisition significantly increased our interest expense, financial leverage and debt service requirements.
In October 2008, in connection with the acquisition of HRH, we incurred incremental borrowings of $1.525 billion which significantly increased our leverage. These borrowings were drawn down under new credit facilities consisting of a $700 million 5-year term loan facility, a $300 million revolving credit facility and a $1 billion interim credit facility. In February 2009, we entered into an agreement with Goldman Sachs Mezzanine Partners to issue notes in an aggregate principal amount of $500 million. We anticipate that the net proceeds of this issuance of approximately $480 million will be applied towards the balance of the interim credit facility. Although consummation of the issuance, which is subject to customary closing conditions, is expected to take place in March 2009, there is no certainty that the transaction will close. In addition, while the closing of the transaction would significantly extend the payment date for amounts otherwise due under the interim credit facility, the issuance of the notes will also result in a significant increase in our interest expense compared to that under the interim credit facility.
Although management believes that our cash flows will be more than adequate to service this debt, there may be circumstances in which required payments of principal and/or interest on this new debt could adversely affect our cash flows and this level of indebtedness may:
The terms of the financing also include certain limitations on the amount and type of investments that may be made, the amount of dividends that may be declared, and the amount of shares that may be repurchased. In addition, any borrowings may be made at variable interest rates, making us vulnerable to increases in interest rates generally.
A failure to comply with the restrictions under our credit facilities and outstanding notes could result in a default under the financing obligations or could require us to obtain waivers from our lenders for failure to comply with these restrictions. The occurrence of a default that remains uncured or the inability to secure a necessary consent or waiver could cause our obligations with respect to our debt to be accelerated and have a material adverse effect on our business, financial condition or results of operations.
A downgrade in the credit ratings of our outstanding debt may adversely affect our borrowing costs and financial flexibility.
As of December 31, 2008, we had total consolidated debt outstanding of approximately $2.7 billion. A downgrade in the credit ratings of our debt would increase our borrowing costs and reduce our financial flexibility. In addition, certain downgrades would trigger a step-up in interest rates under the indenture for our 6.2% senior notes, which would increase our interest expense. If we need to raise capital in the future, any credit rating downgrade could negatively affect our financing costs or access to financing sources.
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If we are unable to repay or refinance the interim credit facility, it could have a significant negative effect on our financial condition.
In connection with the HRH acquisition we entered into an interim credit facility in an aggregate principal amount of $1 billion, of which approximately $750 million remains outstanding. Failure to repay or refinance the interim credit facility at or prior to maturity would constitute an event of default under the interim credit agreement and would trigger cross default provisions in our other debt instruments and agreements, potentially causing such other debt to become immediately due and payable. However, our access to capital is affected by prevailing conditions in the financial and capital markets and other factors beyond our control and, given the current uncertainty in the capital markets, we may not be able to obtain additional financing on favorable terms or at all. While we anticipate applying approximately $480 million of the proceeds of the March 2009 note issuance towards the outstanding balance of the interim credit facility, there is no assurance that the transaction will close. If we are not able to issue new debt to repay the interim credit facility, we may have to use other sources of cash such as drawing down on our current revolving credit facility, future cash flows or cash on hand. The use of our revolving credit facility and other cash resources would restrict our financial flexibility and our ability to use such cash for other purposes and could have a significant negative impact on our liquidity.
Our pension liabilities may increase which could require us to make additional cash contributions to our pension plans.
We have two principal defined benefit plans: one in the United Kingdom and the other in the United States. Cash contributions of approximately $55 million will be required in 2009 for our pension plans, although we may elect to contribute more. Total cash contributions to these defined benefit pension plans in 2008 were $148 million. Future estimates are based on certain assumptions, including discount rates, interest rates, fair value of assets and expected return on plan assets. Following changes to UK pension legislation in 2005, we are now required to agree to a funding strategy for our UK
defined benefit plan with the plan's trustees. In February 2009, we agreed to make full year contributions to the UK plan of $37 million for 2009 through 2012. However, if certain funding targets are not met at the beginning of 2010 and 2011, full year contributions for these years will increase to $74 million. We have taken actions to manage our pension liabilities, including closing our UK and US plans to new participants and restricting final pensionable salaries.
The determinations of pension expense and pension funding are based on a variety of rules and regulations. Changes in these rules and regulations could impact the calculation of pension plan liabilities and the valuation of pension plan assets. They may also result in higher pension costs, additional financial statement disclosure, and accelerate and increase the need to fully fund our pension plans. Our future required cash contributions to our US and UK defined benefit pension plans may increase based on the funding reform provisions that were enacted into law. Further, a significant decline in the value of investments that fund our pension plan, if not offset or mitigated by a decline in our liabilities, may significantly differ from or alter the values and actuarial assumptions used to calculate our future pension expense and we could be required to fund our plan with significant amounts of cash. In addition, if the Pension Benefit Guaranty Corporation requires additional contributions to such plans or if other actuarial assumptions are modified, our future required cash contributions could increase. The need to make these cash contributions may reduce the cash available to meet our other obligations, including the payment obligations under our credit facilities and other long-term debt, or to meet the needs of our business.
In addition to the critical assumptions described above, our plans use certain assumptions about the life expectancy of plan participants and surviving spouses. Periodic revision of those assumptions can materially change the present value of future benefits and therefore the funded status of the plans and the resulting periodic pension expense. 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
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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 estimated.
We have entered into significant put and call arrangements which require us to pay substantial amounts to purchase shares in one of our associates. Those payments would reduce our liquidity and short-term cash flow.
In connection with many of our investments in our associates, we retain rights to increase our ownership percentages over time and, in some cases, the existing owners also have a right to put their shares to us. The put arrangements in place for shares of our associate, Gras Savoye, require us to pay substantial amounts to purchase those shares, which could decrease our liquidity and short-term cash flow.
The rights under the put arrangement may be exercised through 2011. Under the put arrangement, we will be required to buy shares of Gras Savoye increasing our voting rights from the 48 percent we currently hold up to 100 percent if all shareholders put their shares under this arrangement, subject to the pre-emption provisions set out in the bye-laws of Gras Savoye.
Following our initial acquisition of shares, we acquired an additional 5 percent of Gras Savoye at a cost of $25 million under these arrangements in September 2006, another 4 percent at a cost of $31 million in January 2008 and another 5 percent at a cost of $41 million at the end of December 2008.
According to the put arrangement, the aggregate management shareholding may not fall below approximately 10% of Gras Savoye's share capital while the management shareholders remain general partners of the company. The current appointments of the relevant individuals will expire on December 31, 2009. Accordingly (and except in case of death, disability or retirement prior to such date), management shareholders will not have a general put right until January 1, 2011. Payments in connection
with management put rights would not have exceeded $67 million if those rights had been fully exercised at December 31, 2008. In addition, we have a call option to move to majority ownership under certain circumstances and in any event from December 2009. Once we exercise this call option, the remaining Gras Savoye shareholders will have a put option to require us to purchase their shares.
Subject to the pre-emption provisions set out in the bye-laws of Gras Savoye, the incremental 42 percent of Gras Savoye shares held by shareholders (excluding the 10 percent holding of management shareholders described above) may be put to us at a price determined by a contractual formula based on earnings and revenue, which at December 31, 2008 would have amounted to approximately $285 million. The shareholders may put their shares individually at any time during the put period and the amounts we may have to pay in connection with the put arrangements may significantly exceed this estimate. In each case, we would have 90 days from the date of a notification from a shareholder who wished to put his shares to us to acquire those shares. The timing of any exercise of these put and call arrangements could have a material affect on our results of operations or cash flows for a particular quarter or annual period.
We recently received a notification from one of the shareholders of Gras Savoye, namely AXA Corporate Solutions, informing us of its intention to put its shares in Gras Savoye to us, subject to the pre-emption provisions set out in bye-laws of Gras Savoye. The shares held by AXA represent approximately 4 percent of the share capital of Gras Savoye. Notwithstanding that we have received this notice from AXA we believe that it is likely that we will not be required to acquire all of the AXA shares in the immediate future or, in some circumstances, at all. We believe that either:-
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date for payment. In these circumstances we believe that Gras Savoye will buy back all the AXA shares and would agree to pay the amount due in respect of the shares into an escrow account to be paid to AXA upon completion of the acquisition of the shares. Again, as a result, we would not be required to acquire any of the shares; or
In the event that none of the above occurred or an alternative arrangement was agreed, we would be required to acquire the AXA shares on 23 March 2009. The amount payable by us for the AXA shares would be approximately $25 million.
International Risks
Our significant non-US operations, particularly our London market operations, expose us to exchange rate fluctuations and various risks that could impact 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 devaluations and fluctuations in currency exchange rates; imposition of limitations on conversion of foreign currencies into pounds sterling or dollars or remittance of dividends and other payments by foreign subsidiaries; hyperinflation in certain foreign countries; imposition or increase of investment and other restrictions by foreign governments; and the requirement of complying with a wide variety of foreign laws.
We report our operating results and financial condition in US dollars. Our US operations earn revenue and incur expenses primarily in US dollars. In our London market operations, however, we earn revenue in a number of different currencies, but expenses are almost
entirely incurred in pounds sterling. Outside the United States and our London market operations, we predominantly generate revenue and expenses in the local currency. The table gives an approximate analysis of revenues and expenses by currency in 2008, and includes full year HRH results on a proforma basis.
Revenues
Expenses
Because of devaluations and fluctuations in currency exchange rates or the imposition of limitations on conversion of foreign currencies into US dollars, we are subject to currency translation exposure on the profits of our operations, in addition to economic exposure. Furthermore, the mismatch between pounds sterling revenues and expenses, together with any net sterling balance sheet position we hold in our US dollar denominated London market operations, creates an exchange exposure.
For example, as the pound sterling strengthens, the US dollars required to be translated into pounds sterling to cover the net sterling expenses increase, which then causes our results to be negatively impacted. Our results may also be adversely impacted if we are holding a net sterling position in our US dollar denominated London market operations: if the pound sterling weakens any net sterling asset we are holding will be less valuable when translated into US dollars. Given these facts, the relative strength of the pound sterling relative to the US dollar has in the past had a material negative impact on our reported results. This risk could have a material adverse effect on our business financial condition, cash flow and results of operations in the future.
Where possible, we hedge part of our exposure to exchange rate movements, for example:
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Generally, it is our policy to hedge at least 25 percent of the next 12 months' exposure in significant currencies.
We do not hedge exposures beyond three years or exposures arising from items, such as our UK pension asset, which will not be reflected in our cash flows in the short term.
In conducting our businesses around the world, we are subject to political, economic, legal, operational and other risks that are inherent in operating in many countries.
In conducting our businesses and maintaining and supporting our global operations, we are subject to legal, economic and market risks. Our businesses and operations are increasingly expanding into new regions throughout the world, including emerging markets, and we expect this trend to continue. The possible effects of economic and financial disruptions throughout the world could have an adverse impact on our businesses. These risks include:
We could incur substantial losses if one of the financial institutions we use in our operations would happen to fail.
The recent deterioration of the global credit and financial markets has created challenging conditions for financial institutions, including depositories. As the fallout from the credit crisis persists, the financial strength of these institutions may continue to decline. We maintain cash balances at various US depository institutions that are significantly in excess of the US Federal Deposit Insurance Corporation insurance limits. We also maintain cash balances in foreign financial institutions. If one or more of the institutions in which we maintain significant cash balances were to fail, our ability to access these funds might be temporarily or permanently limited, and we could face a material liquidity problem and potentially material financial losses.
Item 1B—Unresolved Staff Comments
The Company had no unresolved commentsfrom the SEC's staff.
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Item 2—Properties
We own and lease a number of properties for use as offices throughout the world and believe that our properties are generally suitable and adequate for the purposes for which they are used. The principal properties are located in the United Kingdom and the United States.
London
We moved into our new London headquarters in Lime Street in April 2008. This 491,000 sq ft development occupies a prime site comprising a 29 story tower and adjoining 10 story building. We have entered into a 25 year lease for this building.
On September 27, 2006, Willis Group Services Limited, a subsidiary of Willis Group Holdings Limited, completed the sale of Ten Trinity Square, the Company's London headquarters building. The building was then leased back at an annual rental of $13 million until the Company occupied its new London headquarters on Lime Street in April 2008.
New York
In New York, we occupy 200,000 sq ft of office space at One World Financial Center under a 20 year lease.
Item 3—Legal Proceedings
Claims, Lawsuits and Other Proceedings
The Company is subject to various actual and potential claims, lawsuits and other proceedings relating principally to alleged errors and omissions in connection with the placement of insurance and reinsurance in the ordinary course of business. Similar to other corporations, the Company is also subject to a variety of other claims, including those relating to the Company's employment practices. Some of the claims, lawsuits and other proceedings seek damages in amounts which could, if assessed, be significant.
Errors and omissions claims, lawsuits and other proceedings arising in the ordinary course of business are covered in part by professional indemnity or other appropriate insurance. The terms of this insurance vary by policy year and self-insured risks have increased significantly in recent years. In respect of self-insured risks, the Company has established provisions which are believed to be adequate in the light of current information and legal advice, and the Company adjusts such provisions from time to time according to developments.
On the basis of current information, the Company does not expect that the actual claims, lawsuits and other proceedings, to which the Company is subject, or potential claims, lawsuits and other proceedings relating to matters of which it is aware will ultimately have a material adverse effect on the Company's financial
condition, results of operations or liquidity. Nonetheless, given the large or indeterminate amounts sought in certain of these actions, and the inherent unpredictability of litigation, it is possible that an adverse outcome in certain matters could, from time to time, have a material adverse effect on the Company's results of operations or cash flows in particular quarterly or annual periods.
The most significant actual or potential claims, lawsuits and other proceedings, of which we are currently aware are:
Inquiries and Investigations
In connection with the investigation commenced by the New York State Attorney General in April 2004 concerning, among other things, contingent commissions paid by insurers to insurance brokers, in April 2005, the Company entered into an Assurance of Discontinuance ("NY AOD") with the New York State Attorney General and the Superintendent of the New York Insurance Department and paid $50 million to eligible customers. As part of the NY AOD the Company also agreed not to accept contingent compensation and to disclose to customers any compensation the Company will receive in connection with providing policy placement services to the customer. The Company also resolved similar investigations commenced by the Minnesota Attorney General, the Florida Attorney General, the Florida
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Department of Financial Services and the Florida Office of Insurance Regulation for amounts that were not material to the Company. Similarly, in August 2005 HRH, which the Company acquired in October 2008, entered into an agreement with the Attorney General of the State of Connecticut (the "CT Attorney General") and the Insurance Commissioner of the State of Connecticut to resolve all issues related to their investigations into certain insurance brokerage and insurance agency practices and to settle a lawsuit brought in August 2005 by the CT Attorney General alleging violations of the Connecticut Unfair Trade Practices Act and the Connecticut Unfair Insurance Practices Act. As part of this settlement, HRH agreed to take certain actions including establishing a $30 million national fund for distribution to certain clients, enhancing disclosure practices for agency and broker clients, and declining contingent compensation on brokerage business. The Company has co-operated fully with other similar investigations by the regulators and/or attorneys general of other jurisdictions, some of which have been concluded with no indication of any finding of wrongdoing.
The European Commission issued questionnaires pursuant to its Sector Inquiry or, in respect of Norway, the European Free Trade Association Surveillance Authority, related to insurance business practices, including compensation arrangements for brokers, to at least 150 European brokers including our operations in nine European countries. The Company responded to the European Commission questionnaires and has filed the European Free Trade Association Surveillance Authority for two of its Norwegian entities. The European Commission reported on a final basis on September 25, 2007, expressing concerns over potential conflicts of interest in the industry relating to remuneration and binding authorities when assuming a dual role for clients and insurers and also over the nature of the coinsurance market. The Company continues to co-operate with both the European Commission and the European Free Trade Association Surveillance Authority.
Since August 2004, the Company and HRH (along with various other brokers and insurers) have been named as defendants in purported class actions in various courts across the United States. All of these actions have been consolidated or are in the process of being consolidated into a single action in the U.S. District Court for the District of New Jersey ("MDL"). There are two amended complaints within the MDL, one that addresses employee benefits ("EB Complaint") and one that addresses all other lines of insurance ("Commercial Complaint"). HRH was a named defendant in the EB Complaint, but has since been voluntarily dismissed. HRH is a named defendant in the Commercial Complaint. The Company is a named defendant in both MDL Complaints. The EB Complaint and the Commercial Complaint seek monetary damages, including punitive damages, and equitable relief and make allegations regarding the practices and conduct that have been the subject of the investigation of state attorneys general and insurance commissioners, including allegations that the brokers have breached their duties to their clients by entering into contingent compensation agreements with either no disclosure or limited disclosure to clients and participated in other improper activities. The Complaints also allege the existence of a conspiracy among insurance carriers and brokers and allege violations of federal antitrust laws, the federal RICO statute and the Employee Retirement Income Security Act of 1974 ("ERISA"). In separate decisions issued in August and September 2007, the antitrust and RICO claims were dismissed with prejudice and the state claims were dismissed without prejudice from both Complaints. Plaintiffs have filed a notice of appeal regarding these dismissal rulings and oral arguments on this appeal are scheduled to be heard in April 2009. In January 2008, the Judge dismissed the ERISA claims with prejudice from the EB Complaint. Additional actions could be brought in the future by individual policyholders. The Company disputes the allegations in all of these suits and has been and intends to continue to defend itself vigorously against these actions. The outcomes of these lawsuits, however, including any losses
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or other payments that may occur as a result, cannot be predicted at this time.
Reinsurance Market Dispute
Various legal proceedings are pending, have been concluded or may commence between reinsurers, reinsureds and in some cases their intermediaries, including reinsurance brokers, relating to personal accident excess of loss reinsurance for the years 1993 to 1998. The proceedings principally concern allegations by reinsurers that they have sustained substantial losses due to an alleged abnormal "spiral" in the market in which the reinsurance contracts were placed, the existence and nature of which, as well as other information, was not disclosed to them by the reinsureds or their reinsurance broker. A "spiral" is a market term for a situation in which reinsureds and reinsurers reinsure each other with the effect that the same loss or portion of that loss moves through the market multiple times.
The reinsurers concerned have taken the position that, despite their decisions to underwrite risks or a group of risks, they are no longer bound by their reinsurance contracts. As a result, they have stopped settling claims and are seeking to recover claims already paid. The Company also understands that there have been at least two arbitration awards in relation to a spiral, among other things, in which the reinsurer successfully argued that it was no longer bound by parts of its reinsurance program. Willis Limited, the Company's principal insurance brokerage subsidiary in the United Kingdom, acted as the reinsurance broker or otherwise as intermediary, but not as an underwriter, for numerous personal accident reinsurance contracts, including two contracts that were involved in one of the arbitrations. Due to the small number of reinsurance brokers generally, Willis Limited was one of a small number of brokers active in the market for this reinsurance during the relevant period. Willis Limited also utilized other brokers active in this market as sub-agents, including brokers who are parties to the legal proceedings described above, for certain contracts and may be responsible for any errors and omissions they may have made.
In July 2003, one of the reinsurers received a judgment in the English High Court against certain parties, including a sub-broker Willis Limited used to place two of the contracts involved in this trial. Although neither the Company nor any of its subsidiaries were a party to this proceeding or any arbitration, Willis Limited entered into tolling agreements with certain of the principals to the reinsurance contracts tolling the statute of limitations pending the outcome of proceedings between the reinsureds and reinsurers.
Two former clients of Willis Limited, American Reliable Insurance Company and one of its associated companies ("ARIC") and CNA Insurance Company Limited and two of its associated companies ("CNA") have each terminated their respective tolling agreements with Willis Limited and commenced litigation in September 2007 and January 2008, respectively, in the English Commercial Court against Willis Limited. ARIC has alleged conspiracy between a former Willis Limited employee and the ARIC underwriter as well as negligence and CNA has alleged deceit and negligence by the same Willis Limited employee both in connection with placements of personal accident reinsurance in the excess of loss market in London and elsewhere. The Company disputes these allegations and is vigorously defending itself in these actions. ARIC's asserted claim is approximately $257 million (plus unspecified interest and costs) and CNA's asserted claim is approximately $251 million (plus various unspecified claims for exemplary damages, interest and costs). Pleadings have been exchanged in both actions and the parties have been and continue to be engaged in extensive discovery prior to the trial which the Court has fixed on a preliminary basis for ten weeks commencing October 7, 2009. The Company cannot predict at this time what, if any, damages might result from these claims but has kept its errors and omissions insurance carriers fully informed of developments in the claims. The Company believes that any amounts required to resolve the claims will be covered by errors and omissions insurance.
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Various arbitrations continue to be active and from time to time the principals request co-operation from the Company and suggest that claims may be asserted against the Company. Such claims may be made against the Company if reinsurers do not pay claims on policies issued by them. The Company cannot predict at this time whether any such claims will be made or the damages that may be alleged.
Gender Discrimination Class Action
In March 2008, the Company settled an action in the United States District Court for the Southern District of New York commenced against the Company in 2001 on behalf of an alleged nationwide class of present and former female officer and officer equivalent employees alleging that the Company discriminated against them on the basis of their gender and seeking injunctive relief, money damages, attorneys' fees and costs. Although the Court had denied plaintiffs' motions to certify a nationwide class or to grant nationwide discovery, it did certify a class of approximately 200 female officers and officer equivalent employees based in the Company's offices in New York, New Jersey and Massachusetts. The settlement agreement provides for injunctive relief and a monetary payment, including the amount of attorney fees plaintiffs' counsel are entitled to receive, which was not material to the Company. In December 2006, a former female employee, whose motion to intervene in the class action was denied, filed a purported class action in the United States District Court, Southern District of New York, with almost identical allegations as those contained in the suit that was settled in 2008, except seeking a class period of 1998 to the time of trial (the class period in the settled suit was 1998 to the end of 2001). The Company's motion to dismiss this suit was denied and the
Court did not grant the Company permission to immediately file an appeal from the denial of its motion to dismiss. The suit was recently amended to include two additional plaintiffs. The parties are in the discovery phase of the litigation. The Company cannot predict at this time what, if any, damages might result from this action.
