filings.toolsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
EXECUTIVE