World Trade Center
We acted as the insurance broker, but not as an underwriter, for the placement of both property and casualty insurance for a number of entities which were directly impacted by the September 11, 2001 destruction of the World Trade Center complex, including Silverstein Properties LLC, which acquired a 99-year leasehold interest in the twin towers and related facilities from the Port Authority of New York and New Jersey in July 2001. Although the World Trade Center complex insurance was bound at or before the July 2001 closing of the leasehold acquisition, consistent with standard industry practice, the final policy wording for the placements was still in the process of being finalized when the twin towers and other buildings in the complex were destroyed on September 11, 2001. There have been a number of lawsuits in the United States between the insured parties and the insurers for several placements and other disputes may arise in respect of insurance placed by us which could affect the Company including claims by one or more of the insureds that we made culpable errors or omissions in connection with our brokerage activities. However, we do not believe that our role as broker will lead to liabilities which in the aggregate would have a material adverse effect on our results of operations, financial condition or liquidity.
Item 4—Submission of Matters to a Vote of Security Holders
None.
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PART II
Item 5—Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information
Our Shares have been traded on the New York Stock Exchange under the symbol "WSH" since June 11, 2001. The high and low sale prices of our Shares, as reported by the New York Stock Exchange, are set forth below for the periods indicated.
2007:
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
2008:
2009:
First Quarter (through February 17, 2009)
On February 17, 2009, the last reported sale price of our Shares as reported by the New York Stock Exchange was $23.97 per Share. As of February 17, 2009 there were approximately 2,600 shareholders of record of our Shares.
Dividends
We normally pay dividends on a quarterly basis to shareholders of record on March 31, June 30, September 30 and December 31. The dividend payment dates and amounts are as follows:
January 15, 2007
April 16, 2007
July 16, 2007
October 15, 2007
January 14, 2008
April 14, 2008
July 14, 2008
October 13, 2008
January 16, 2009
On February 11, 2009 our Board of Directors declared a regular quarterly cash dividend of $0.26 per share, which will be payable on April 13, 2009 to shareholders of record on March 31, 2009.
There are no governmental laws, decrees or regulations in Bermuda which will restrict the remittance of dividends or other payments to non-resident holders of the Company's common stock.
On the date of this document there is no Bermuda income, corporation or profits tax, withholding tax, capital gains tax, capital transfer tax, estate duty or inheritance tax payable by us or our shareholders, other than shareholders ordinarily resident in Bermuda.
Pursuant to the Exempted Undertakings Tax Protection Act 1966, as amended, we have received an undertaking from the Bermuda Ministry of Finance, that, in the event of there being enacted in Bermuda any legislation imposing withholding or other tax computed on profits or income, or computed on any capital assets, gain or appreciation or any tax in the nature of estate duty or inheritance tax, such tax shall not until March 28, 2016 be applicable to us or to any of our operations, or to our Shares, debentures or other obligations except and so far as such tax applies to persons ordinarily resident in Bermuda and holding such shares, debentures or other obligations or any land leased or let to us in Bermuda.
The gross amount of dividends paid to US shareholders will be treated as dividend income to such holders, to the extent paid out of current or accumulated earnings and profits, as determined under United States federal income tax principles. This income will be includable in the gross income of a US shareholder as ordinary income on the day received by the US shareholder. These dividends will not be eligible for the dividends received deduction allowed to corporations under the Internal Revenue Code of 1986, as amended.
With respect to non-corporate US shareholders, certain dividends received before January 1, 2009
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from a qualified foreign corporation may be subject to reduced rates of taxation. A foreign corporation is treated as a qualified foreign corporation with respect to dividends received from that corporation on shares that are readily tradable on an established securities market in the United States, such as our shares. Non-corporate US shareholders that do not meet a minimum holding period requirement for our Shares during which they are not protected from the risk of loss or that elect to treat the dividend income as "investment income" pursuant to section 163(d)(4) of the Code will not be eligible for the reduced rates of taxation regardless of our status as a qualified foreign corporation. In addition, the rate reduction will not apply to dividends if the recipient of a dividend is obligated to make related payments with respect to positions in substantially similar or related property. This disallowance applies even if the minimum holding period has been met. Non-corporate US shareholders should consult their own tax advisors regarding the application of these rules given their particular circumstances.
Total Shareholder Return
The following graph demonstrates a five year comparison of cumulative total returns for the Company, the S&P 500 and a peer group comprised of the Company, Aon Corporation, Arthur J. Gallagher & Co., Brown & Brown Inc., and Marsh & McLennan Companies, Inc. The comparison charts the performance of $100 invested in the Company, the S&P 500 and the peer group on January 1, 2003, assuming full dividend reinvestment.
Unregistered Sales of Equity Securities and Use Of Proceeds
In addition to issuances disclosed in our quarterly filings throughout 2008 the Company issued a total of 71,989 shares of common stock, during the period from October 1, 2008 to December 31, 2008 without registration under the Securities Act of 1933, as amended, in reliance upon the exemption under Section 4(2) of such Act relating to sales by an issuer not involving a public offering, none of which involved the sale of more than 1 percent of the outstanding shares of common stock of the Company.
The following sales of shares related to partial consideration for the acquisition of interests in the following companies to their former shareholders, other than for the company last listed, which related to full consideration for the shares acquired:
December 1, 2008
December 20, 2008
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Issuer Purchases of Equity Securities
The following shares of the Company's common stock were repurchased by the Company during the fourth quarter on a trade date basis:
October 1, to October 31, 2008
November 1, to November 30, 2008
December 1, to December 31, 2008
Following the acquisition of HRH on October 1, 2008, certain HRH employees surrendered 7,342 shares to the Company in lieu of taxes payable on HRH restricted stock which vested immediately prior to the acquisition. There were no other repurchases of the Company's common stock during the quarter ended December 31, 2008.
On November 1, 2007, the Board of Directors authorized an open-ended plan to purchase, from time to time in the open market or
through negotiated trades with persons who are not affiliates of the Company, shares of the Company's common stock at an aggregate purchase price of up to $1 billion. This authorization replaced the $308 million remaining under the Company's previously announced $1 billion repurchase plan. In addition the board authorized in June 2008, the repurchase of up to the number of shares issued by the Company in connection with the acquisition of HRH.
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Item 6—Selected Financial Data
Selected Historical Consolidated Financial Data
The selected consolidated financial data presented below should be read in conjunction with the audited consolidated financial statements of the Company and the related notes and Item 7—"Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this report.
The selected historical consolidated financial data presented below as of and for each of the five years ended December 31, 2008 have been derived from the audited consolidated financial statements of the Company, which have been prepared in accordance with accounting principles generally accepted in the United States of America ("US GAAP").
Statement of Operations Data
Total revenues
Salaries and benefits (including share-based compensation of $20, $18, $18, $33, $40)
Other operating expenses
Regulatory settlements
Depreciation expense
Amortization of intangible assets
Gain on disposal of London headquarters
Net gain (loss) on disposal of operations
Operating income
Interest expense
Premium on redemption of subordinated notes
Income before income taxes, interest in earnings of associates and minority interest
Income taxes
Interest in earnings of associates, net of tax
Minority interest, net of tax
Net income
Earnings per share—basic
Earnings per share—diluted
Average number of shares outstanding
—basic
—diluted
Balance Sheet Data (as of year end)
Goodwill
Other intangible assets
Total assets(i)
Net assets
Total long-term debt
Common shares and additional paid-in capital
Total stockholders' equity
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Other Financial Data
Capital expenditures
Cash dividends declared per common share
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Item 7—Management's Discussion and Analysis of Financial Condition and Results of Operations
This discussion includes references to non-GAAP financial measures as defined in Regulation G of SEC rules. We present such non-GAAP financial measures, as we believe such information is of interest to the investment community because it provides additional meaningful methods of evaluating certain aspects of the Company's operating performance from period to period on a basis that may not be otherwise apparent on a GAAP basis. These financial measures should be viewed in addition to, not in lieu of, the Company's consolidated financial statements for the year ended December 31, 2008.
This discussion includes forward-looking statements, including under the heading "Summary—2008 Expense Review," "—Market outlook" and "—Financial Targets". Please see "Information Concerning Forward-Looking Statements" for certain cautionary information regarding forward-looking statements and a list of factors that could cause actual results to differ materially from those predicted in the forward-looking statements.
BUSINESS OVERVIEW AND MARKET OUTLOOK
We provide a broad range of insurance brokerage and risk management consulting services to our worldwide clients. Our core businesses include Aerospace; Energy; Marine; Construction; Financial and Executive Risks; Fine Art, Jewelry and Specie; Special Contingency Risks; and Reinsurance.
In our capacity as an advisor and insurance broker, we act as an intermediary between our clients and insurance carriers by advising our clients on their risk management requirements, helping clients determine the best means of managing risk, and negotiating and placing insurance risk with insurance carriers through our global distribution network.
We derive most of our revenues from commissions and fees for brokerage and consulting services and we do not determine the insurance premiums on which our commissions are generally based. Fluctuations in these premiums charged by the insurance carriers have a direct and potentially material impact on our results of operations. Commission levels generally trend with such premium levels as they are derived from a percentage of the premiums paid by the insureds. Due to the cyclical nature and impact of other market conditions on insurance premiums, they may vary widely between accounting periods. Such variations can result in a reduction in premium rates leading to downward pressure on commission revenues (a "soft" market) which in turn can have a
potentially material impact on our commission revenues and operating margin.
A "hard" market occurs when premium uplifting factors, including a greater than anticipated loss experience or capital shortages, more than offset any downward pressures on premiums. This usually has a favorable impact on our commission revenues and operating margin.
From 2000 through 2003 we benefited from a hard market with premium rates stable or increasing. During 2004, we saw a rapid transition from a hard market to a soft market, with premium rates falling in most markets. The soft market continued through 2005 and 2006 with rates declining in most sectors, with the exception of catastrophe exposed markets.
In 2007, the market softened further and this has continued through 2008 with year on year premium rate decreases averaging approximately 10 percent across our market sectors during 2008.
It is possible that the market may harden in 2009 as insurers seek higher premiums to cover a combination of weak investment returns, significant losses in 2008 and three years of soft market underwriting. In the reinsurance market, we have seen stabilization in rates and early signs of market recovery going into 2009.
However, these potential benefits may be offset in whole or in part by potential changes in the
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buying behavior of some of our clients as their businesses suffer from the current global market uncertainty. In particular, financial institutions, construction, aviation, and logistics businesses such as marine cargo are most likely to be affected. Further, the global economic activity is
also negatively affecting some of the international economies that have supported the strong growth in our International operations. Our employee benefits practice may also be adversely affected as businesses continue to downsize during this period of economic turmoil.
EXECUTIVE SUMMARY
Overview
Despite the difficult trading conditions in 2008, we reported 4 percent organic commissions and fee growth in 2008 compared with 2007, reflecting growth in our International and Global Specialties operations, partly offset by a 1 percent fall in North America organic commissions and fees.
Operating margin for full year 2008 was 18 percent compared with 24 percent for 2007, of which 4 percentage points were attributable to charges relating to our 2008 expense review and 2 percentage points were attributable to the impact of foreign exchange movements.
In October 2008, we completed the acquisition of HRH, the eighth largest insurance and risk intermediary in the United States. The acquisition doubled our North America revenues and the combined Willis HRH operation has critical mass in key markets including California, Florida, Texas, Illinois, New York, Boston, New Jersey and Philadelphia.
Results 2008 compared with 2007
Net income in 2008 was $303 million, or $2.05 per diluted share, compared with $409 million, or $2.78 per diluted share, in 2007. The benefits of good organic revenue growth, improved margins in our International and Global operations and a lower effective tax rate were more than offset by a $0.45 per diluted share impact of charges for the 2008 expense review and a $0.27 per diluted share year on year impact from foreign exchange, discussed in detail within "General and administrative expenses" below.
HRH's fourth quarter results, net of related funding costs and intangible amortization, contributed $0.04 per diluted share. New shares
issued as part consideration for the HRH acquisition had an $0.11 dilutive impact on full year diluted earnings per share.
Total revenues at $2,834 million were $256 million, or 10 percent, higher than in 2007. Organic revenue growth of 4 percent, a 7 percent benefit from net acquisitions and disposals primarily reflecting the HRH acquisition and a 1 percentage point benefit from foreign currency translation were partly offset by lower investment and other income. Organic revenue growth of 4 percent reflected net new business growth of 6 percent and a 2 percent negative impact from declining rates and other market factors. Net new business growth benefitted from a 1 percentage point improvement in client retention rate to 91 percent, compared with 90 percent in 2007.
Operating margin at 18 percent in 2008 was 6 percentage points lower than in 2007 with the decrease mainly reflecting:
partly offset by
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A combination of factors, including a reduction in the UK corporate tax rate and a change in our geographical mix of income, enabled us to reduce our effective underlying tax rate to 26 percent in 2008 compared with 30 percent in 2007. This underlying rate excludes the tax effects of the disposal of our London headquarters, gains and losses on disposal of operations and the benefit of the release of tax provisions relating to the resolution of prior period tax positions.
Results 2007 compared with 2006
Net income in 2007 was $409 million, or $2.78 per diluted share, compared with $449 million, or $2.84 per diluted share, in 2006 as the benefits of increased revenues and a 1 percent increase in margin were more than offset by the non-recurrence of a $71 million tax credit in fourth quarter 2006, primarily relating to the resolution of certain prior year tax matters.
Total revenues at $2,578 million were $150 million, or 6 percent, higher than in 2006 of which 2 percent related to foreign currency translation and 1 percent to net acquisitions and disposals. Organic revenue growth was 3 percent reflecting net new business growth of 4 percent and a 1 percent negative impact from declining rates and other market factors.
Operating margin at 24 percent was 1 percentage point higher than in 2006 mainly reflecting:
HRH acquisition
On October 1, 2008, we completed the acquisition of HRH, the eighth largest insurance and risk management intermediary in the United States.
We believe that the acquisition of HRH will:
We also expect to achieve significant synergies by 2010 of approximately $140 million as we centralize HRH's dispersed back office processes and integrate these into Willis hubs, rationalize the combined office network and close down HRH's Richmond head office.
Assuming the acquisition had occurred on January 1, 2007, pro forma combined revenues for the Group for full year 2008 would have been $3,451 million (2007: $3,378 million), of which $1,546 million, or 45 percent (2007: $1,586 million, or 47 percent), would be attributable to North America operations.
Total consideration paid by Willis for HRH was approximately $1.8 billion, which comprised approximately 24.4 million shares of common stock valued at $792 million and $982 million of cash. The total purchase price of approximately $2.1 billion included the assumption of approximately $340 million of HRH existing debt. The funding of the HRH transaction is discussed in "Cash and financing" below.
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On acquisition we recognized an intangible asset of $639 million comprising:
Customer relationships
Non-compete agreements
Trade names
Customer relationships were identified as the key intangible asset as HRH has historically generated approximately 95 percent of its revenues from existing customers. The charge for HRH's intangible amortization was $21 million in fourth quarter 2008; we expect the full year 2009 charge relating to HRH's intangibles to be $82 million.
We recognized goodwill on the acquisition of $1.6 billion. However, we are still in the process of finalizing the valuation of certain assets and liabilities, thus the purchase price allocation is still subject to refinement.
HRH is being rapidly integrated into our North America segment. We complete our annual goodwill impairment review in the fourth quarter. Based on our forecasts of the combined Willis HRH's future revenue streams and anticipated synergies from the deal, we believe the combined goodwill for North America of $1,810 million was not impaired as of December 31, 2008. However, if we fail to recognize some or all of the strategic benefits and synergies expected from the HRH transaction, goodwill may be impaired in future periods.
Other acquisitions
Additionally in 2008, we acquired a further 10 percent of voting rights in Gras Savoye & Cie, our French associate at a cost of approximately $70 million, bringing our ownership share of voting rights to approximately 48 percent as at December 31, 2008.
2008 expense review
Our Shaping our Future strategy is a series of initiatives designed to deliver profitable growth. As previously announced, we decided:
and, in order to fund a portion of these initiatives,
In 2008, we incurred a pre-tax charge of $92 million ($66 million net of tax, equivalent to $0.45 per diluted share) comprising:
In light of the current global economic uncertainty, we are vigorously reviewing our cost base and will continue our right-sizing initiatives in 2009. Our current right-sizing initiatives emphasize cost discipline including talent management, location optimization and aggressive reduction of discretionary spending. We now expect that the 2008 charges above, together with the benefits of the ongoing review, may lead to 2009 cost savings in excess of the $45 million to $55 million originally estimated.
Financial targets
In light of the current uncertainty in the global economy, we have suspended our practice of providing annual earnings guidance for the year ahead, as we cannot predict the potential impact of this uncertainty on insurance pricing or on potential changes in the buying decisions of clients with any degree of certainty.
In addition, our previously stated earnings per share targets should not be relied upon.
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Cash and financing
Cash at December 31, 2008 was $176 million; $24 million lower than at December 31, 2007.
Net cash from operating activities of $211 million and net proceeds from the issuance of long and short-term debt totaling $1,669 million, together with a net $30 million benefit from other smaller cash flows less the impact of foreign exchange, were used to fund:
Total long-term debt at December 31, 2008 was $1,865 million (December 31, 2007: $1,250 million), total short-term debt was $785 million (December 31, 2007: nil) and total stockholders' equity was $1,845 million (December 31, 2007: $1,347 million) giving a capitalization ratio (total long-term and short-term debt to total long-term debt, short-term debt and stockholders' equity) of 59 percent at December 31, 2008 compared with 48 percent at December 31, 2007. The 11 percent increase in the capitalization ratio is mainly attributable to debt drawn down as part of the HRH acquisition, partly offset by the $792 million equity issued to fund the remainder of the transaction.
On October 1, 2008, we funded the HRH acquisition with $1 billion from an interim credit facility and $525 million from a $700 million 5-year term loan facility. In addition, we repaid the outstanding balance on our existing revolving credit facility and replaced this with a new 5-year $300 million line of credit.
During fourth quarter 2008, we repaid $250 million of the then outstanding $1 billion balance on the interim credit facility funded by
using free cash flow (cash flow from operating and investing activities excluding acquisitions, disposals and additional pension contributions) of $75 million together with the draw down of the remaining $175 million available under the 5-year term loan facility.
In February 2009, we entered into an agreement with Goldman Sachs Mezzanine Partners to issue 12.875 percent senior unsecured notes due 2016 in an aggregate principal amount of $500 million. The transaction is subject to customary closing conditions and is expected to close during March 2009. The net proceeds of the issue will be used to repay approximately $480 million of the interim credit facility. We expect to be able to repay the approximately $270 million remaining balance on this short-term facility over the next two quarters from free cash flow and proceeds from the sale of non-core businesses.
Over time, following full repayment of the interim credit facility, and subject to limitations in our debt facilities, we also plan to repurchase the majority of the shares issued in connection with the acquisition of HRH under our existing $1 billion buyback authorization.
Liquidity
We believe that existing cash and cash equivalents at December 31, 2008 of $176 million, the consummation of the agreement with Goldman Sachs Mezzanine Partners to issue $500 million of senior unsecured notes, availability under our $300 million revolving credit facility together with future generation of free cash flow and proceeds from the sale of non-core businesses should be adequate to meet our cash needs for at least the next 12 months. These sources of liquidity should also be adequate to finance full repayment of the $750 million outstanding balance on our interim credit facility, current portions of our long-term debt and other contractual obligations and presently known operating needs.
Long-term liquidity for debt service and other contractual obligations will be dependent on continued generation of free cash flow and,
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given favorable market conditions, future borrowings or refinancing. However, our cash requirements could be materially affected by a deterioration in our results of operations, as well as various uncertainties discussed in this section and elsewhere in this document, which could require us to pursue other financing options, including, but not limited to, additional borrowings, debt refinancing, asset sales or other financing alternatives. With the current tightening in the credit markets, the amount and terms, if any, of these financing sources cannot be assured.
We continue to identify and implement further actions to control costs and enhance our operating performance, including cash flow. These actions include the rationalization of our cost base through the 2008 expense review and our ongoing right-sizing initiatives to achieve best fit within the current environment.
Share buybacks
On November 1, 2007, the Board authorized a new share buyback program for $1 billion. This replaced our previous $1 billion buyback program and its remaining $308 million
authorization. In addition the board authorized in June 2008, the repurchase of up to the number of shares issued by the Company in connection with the acquisition of HRH.
In first quarter 2008, we repurchased 2.3 million shares at a cost of $75 million under the new authorization of which $925 million is outstanding.
London headquarters
We completed the move from Ten Trinity Square into our new London headquarters on Lime Street in April 2008. We entered into an agreement to lease the Lime Street building in November 2004, and took control of the building in June 2007, under a 25 year lease. Annual rentals are approximately $35 million per year and we have subleased or agreed to sublease approximately 30 percent of the site under leases with terms up to 15 years. The outstanding contractual obligation for lease rentals at December 31, 2008 was $720 million and the amounts receivable from committed subleases were $106 million.
OPERATING RESULTS—GROUP
2008 compared with 2007
Commissions and fees
Investment income
Other income
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Our 2008 total revenues at $2,834 million were $256 million, or 10 percent, higher than in 2007, reflecting a 7 percent benefit from net acquisitions and disposals principally attributable to HRH, organic commissions and fee growth of 4 percent and a 1 percentage point benefit from foreign currency translation, partly offset by lower investment and other income.
Our International and Global operations earn a significant portion of their revenues in currencies other than the US dollar. For the year ended December 31, 2008, reported revenues in International benefited from the year on year weakening of the US dollar against the euro, compared with 2007. However, in our Global operations the revenue line benefit of the stronger euro was offset by sterling weakening against the US dollar, compared with 2007.
Investment income was $81 million for 2008, $15 million lower than in 2007, with the decrease reflecting lower average interest rates in 2008. We expect investment income to decrease by approximately $20 million in 2009 compared with 2008 as interest rates have continued to experience sharp declines across the globe. This estimated decrease includes the mitigating effect of our forward hedging program, from which we expect to generate significant savings compared to LIBOR based rates.
Other income was $2 million for 2008, $17 million lower than in 2007 which benefited
from a higher than usual level of proceeds from the sale of books of business.
Organic growth in commissions and fees in 2008 was 4 percent compared with 2007, reflecting
Organic revenue growth by segment is discussed further in "Operating Results—Segment Information" below.
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2007 compared with 2006
Our 2007 total revenues of $2,578 million were $150 million, or 6 percent, higher than in 2006 of which 2 percent was attributable to foreign currency translation and 1 percent to net acquisitions and disposals.
For the year ended December 31, 2007, reported revenues in International benefited significantly from the year on year effect of foreign currency translation, in particular due to the weakening of the dollar against both sterling and the euro, compared with 2006.
Net acquisitions and disposals added a net 1 percent to total revenues in 2007 which was primarily attributable to the acquisitions of: InsuranceNoodle in Chicago; Burkart Risk Consulting and Partner in Switzerland; and Gras Savoye Re, a new venture with Gras Savoye & Cie.
Organic growth in commissions and fees in 2007 was 3 percent compared with 2006, reflecting
General and administrative expenses
Salaries and benefits
Other
Salaries and benefits as a percentage of revenues
Other as a percentage of revenues
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General and administrative expenses at $2,247 million for 2008 were $339 million, or 18 percent, higher than in 2007 of which:
Salaries and benefits were 58 percent of 2008 revenues, compared with 56 percent in 2007, with the increase reflecting:
Net headcount on an FTE basis at December 31, 2008 was approximately 17,000 compared with approximately 13,000 at December 31, 2007, with the increase primarily reflecting the acquisition of HRH. The increase in average revenues per FTE employee discussed above reflected growth
across all business units, particularly driven by our International business which has continued its record of outstanding growth.
Other expenses were 21 percent of revenues in 2008 compared with 18 percent in 2007, with the increase reflecting:
We have a program that hedges our sterling cash outflows from our London market operations, as part of which we hedge the sterling denominated cash contributions into the UK pension plan. However, we do not hedge against the pension benefits asset or liability recognized for accounting purposes.
The effects of the above increases were partly mitigated by the benefits of our continued focus on cost controls.
General and administrative expenses at $1,908 million for 2007 were $3 million lower than in 2006. This decrease was mainly attributable to:
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Salaries and benefits were 56 percent of 2007 revenues, compared with 60 percent in 2006, with the decrease reflecting:
Other expenses were 18 percent of revenues in 2007 compared with 19 percent in 2006, with the decrease reflecting:
Other expenses in 2007 also included $13 million of rent on our then existing London headquarters building, following its sale and leaseback in September 2006. We terminated this lease when we completed the move to our new London headquarters in April 2008. Of the $121 million pre-tax gain on the sale of the building, $22 million was deferred and subsquently recognized over the revised life of the lease, of which $14 million was recognized in 2007.
Depreciation and amortization
Depreciation and amortization of $90 million in 2008 was $24 million higher than in 2007 with the increase primarily attributable to a $21 million charge in fourth quarter 2008 in respect of intangible assets recognized on the HRH acquisition.
Depreciation and amortization was $66 million in 2007 compared to $63 million in 2006 with the increase mainly attributable to the initial depreciation of assets associated with World Financial Center, our new lease in New York.
Operating income and margin (operating income as a percentage of revenues)
Operating margin or operating income as a percentage of revenues
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Operating margin was 18 percent in 2008 compared with 24 percent in 2007. This decrease reflected the impact of:
Operating margin was 24 percent in 2007 compared with 23 percent in 2006. This increase reflected the impact of:
Operating segment margins are discussed further in "Operating Results—Segment Information" below.
Interest expense in 2008 of $105 million was $39 million higher than in 2007 with the increase reflecting:
Interest expense was $66 million in 2007 compared with $38 million in 2006, with the increase due to higher average levels of debt at higher interest rates following the issuance of $600 million of senior notes in March 2007. Interest expense will increase in 2009 as a result of higher average levels of debt due to the HRH acquisition and higher rates of interest on the anticipated Goldman Sachs financing.
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Income before taxes
Effective tax rate
The effective tax rate in 2008 was 24 percent compared with 26 percent in 2007, with the decrease in rate reflecting:
benefited from the release of tax provisions relating to prior tax periods following the resolution of tax issues surrounding prior debt refinancing; and
The effective tax rate in 2007 was 26 percent compared with 12 percent in 2006. The lower effective tax rate in 2006 is primarily attributable to a $65 million tax credit in 2006 arising following the resolution of complex tax issues associated with the original KKR acquisition structure, together with a low tax rate on the gain on disposal of our previous London headquarters also in 2006.
Net income and diluted earnings per share
Diluted earnings per share
Average diluted number of shares outstanding
Net income for 2008 was $303 million, or $2.05 per diluted share, compared to $409 million, or $2.78 per diluted share, in 2007 with the decrease mainly reflecting the impact of:
"General and administrative expenses" above;
HRH's fourth quarter results, net of related funding costs and intangible amortization, contributed $0.04 per diluted share.
Average diluted sharecount increased from 147 million in 2007 to 148 million in 2008 as the impact of the 11.5 million shares
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repurchased under accelerated share repurchase programs in first half 2007 was more than offset by the additional 24.4 million shares issued on October 1, 2008 as part consideration for the HRH acquisition. The additional shares issued had a negative $0.11 cent impact on earnings per diluted share in 2008.
Net income for 2007 was $409 million, or $2.78 per diluted share, compared with $449 million, or $2.84 per diluted share, in 2006 with the decrease mainly reflecting the impact of:
additional pension contributions, equivalent to $0.14 per diluted share;
Foreign currency translation had a $0.06 negative year on year impact on diluted earnings per share in 2007.
Average diluted sharecount reduced from 158 million in 2006 to 147 million in 2007 primarily reflecting the impact of the 15 million shares repurchased under accelerated share repurchase programs in November 2006 and March 2007. After taking into account incremental funding costs, there was a $0.09 benefit to diluted earnings per share from these share buybacks for 2007.
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OPERATING RESULTS—SEGMENT INFORMATION
We organize our business into three segments: Global, North America and International. Our Global business provides specialist brokerage and consulting services to clients worldwide for risks arising from specific industries and activities. North America and International
comprise our retail operations and provide services to small, medium and major corporates.
The following table is a summary of our operating results by segment for the three years ending December 31, 2008:
Total Retail
Corporate & Other(ii)
Total Consolidated
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Our Global operations comprise Global Specialties and Reinsurance. The following table sets out revenues, organic revenue growth and
operating income and margin for the three years ended December 31, 2008:
Operating income(i)
Organic revenue growth(ii)(iii)
Operating margin(i)
Revenues: 2008 compared with 2007
Commissions and fees were $34 million, or 5 percent, higher in 2008 compared with 2007 of which 3 percent was attributable to the net impact of acquisitions and disposals, mainly due to HRH's UK-based specialty business. There was no net impact from foreign currency translation as a benefit from the euro strengthening year on year against the dollar was offset by a negative impact from sterling weakening against the dollar.
Organic revenue growth was 2 percent as the benefit of good growth in Global Specialties was partly offset by lower commissions and fees in Reinsurance.
Global Specialties revenue growth reflected the benefit of good growth in Marine, Financial Institutions, Bloodstock, Jewelry, Specie and Global Markets and was achieved despite significant rate reductions.
Organic revenues in Reinsurance in 2008 were adversely impacted by a combination of declining rates and a reduction in amounts reinsured. We continue to make investments in Reinsurance to strengthen capital markets and analytics capabilities throughout the soft market and are beginning to see the positive results of this investment as we move into 2009.
Client retention levels in Global improved to 90 percent in 2008 compared with 89 percent in 2007.
Revenues: 2007 compared with 2006
Commissions and fees were $13 million, or 2 percent, higher in 2007 compared with 2006 of which 1 percent was attributable to the net impact of acquisitions and disposals and 1 percent to foreign currency translation. Organic revenue growth was flat in 2007 with the benefit of a 6 percent increase in Global
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Specialties offset by a 4 percent decrease in Reinsurance.
Global Specialties revenue growth reflected the benefit of one-time income from satellite launches and strong growth in Construction, especially in global infrastructure projects, together with good performances from Energy, Financial Institutions and Niche. This revenue growth was achieved despite significant rate reductions with rates decreasing in: Aerospace by some 15 to 20 percent year on year; Marine Hull by 15 to 20 percent; Marine cargo by 25 to 40 percent; and Financial Institutions, Energy and Niche by some 10 to 15 percent.
Organic revenues in Reinsurance declined in 2007 and were adversely impacted by a combination of declining rates, a reduction in amounts reinsured and other changes, including recent changes in Florida legislation which significantly increased capacity and reduced prices.
Operating margin: 2008 compared with 2007
Operating margin in our Global operations was 29 percent in 2008 compared with 28 percent in 2007, as the benefit of organic revenue growth in Global Specialties was partly offset by the impact of lower revenues in Reinsurance and an adverse impact from foreign exchange.
Operating margin in Global Specialties increased in 2008 compared with 2007 as the benefit from organic revenue growth, lower pension costs and our Shaping our Future initiatives more than offset further spend on targeted hires and strategic initiatives.
Operating margin in Reinsurance in 2008 was broadly in line with 2007 as the impact of lower
commissions and fees was largely offset by the benefits of Shaping our Future initiatives, lower pension costs and the positive results of our continued investments to strengthen capital markets and analytics capabilities throughout the soft market.
Operating margin: 2007 compared with 2006
Operating margin in our Global operations was 28 percent in 2007 compared with 31 percent in 2006. Revenues in our Global operations are largely US dollar denominated while our expense base is primarily sterling denominated. The weakening of average dollar rates against sterling generated a negative 2 percentage point impact on Global's margin.
Operating margin in Global Specialties decreased in 2007 compared with 2006 as the moderate revenue growth achieved against the backdrop of a very tough rate environment was more than offset by expense growth. The expense growth reflected an adverse impact from foreign exchange and continued hiring in targeted areas such as Construction, Energy and Financial Institutions, partly offset by the benefits of Shaping our Future initiatives, lower charges for pension costs and legal provisions and good cost control.
Reinsurance's operating margin in 2007 was broadly in line with 2006 as the decline in revenues, an adverse impact from foreign exchange and our continued investment in analytics were offset by the benefit of lower charges for pension costs and legal provisions, and good cost control.
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Other income(i)
Operating income(ii)
Organic revenue growth(iii)(iv)
Operating margin(ii)
Commissions and fees in North America were $161 million, or 21 percent, higher in 2008 compared with 2007, of which $181 million was attributable to HRH's fourth quarter 2008 revenues. Excluding HRH, organic commissions and fees declined by 1 percent reflecting the soft market conditions.
Chicago, Georgia, Houston, Boston and Knoxville all generated growth in excess of 5 percent though several offices recorded significant declines in the difficult market conditions.
The integration of the HRH acquisition made good progress in fourth quarter 2008 with only 2 percent attrition of legacy HRH producers since the announcement of the HRH acquisition in June 2008.
Client retention levels improved to 91 percent in 2008, an increase of 3 percentage points from 2007, and productivity continued to improve with an approximately 2 percent rise in revenues per FTE employee in 2008 compared with 2007.
Commissions and fees in North America were $7 million, or 1 percent, higher in 2007 compared with 2006 which was attributable to organic growth. The organic revenue growth was achieved in the face of declining rates across most regions of the United States: MarketScout data for 2007 showed average property and casualty rate declines in the year of 13 percent. Despite the declining rates, we saw good growth in the Southeast, Central and New York regions and in our program business and employee benefits.
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The rate of organic revenue growth moderated in 2007 compared to previous years as the focus was on profitable growth. From mid-2006 we moderated the pace of hiring and at the same time managed out under performers. Consequently, while there was a year on year decline in producers, revenue per FTE employee was 5 percent higher in 2007 compared with 2006.
Operating margin in North America in 2008 was 15 percent compared with 19 percent in 2007. The decrease of 4 percentage points reflected:
Operating margin in North America was 19 percent in 2007 compared with 17 percent in 2006 and reflected the benefit of the increased revenue per employee and effective expense control, together with a $5 million increase in proceeds from the sale of books of business. Margin improvement was most significant in our New York and Central regions.
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Commissions and fees in International were $93 million, or 10 percent, higher than in 2008 compared with 2007.
A significant part of International's revenues are earned in currencies other than the US dollar and foreign currency translation benefited 2008 revenues by 1 percent compared with 2007.
Organic revenue growth of 9 percent in 2008 was achieved despite declining rates in most countries.
We have seen consistent growth in our International business over the last three years, with all twelve quarters in this period showing growth of 5 percent or higher, with Spain, Denmark and Latin America continuing to contribute significantly.
Productivity in International continued to improve with revenues per FTE employee rising by 6 percent in 2008 compared with 2007 and average client retention levels remaining high at 91 percent.
Commissions and fees in International were $115 million, or 14 percent, higher in 2007 compared with 2006. Some 6 percent of this increase was attributable to foreign currency translation as a significant part of International's revenues are earned in currencies that have strengthened against the dollar on a year on year basis, in particular the euro. Organic growth of 8 percent was achieved despite declining rates in most countries, with decreases of between 5 and 20 percent.
Organic growth in 2008 was driven by the emerging markets, particularly Latin America, China and Asia, all of which continued to generate strong double-digit growth. The emerging market growth was complemented by good growth in mainland Europe, especially in the Nordic region, Spain, Italy and Eastern Europe. However, there was a modest decline in our UK and Irish operations revenues compared with 2006 primarily due to the declining rates environment, with decreases averaging between 15 and 20 percent.
Operating margin in International was 28 percent in 2008 compared with 25 percent in 2007, with the 3 percentage point improvement reflecting the strong organic revenue growth, increased productivity and continued expense discipline partly offset by significant investment in targeted hires and the adverse impact of declining rates in most countries.
Operating margin in International was 25 percent in 2007 compared with 20 percent in 2006, with the 5 percentage point improvement reflecting the strong organic revenue growth, particularly in the emerging markets, coupled with sustained cost control and a lower UK pension expense.
Significant operating margin improvement was reported across most areas of our International segment as the effect of strong organic revenue growth, our productivity efficiencies and joint focus more than offset the adverse impact of declining rates in most countries.
CRITICAL ACCOUNTING ESTIMATES
Our accounting policies are described in Note 2 to the Consolidated Financial Statements. Management considers that the following accounting estimates or assumptions are the most important to the presentation of our financial condition or operating performance. Management has discussed its critical accounting estimates and associated disclosures with our Audit Committee.
Pension expense
We maintain defined benefit pension plans that cover a majority of our employees in the United States and United Kingdom. Both these plans are now closed to new entrants. New entrants in the United Kingdom are offered the opportunity to join a defined contribution plan and in the United States are offered the opportunity to join a 401(k) plan. We also have smaller defined benefit schemes in Ireland, Germany, Denmark
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and the Netherlands: these schemes have combined total assets of $89 million and a combined liability for pension benefits of $29 million as of December 31, 2008. Elsewhere, pension benefits are typically provided through defined contribution plans.
We make a number of assumptions when determining our pension liabilities and pension expense which are reviewed annually by senior management and changed where appropriate. The discount rate will be changed annually if underlying rates have moved whereas the expected long-term return on assets will be changed less frequently as longer term trends in asset returns emerge. Other material assumptions include rates of participant mortality, the expected long-term rate of compensation and pension increases and rates of employee termination.
We recorded a net pension credit on our UK and US defined benefit pension plans in 2008 of $25 million, compared to a net pension credit of $10 million in 2007, an increase of $15 million.
The UK plan increase was $17 million mainly reflecting an increase in the expected return on assets in the UK plan due to higher asset levels following significant additional contributions in 2007 and 2008 and increased member contributions in 2008. The US pension charge was $2 million higher in 2008 compared with 2007.
Based on December 31, 2008 assumptions, we expect the net pension credit in 2008 to decrease to a net pension expense in 2009 of between $50 to $60 million due to lower expected asset returns and increased amortization following the significant asset losses in the UK and US during 2008.
UK plan
Estimated 2009 expense
Projected benefit obligation at December 31, 2008
Expected long-term rates of return on plan assets are developed from the expected future returns of the various asset classes using the target asset allocations. The expected long-term rate of return used for determining the net UK pension expense in 2008 remained unchanged at 7.75 percent, equivalent to an expected return in 2008 of $184 million. The expected and actual returns on UK plan assets for the three years ended December 31, 2008 were as follows:
2008
2007
2006
During the latter half of 2008 the value of assets held by our pension plans has been significantly adversely affected by the turmoil in worldwide markets. The holdings of equity securities by our UK and US pension plans have been particularly affected.
Rates used to discount pension plan liabilities at December 31, 2008 were based on yields prevailing at that date of high quality corporate bonds of appropriate maturity. The selected rate used to discount UK plan liabilities was 6.5 percent compared with 5.9 percent at December 31, 2007 with the increase reflecting an increase in UK long-term bond rates in the latter part of 2008. The higher discount rate and reduced inflation assumption generated an actuarial gain of $248 million at December 31, 2008.
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Mortality assumptions at December 31, 2008 were changed from December 31, 2007. The new mortality assumption is the 100 percent PNA00 table without an age adjustment. As an
indication of the longevity assumed, our calculations assume that a UK male retiree aged 65 at December 31, 2008 would have a life expectancy of 22 years.
US plan
The expected long-term rate of return used for determining the net US pension scheme expense in 2008 was 8.0 percent, consistent with 2007. The rate used to discount US plan liabilities at December 31, 2008 was 6.3 percent, determined based on expected plan cash flows discounted using a corporate bond yield curve, an increase from 6.0 percent at December 31, 2007. The expected and actual returns on US plan assets for the three years ended December 31, 2008 were as follows:
The mortality assumption at December 31, 2008 is the RP-2000 Mortality Table (blended for annuitants and non-annuitants), projected to 2009 by Scale AA (December 31, 2007: projected to 2008 by Scale AA). As an indication of the longevity assumed, our calculations assume that a US male retiree aged 65 at December 31, 2008, would have a life expectancy of 18 years.
Intangible assets
Intangible assets represent the excess of cost over the value of net tangible assets of
businesses acquired. We classify our intangible assets into three categories:
Client relationships acquired on the HRH acquisition are amortized over twenty years in line with the pattern in which the economic benefits of the client relationships are expected to be consumed. Over 80 percent of the client relationships intangible will have been amortized after 10 years. Non-compete agreements acquired in connection with the HRH acquisition are amortized over two years on a straight line basis. Intangible assets acquired in connection with other acquisitions are amortized over their estimated useful lives on a straight line basis. Goodwill is not subject to amortization.
To determine the allocation of intangible assets between goodwill and other intangible assets and the estimated useful lives in respect of the HRH acquisition we considered a report produced by a qualified independent appraiser. The calculation of the allocation is subject to a number of estimates and assumptions. We base our allocation on assumptions we believe to be reasonable. However, changes in these estimates and assumptions could affect the allocation between goodwill and other intangible assets.
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Impairment review
We review all our intangible assets for impairment periodically (at least annually) or whenever events or circumstances indicate impairment may have occurred. Application of the impairment test requires judgment, including:
The fair value of each reporting unit is estimated using a discounted cash flow methodology and, in aggregate, validated against our market capitalization. This analysis requires significant judgments, including:
We base our fair value estimates on assumptions we believe to be reasonable. However, changes in these estimates and assumptions could materially affect the determination of fair value and goodwill impairment for each reporting unit.
Our annual goodwill impairment analysis, which we performed during the fourth quarter of 2008, did not result in an impairment charge (2007: $nil, 2006: $nil).
We recognize deferred tax assets and liabilities for the estimated future tax consequences of events attributable to differences between the financial statements carrying amounts of existing assets and liabilities and their respective tax bases and operating and capital loss and tax credit carryforwards. We estimate deferred tax assets and liabilities and assess the need for any valuation allowances using enacted rates in effect for the year in which the differences are
expected to be recovered or settled taking into account our business plans and tax planning strategies.
At December 31, 2008, the Company had gross deferred tax assets of $362 million (2007: $184 million) against which a valuation allowance of $85 million (2007: $69 million) had been recognized. To the extent that:
the Company may adjust the deferred tax asset considered realizable in future periods. Such adjustments could result in a significant increase or decrease in the effective tax rate and have a material impact on our net income.
Positions taken in the Company's tax returns may be subject to challenge by the taxing authorities upon examination. The Company recognizes the benefit of uncertain tax positions in the financial statements when it is more likely than not that the position will be sustained on examination by the tax authorities. The benefit recognized is the largest amount of tax benefit that is greater than 50 percent likely of being realized on settlement with the tax authority, assuming full knowledge of the position and all relevant facts. The Company adjusts its recognition of these uncertain tax benefits in the period in which new information is available impacting either the recognition or measurement of its uncertain tax positions.
Commitments, contingencies and accrued liabilities
We purchase professional indemnity insurance for errors and insurance claims. The terms of this insurance vary by policy year and self-insured risks have increased significantly over recent years. We have established provisions against various actual and potential claims, lawsuits and other proceedings relating
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principally to alleged errors and omissions in connection with the placement of insurance and reinsurance in the ordinary course of business. Such provisions cover claims that have been reported but not paid and also claims that have
been incurred but not reported. These provisions are established based on actuarial estimates together with individual case reviews and are believed to be adequate in the light of current information and legal advice.
NEW ACCOUNTING STANDARDS
New accounting standards issued during the year that would have a significant impact on the
Company's reporting are described in Note 2 to the Consolidated Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES
On October 1, 2008, the Company completed the acquisition of HRH.
Under the terms of the definitive merger agreement, we acquired all of the outstanding shares of common stock of HRH for $46.00 per share, with approximately 55 percent of the total consideration being paid in cash and 45 percent being paid in our stock. The total purchase price of approximately $2.1 billion included the assumption of approximately $340 million of HRH existing debt.
We funded the transaction on October 1, 2008 from committed bank financing, with a $1 billion drawdown from an interim credit facility and a $525 million draw down from a $700 million 5-year term loan facility. In addition, we repaid approximately $340 million of HRH existing debt and the $170 million outstanding balance on our existing revolving credit facility, which has been replaced by a new $300 million facility, all of which remains available to draw at December 31, 2008.
During fourth quarter 2008, we repaid $250 million of the then outstanding $1 billion balance on the interim credit facility funded by using free cash flow of $75 million together with the drawdown of the remaining $175 million available under the 5-year term loan facility.
Total long term debt at December 31, 2008 was $1,865 million and total short term debt was $785 million. Included in total long-term debt is $250 million of 5.125% senior notes due 2010.
In February 2009, we entered into an agreement with Goldman Sachs Mezzanine Partners to issue 12.875 percent senior unsecured notes due 2016 in an aggregate principal amount of $500 million. The transaction is subject to customary closing conditions and is expected to
close during March 2009. The net proceeds of the issue will be used to repay approximately $480 million of the interim credit facility. We expect to be able to repay the approximately $270 million remaining balance on this short-term facility over the next two quarters from free cash flow and proceeds from the sale of non-core businesses.
We believe that existing cash and cash equivalents at December 31, 2008 of $176 million, the consummation of the agreement with Goldman Sachs Mezzanine Partners to issue $500 million of senior unsecured notes, availability under our $300 million revolving credit facility together with future generation of free cash flow and proceeds from the sale of non-core businesses should be adequate to meet our cash needs for at least the next 12 months. These sources of liquidity should also be adequate to finance full repayment of the interim credit facility, current portions of our long-term debt and other contractual obligations and presently known operating needs.
Long-term liquidity for debt service and other contractual obligations will be dependent on continued generation of free cash flow and, given favorable market conditions, future borrowings or refinancing. However, our cash requirements could be materially affected by a deterioration in our results of operations, as well as various uncertainties discussed in this section and elsewhere, which could require us to pursue other financing options, including, but not limited to, additional borrowings, debt refinancing, asset sales or other financing alternatives. With the current tightening in the
53
credit markets, the level, if any, of these financing sources cannot be assured.
On November 1, 2007, the Board authorized a new share buyback program for $1 billion. This replaced our previous $1 billion buyback program and its remaining $308 million authorization. In first quarter 2008, we repurchased 2.3 million shares at a cost of $75 million under the new authorization.
Fiduciary funds
As an intermediary, we hold funds generally in a fiduciary capacity for the account of third parties, typically as the result of premiums received from clients that are in transit to insurers and claims due to clients that are in transit from insurers. We report premiums, which are held on account of, or due from, clients as assets with a corresponding liability due to the insurers. Claims held by, or due to, us which are due to clients are also shown as both assets and liabilities. All these balances due or payable are included in accounts receivable and accounts payable on the balance sheet. We earn interest on these funds during the time between the receipt of the cash and the time the cash is paid out. Fiduciary cash must be kept in certain regulated bank accounts subject to guidelines, which generally emphasize capital preservation and liquidity, and is not generally available to service our debt or for other corporate purposes.
Own funds
As of December 31, 2008, we had cash and cash equivalents of $176 million, compared with $200 million at December 31, 2007, and all of
our $300 million revolving credit facility remained available to draw.
Operating activities
Net cash provided by operations was $211 million in 2008 compared with $268 million in 2007 and $147 million in 2006. Net cash provided by operations has been significantly impacted by the accelerated funding of our pensions schemes over the last three years, with additional contributions of $107 million in 2008, $153 million in 2007 and $211 million in 2006.
Net cash from operations in 2008 was $57 million lower than in 2007, mainly reflecting:
Net cash from operations in 2007 was $121 million higher than in 2006, mainly reflecting:
Investing activities
Total net cash used in investing activities was $1,040 million in 2008 compared with $221 million in 2007 and an inflow of $67 million in 2006.
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The net increase in cash used in investing activities of $819 million in 2008 compared with 2007 was attributable to:
The net increase in cash used in investing activities of $288 million in 2007 compared with 2006 was mainly attributable to:
In 2008 we completed the acquisition of HRH with approximately 55 percent of the total consideration being paid in cash, as described above. This payment for acquisitions of $926 million was in addition to a payment of $31 million to acquire an additional 4 percent of voting rights in Gras Savoye & Cie, our French associate. We also acquired a further 5.5 percent of Gras Savoye & Cie effective fourth quarter 2008 for which the $41 million in cash was paid in January 2009. The Gras Savoye acquisitions were pursuant to put arrangements, see "Contractual Obligations" below.
In 2007 we purchased an additional 17 percent of Coyle Hamilton Willis (since renamed Willis Risk Services Ireland Limited), our Irish subsidiary, for $33 million; and acquired InsuranceNoodle, a US internet distributor of small business property-casualty insurance for $29 million.
Financing activities
Cash provided by financing activities amounted to $828 million in 2008 compared with outflows of $146 million in 2007 and $129 million in 2006.
Long-term debt
In connection with the HRH acquisition on October 1, 2008, we drew down $1 billion from an interim credit facility and a further $525 million from a 5-year term loan facility. During fourth quarter 2008, we subsequently repaid $250 million of the outstanding balance on the interim credit facility using $175 million proceeds from an additional drawdown of the 5-year term loan facility together with $75 million from free cash flow.
As at December 31, 2008, total short-term debt was $785 million and total long-term debt was $1,865 million.
In February 2009, we entered into an agreement with Goldman Sachs Mezzanine Partners to issue 12.875 percent senior unsecured notes due 2016 in an aggregate principal amount of $500 million. The transaction is subject to customary closing conditions and is expected to close during March 2009. We expect the net proceeds of the issue to be used to repay approximately a further $480 million of the $750 million outstanding balance on the interim credit facility as at December 31, 2008.
In addition, we repaid the outstanding balance on our previously existing revolving credit facility and replaced it with a new 5-year $300 million line of credit.
We also repaid the previously existing HRH debt of $341 million assumed with the acquisition.
In March 2007, we issued $600 million of 10 year senior notes at 6.20 percent. We used the proceeds of the notes to fund share buybacks and to repay a net $150 million on our then existing revolving credit facility.
In 2006, we drew down $200 million on our then existing revolving credit facility primarily to fund our increased pension contributions.
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We repurchased 2.3 million shares for $75 million of cash in the first quarter of 2008 compared with 11.5 million shares for $480 million of cash in 2007 and 5.4 million shares for $211 million of cash in 2006.
Cash dividends paid in 2008 were $146 million compared with $143 million in 2007 and $145 million in 2006. In February 2009, we declared a quarterly cash dividend of $0.26 per share, an annual rate of $1.04 per share.
CONTRACTUAL OBLIGATIONS
Our contractual obligations at December 31, 2008 were:
5.125% Senior notes due 2010
5.625% Senior notes due 2015
6.200% Senior notes due 2017
Interest on senior notes
Term loan expires 2013
Interest on term loan
Interim credit facility expires September 30, 2009
Interest on interim credit facility
Total debt and related interest
Operating leases(i)
Pensions
Put options relating to subsidiaries and associates(ii)
Total contractual obligations
Debt financing
On October 1, 2008, we funded the HRH acquisition with $1 billion from an interim credit facility and $525 million from a $700 million 5-year term loan facility. In addition, we repaid the outstanding balance on our existing revolving credit facility and replaced this with a new $300 million line of credit. In fourth quarter 2008, we repaid $250 million of the interim credit facility and at the same time drew down a further $175 million under the 5-year term loan facility.
In February 2009, the Company entered into an agreement with Goldman Sachs Mezzanine Partners to issue 12.875 percent senior unsecured notes due 2016 in an aggregate principal amount of $500 million. The Company
anticipates that approximately $480 million net proceeds of this issuance will be applied towards the balance of the interim credit facility. Consummation of the issuance, which is subject to customary closing conditions, is expected to take place in March 2009.
Operating leases
We moved from Ten Trinity Square into our new London headquarters in Lime Street in April 2008. In November 2004, we entered into an agreement to lease the Lime Street building and took control of the building in June 2007 under a 25 year operating lease. Annual rentals are $35 million per year and we have subleased approximately 30 percent of the premises under leases up to 15 years long. The outstanding
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contractual obligation for lease rentals at December 31, 2008 was $720 million and the amounts receivable from committed subleases was $106 million.
Contractual obligations for our pension plans reflect the contributions we expect to make over the next five years into our US and UK plans. These contributions are based on current funding positions and may increase or decrease dependent on the future performance of the two plans.
In the UK, we are required to agree a funding strategy for our UK defined benefit plan with the plan's trustees. In February 2009, we agreed to make full year contributions to the UK plan of $37 million for 2009 through 2012. However, if certain funding targets are not met at the beginning of 2010 and 2011, full year contributions for these years will increase to $74 million.
For the US plan, expected contributions are the contributions we will be required to make under US pension legislation based on our December 31, 2008 balance sheet position. We currently expect to contribute $18 million in 2009 and between $45 and $50 million per year from 2010 to 2013.
Put options relating to subsidiaries and associates
In connection with many of our investments in less than wholly-owned subsidiaries and associates, we retain rights to increase our ownership percentage over time, typically to a majority or 100 percent ownership position. In addition, in certain instances, the other owners have a right, typically at a price calculated pursuant to a formula based on revenues or earnings, to put some or all of their shares to us.
As part of the 1997 acquisition of our initial 33 percent shareholding of Gras Savoye, we entered into a put arrangement, whereby the other shareholders in Gras Savoye (primarily two families, two insurance companies and Gras Savoye's executive management team) could put their shares to us. Until 2011, we will be obligated to buy the shares of certain
shareholders to the extent those shareholders put their shares, potentially increasing our ownership from the 48 percent holding at December 31, 2008 to 90 percent if all shareholders put their shares, at a price determined by a contractual formula based on earnings and revenue.
Management shareholders of Gras Savoye (representing approximately 10 percent of shares) do not have general put rights before 2011, but have certain put rights on their death, disability or retirement from which payments, at December 31, 2008 based on the formula would not have exceeded $67 million. The shareholders may put their shares individually at any time during the put period.
We believe that, should the aggregate amount of Gras Savoye shares be put to us, sufficient funds would be available to satisfy this obligation. In addition, we have a call option to move to majority ownership under certain circumstances and in any event by December 2009. Upon exercising this call option, the remaining Gras Savoye shareholders have a put option.
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escrow account to be paid to AXA upon completion of the acquisition of the shares. Again, as a result, we would not be required to acquire any of the shares; or
Off-balance sheet transactions
Apart from commitments, guarantees and contingencies, as disclosed in Note 17 of the Consolidated Financial Statements, the Company has no off-balance sheet arrangements that have, or are reasonably likely to have, a material effect on the Company's financial condition, results of operations or liquidity.
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Item 7A—Quantitative and Qualitative Disclosures about Market Risk
Financial Risk Management
We are exposed to market risk from changes in foreign currency exchange rates and interest rates. In order to manage the risk arising from these exposures, we enter into a variety of interest rate and foreign currency derivatives. We do not hold financial or derivative instruments for trading purposes.
A discussion of our accounting policies for financial and derivative instruments is included in Note 2—Basis of Presentation and Significant Accounting Policies of Notes to the Consolidated Financial Statements, and further disclosure is provided in Note 21—Financial Instruments of Notes to the Consolidated Financial Statements.
Foreign exchange risk management
Because of the large number of countries and currencies we operate in, movements in currency exchange rates may affect our results.
We report our operating results and financial condition in US dollars. Our US operations earn revenue and incur expenses primarily in US dollars. Outside the United States, we predominantly generate revenues and expenses in the local currency with the exception of our London market operations which earns revenues in several currencies but incurs expenses predominantly in pounds sterling.
The table below gives an approximate analysis of revenues and expenses by currency in 2008 and includes full year HRH results on a proforma basis.
Our principal exposures to foreign exchange risk arise from:
London market operations
In our London market operations, we earn revenue in a number of different currencies, principally US dollars, pounds sterling, euros and Japanese yen, but incur expenses almost entirely in pounds sterling.
We hedge this risk as follows:
Generally, it is our policy to hedge at least 25 percent of the next 12 months' exposure in significant currencies. We do not hedge exposures beyond three years.
In addition, we are also exposed to foreign exchange risk on any net sterling asset or liability position in our London market operations. Where this risk relates to short-term cash flows, we hedge all or part of the risk by forward purchases or sales.
However, where the foreign exchange risk relates to any sterling pension assets benefit or liability for pensions benefit, we do not hedge the risk. Consequently, if our London market operations have a significant pension asset or liability, we may be exposed to accounting gains and losses if the US dollar and pounds sterling exchange rate changes. We do, however, hedge the pounds sterling contributions into the pension plan.
Translation risk
Outside our US and London market operations, we predominantly earn revenues and incur expenses in the local currency. When we
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translate the results and net assets of these operations into US dollars for reporting purposes, movements in exchange rates will affect reported results and net assets. For example, if the US dollar strengthens against the euro, the reported results of our Eurozone operations in US dollar terms will be lower.
We do not hedge translation risk.
The table below provides information about our foreign currency forward exchange contracts, which are sensitive to exchange rate risk. The table summarizes the US dollar equivalent amounts of each currency bought and sold forward and the weighted average contractual exchange rates. All forward exchange contracts mature within three years.
Foreign currency sold
US dollars sold for sterling
Euro sold for US Dollars
Japanese Yen sold for US Dollars
Total
Fair Value(1)
Income earned within foreign subsidiaries outside of the UK is generally offset by expenses in the same local currency but the Company does have exposure to foreign exchange movements on the net income of these entities. The Company does not hedge net income earned within foreign subsidiaries outside of the UK.
Interest rate risk management
Our operations are financed principally by $1,200 million fixed rate senior notes issued by a subsidiary, which are split between $250 million due 2010, $350 million due 2015 and $600 million due 2017 and by $1,450 million bank facilities which are split between $750 million due 2009 and $700 million which matures in 2013. The 5-year term loan facility
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amortizes at the rate of $35 million per quarter commencing from December 31, 2009. As of December 31, 2008 we had access to, but had not drawn $300 million under a revolving credit facility that expires in 2013. The interest rate applicable to the bank borrowing is variable according to the period of each individual drawdown.
We are also subject to market risk from exposure to changes in interest rates based on our investing activities where our primary interest rate risk arises from changes in short-term interest rates in both US dollars and pounds sterling.
As a consequence of our insurance and reinsurance broking activities, there is a delay between the time we receive cash for premiums and claims and the time the cash needs to be paid. We earn interest on this float, which is included in our consolidated financial statements as investment income.
This float is regulated in terms of access and the instruments in which it may be invested, most of
which are short-term in maturity. We manage the interest rate risk arising from this exposure primarily through the use of interest rate swaps. It is our policy that, for currencies with significant balances, a minimum of 25 percent of forecast income arising is hedged for each of the next three years.
The table below provides information about our derivative instruments and other financial instruments that are sensitive to changes in interest. For interest rate swaps, the table presents notional principal amounts and average interest rates analyzed by expected maturity dates. Notional principal amounts are used to calculate the contractual payments to be exchanged under the contracts. The duration of interest rate swaps varies between one and four years, with re-fixing periods of three months. Average fixed and variable rates are, respectively, the weighted-average actual and market rates for the interest hedges in place. Market rates are the rates prevailing at December 31, 2008 or 2007, as appropriate.
Short-term investments
Principal ($)
Fixed rate receivable
Principal (£)
Fixed rate debt
Fixed rate payable
Floating rate debt
Variable rate payable
Interest rate swaps
Principal (€)
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Forward rate agreements
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WILLIS GROUP HOLDINGS LIMITED
Item 8—Financial Statements and Supplementary Data
Index to Consolidated Financial Statements and Supplementary Data
Report of Independent Registered Public Accounting Firm
Consolidated Statements of Operations for each of the three years in the period ended December 31, 2008
Consolidated Balance Sheets as of December 31, 2008 and 2007
Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 2008
Consolidated Statements of Stockholders' Equity and Comprehensive Income for each of the three years in the period ended December 31, 2008
Notes to the Consolidated Financial Statements
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of Willis Group Holdings LimitedHamilton, Bermuda
We have audited the accompanying consolidated balance sheets of Willis Group Holdings Limited and subsidiaries (the "Company") as of December 31, 2008 and 2007, and the related consolidated statements of operations, stockholders' equity and comprehensive income, and cash flows for each of the three years in the period ended December 31, 2008. Our audits also included the consolidated financial statement schedule listed in the Index at Item 15. These financial statements and financial statement schedule are the responsibility of Willis Group Holdings Limited management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.
We conducted our audits 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 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, such consolidated financial statements present fairly, in all material respects, the financial position of Willis Group Holdings Limited and subsidiaries as of December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2008, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of December 31, 2008, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 27, 2009 expressed an unqualified opinion on the Company's internal control over financial reporting.
Deloitte LLPLondon, United KingdomFebruary 27, 2009
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WILLIS GROUP HOLDINGS LIMITED CONSOLIDATED STATEMENTS OF OPERATIONS
REVENUES
Other income (Note 2)
EXPENSES
Salaries and benefits (including share-based compensation of $40 million, $33 million and $18 million (Note 4))
Gain on disposal of London headquarters (Note 5)
Net gain (loss) on disposal of operations (Note 6)
Total expenses
OPERATING INCOME
INCOME BEFORE INCOME TAXES, INTEREST IN EARNINGS OF ASSOCIATES AND MINORITY INTEREST
Income taxes (Note 7)
INCOME BEFORE INTEREST IN EARNINGS OF ASSOCIATES AND MINORITY INTEREST
Interest in earnings of associates, net of tax (Note 14)
NET INCOME
EARNINGS PER SHARE (Note 8)
—Basic
—Diluted
AVERAGE NUMBER OF SHARES OUTSTANDING (Note 8)
CASH DIVIDENDS DECLARED PER COMMON SHARE
The accompanying notes are an integral part of these consolidated financial statements.
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WILLIS GROUP HOLDINGS LIMITED CONSOLIDATED BALANCE SHEETS
ASSETS
Cash and cash equivalents
Fiduciary funds—restricted (Note 10)
Short-term investments (Note 10)
Accounts receivable, net of allowance for doubtful accounts of $24 million in 2008 and $32 million in 2007
Fixed assets, net of accumulated depreciation of $236 million in 2008 and $211 million in 2007 (Note 11)
Goodwill (Note 12)
Other intangible assets, net of accumulated amortization of $79 million in 2008 and $46 million in 2007 (Note 13)
Investments in associates (Note 14)
Deferred tax assets (Note 7)
Pension benefits asset (Note 15)
Other assets
TOTAL ASSETS
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable
Deferred revenue and accrued expenses
Deferred tax liabilities (Note 7)
Income taxes payable
Short-term debt (Note 16)
Long-term debt (Note 16)
Liability for pension benefits (Note 15)
Other liabilities
Total liabilities
COMMITMENTS AND CONTINGENCIES (Note 17)
MINORITY INTEREST
STOCKHOLDERS' EQUITY
Common shares, $0.000115 par value; Authorized: 4,000,000,000; Issued and outstanding, 166,757,654 shares in 2008 and 143,093,509 shares in 2007
Additional paid-in capital
Retained earnings
Accumulated other comprehensive loss, net of tax (Note 18)
Treasury stock, at cost, 83,580 shares in 2008 and 71,858 shares in 2007
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
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WILLIS GROUP HOLDINGS LIMITED CONSOLIDATED STATEMENTS OF CASH FLOWS
CASH FLOWS FROM OPERATING ACTIVITIES
Adjustments to reconcile net income to net cash provided by operating activities:
Net (gain) loss on disposal of operations, fixed and intangible assets and short-term investments
Provision for doubtful accounts
Minority interest
Provision for deferred income taxes
Excess tax benefits from share-based payment arrangements
Share-based compensation (Note 4)
Undistributed earnings of associates
Changes in operating assets and liabilities, net of effects from purchase of subsidiaries:
Fiduciary funds—restricted
Accounts receivable
Additional funding of UK and US pension plans
Effect of exchange rate changes
Net cash provided by operating activities
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds on disposal of fixed and intangible assets
Additions to fixed assets
Net cash proceeds from disposal of operations, net of cash disposed
Acquisitions of subsidiaries, net of cash acquired
Investments in associates
Proceeds on sale of short-term investments
Net cash (used in) provided by investing activities
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from draw down of revolving credit facility
Proceeds from short-term debt, net of debt issuance costs
Proceeds from long-term debt, net of debt issuance costs
Repayments of debt
Senior notes issued, net of debt issuance costs
Repurchase of shares (Note 20)
Proceeds from issue of shares
Dividends paid
Net cash provided by (used in) financing activities
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS
Effect of exchange rate changes on cash and cash equivalents
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR
CASH AND CASH EQUIVALENTS, END OF YEAR
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WILLIS GROUP HOLDINGS LIMITED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
COMMON SHARES OUTSTANDING (thousands)
Balance, beginning of year
Common shares issued
Exercise of stock options
Balance, end of year
ADDITIONAL PAID-IN CAPITAL
Issue of common shares under employee stock compensation plans and related tax benefits
Issue of common shares for acquisitions
Share-based compensation
Gains on sale of treasury stock
RETAINED EARNINGS
Adjustment on adoption of FIN 48
Net income (a)
ACCUMULATED OTHER COMPREHENSIVE LOSS, NET OF TAX
Foreign currency translation adjustment (b)
Unrealized holding loss (c)
Minimum pension liability adjustment (d)
FAS 158 pension funding adjustment (e)
Net (loss) gain on derivative instruments (f)
Other comprehensive (loss) income, net of tax
Adjustment on initial application of FAS 158
TREASURY STOCK
Shares reissued under stock compensation plans
TOTAL STOCKHOLDERS' EQUITY
TOTAL COMPREHENSIVE (LOSS) INCOME (a+b+c+d+e+f)
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WILLIS GROUP HOLDINGS LIMITED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF OPERATIONS
Willis Group Holdings Limited ("Willis Group Holdings") and subsidiaries (collectively, the "Company") provide a broad range of insurance brokerage, reinsurance and risk management consulting services to its worldwide clients, both directly and indirectly through its associates. The Company provides both specialized risk management advisory and consulting services on a global basis to clients worldwide in specific industrial and commercial activities, and services to small, medium and major corporates through its retail operations.
In its capacity as an advisor and insurance broker, the Company acts as an intermediary between clients and insurance carriers by advising clients on risk management requirements, helping clients determine the best means of managing risk, and negotiating and placing insurance risk with insurance carriers through the Company's global distribution network.
2. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
These consolidated financial statements conform to accounting principles generally accepted in the United States of America ("US GAAP"). Presented below are summaries of:
Recent Accounting Policy Changes
Fair value measurement—adoption of FAS 157
The Company adopted Financial Accounting Standards No. 157 Fair Value Measurement("FAS 157") on January 1, 2008. FAS 157:
FAS 157 requires that assets and liabilities carried at fair value are classified and disclosed in one of the following three categories:
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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Continued)
2. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
The following table summarizes the valuation of the Company's assets and liabilities by the FAS 157 fair value hierarchy at December 31, 2008:
Assets at fair value:
Derivative financial instruments
Total assets
Liabilities at fair value:
The Company's fiduciary funds—restricted and short-term investments consist mainly of cash and time deposits. Fair values are based on quoted market values.
The fair value of the Company's derivative financial instruments is computed based on a market approach using information generated by market transactions involving comparable instruments.
Derivative financial instruments are included within 'other assets' and 'other liabilities' on the balance sheet.
Other Income
Other income comprises gains on the disposals of intangible assets, which primarily arise on the disposal of books of business. Prior to January 1, 2008, the Company reported these gains within "Commissions and fees". Comparatives have been adjusted accordingly.
Although the Company is not in the business of selling intangible assets (mainly books of business), from time to time the Company will dispose of a book of business (a customer list) or other intangible asset that does not produce adequate margins or fit with the Company's strategy.
Recent Accounting Pronouncements
Business Combinations
In December 2007, the FASB issued Financial Accounting Standard No. 141 (revised 2007) Business Combinations ("FAS 141R"). FAS 141R makes substantial changes to how entities account for business combinations, establishing principles and requirements for how the acquirer:
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FAS 141R is effective for financial years beginning after December 15, 2008 and is effective for the Company from January 1, 2009. Adoption is prospective and early adoption is not permitted. Assets and liabilities that arose from business combinations with acquisition dates prior to the effective date of FAS 141R are not adjusted upon adoption of FAS 141R with certain exceptions for acquired deferred tax assets and acquired income tax positions.
The income tax provisions of FAS 141R pertaining to changes in the valuation allowance of deferred tax assets and uncertain tax positions are applicable prospectively to business combinations occurring prior to the effective date of FAS 141R. Reductions to the valuation allowance of acquired deferred tax assets and all changes to acquired uncertain tax positions occurring after the measurement period are now recorded to the statement of operations.
Noncontrolling Interests in Consolidated Financial Statements
In December 2007, the FASB issued FAS No. 160, Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51, (SFAS No. 160). FAS No. 160 establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the retained interest and gain or loss when a subsidiary is deconsolidated. It clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity and should be reported as equity in the Consolidated Financial Statements. This statement is effective for financial statements issued for fiscal years beginning on or after December 15, 2008. Upon the initial adoption of this statement on January 1, 2009, the Company will change the classification and presentation of Noncontrolling Interest in the financial statements, which is currently referred to as Minority Interest to within stockholders' equity. At December 31, 2008, the Company reported minority interest of $50 million as a mezzanine item on the balance sheet.
Significant Accounting Policies
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of Willis Group Holdings and its subsidiaries, all of which are controlled through the ownership of a majority voting interest. Intercompany balances and transactions have been eliminated on consolidation.
Foreign Currency Translation
Transactions in currencies other than the functional currency of the entity are recorded at the rates of exchange prevailing at the date of the transaction. Monetary assets and liabilities in currencies other than the functional currency are translated at the rates of exchange prevailing at the balance sheet date and the related transaction gains and losses are reported in the statements of operations. Certain intercompany loans are determined to be of a long-term investment nature. The Company records transaction gains and losses from remeasuring such loans as a component of other comprehensive income.
Upon consolidation, the results of operations of subsidiaries and associates whose functional currency is other than the US dollar are translated into US dollars at the average exchange rate and assets and liabilities are translated at year-end exchange rates. Translation adjustments are presented as a separate
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component of other comprehensive income in the financial statements and are included in net income only upon sale or liquidation of the underlying foreign subsidiary or associated company.
Use of Estimates
The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of the dates of the financial statements and the reported amounts of revenues and expenses during the year. In the preparation of these consolidated financial statements, estimates and assumptions have been made by management concerning: the valuation of intangible assets (including those acquired through business combinations), the selection of useful lives of fixed and intangible assets; impairment testing; provisions necessary for accounts receivable, commitments and contingencies and accrued liabilities; long-term asset returns, discount rates and mortality rates in order to estimate pension liabilities and pension expense; income tax valuation allowances; and other similar evaluations. Actual results could differ from the estimates underlying these consolidated financial statements.
Cash and Cash Equivalents
Cash and cash equivalents primarily consist of time deposits with original maturities of three months or less.
Short-Term Investments
The Company classifies all short-term investments as available-for-sale. These securities are carried at fair market value, with unrealized gains and losses reported in other comprehensive income. Realized gains and losses on investments sold are included in net income.
Fiduciary Funds—Restricted
Fiduciary funds—restricted represent unremitted premiums received from insureds and unremitted claims received from insurers. Fiduciary funds are generally required to be kept in certain regulated bank accounts subject to guidelines which emphasize capital preservation and liquidity; such funds are not available to service the Company's debt or for other corporate purposes. Notwithstanding the legal relationships with clients and insurers, the Company is entitled to retain investment income earned on fiduciary funds in accordance with industry custom and practice and, in some cases, as supported by agreements with insureds.
Included in fiduciary funds—restricted are cash and cash equivalents consisting primarily of time deposits. The debt securities are classified as available-for-sale. Accordingly, they are recorded at fair market value with unrealized holding gains and losses reported, net of tax, as a component of other comprehensive income.
Accounts Receivable and Accounts Payable
In its capacity as an insurance agent or broker, the Company collects premiums from insureds and, after deducting its commissions, remits the premiums to the respective insurers; the Company also collects claims or refunds from insurers on behalf of insureds. Uncollected premiums from insureds and
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uncollected claims or refunds from insurers are recorded as accounts receivable on the Company's consolidated balance sheets. Unremitted insurance premiums and claims are held in a fiduciary capacity. The obligation to remit these funds is recorded as accounts payable on the Company's consolidated balance sheets. The period for which the Company holds such funds is dependent upon the date the insured remits the payment of the premium to the Company and the date the Company is required to forward such payment to the insurer. Balances arising from insurance brokerage transactions are reported as separate assets or liabilities unless such balances are due to or from the same party and a right of offset exists, in which case the balances are recorded net.
Accounts receivable are stated at estimated net realizable values. Allowances are recorded, when necessary, in an amount considered by management to be sufficient to meet probable future losses related to uncollectible accounts.
Fixed Assets
Fixed assets are stated at cost less accumulated depreciation. Expenditures for improvements are capitalized; repairs and maintenance are charged to expenses as incurred. Depreciation is computed using the straight-line method based on the estimated useful lives of assets.
Depreciation on buildings and long leaseholds is calculated over the lesser of 50 years or the lease term. Depreciation on leasehold improvements is calculated over the lesser of the useful life of the assets or the lease term. Depreciation on furniture and equipment is calculated based on a range of 3 to 10 years.
Recoverability of Fixed Assets
Long-lived assets are tested for recoverability whenever events or changes in circumstance indicate that their carrying amounts may not be recoverable. An impairment loss is recognized if the carrying amount of a long-lived asset is not recoverable and exceeds its fair value. Recoverability is determined based on the undiscounted cash flows expected to result from the use and eventual disposition of the asset or asset group. Long-lived assets and certain identifiable intangible assets to be disposed of are reported at the lower of carrying amount or fair value less cost to sell.
Rentals payable on operating leases are charged straight line to expense over the lease term as the rentals become payable.
Goodwill and Other Intangible Assets
Goodwill represents the excess of the cost of businesses acquired over the fair market value of identifiable net assets at the dates of acquisition. The Company reviews goodwill for impairment annually and whenever facts or circumstances indicate that the carrying amounts may not be recoverable. As part of the evaluation the estimated future discounted cash flows associated with the underlying business operation are compared to the carrying amount of goodwill to determine if a write-down is required. If such an assessment indicates that the discounted future cash flows are not sufficient, the carrying amount is reduced to the estimated fair value. Acquired intangible assets are
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being amortized on a straight-line basis over their estimated useful life with the exception of customer relationships for HRH which are amortized in line with the underlying cash flows.
Investments in Associates
Investments are accounted for using the equity method of accounting if the Company has the ability to exercise significant influence, but not control, over the investee. Significant influence is generally deemed to exist if the Company has an equity ownership in the voting stock of the investee between 20 and 50 percent, although other factors, such as representation on the Board of Directors and the impact of commercial arrangements, are considered in determining whether the equity method of accounting is appropriate. Under the equity method of accounting the investment is carried at cost of acquisition, plus the Company's equity in undistributed net income since acquisition, less any dividends received.
The Company periodically reviews its investments in associates for which fair value is less than cost to determine if the decline in value is other than temporary. If the decline in value is judged to be other than temporary, the cost basis of the investment is written down to fair value. The amount of any write-down is included in the statements of operations as a realized loss.
All other equity investments where the Company does not have the ability to exercise significant influence are accounted for by the cost method. Such investments are not publicly traded.
Put and Call Options Relating to Subsidiaries and Associates
For certain subsidiaries and associates, the Company has the right to purchase shares (a call option) from co-shareholders at various dates in the future. In addition, the co-shareholders of certain subsidiaries and associates have the right to sell their shares (a put option) to the Company at various dates in the future. Generally, the exercise price of such puts and calls is formula-based (using revenues and earnings) and is designed to reflect fair value. These put and call options fall outside the scope of FAS 133, Accounting for Derivative Instruments and Hedging Activities. Provision is made for any put options that are out of the money at the balance sheet date.
Derivative Financial Instruments
The Company uses derivative financial instruments for other than trading purposes to alter the risk profile of an existing underlying exposure. Interest rate swaps are used to manage interest risk exposures. Forward foreign currency exchange contracts are used to manage currency exposures arising from future income and expenses. The fair values of derivative contracts are recorded in other assets and other liabilities. Changes in the fair value of derivatives that qualify for hedge accounting are recorded in other comprehensive income. Amounts are reclassified from other comprehensive income into earnings when the hedged exposure affects earnings. Changes in fair value of derivatives that do not qualify for hedge accounting, together with any hedge ineffectiveness, are recorded in other operating expenses or interest expense as appropriate.
Income Taxes
The Company recognizes deferred tax assets and liabilities for the estimated future tax consequences of events attributable to differences between the financial statement carrying amounts of existing assets
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and liabilities and their respective tax bases and operating and capital loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted rates in effect for the year in which the differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of changes in tax rates is recognized in the statement of operations in the period in which the enactment date changes. Deferred tax assets are reduced through the establishment of a valuation allowance at such time as, based on available evidence, it is more likely than not that the deferred tax assets will not be realized.
The Company recognizes interest relating to unrecognized tax benefits and penalties within income taxes.
The Company has two principal defined benefit pension plans which cover the majority of employees in the United States and United Kingdom. Both these plans are now closed to new entrants. New entrants in the United Kingdom are offered the opportunity to join a defined contribution plan and in the United States are offered the opportunity to join a 401(k) plan. In addition, there are some smaller plans in Ireland, Germany, Denmark and the Netherlands. Elsewhere, pension benefits are typically provided through defined contribution plans.
Defined benefit plans
The net periodic cost of the Company's defined benefit plans are measured on an actuarial basis using the projected unit credit method and several actuarial assumptions. The most significant of which are the discount rate and the expected long-term rate of return on plan assets. Other material assumptions include rates of participant mortality, the expected long-term rate of compensation and pension increases and rates of employee termination. Gains and losses occur when actual experience differs from actuarial assumptions. If such gains or losses exceed ten percent of the greater of plan assets or plan liabilities the Company amortizes those gains or losses over the average remaining service period of the employees.
In accordance with FAS 158, the Company records on the balance sheet the funded status of its pension plans based on the projected benefit obligation.
Defined contribution plans
Contributions to the Company's defined contribution plans is recognized as they fall due. Differences between contributions payable in the year and contributions actually paid are shown as either other assets or other liabilities in the consolidated balance sheets.
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Share-Based Compensation
The Company accounts for share-based compensation as follows:
Revenue Recognition
Revenue includes insurance commissions, fees for services rendered, certain commissions receivable from insurance carriers and investment income earned on fiduciary balances.
Brokerage income and fees negotiated instead of brokerage are recognised at the later of policy inception date or when the policy placement is complete. Commissions on additional premiums and adjustments are recognized as and when advised.
Fees for risk management and other services are recognized as the services are provided. Negotiated fee arrangements for an agreed period covering multiple insurance placements, the provision of risk management and/or other services are determined, contract by contract, on the basis of the relative fair value of the services completed and the services yet to be rendered. The Company establishes contract cancellation reserves where appropriate; at December 31, 2008, 2007 and 2006, such amounts were not material.
Investment income is recognized as earned.
3. SEVERANCE COSTS
As part of the Company's 2008 expense review, the Company incurred $24 million of severance costs in the year ended December 31, 2008 relating to approximately 350 positions that have been eliminated. Severance costs for these employees were recognized pursuant to the terms of their existing benefit arrangements or employment agreements.
The Company has also incurred or expects to incur severance expenses as it integrates HRH into its previously existing North America operations. Severance costs of $2 million relating to the elimination of approximately 100 positions in the Company's previously existing operations were recognized through the consolidated statement of operations in 2008. In addition, $16 million of severance expenses relating to 900 HRH positions that will be eliminated as part of the integration plan have been recognized as a liability on acquisition (see Note 9—Acquisition of Hilb Rogal & Hobbs).
Severance costs also arise in the normal course of business and these charges amounted to $2 million in the year ended December 31, 2008 (2007: $2 million, 2006: $6 million).
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4. SHARE-BASED COMPENSATION
On December 31, 2008, the Company had three share-based compensation plans, under which options and other share based grants may be made to employees. All of the Company's share-based compensation plans under which any options or other share-based grants are outstanding as at December 31, 2008 are described below. The compensation cost that has been charged against income for those plans for the year ended December 31, 2008 was $40 million (2007: $33 million; 2006: $18 million). The total income tax benefit recognized in the statement of operations for share-based compensation arrangements for the year ended December 31, 2008 was $12 million (2007: $10 million; 2006: $6 million).
Stock Option Plans
The Company has adopted the plans described below, which provide for the grant of time-based options and performance-based options and various other share-based grants to employees. The objectives of these plans include attracting and retaining the best personnel, motivating management personnel by means of growth-related incentives to achieve long-range goals and providing employees with the opportunity to increase their share ownership in the Company.
Amended and Restated 1998 Share Purchase and Option Plan
This plan, which was established on December 18, 1998, provides for the granting of time-based and performance-based options to employees of the Company. There are 30,000,000 shares available for grant under this plan, provided, however, that in no event shall the total number of shares subject to options and other equity for current and future participants exceed 25 percent of the equity of Willis Group Holdings on a fully diluted basis. All options granted under this plan are exercisable at £2 per share ($2.92 using the year-end exchange rate of £1 = $1.46) except for 111,111 time-based options which are exercisable at $13.50. No further grants are to be made under this plan, which expired on December 18, 2008. Outstanding grants will not be affected.
Time-based options are earned upon the fulfillment of vesting requirements. Options are generally exercisable in equal installments of 20 percent per year over a five-year period commencing on or after December 18, 2000.
Performance-based options became exercisable, subject to the fulfillment of vesting requirements with effect from January 1, 2003, upon the achievement of cash flow and EBITDA (as defined in the plan agreements) targets of Willis Group Limited. Options are generally exercisable in equal installments of 25 percent per year over a four-year period commencing on or after December 18, 2001.
Willis Award Plan
This plan, which was established on July 13, 2000, provides for the granting of time-based options to selected employees who have been identified as superior performers. There are 5,000,000 shares available for grant under this plan provided, however, that in no event may the total number of shares subject to options and other equity for current and future participants exceed 25 percent of the equity of Willis Group Holdings on a fully diluted basis.
All options granted under this plan are exercisable at £2 per share ($2.92 using the year-end exchange rate of £1 = $1.46). The options vest immediately on the grant date and are exercisable any time up to July 13, 2010.
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4. SHARE-BASED COMPENSATION (Continued)
2001 Share Purchase and Option Plan
This plan, which was established on May 3, 2001, provides for the granting of time-based options and various other share-based grants at fair market value to employees of the Company. There are 25,000,000 shares available for grant under this plan. Options are exercisable on a variety of dates, including from the first, second, third, sixth or eighth anniversary of grant, although for certain options the exercisable date may accelerate depending on the achievement of certain performance goals. Unless terminated sooner by the Board of Directors, the 2001 Plan will expire 10 years after the date of its adoption. That termination will not affect the validity of any grant outstanding at that date.
2008 Share Purchase and Option Plan
This plan, which was established on April 23, 2008, provides for the granting of time and performance based options and various other share-based grants at fair market value to employees of the Company. There are 8,000,000 shares available for grant under this plan. Options are exercisable on a variety of dates, including from the third, fourth or fifth anniversary of grant. Unless terminated sooner by the Board of Directors, the 2008 Plan will expire 10 years after the date of its adoption. That termination will not affect the validity of any grant outstanding at that date.
HRH Option Plans
Options granted under the Hilb, Rogal and Hamilton Company 2000 Stock Incentive Plan, the Hilb, Rogal & Hobbs Company 2007 Stock Incentive Plan and the Hilb Rogal & Hobbs Company Non-Employee Directors Stock Incentive Plan were converted into options to acquire shares of Willis common stock. No further grants are to be made under these plans.
Option Valuation Assumptions
The fair value of each option is estimated on the date of grant using the Black-Scholes option pricing model that uses the assumptions noted in the following table. Expected volatility is based on historical volatility of the Company's stock. With effect from January 1, 2006, the Company uses the simplified method set out in Staff Accounting Bulletin No. 107 to derive the expected term of options granted. The risk-free rate for periods within the expected life of the option is based on the US Treasury yield curve in effect at the time of grant.
Expected volatility
Expected dividends
Expected life (years)
Risk-free interest rate
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A summary of option activity under the plans at December 31, 2008, and changes during the year then ended is presented below:
Time-based stock options
Granted
Exercised
Forfeited
Expired
Options vested or expected to vest at December 31, 2008
Options exercisable at December 31, 2008
Performance-based stock options
The weighted average grant-date fair value of time-based options granted during the year ended December 31, 2008 was $6.20 (2007: $11.06; 2006: $9.82). The total intrinsic value of options exercised during the year ended December 31, 2008 was $7 million (2007: $24 million; 2006: $26 million). At December 31, 2008 there was $52 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements under time-based stock option plans; that cost is expected to be recognized over a weighted average period of 2 years.
The weighted average grant-date fair value of performance based options granted during the year ended December 31, 2008 was $9.37 (2007: $nil; 2006: $nil). The total intrinsic value of options exercised during the year ended December 31, 2008 was $3 million (2007: $7 million; 2006: $18 million). At December 31, 2008 there was $42 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements under performance-based stock option plans; that cost is expected to be recognized over a weighted-average period of 2 years.
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A summary of restricted stock unit activity under the Plans at December 31, 2008, and changes during the year then ended is presented below:
Nonvested shares (restricted stock units)
Vested
The total of restricted stock units vested during the year ended December 31, 2008 was 435,855 shares at an average share price of $32.78 (2007: 123,139 shares at an average share price of $41.21). At December 31, 2008 there was $25 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements under the plan; that cost is expected to be recognized over a weighted average period of 1 year.
Cash received from option exercises under all share-based payment arrangements for the year ended December 31, 2008 was $11 million (2007: $21 million; 2006: $10 million). The actual tax benefit realized for the tax deductions from option exercise of the share-based payment arrangements totaled $7 million for the year ended December 31, 2008 (2007: $9 million; 2006: $11 million).
5. GAIN ON DISPOSAL OF LONDON HEADQUARTERS
On September 27, 2006 Willis Group Services Limited, a subsidiary of Willis Group Holdings Limited, completed the sale of Ten Trinity Square, the Company's London headquarters building. The building was then leased back at an annual rental of $13 million until the Company occupied its new London headquarters on Lime Street. The move was completed in April 2008. Gross proceeds were $202 million of which 25 percent was received in cash on completion and 75 percent was received on November 27, 2006. Of the total pre-tax gain on disposal, $102 million was recognized in 2006; $14 million in 2007 and $7 million in 2008.
6. NET GAIN (LOSS) ON DISPOSAL OF OPERATIONS
Total proceeds for 2008 were $11 million, inclusive of $7 million relating to 2008 dispositions of subsidiaries and associates and $4 million of deferred proceeds relating to prior years, with a gain on disposal of $nil recorded in the consolidated statements of operations.
Total proceeds for 2007 were $2 million, inclusive of $nil relating to 2007 dispositions of subsidiaries and associates and $2 million of deferred proceeds relating to prior years, with a gain on disposal of $2 million recorded in the consolidated statements of operations.
Total proceeds for 2006 were $6 million, inclusive of $3 million relating to 2006 dispositions of subsidiaries and associates and $3 million of deferred proceeds relating to prior years, with a loss on disposal of $4 million recorded in the consolidated statements of operations.
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7. INCOME TAXES
The components of income before income taxes, interest in earnings of associates and minority interest are as follows:
US
UK
Other jurisdictions
Income before incomes taxes, interest in earnings of associates and minority interest
The provision for income taxes by location of the taxing jurisdiction consisted of the following:
Current income taxes:
US federal tax
US state and local taxes
UK corporation tax
Total current taxes
Deferred taxes:
Total deferred taxes
Total income taxes
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7. INCOME TAXES (Continued)
Under current Bermuda law, the Company is not required to pay any taxes in Bermuda on its income, profits or capital gains. The following table reconciles the income taxes in these financial statements to that which would be expected at the US federal statutory income tax rate:
US federal statutory income tax rate
Income tax expense at US federal tax rate
Adjustments to derive effective rate:
Non-deductible items:
Other items:
FIN 48 movement
Resolution of tax authority enquiries
Rate change impact
Prior year adjustment
Sale of property
Tax differentials of foreign earnings:
UK earnings
Other jurisdictions and US State Taxes
Provision for income taxes
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The significant components of deferred income tax assets and liabilities and their balance sheet classifications are as follows:
Deferred tax assets:
Accrued expenses not currently deductible
US State net operating losses
UK net operating losses
UK capital losses
Financial derivative transactions
Accrued retirement benefits
Provisions
Deferred compensation
Stock options
Gross deferred tax assets
Less: valuation allowance
Net deferred tax assets
Deferred tax liabilities:
Cost of intangible assets, net of related amortization
Prepaid retirement benefits
Tax-leasing transactions
Unremitted foreign earnings
Deferred tax liabilities
Net deferred tax assets (liabilities)
Balance sheet classifications:
Deferred tax assets
At December 31, 2008, the Company had a valuation allowance of $85 million (2007: $69 million) to reduce its deferred tax assets to estimated realizable value. The valuation allowances at December 31, 2008 and 2007 relate to the deferred tax assets arising from UK capital loss carryforwards ($51 million), which have no expiration date and to the deferred tax assets arising from US State net operating losses ($34 million). Capital loss carryforwards can only be offset against future UK capital gains.
At December 31, 2008, the Company had deferred tax assets of $277 million (2007: $115 million), net of the valuation allowance. Management believes, based upon the level of historical taxable income and projections for future taxable income, it is more likely than not that the Company will realize the
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benefits of these deductible differences, net of the valuation allowance. However, the amount of the deferred tax asset considered realizable could be adjusted in the future if estimates of taxable income are revised.
The Company recognizes deferred tax balances related to the undistributed earnings of subsidiaries when the Company expects that it will recover those undistributed earnings in a taxable manner, such as through receipt of dividends or sale of the investments. The Company does not, however, provide for income taxes on the unremitted earnings of certain other subsidiaries where, in management's opinion, such earnings have been indefinitely reinvested in those operations, or will be remitted either in a tax free liquidation or as dividends with taxes substantially offset by foreign tax credits. It is not practical to determine the amount of unrecognized deferred tax liabilities for temporary differences related to these investments.
Unrecognized tax benefits
Total unrecognized tax benefits as at December 31, 2008 totaled $33 million. During the next 12 months it is reasonably possible that the Company will recognize approximately $9 million of tax benefits related to the release of provisions no longer required due to either settlement through negotiation or closure of the statute of limitations on assessment.
A reconciliation of the beginning and ending amounts of unrecognized tax benefits is as follows:
Balance at January 1, 2008
Reductions due to a lapse of the applicable statute of limitation
Increase for HRH opening balances
Other movements
Balance at December 31, 2008
The Company files tax returns in the various tax jurisdictions in which it operates. The 2004 US tax year closed in 2008 upon the expiration of the statute of limitations on assessment. US tax returns have been timely filed. The Company has not received notice that the IRS will be conducting an audit of the open years. Texas and Wisconsin are the only states with an active income tax audit. The Company has not extended the federal statute of limitations for assessment in the US.
All UK tax returns have been timely filed and are in the normal process of being reviewed, with HM Revenue & Customs making enquiries to obtain additional information. There are no material ongoing enquiries in relation to filed UK returns other than in relation to the quantification of foreign tax reliefs available on the remittance of foreign earnings.
8. EARNINGS PER SHARE
Basic and diluted earnings per share are calculated by dividing net income by the average number of shares outstanding during each period. The computation of diluted earnings per share reflects the potential dilution that could occur if dilutive securities and other contracts to issue shares were exercised or converted into shares or resulted in the issue of shares that then shared in the net income of the Company.
For the year ended December 31, 2008, time-based and performance-based options to purchase 16.9 million and 5.8 million (2007: 15.3 million and 0.2 million; 2006: 15.0 million and 0.4 million) shares of Willis common stock, respectively, and 1.4 million restricted shares (2007: 1.6 million; 2006: 1.1 million), respectively, were outstanding.
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8. EARNINGS PER SHARE (Continued)
Basic and diluted earnings per share are as follows:
Basic average number of shares outstanding
Dilutive effect of potentially issuable shares
Diluted average number of shares outstanding
Basic earnings per share
Options to purchase 22.1 million shares of Willis common stock for the year ended December 31, 2008 were not included in the computation of the dilutive effect of stock options because the effect was antidilutive (2007: 2.6 million shares; 2006: 5.7 million shares).
9. ACQUISITION OF HILB ROGAL & HOBBS COMPANY
On October 1, 2008, Willis completed the acquisition of HRH in a transaction involving both cash and stock consideration. The acquisition was effected by merging Willis HRH Inc, an indirect wholly owned subsidiary of Willis, with and into HRH.
The acquisition of HRH has been accounted for using the purchase method in accordance with FAS No. 141. Under the purchase method of accounting, the assets and liabilities of HRH are recorded at their fair values at the acquisition date. The financial statements and reported results of the operations of Willis after the completion of the acquisition reflect these fair values. The results of HRH are included within the consolidated statement of operations from October 1, 2008.
Prior to the acquisition, the Company had targeted key US locations and practice areas where it wished to expand and had made a series of piecemeal acquisitions. The acquisition of HRH, the eighth largest insurance and risk management intermediary in the United States, enabled the Company to achieve many of these targets and with a relatively low level of geographical and client overlap.
The Company believes that the HRH acquisition will:
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9. ACQUISITION OF HILB ROGAL & HOBBS COMPANY (Continued)
The Company also expects to extract significant cost savings through synergies between the two companies.
Consideration
The consideration paid by Willis including amounts payable in respect of stock options and costs directly attributable to the business combination was approximately $1.8 billion, as analyzed below:
Fair value of 24.38m shares of Willis common stock at $32.46
Cash paid to HRH shareholders
Estimated fair value of 3,825,652 fully vested HRH stock options
Unrecognized stock based compensation relating to non-vested restricted HRH shares
Transaction costs
Willis funded the cash consideration, the repayment of $341 million of existing HRH debt and the transaction costs with $1 billion from an interim credit facility and $525 million from a $700 million 5-year term loan facility. In addition, the Company repaid the $170 million outstanding at September 30, 2008 on its previously existing revolving credit facility and replaced this with a new $300 million facility, all of which remained available to draw at December 31, 2008. Over time the company plans to repurchase the majority of the shares issued in connection with the merger under the existing $1 billion buy back authorization.
Purchase price allocation
Willis' cost of acquiring HRH of $1.8 billion has been allocated on a preliminary basis to the assets acquired and liabilities assumed according to their estimated fair values at the date of acquisition. However, the Company is still in the process of finalizing the valuation of certain assets and liabilities, thus the allocation of the purchase price is subject to refinement. The final determination of these fair values will be completed as soon as possible but no later than one year from the acquisition date.
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The following table presents the Company's preliminary allocation of the purchase price to the assets acquired and liabilities assumed, based on their fair values:
Fixed assets
LIABILITIES
Due to affiliates
TOTAL LIABILITIES
NET ASSETS ACQUIRED
Identifiable Intangible Assets
The acquired intangible assets are attributable to the following categories:
Customer relationships were identified as the key intangible asset as approximately 95 percent of HRH's revenue has historically been generated by existing customer relationships. The fair value of customer relationships has been estimated using the discounted cash flow income approach. This involves calculating the present value of future cash flows arising from customer relationships existing at the acquisition date.
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Non compete agreements have also been valued by estimating the present value of the cashflows protected by the non-compete arrangement over their expected enforcement period of 3 years.
Trade names have been valued using the relief from royalty method, whereby the fair value of the trademark is estimated as the present value of the after tax royalty income stream that could be derived by licensing out the trade names.
The weighted average amortization period for the acquired intangible assets is 18.7 years.
The total amount of goodwill recognized on the purchase of HRH is $1.6 billion of which $1,551 million is attributable to our North America operations and $52 million to our Global operations.
Among the assets and liabilities acquired is tax deductible goodwill in HRH of $325 million that arose in a previous business combination by HRH. The tax basis in this historical goodwill of HRH continues to have tax basis after the acquisition of HRH by Willis, and will continue to be amortized for tax purposes. At the transaction date there is no temporary difference relating to the historical tax deductible goodwill, and therefore no deferred taxes. A temporary difference will arise in future periods as the tax deductible goodwill is amortized for tax purposes. Goodwill arising on the transaction above the historical HRH goodwill is not deductible for tax purposes and will not generate a temporary difference currently or in the future.
Supplemental Disclosure of Pro Forma Information
The following unaudited pro forma consolidated results of operations have been prepared as if the acquisition of HRH occurred at January 1, 2007.
Income before taxes, interest in earnings of associates and minority interest
Earnings per share—Basic
Earnings per share—Diluted
The unaudited pro forma financial information above reflects the following pro forma adjustments:
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The pro forma information is presented for informational purposes only and is not necessarily indicative of the results of operations that actually would have been consummated as of that time, nor is it intended to be indicative of future results.
Integration costs
Once the proposed acquisition of HRH was announced, the Company worked with HRH management to develop a plan to integrate HRH and its previously existing North America operations. This plan was substantially complete at the time of the acquisition. The plan seeks to centralize HRH's dispersed back office processes and integrate these with Willis' existing service hubs and to close down HRH's Richmond Head Office. The plan also identified locations where office space was duplicated or could be rationalized. In implementing the integration plan, the Company has incurred or expects to incur $34 million of severance expenses and vacant space provisions relating to HRH staff and premises. This has been recognized as a liability assumed in the purchase business combination within Accounts payable and accrued expenses.
10. FIDUCIARY FUNDS—RESTRICTED AND SHORT-TERM INVESTMENTS
The Company's fiduciary funds—restricted and short-term investments consist mainly of cash and time deposits. Accrued interest on investments is recorded as other assets.
Debt securities are classified as available-for-sale. Accordingly, they are recorded at fair market value with unrealized holding gains and losses reported, net of tax, as a component of other comprehensive income. As of December 31, 2008 and 2007, the amortized cost of such securities approximated fair value.
Realized gains and losses, net of tax, on debt securities are included in net income. During the years ended December 31, 2008, 2007 and 2006, sales of debt securities totaled $15 million, $19 million and $10 million, respectively, on which realized gains and losses were not material to the consolidated results of the Company. Fiduciary funds—restricted, consisting primarily of time deposits with original maturities of less than or equal to three months, were $1,854 million as of December 31, 2008 (2007: $1,520 million).
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10. FIDUCIARY FUNDS—RESTRICTED AND SHORT-TERM INVESTMENTS (Continued)
Short-term investments consist of the following:
Short-term investments:(1)
US, UK and other Government securities
Corporate debt securities
The following table summarizes the estimated fair value of investments in marketable securities designated as available-for-sale classified by the contractual maturity date of the security:
Total marketable securities—due within 1 year through 5 years
Consolidation of fiduciary funds
In accordance with FASB Interpretation No. 46(R), Consolidation of Variable Interest Entities an interpretation of ARB No. 51, the financial statements for the years ended December 31, 2008 and 2007 reflect the consolidation of one Variable Interest Entity ("VIE"), a UK non-statutory trust that was established in January 2005 following the introduction of statutory regulation of insurance in the UK by the Financial Services Authority. The regulation requires that all fiduciary funds collected by an insurance broker such as the Company be paid into a non-statutory trust designed to give additional credit protection to the clients and insurance carriers of the Company. This trust restricts the financial instruments in which such funds may be invested and affects the timing of transferring commission from fiduciary funds to own funds.
As of December 31, 2008, the fair value of the assets in the VIE was approximately $931 million (2007: $912 million) and the fair value of the associated liabilities was approximately $931 million (2007: $912 million). There are no assets of the Company that serve as collateral for the VIE.
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11. TANGIBLE FIXED ASSETS
The components of fixed assets are as follows:
Land and buildings
Leasehold improvements
Furniture and equipment
Total fixed assets, cost
Less accumulated depreciation
Total fixed assets, net
The Company recognized a depreciation charge of $54 million, $52 million and $49 million in the years ended December 31, 2008, 2007 and 2006, respectively.
12. GOODWILL
Goodwill represents the excess of the cost of businesses acquired over the fair market value of identifiable net assets at the dates of acquisition. Goodwill is not amortized but is subject to impairment testing annually and whenever facts or circumstances indicate that the carrying amounts may not be recoverable. As part of the evaluation the estimated future discounted cash flows associated with the underlying business operation are compared to the carrying amount of goodwill to determine if a write-down is required. If such an assessment indicates that the discounted future cash flows are not sufficient, the carrying amount is reduced to the estimated fair value.
The Company's annual goodwill impairment test which was performed during the fourth quarter of 2008, did not result in an impairment charge (2007: $nil, 2006: $nil).
When a business entity is sold, goodwill is allocated to the disposed entity based on the fair value of that entity compared to the fair value of the reporting unit in which it is included.
The changes in the carrying amount of goodwill by operating segment for the years ended December 31, 2008 and 2007 are as follows:
Balance at January 1, 2007
Goodwill acquired during 2007
Foreign exchange
Balance at December 31, 2007
Goodwill acquired during 2008
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13. OTHER INTANGIBLE ASSETS
Other intangible assets are classified into two categories:
The major classes of amortizable intangible assets are as follows:
Customer and Marketing related
Less: accumulated amortization
Net amortizable Customer and Marketing related
Contract based, Technology and Other
Net amortizable Contract based, Technology and Other
Total amortizable intangible assets
Net total amortizable intangible assets
The aggregate amortization of intangible assets for the year ended December 31, 2008 was $36 million. The estimated aggregate amortization of intangible assets for each of the next five years ended December 31 is as follows:
2009
2010
2011
2012
2013
14. INVESTMENTS IN ASSOCIATES
The Company holds a number of investments which it accounts for using the equity method. The Company's interest in the outstanding stock of the more significant associates is as follows:
Al-Futtaim Willis Co. L.L.C.
Gras Savoye & Cie ("Gras Savoye")
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14. INVESTMENTS IN ASSOCIATES (Continued)
Of those listed above, the Company's principal investment as of December 31, 2008 and 2007 is Gras Savoye, France's leading insurance broker. Included in the carrying amount of the Gras Savoye investment as of December 31, 2008 is goodwill of $141 million (2007: $93 million). Of this total, $21 million was recognized in respect of an additional 4.3 percent purchased in January 2008 and $27 million was recognized in December 2008 in respect of an additional 5.5 percent. The additional acquisition increases the Company's total voting interest to 48%.
As of December 31, 2008 and 2007, the Company's other investments in associates individually and in the aggregate were not material to the Company's operations.
On July 23, 1997, the Company entered into an agreement with Gras Savoye whereby, among other things, the co-shareholders of Gras Savoye (other than management) have the right to sell "put option" their shares to the Company, possibly increasing the Company's ownership interest from 48 percent to 90 percent. Management shareholders of Gras Savoye, representing approximately 10 percent of the outstanding shares, do not have general put rights before 2011, but have certain put rights on their death, disability or retirement. The option expires at the end of 2011 and Gras Savoye's eligible co-shareholders may exercise their rights from January 1, 2001. In addition, the Company has the right to purchase (call option) at least 50.1 percent of Gras Savoye's shares from the co-shareholders. The call option is exercisable from December 1, 2009 until February 1, 2010. The exact amount payable by the Company under the put option and call option is based on formula-based price contingent on Gras Savoye's future results.
Unaudited condensed financial information for associates, in the aggregate, as of and for the years ended December 31, is presented below. For convenience purposes: (i) balance sheet data has been translated to US dollars at the relevant year-end exchange rate, and (ii) condensed statements of operations data has been translated to US dollars at the relevant average exchange rate.
Condensed statements of operations data:
Income before income taxes
Condensed balance sheets data:
Stockholders' equity
For the year ended December 31, 2008, the Company recognized $9 million (2007: $6 million; 2006: $5 million) in respect of dividends received from associates.
15. PENSION PLANS
The Company maintains two principal defined benefit pension plans that cover almost all our employees in the United States and United Kingdom. Both these plans are now closed to new entrants. New entrants in the United Kingdom are offered the opportunity to join a defined contribution plan and in the United States are offered the opportunity to join a 401(k) plan. In addition to the Company's UK and US defined benefit pension plans, the Company has several smaller defined benefit
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15. PENSION PLANS (Continued)
pension plans in Ireland, Germany, Denmark and the Netherlands. Elsewhere, pension benefits are typically provided through defined contribution plans. It is the Company's policy to fund pension costs as required by applicable laws and regulations.
At December 31, 2008, the Company recorded, on the Consolidated Balance Sheets:
UK and US defined benefit plans
The following schedules provide information concerning the Company's UK and US defined benefit pension plans as of and for the years ended December 31:
Change in benefit obligation:
Benefit obligation, beginning of year
Service cost
Interest cost
Employee contributions
Actuarial (gain) loss
Benefits paid
Foreign currency changes
Plan amendments
Benefit obligations, end of year
Change in plan assets:
Fair value of plan assets, beginning of year
Actual return on plan assets
Employer contributions
Fair value of plan assets, end of year
Funded status at end of year
Components on the Consolidated Balance Sheets:
Pension benefits asset
Liability for pension benefits
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Amounts recognized in accumulated other comprehensive loss consist of:
Net actuarial loss
Prior service gain
The accumulated benefit obligations for the Company's UK and US defined benefit pension plans were $1,377 million and $635 million, respectively (2007: $2,014 million and $619 million, respectively).
The components of the net periodic benefit cost and other amounts recognized in other comprehensive loss for the UK and US defined benefit plans are as follows:
Components of net periodic benefit cost:
Expected return on plan assets
Amortization of unrecognized prior service gain
Amortization of unrecognized actuarial loss
Net periodic benefit (income) cost
Other changes in plan assets and benefit obligations recognized in other comprehensive income (loss):
Net actuarial loss (gain)
Total recognized in other comprehensive income (loss)
Total recognized in net periodic benefit cost and other comprehensive income
The estimated net loss and prior service cost for the UK and US defined benefit plans that will be amortized from accumulated other comprehensive loss into net periodic benefit cost over the next fiscal year are $31 million loss and $4 million gain, respectively (using the year-end exchange rate of £1 = $1.46) for the UK plan and $19 million loss and $2 million gain for the US plan, respectively.
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The following schedule provides other information concerning the Company's UK and US defined benefit pension plans:
Weighted-average assumptions to determine benefit obligations:
Discount rate
Rate of compensation increase
Weighted-average assumptions to determine net periodic benefit cost:
The expected return on plan assets was determined on the basis of the weighted-average of the expected future returns of the various asset classes, using the target allocations shown below. The expected returns on UK plan assets are UK and foreign equities 8.80 percent, debt securities 5.40 percent and real estate 6.40 percent. The expected returns on US plan assets are US and foreign equities 9.25 percent and debt securities 5.75 percent.
The Company's pension plan asset allocations based on fair values were as follows:
Equity securities
Debt securities
Real estate
The Company's investment policy includes a mandate to diversify assets and the Company invests in a variety of asset classes to achieve that goal. The UK plan's assets are divided into 10 separate portfolios according to asset class and managed by 12 investment managers. The broad target allocations are UK and foreign equities (75 percent), debt securities (20 percent) and real estate (5 percent). The US plan's assets are currently invested in 17 funds representing most standard equity and debt security classes. The broad target allocations are US and foreign equities (64 percent) and debt securities (36 percent).
In 2009, the Company expects to contribute $37 million to the UK plan and $18 million to the US plan.
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The following benefit payments, which reflect expected future service, as appropriate, are estimated to be paid by the UK and US defined benefit pension plans:
2014-2018
Willis North America has a 401(k) plan covering all eligible employees of Willis North America and its subsidiaries. The plan allows participants to make pre-tax contributions and the Company provides a matching contribution of 3 percent of employees' annual eligible compensation. All investment assets of the plan are held in a trust account administered by independent trustees. The Company's 401(k) matching contributions for 2008 were $8 million (2007: $6 million; 2006: $5 million).
International defined benefit pension plans
In addition to the Company's UK and US defined benefit pension plans, the Company has several smaller defined benefit pension plans in Ireland, Germany, Denmark and the Netherlands. In prior years, management determined that these International plans were not material to the Company's results of operations, financial condition or liquidity: as at December 31, 2007 the net pension liability in respect of these schemes was $2 million. Consequently such plans were not included in the Company's pension plan disclosures.
However, as a result of the turmoil in worldwide equity markets in the latter half of 2008 and consequent declines in pension plan asset values, a $29 million pension benefit liability has been recognized in respect of these schemes. Accordingly, the Company is now providing pension plan disclosures for these schemes.
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The following schedules provide information concerning the Company's international defined benefit pension plans as of and for the year ended December 31, 2008. Comparative information has not been presented.
Actuarial gain
Amounts recognized in accumulated other comprehensive loss consist of a net actuarial loss of $27 million.
The accumulated benefit obligation for the Company's International defined benefit pension plans was $104 million.
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The components of the net periodic benefit cost and other amounts recognized in other comprehensive loss for the International defined benefit plans for the year ended December 31, 2008 are as follows:
Net periodic benefit cost
Net actuarial gain
Total recognized in other comprehensive income
The estimated net loss for the International defined benefit plans that will be amortized from accumulated other comprehensive loss into net periodic benefit cost over the next fiscal year is $2 million (using the year-end exchange rate of £1 = $1.46).
The following schedule provides other information concerning the Company's International defined benefit pension plans:
The determination of the expected long-term rate of return on the International plan assets is dependent upon the specific circumstances of each individual plan. The assessment may include analyzing historical investment performance, investment community forecasts and current market conditions to develop expected returns for each asset class used by the plans.
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The Company's International pension plan asset allocations at December 31, 2008 based on fair values were as follows:
The investment policies for the International plans vary by jurisdiction but are typically established by the local pension plan trustees, where applicable, and seek to maintain the plans' ability to meet liabilities of the plans as they fall due and to comply with local minimum funding requirements.
In 2009, the Company expects to contribute $6 million to the International plans.
The following benefit payments, which reflect expected future service, as appropriate, are estimated to be paid by the International defined benefit pension plans:
16. DEBT
Short-term debt consists of the following:
Current portion of 5-year term loan facility
Interim credit facility
The $1 billion interim credit facility bears interest at LIBOR plus 2.250% and is repayable on September 30, 2009. Duration fees of 0.50% of any balance then outstanding are payable on March 31, 2009 and June 30, 2009.
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16. DEBT (Continued)
Long-term debt consists of the following:
5-year term loan facility
Revolving credit facility
On October 1, 2008, we funded the HRH acquisition with $1 billion from an interim credit facility and $525 million from a $700 million 5-year term loan facility. In addition, we repaid the outstanding balance on our existing revolving credit facility and replaced this with a new $300 million revolving credit facility. During fourth quarter 2008, we repaid $250 million of the interim credit facility and drew down an additional $175 million under the 5-year term loan.
The $1 billion interim credit facility bears interest at LIBOR plus 2.250% and is repayable on September 30, 2009; the 5-year term loan facility and the revolving credit facility also bear interest at LIBOR plus 2.250%. 1 month LIBOR at December 31, 2008 was 0.436%.
The agreements relating to the new senior credit facilities and revolving credit facility contain numerous operating and financial covenants, including requirements to maintain minimum ratios of consolidated adjusted EBITDA to consolidated fixed charges and maximum levels of consolidated funded indebtedness in relation to consolidated EBITDA, in each case subject to certain adjustments.
In addition, the credit agreements include covenants relating to the delivery of financial statements, reports and notices, limitations on liens, limitations on sales and other disposals of assets, limitations on indebtedness and other liabilities, limitations on sale and leaseback transactions, limitations on mergers and other fundamental changes, maintenance of property, maintenance of insurance, nature of business, compliance with applicable laws, maintenance of corporate existence and rights, use of proceeds, payment of taxes and access to information and properties. At December 31, 2008, the Company was in compliance with all covenants.
All obligations of Willis North America Inc. ("Willis North America") (the borrower) under the credit agreements and under the senior notes listed above are guaranteed by Willis Group Holdings Limited, Willis Investment UK Holdings Limited, Trinity Acquisition Limited, Willis Group Limited, TA I Limited, TA II Limited, TA III Limited and TA IV Limited.
In February 2009, the Company entered into an agreement with Goldman Sachs Mezzanine Partners to issue notes in an aggregate principal amount of $500 million. The Company anticipates that the net proceeds of this issuance of approximately $480 million will be applied towards the balance of the interim credit facility. Consummation of the issuance, which is subject to customary closing conditions, is expected to take place in March 2009.
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Lines of credit
Excluding the $300 million revolving credit facility, the Company also has available $10 million (2007: $8 million) in lines of credit, of which $1 million was drawn as of December 31, 2008 (2007: $nil).
17. COMMITMENTS AND CONTINGENCIES
Operating Leases
The Company leases certain land, buildings and equipment under various operating lease arrangements. Original non-cancellable lease terms typically are between 10 and 20 years and may contain escalation clauses, along with options that permit early withdrawal. The total amount of the minimum rent is expensed on a straight-line basis over the term of the lease.
As of December 31, 2008, the aggregate future minimum rental commitments under all non-cancellable operating lease agreements are as follows:
Thereafter
We moved from Ten Trinity Square into our new London headquarters in Lime Street in April 2008. In November 2004, the Company entered into an agreement with long time client British Land plc to lease the Lime Street building and took control of the building in June 2007 under a 25-year operating lease. The Company's contractual obligations in relation to this commitment total $720 million and are included in the table above.
Rent expense amounted to $151 million for the year ended December 31, 2008 (2007: $132 million; 2006: $93 million). The Company's rental income from subleases was $22 million for the year ended December 31, 2008 (2007: $14 million; 2006: $11 million).
Guarantees
Guarantees issued by certain of Willis Group Holdings' subsidiaries with respect to the senior credit facility and the senior notes are discussed in note 16—Debt in these consolidated financial statements.
Certain of Willis Group Holdings' subsidiaries have given the landlords of some leasehold properties occupied by the Company in the United Kingdom and the United States guarantees in respect of the performance of the lease obligations of the subsidiary holding the lease. The operating lease obligations subject to such guarantees amounted to $804 million and $1,035 million at December 31, 2008 and 2007, respectively.
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17. COMMITMENTS AND CONTINGENCIES (Continued)
In addition, the Company has given guarantees to bankers and other third parties relating principally to letters of credit amounting to $4 million and $4 million at December 31, 2008 and 2007, respectively.
For certain subsidiaries and associates, the Company has the right to purchase shares (a call option) from co-shareholders at various dates in the future. In addition, the co-shareholders of certain subsidiaries and associates have the right to sell (a put option) their shares to the Company at various dates in the future. Generally, the exercise price of such put options and call options is formula-based (using revenues and earnings) and is designed to reflect fair value. Based on current projections of profitability and exchange rates, the potential amount payable from these options is not expected to exceed $434 million. Of this balance, $359 million relates to Gras Savoye.
On the basis of current information, the Company does not expect that the actual claims, lawsuits and other proceedings, to which the Company is subject, or potential claims, lawsuits and other proceedings relating to matters of which it is aware will ultimately have a material adverse effect on the Company's financial condition, results of operations or liquidity. Nonetheless, given the large or indeterminate amounts sought in certain of these actions, and the inherent unpredictability of litigation, it is possible that an adverse outcome in certain matters could, from time to time, have a material adverse effect on the Company's results of operations or cash flows in particular quarterly or annual periods.
In connection with the investigation commenced by the New York State Attorney General in April 2004 concerning, among other things, contingent commissions paid by insurers to insurance brokers, in April 2005, the Company entered into an Assurance of Discontinuance ("NY AOD") with the New York State Attorney General and the Superintendent of the New York Insurance Department and paid $50 million to eligible customers. As part of the NY AOD, the Company also agreed not to accept contingent compensation and to disclose to customers any compensation the Company will receive in connection with providing policy placement services to the customer. The Company also resolved
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similar investigations commenced by the Minnesota Attorney General, the Florida Attorney General, the Florida Department of Financial Services and the Florida Office of Insurance Regulation for amounts that were not material to the Company. Similarly, in August 2005 HRH entered into an agreement with the Attorney General of the State of Connecticut (the "CT Attorney General") and the Insurance Commissioner of the State of Connecticut to resolve all issues related to their investigations into certain insurance brokerage and insurance agency practices and to settle a lawsuit brought in August 2005 by the CT Attorney General alleging violations of the Connecticut Unfair Trade Practices Act and the Connecticut Unfair Insurance Practices Act. As part of this settlement, HRH agreed to take certain actions including establishing a $30 million national fund for distribution to certain clients, enhancing disclosure practices for agency and broker clients, and declining contingent compensation on brokerage business. The Company has co-operated fully with other similar investigations by the regulators and/or attorneys general of other jurisdictions, some of which have been concluded with no indication of any finding of wrongdoing.
Since August 2004, the Company and HRH (along with various other brokers and insurers) have been named as defendants in purported class actions in various courts across the country. All of these actions have been consolidated or are in the process of being consolidated into a single action in the U.S. District Court for the District of New Jersey ("MDL"). There are two amended complaints within the MDL, one that addresses employee benefits ("EB Complaint") and one that addresses all other lines of insurance ("Commercial Complaint"). HRH was a named defendant in the EB Complaint, but has since been voluntarily dismissed. HRH is a named defendant in the Commercial Complaint. The Company is a named defendant in both MDL Complaints. Each of the EB Complaint and the Commercial Complaint seek monetary damages, including punitive damages, and equitable relief and make allegations regarding the practices and conduct that have been the subject of the investigation of state attorneys general and insurance commissioners, including allegations that the brokers have breached their duties to their clients by entering into contingent compensation agreements with either no disclosure or limited disclosure to clients and participated in other improper activities. The Complaints also allege the existence of a conspiracy among insurance carriers and brokers and allege violations of federal antitrust laws, the federal RICO statute and the Employee Retirement Income Security Act of 1974 ("ERISA"). In separate decisions issued in August and September 2007, the antitrust and RICO claims were dismissed with prejudice and the state claims were dismissed without prejudice from both Complaints. Plaintiffs have filed a notice of appeal regarding these dismissal rulings and oral arguments on this appeal are scheduled to be heard in April 2009. In January 2008, the Judge dismissed the ERISA claims with prejudice from the EB Complaint. Additional actions could be brought in the future by individual policyholders. The Company disputes the allegations in all of these suits and has been and intends to continue to defend itself vigorously against these actions. The
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outcomes of these lawsuits, however, including any losses or other payments that may occur as a result, cannot be predicted at this time.
The reinsurers concerned have taken the position that, despite their decisions to underwrite risks or a group of risks, they are no longer bound by their reinsurance contracts. As a result, they have stopped settling claims and are seeking to recover claims already paid. The Company also understands that there have been at least two arbitration awards in relation to a spiral, among other things, in which the reinsurer successfully argued that it was no longer bound by parts of its reinsurance program. Willis Limited, the Company's principal insurance brokerage subsidiary in the United Kingdom, acted as the reinsurance broker or otherwise as intermediary, but not as an underwriter, for numerous personal accident reinsurance contracts, including two contracts that were involved in one of the arbitrations. Due to the small number of reinsurance brokers generally, Willis Limited was one of a small number of brokers active in the market for this reinsurance during the relevant period. Willis Limited also utilized other brokers active in this market as sub-agents, including brokers who are parties to the legal proceedings described above, for certain contracts and may be responsible for any errors and omissions they may have made. In July 2003, one of the reinsurers received a judgment in the English High Court against certain parties, including a sub-broker Willis Limited used to place two of the contracts involved in this trial.
Although neither the Company nor any of its subsidiaries were a party to this proceeding or any arbitration, Willis Limited entered into tolling agreements with certain of the principals to the reinsurance contracts tolling the statute of limitations pending the outcome of proceedings between the reinsureds and reinsurers.
Two former clients of Willis Limited, American Reliable Insurance Company and one of its associated companies ("ARIC") and CNA Insurance Company Limited and two of its associated companies ("CNA") have each terminated their respective tolling agreements with Willis Limited and commenced litigation in September 2007 and January 2008, respectively, in the English Commercial Court against Willis Limited. ARIC has alleged conspiracy between a former Willis Limited employee and the ARIC underwriter as well as negligence and CNA has alleged deceit and negligence by the same Willis Limited employee both in connection with placements of personal accident reinsurance in the excess of loss market in London and elsewhere. The Company disputes these allegations and is vigorously defending itself in these actions. ARIC's asserted claim is approximately $257 million (plus unspecified interest and costs) and CNA's asserted claim is approximately $251 million (plus various unspecified claims for exemplary damages, interest and costs). Pleadings have been exchanged in both actions and the parties have been and continue to be engaged in extensive discovery prior to the trial which the Court has fixed on a preliminary basis for ten weeks commencing October 7, 2009. The Company
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cannot predict at this time what, if any, damages might result from these claims but has kept its errors and omissions insurance carrier fully informed of developments in the claims. The Company believes that any amounts required to resolve the claims will be covered by errors and omissions insurance. Various arbitrations continue to be active and from time to time the principals request co-operation from the Company and suggest that claims may be asserted against the Company. Such claims may be made against the Company if reinsurers do not pay claims on policies issued by them. The Company cannot predict at this time whether any such claims will be made or the damages that may be alleged.
In March 2008, the Company settled an action in the United States District Court for the Southern District of New York commenced against the Company in 2001 on behalf of an alleged nationwide class of present and former female officer and officer equivalent employees alleging that the Company discriminated against them on the basis of their gender and seeking injunctive relief, money damages, attorneys' fees and costs. Although the Court had denied plaintiffs' motions to certify a nationwide class or to grant nationwide discovery, it did certify a class of approximately 200 female officers and officer equivalent employees based in the Company's offices in New York, New Jersey and Massachusetts. The settlement agreement provides for injunctive relief and a monetary payment, including the amount of attorney fees plaintiffs' counsel are entitled to receive, which was not material to the Company. In December 2006, a former female employee, whose motion to intervene in the class action was denied, filed a purported class action in the United States District Court, Southern District of New York, with almost identical allegations as those contained in the suit that was settled in 2008, except seeking a class period of 1998 to the time of trial (the class period in the settled suit was 1998 to the end of 2001). The Company's motion to dismiss this suit was denied and the Court did not grant the Company permission to immediately file an appeal from the denial of its motion to dismiss. The suit was recently amended to include two additional plaintiffs. The parties are in the discovery phase of the litigation. The Company cannot predict at this time what, if any, damages might result from this action.
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18. ACCUMULATED OTHER COMPREHENSIVE LOSS, NET OF TAX
The components of comprehensive (loss) income are as follows:
Other comprehensive (loss) income, net of tax:
Foreign currency translation adjustment (net of tax of $nil in 2008, 2007 and 2006)
Unrealized holding loss (net of tax of $nil in 2008, 2007 and 2006)
Minimum pension liability adjustment, prior to the adoption of FAS 158 (net of tax of $(97) million in 2006)
FAS 158 pension funding adjustment (net of tax of $160 million in 2008 and $(6) million in 2007)
Net (loss) gain on derivative instruments (net of tax of $13 million in 2008, $nil in 2007, $1 million in 2006)
Other comprehensive (loss) income (net of tax of $173 million in 2008, $(6) million in 2007, $(96) million in 2006)
Comprehensive (loss) income
The components of accumulated other comprehensive loss, net of tax, are as follows:
Net foreign currency translation adjustment
Net unrealized holding loss
Net minimum pension liability adjustment, prior to the adoption of FAS 158
FAS 158 pension funding adjustment
Net unrealized loss on derivative instruments
Accumulated other comprehensive (loss) income pre application of FAS 158, net of tax
Net adjustment on initial application of FAS 158
Accumulated other comprehensive loss, net of tax
It is estimated that $37 million of net derivative losses included in accumulated other comprehensive loss will be reclassified into earnings within the next twelve months.
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19. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Supplemental disclosures regarding cash flow information and non-cash flow investing and financing activities are as follows:
Supplemental disclosures of cash flow information:
Cash payments for income taxes
Cash payments for interest
Supplemental disclosures of non-cash flow investing and financing activities:
Liabilities accrued for additions to fixed assets
Issue of stock on acquisitions of subsidiaries
Deferred payments on acquisitions of subsidiaries
Acquisitions:
Fair value of assets acquired
Less:
liabilities assumed
cash acquired
Net assets assumed, net of cash acquired
20. SHARE BUYBACKS
On November 1, 2007, the Board authorized a new share buyback program for $1 billion. This replaced the previous $1 billion buyback program and its remaining $308 million authorization. The program is an open-ended plan to repurchase the Company's shares from time to time in the open market or through negotiated sales with persons who are not affiliates of the Company. In addition the board authorized in June 2008, the repurchase of up to the number of shares issued by the Company in connection with the acquisition of HRH.
During the year ended December 31, 2008, the Company repurchased 2.3 million shares for a total consideration of $75 million at an average price of $33.12. Repurchased shares were subsequently canceled. There was also a $1 million adjustment in 2008 relating to prior year price adjustments.
Accelerated Share Repurchase Programs
During the year ended December 31, 2007, the Company completed the $150 million November 2006 accelerated share repurchase program and started and completed two further accelerated share repurchase programs, one for $50 million and one for $400 million.
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20. SHARE BUYBACKS (Continued)
The details of the various programs are as follows:
November 2006
March 2007
The $481 million excess of the initial purchase price over nominal value for the two 2007 programs, together with the price adjustments in respect of the completed November 2006 and March 2007 programs has been charged to stockholders' equity; $432 million was charged against additional paid-in capital and $49 million against retained earnings.
21. FINANCIAL INSTRUMENTS
The Company's principal financial instruments, other than derivatives, comprise the fixed rate senior notes, the new 5-year term loan and interim credit facilities, a revolving credit facility, cash deposits and short-term investments. The Company also enters into derivative transactions (principally interest rate swaps and forward foreign currency contracts) in order to manage interest rate and currency risks arising from the Company's operations and its sources of finance. The Company does not hold financial or derivative instruments for trading purposes.
The main risks arising from the Company's financial instruments are interest rate risk, liquidity risk, foreign currency risk and credit risk. The Company's board of directors reviews and agrees policies for managing each of these risks as summarized below.
Interest Rate Risk
The Company's operations are financed principally by $1,200 million fixed rate senior notes, $700 million under a new 5-year term loan facility and $750 million under an interim credit facility that expires on September 30, 2009. Of the fixed rate senior notes $250 million are due 2010, $350 million are due 2015 and $600 million are due 2017. The Company also has a new 5-year $300 million revolving credit facility which was undrawn as of December 31, 2008. All debt is issued by a subsidiary of the Company.
The interest rate applicable to the borrowings under the new facilities varies according to LIBOR on the date of individual drawdowns. In addition, duration fees of $9 million are payable on the interim credit facility.
As a result of the Company's operating activities, the Company receives cash for premiums and claims which it deposits in short-term investments denominated in US dollars and other currencies. The Company earns interest on these funds, which is included in the Company's financial statements as investment income. These funds are regulated in terms of access and the instruments in which they may be invested, most of which are short-term in maturity. In order to manage interest rate risk arising from these financial assets, the Company enters into interest rate swaps to receive a fixed rate of
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21. FINANCIAL INSTRUMENTS (Continued)
interest and pay a variable rate of interest fixed in the various currencies related to the short-term investments. The use of interest rate contracts essentially converts groups of short-term variable rate investments to fixed rates.
The fair value of these contracts is recorded in other assets and other liabilities. For contracts that qualify as accounting hedges, changes in fair value are recorded as a component of other comprehensive income.
Amounts are reclassified from other comprehensive income into earnings when the hedged exposure affects earnings. For contracts that do not qualify for hedge accounting, changes in fair value are recorded in other operating expenses.
Other Operating Expenses
Interest rate contracts
Other Comprehensive Income
Interest rate contracts (net of tax of $(7), $(6) and $1)
A summary of the Company's interest rate swaps by major currency is as follows:
US dollar
Pounds sterling
Euro
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A summary of the Company's forward rate agreements by major currency is as follows:
None Outstanding
Liquidity Risk
The Company's objective is to ensure that it has the ability to generate sufficient cash either from internal or external sources, in a timely and cost-effective manner, to meet its commitments as they fall due. The Company's management of liquidity risk is embedded within its overall risk management framework. Scenario analysis is continually undertaken to ensure that the Company's resources can meet its liquidity requirements. These resources are supplemented by a $300 million revolving credit facility which expires on October 1, 2013, all of which was available to draw as at December 31, 2008. As of the year end the Company had exposure of $750 million under an interim credit facility that expires on September 30, 2009. In February 2009, the Company entered into an agreement to issue $500 million 12.875% senior unsecured notes due 2016. The net proceeds of approximately $480 million will be applied towards the balance on the interim credit facility. The Company expects to repay the balance on the facility of approximately $270 million out of free cash flow and from the sale of non-core businesses.
Foreign Currency Risk
The Company's primary foreign exchange risks arise:
The foreign exchange risks in its London market operations are hedged as follows:
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The Company does not hedge net income earned within foreign subsidiaries outside of the UK.
The fair value of foreign currency contracts is recorded in other assets and other liabilities. For contracts that qualify as accounting hedges, changes in fair value resulting from movements in the spot exchange rate are recorded as a component of other comprehensive income whilst changes resulting from a movement in the time value are recorded in interest expense. For contracts that do not qualify for hedge accounting, the total change in fair value is recorded in interest expense. Amounts held in comprehensive income are reclassified into earnings when the hedged exposure affects earnings.
Interest Expense
Foreign currency contracts
Foreign currency contracts (net of tax of $20, $6 and $nil)
The table below summarizes by major currency the contractual amounts of the Company's forward contracts to exchange foreign currencies for pounds sterling. Foreign currency notional amounts are reported in US dollars translated at spot rates at December 31.
Japanese yen
Credit Risk and Concentrations of Credit Risk
Credit risk represents the loss that would be recognized at the reporting date if counterparties failed to perform as contracted and from movements in interest rates and foreign exchange rates. The Company does not anticipate non-performance by counterparties. The Company generally does not require
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collateral or other security to support financial instruments with credit risk; however, it is the Company's policy to enter into master netting arrangements with counterparties as practical.
Concentrations of credit risk that arise from financial instruments exist for groups of customers or counterparties when they have similar economic characteristics that would cause their ability to meet contractual obligations to be similarly affected by changes in economic or other conditions. Financial instruments on the balance sheet that potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents, accounts receivable, and derivatives which are recorded at fair value.
The Company maintains a policy providing for the diversification of cash and cash equivalent investments and places such investments in an extensive number of financial institutions to limit the amount of credit risk exposure. These financial institutions are monitored on an ongoing basis for credit quality predominantly using information provided by credit agencies.
Concentrations of credit risk with respect to receivables are limited due to the large number of clients and markets in which the Company does business, as well as the dispersion across many geographic areas. Management does not believe significant risk exists in connection with the Company's concentrations of credit as of December 31, 2008.
Fair Value
The estimated fair value of the Company's financial instruments held or issued to finance the Company's operations is summarized below. Certain estimates and judgments were required to develop the fair value amounts. The fair value amounts shown below are not necessarily indicative of the amounts that the Company would realize upon disposition nor do they indicate the Company's intent or ability to dispose of the financial instrument.
Assets:
Liabilities:
Short-term debt
The following methods and assumptions were used by the Company in estimating its fair value disclosure for financial instruments:
Cash and Cash Equivalents—The estimated fair value of these financial instruments approximates their carrying values due to their short maturities.
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Fiduciary Funds—Restricted and Short-Term Investments—Fair values are based on quoted market values.
Long-Term Debt—Fair values are based on quoted market values.
Derivative Financial Instruments—Market values have been used to determine the fair value of interest rate swaps and forward foreign exchange contracts based on estimated amounts the Company would receive or have to pay to terminate the agreements, taking into account the current interest rate environment or current foreign currency forward rates.
22. SEGMENT INFORMATION
During the periods presented, the Company operated through three segments: Global; North America and International. Global provides specialist brokerage and consulting services to clients worldwide for specific industrial and commercial activities and is organized by specialism. North America and International predominantly comprise our retail operations which provide services to small, medium and major corporates, accessing Global's specialist expertise when required.
The Company evaluates the performance of its operating segments based on organic revenue growth and operating income. For internal reporting and segmental reporting, the following items for which segmental management are not held accountable are excluded from segmental expenses:
The accounting policies of the operating segments are consistent with those described in Note 2—Basis of Presentation and Significant Accounting Policies. There are no inter-segment revenues, with segments operating on a revenue-sharing basis equivalent to that used when sharing business with other third-party brokers.
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22. SEGMENT INFORMATION (Continued)
In 2008, the Company changed its basis of segmental allocation for central costs. All accounting adjustments for foreign exchange hedging activities and foreign exchange movements on the UK pension plan asset or liability are held at the Corporate level, together with legal costs that are managed centrally. As a result of this change, $nil in 2007 and $2 million net operating loss for full year 2006, previously allocated to the operating segments, has been reported within Corporate.
Selected information regarding the Company's operating segments is as follows:
Year ended December 31, 2008
Total Operating Segments
Corporate and Other(2)
Year ended December 31, 2007
Year ended December 31, 2006
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The following table reconciles total consolidated operating income, as disclosed in the operating segment tables above, to consolidated income before income taxes, interest in earnings of associates and minority interest.
Total consolidated operating income
The Company does not routinely evaluate the total asset position by segment, and the following allocations have been made based on reasonable estimates and assumptions:
Total assets:
Corporate and Eliminations
Operating segment revenue by product is as follows:
Commissions and fees:
Retail insurance services
Specialty insurance services
Total commissions and fees
Total Revenues
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None of the Company's customers represented more than 10 percent of the Company's consolidated commissions and fees for the years ended December 31, 2008, 2007 and 2006.
Information regarding the Company's geographic locations is as follows:
Commissions and fees(1)
Other(2)
Long-lived assets(3)
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23. FINANCIAL INFORMATION FOR PARENT GUARANTOR, OTHER GUARANTOR SUBSIDIARIES AND NON-GUARANTOR SUBSIDIARIES
On July 1, 2005, Willis North America Inc. ("Willis North America") issued debt securities totaling $600 million under its April 2003 registration statement. On March 28, 2007, Willis North America issued further debt securities totaling $600 million under its June 2006 registration statement (Note 16—Debt). The debt securities are jointly and severally, irrevocably and fully and unconditionally guaranteed by Willis Group Holdings, Willis Investment UK Holdings Limited, Willis Group Limited, Trinity Acquisition Limited, TA I Limited, TA II Limited, TA III Limited and TA IV Limited.
Presented below is condensed consolidating financial information for: i) Willis Group Holdings, which is a guarantor, on a parent company only basis; ii) the Other Guarantors which are all 100 percent owned subsidiaries of the parent; iii) the Issuer, Willis North America; iv) Other, which are the non-guarantor subsidiaries, on a combined basis; v) Eliminations; and vi) Consolidated Company and subsidiaries. The equity method has been used for all investments in subsidiaries.
The entities included in the Other Guarantors column are Willis Investment UK Holdings Limited, Trinity Acquisition Limited, TA I Limited, TA II Limited, TA III Limited, TA IV Limited and Willis Group Limited.
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23. FINANCIAL INFORMATION FOR PARENT GUARANTOR, OTHER GUARANTOR SUBSIDIARIES AND NON-GUARANTOR SUBSIDIARIES (Continued)
Condensed Consolidating Statement of Operations
Salaries and benefits (including share-based compensation of $40 million in Other)
Net loss on disposal of operations
OPERATING (LOSS) INCOME
Investment income from Group undertakings
EQUITY ACCOUNT FOR SUBSIDIARIES
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Salaries and benefits (including share-based compensation of $33 million in Other)
Net gain on disposal of operations
NET INCOME (LOSS)
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Salaries and benefits (including share-based compensation of $18 million in Other)
Gain on disposal of London Headquarters
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Condensed Consolidating Balance Sheet
Equity accounted subsidiaries
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Condensed Consolidating Statement of Cash Flows
NET CASH PROVIDED BY OPERATING ACTIVITIES
Proceeds on disposal of fixed and other intangible assets
Proceeds on disposal of short-term investments
Net cash used in investing activities
Repurchase of shares
Amounts owed by and to Group undertakings
Net cash (used in) provided by financing activities
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Net cash used in financing activities
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INCREASE IN CASH AND CASH EQUIVALENTS
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24. FINANCIAL INFORMATION FOR PARENT GUARANTOR, OTHER GUARANTOR SUBSIDIARIES AND NON-GUARANTOR SUBSIDIARIES
The Company filed a shelf registration on Form S-3 on June 21, 2006 under which Willis Group Holdings may offer debt securities, preferred stock, common stock and other securities. In addition, Trinity Acquisition Limited may offer debt securities ("the Subsidiary Debt Securities"). The Subsidiary Debt Securities, if issued, will be guaranteed by certain of the Company's subsidiaries.
Presented below is condensed consolidating financial information for: i) Willis Group Holdings, which will be a guarantor, on a parent company only basis; ii) the Other Guarantors, which are all wholly owned subsidiaries of the parent; iii) the Issuer, Trinity Acquisition Limited; iv) Other, which are the non-guarantor subsidiaries, on a combined basis; v) Eliminations; and vi) Consolidated Company and subsidiaries. The equity method has been used for all investments in subsidiaries.
The entities included in the Other Guarantors column are Willis Investment UK Holdings Limited, TA I Limited, TA II Limited and TA III Limited.
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24. FINANCIAL INFORMATION FOR PARENT GUARANTOR, OTHER GUARANTOR SUBSIDIARIES AND NON-GUARANTOR SUBSIDIARIES (Continued)
INCOME (LOSS) BEFORE INTEREST IN EARNINGS OF ASSOCIATES AND MINORITY INTEREST
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129
130
131
132
DECREASE IN CASH AND CASH EQUIVALENTS
133
134
Net cash provided by investing activities
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
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25. QUARTERLY FINANCIAL DATA
Quarterly financial data for 2008 and 2007 were as follows:
Earnings per share
26. POST BALANCE SHEET EVENTS
In February 2009, the Company entered into an agreement with Goldman Sachs Mezzanine Partners to issue notes in an aggregate principal amount of up to $500 million. The Company anticipates that the net proceeds of this issuance of approximately $480 million will be applied towards the balance of the interim credit facility. Consummation of the issuance, which is subject to customary closing conditions, is expected to take place in March 2009.
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Item 9—Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A—Controls and Procedures
Evaluation of Disclosure Controls and Procedures
As of December 31, 2008, the Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Chairman and Chief Executive Officer and the Group Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(e). Based upon that evaluation, the Chief Executive Officer and the Group Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective in ensuring that the information required to be included in the Company's periodic SEC filings is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms and that such information is accumulated and communicated to them as appropriate to allow for timely decisions regarding required disclosure.
Management's Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934.
Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness
of our internal control over financial reporting as of December 31, 2008, based on the criteria related to internal control over financial reporting described in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation, management concluded that our internal control over financial reporting was effective as of December 31, 2008.
Our assessment of the effectiveness of the Company's internal control over financial reporting as of December 31, 2008, excludes Hilb Rogal & Hobbs Company (HRH), which was acquired by the Company in a purchase transaction on October 1, 2008. HRH is a wholly-owned subsidiary of the Company whose total assets and total revenue represents less than 25 percent and 10 percent, respectively, of the related consolidated financial statement amounts as of and for the year ended 31 December 2008. Under guidelines established by the Securities and Exchange Commission, companies are allowed to exclude acquisitions from their assessment of internal control over financial reporting during the first year of an acquisition while integrating the acquired company.
Our independent registered public accountants, Deloitte LLP, who have audited and reported on our financial statements, have undertaken an assessment of the Company's internal control over financial reporting. Deloitte's report is presented below.
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We have audited the internal control over financial reporting of Willis Group Holdings Limited and subsidiaries (the "Company") as of December 31, 2008, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Willis Group Holdings Limited'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, included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.
As described in Management's Report on Internal Control over Financial Reporting, management's assessment of the effectiveness of the Company's internal control over financial reporting as of December 31, 2008 excludes Hilb Rogal & Hobbs Company (HRH), which was acquired by the Company in a purchase transaction on October 1, 2008. HRH is a wholly-owned subsidiary of the Company whose total assets, total revenues and net income represent 21 percent, 6 percent and 9 percent, respectively, of the consolidated financial statement amounts as of and for the year ended December 31, 2008.
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, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, 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 by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel 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 the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the 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, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedule as of and for the year ended December 31, 2008 of the Company and our report dated February 27, 2009 expressed an unqualified opinion on those financial statements and financial statement schedule.
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Annual Certifications
The 2008 Annual Certification of the Chief Executive Officer in respect of the Company's compliance with the Corporate Governance Rules of the New York Stock Exchange was filed without qualification with the New York Stock Exchange on May 20, 2008.
The Certifications of the Chief Executive Officer and the Chief Financial Officer required pursuant to Section 302 of the Sarbanes-Oxley Act are filed as exhibits to this Annual Report on Form 10-K for the year ended December 31, 2008.
Changes in Internal Control over Financial Reporting
There have been no changes in the Company's internal controls over financial reporting during the fourth fiscal quarter ended December 31, 2008 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.
Item 9B—Other Information
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PART III
Item 10—Directors and Executive Officers of the Registrant
The Executive Officers of Willis Group Holdings Limited, as of February 27, 2009 (except as otherwise specified), are Joseph J. Plumeri, William W. Bradley, Joseph A. Califano, Jr., Anna C. Catalano, Sir Roy Gardner, The Rt. Hon. Sir Jeremy Hanley, KCMG, Robyn S. Kravit, Jeffrey B. Lane, Wendy E. Lane, James F. McCann and Douglas B. Roberts. Information is set out below for our Executive Officers.
Donald J. Bailey—Mr. Bailey, age 44, was appointed an Executive Officer and Chief Executive Officer of Willis North America on September 29, 2006. In October 2008, he was appointed Chairman and Chief Executive Officer of Willis HRH. Mr. Bailey joined the Willis Group in March, 2003, and held several senior positions, including Chief Operating Officer of Willis North America. Prior to joining Willis he had been with Allianz Insurance Company, Aon and Marsh. Mr. Bailey has 22 years of experience in the insurance industry.
Adam G. Ciongoli—Mr. Ciongoli, age 40, was appointed an Executive Officer and Group General Counsel on March 26, 2007. Prior to joining the Willis Group, he served as a counselor and law clerk to US Supreme Court Justice Samuel A. Alito, Jr. during the Justice's first Term on the Court. Previously, Mr. Ciongoli was Senior Vice President and General Counsel for TimeWarner Europe, and the Counselor to United States Attorney General John Ashcroft. Mr. Ciongoli also serves as a special consultant to the New York City Police Department, and as an adjunct professor of law at Columbia University Law School.
Allan C. A. Gribben—Mr. Gribben, age 55, was appointed an Executive Officer on February 13, 2006. He joined the Willis Group in December 2002 and was Chief Executive Officer, Willis UK and Ireland until November 2006, when he was appointed Chief Executive Officer of Willis International. In October 2008, he was appointed Global Sales and Marketing Director. Prior to joining the Willis Group Mr. Gribben had been with Aon since 1981, holding a number of senior executive positions. Mr. Gribben has over 31 years experience in the insurance brokerage industry.
Peter Hearn—Mr. Hearn, age 53, was appointed an Executive Officer on April 10, 2007. Mr. Hearn joined the Willis Group in January 1994 as a Senior Vice President to open and manage the Philadelphia office and was appointed Eastern Region Manager in October 1994 and Executive Vice President in 1997. Most recently, Mr. Hearn was appointed Chief Executive Officer of Willis Re. in November 2006. Prior to joining Willis, Mr. Hearn served as Vice President and Principal of Towers Perrin Reinsurance. Mr. Hearn has 30 years of experience in the insurance brokerage Industry.
David B. Margrett—Mr. Margrett, age 55, was appointed an Executive Officer on January 25, 2005. Mr. Margrett joined the Willis Group in September 2004 as a Managing Director of Global Markets. He was appointed Chief Executive Officer, Global Specialties in January 2005 and Chairman and Chief Executive Officer of Willis Limited on April 1, 2007. Prior to joining the Willis Group, Mr. Margrett had been with Heath Lambert Group, or its predecessors, since 1973, holding a number of senior positions, including Chief Executive from 1996 to 2004. Mr. Margrett has 35 years experience of the insurance industry.
Grahame J. Millwater—Mr. Millwater, age 45, was appointed an Executive Officer on December 18, 2001. He was appointed Group President on February 29, 2008, having been Chief Operating Officer since November 29, 2006. He has held several other senior positions since joining the Willis Group in September 1985, including Chairman and Chief Executive Officer Willis Re. Mr. Millwater has 23 years of experience in the insurance brokerage industry, all of which have been with us.
Patrick C. Regan—Mr. Regan, age 42, was appointed an Executive Officer on January 1, 2006, and was appointed Group Chief Financial Officer on March 3, 2006. Mr. Regan was additionally appointed
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Group Chief Operating Officer on February 29, 2008. Before joining the Willis Group, Mr. Regan was Group Financial Controller for Royal & Sun Alliance for two years, prior to which he held senior finance positions in both Axa Insurance and GE Capital. Mr. Regan has 20 years of finance experience gained in both the UK and USA.
Susan A. Sztuka—Ms. Sztuka, age 37, was appointed an Executive Officer on April 10, 2007. She was appointed Group Director of Human Resources on April 1, 2007, having joined the Willis Group in December 2005 as Senior Vice President of Human Resources for Willis North America. Prior to joining the Willis Group, Ms. Sztuka held senior positions at Seagram, Vivendi Universal and Revlon. She has 17 years of experience in the human resources sector.
Sarah J. Turvill—Ms. Turvill, age 55, was appointed an Executive Officer on July 1, 2001. Ms. Turvill joined the Willis Group in May 1978 and has held a number of senior management roles in our international business, particularly in Europe where she was Managing Director from 1995 to 2001. Ms. Turvill is currently Chief Executive Officer of Willis International, a position she has held since July 2001, and was additionally appointed Chairman in November 2006. She has 30 years of experience in the insurance brokerage industry, all of which have been with us.
Timothy D. Wright—Mr. Wright, age 47, was appointed an Executive Officer and Group Chief Operating Officer on September 1, 2008. Prior to joining the Willis Group, he was a Partner of Bain & Company where he led their Financial Services practice in London. Mr. Wright was previously UK Managing Partner of Booz Allen & Hamilton and led their insurance work globally. He has more than 20 years of experience in the insurance and financial service industries internationally.
F. Michael Crowley—Mr. Crowley, age 57, was appointed an Executive Officer and President of Willis HRH on October 1, 2008. Mr. Crowley joined HRH in 2004 as Executive Vice President and the National Director for the property and casualty division. In September 2005, he was appointed President of HRH, and in June 2008, he was also appointed Chief Operating Officer. Prior to joining HRH, he was Vice Chairman of Palmer & Cay, Inc. from 2002 to 2004 and President and Chief Operating Officer of Palmer & Cay, Inc. from 1998 to 2002. Mr. Crowley ceased to be a Willis employee on January 31, 2009.
Ethical Code
The Company has adopted an Ethical Code applicable to all our employees, including our Chairman and Chief Executive Officer, the Group Chief Financial Officer, the Group Financial Controller and all those involved in the Company's accounting functions. Our Ethical Code can be found in the Corporate Governance Section on the Company's website at www.willis.com. A copy is also available free of charge on request from the Company Secretary, Willis Group Holdings Limited, c/o Willis Group Limited, The Willis Building, 51 Lime Street, London EC3M 7DQ.
Except for the information regarding executive officers required by Item 401 of Regulation S-K and the information regarding the Company's Code of Ethics required by Item 406 of Regulation S-K, each of which is set forth above, we incorporate the information required by this item by reference to our definitive proxy statement for our annual meeting of shareholders currently scheduled to be held on April 22, 2009. We refer to this proxy statement as the "2009 Proxy Statement".
Item 11—Executive Compensation
The information under the heading "Executive Compensation" in the 2009 Proxy Statement is incorporated herein by reference. Nothing in this report shall be construed to incorporate by reference the Board Compensation Committees Report on Executive Compensation which is contained in the 2009 Proxy Statement but expressly not incorporated herein.
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Item 12—Security Ownership of Certain Beneficial Owners and Management
Securities Authorized for Issuance Under Equity Compensation Plans
Equity compensation plans approved by security holders
Equity compensation plans not approved by security holders(i)
The Amended and Restated 1998 Share Purchase and Option Plan for Key Employees (the "1998 Plan") and the Amended and Restated Willis Award Plan for Key Employees (the "Willis Award Plan"), are not approved by the Company's shareholders. Each provides for the grant of time-based vesting options, performance-based vesting options and various other share-based grants to our employees to purchase Shares. The 1998 Plan and the Willis Award Plan are intended to promote the Company's long-term financial interests and growth by attracting and retaining management personnel with the training, experience and ability to enable them to make a substantial contribution to the success of our business; motivate management personnel by means of growth-related incentives to achieve long range goals; and further the alignment of interests of participants with those of shareholders of the Company through opportunities for increased share ownership in us.
As of February 17, 2009, of the time and performance-based options granted, 90,084 remained unforfeited under the 1998 Plan and 3,810 remained unforfeited under the Willis Award Plan. No further grants are to be made under the 1998 Plan. There are 4,851,270 shares available to be granted under the Willis Award Plan. Under the 1998 Plan, unless otherwise provided by our Board of Directors, time-based options generally became exercisable in five equal annual installments beginning on the second anniversary of the date of grant and performance-based options generally became exercisable in four equal annual installments, beginning on the third anniversary of grant, subject to performance targets. Effective from January 1, 2003, it was determined that these financial performance targets had been achieved. The exercisability of the options may accelerate or terminate based on the circumstances surrounding an optionee's termination of employment, and both time-based and performance-based options may (in the discretion of our Board of Directors), fully accelerate upon a change in control of the Company.
Unless sooner terminated by our Board of Directors, the 1998 Plan and Willis Award Plan will expire 10 years after its adoption. That termination will not affect the validity of any grant outstanding on the date of the termination of either of the 1998 Plan or the Willis Award Plan.
Our Board of Directors and its Compensation Committee administer the 1998 Plan and Willis Award Plan. Our Board of Directors may from time to time amend the terms of any grant, but, except for adjustments made upon a change in our Shares by reason of a stock split, spin-off, stock dividend, stock combination or reclassification, recapitalization, reorganization, consolidation, change of control or similar event, that action may not adversely affect the rights of any participant under the 1998 Plan or Willis Award Plan, as applicable, with respect to the options without at least a majority of the
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participants approving such action. Our Board of Directors retains the right to amend, suspend or terminate the 1998 Plan and Willis Award Plan at any time.
Our UK subsidiary, Willis Group Limited, maintains Employee Share Ownership Plans, which as of February 17, 2009, held 20,520 Shares for the benefit of Willis Group employees. These Shares were acquired by the Plans at the time of the 1998 acquisition of Willis Group Limited by Profit Sharing (Overseas) in return for the employees forfeiting cash awards held by the Plans for their benefit. As part of the forfeiture arrangements, certain employees were granted either restricted stock awards or options, under our Zero Cost Share Option Scheme, the value of which equaled on grant the cash amount of forfeited cash awards. Those employees who forfeited cash awards but did not receive a zero cost option grant have their Shares vested under the Plans at the same time they would have received the cash awards. All obligations under the Zero Cost Share Option Scheme and restricted stock awards have now been satisfied, and no further awards under the Zero Cost Option Scheme will be made.
In connection with the employee stock purchase agreements described above, a trust was established at the time of the 1998 acquisition of Willis Group Limited by Profit Sharing (Overseas), which through its trustees, is a party to the Management and Employee Shareholders' and Subscription Agreement, which governed the Shares purchased by our employees at that time. Under this agreement, the trust repurchased Shares and options owned by those employees whose employment with us terminated. Also, the trust has the power to sell Shares at fair market value to current employees which is undertaken in connection with certain option grants under the 2001 Plan. As of February 17, 2009, the trust had an interest in 55,718 Shares which can be purchased by employees or used to satisfy options grants made by us.
The Information under the heading "Security Ownership of Certain Beneficial Owners and Management" in the 2009 Proxy Statement is incorporated herein by reference.
Item 13—Certain Relationships and Related Transactions
The information under the headings "Transactions with Management and Others" and "Election of Directors" in the 2009 Proxy Statement is incorporated herein by reference.
Item 14—Principal Accountant Fees and Services
The information under the headings "Fees to Deloitte LLP" and "Audit Committee Report" in the 2009 Proxy Statement is incorporated herein by reference.
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PART IV
Item 15—Exhibits, Financial Statement Schedules
The following documents are filed as a part of this report:
All other schedules are omitted because they are not applicable, or not required, or because the required information is included in the Consolidated Financial Statements or the Notes thereto.
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Limited, TA III Limited, Trinity Acquisition Limited, TA IV Limited and Willis Group Limited, as the Guarantors; and The Bank of New York, as the Trustee; for the issuance of the 6.20% Senior Notes Due 2017 (incorporated by reference to Exhibit 4.1 to Form 8-K filed on March 29, 2007)
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SCHEDULE II
WILLIS GROUP HOLDINGS LIMITED VALUATION AND QUALIFYING ACCOUNTS
Provision for bad and doubtful debts
Deferred tax valuation allowance
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated this 27th day of February 2009.
Adam G. Ciongoli, pursuant to the Power of Attorney executed by each of the individuals whose name is followed by an (*) and filed herewith, by signing his name hereunto does hereby sign and execute this Form 10-K of Willis Group Holdings Limited on behalf of such individual in the capacities in which the names of each appear above.
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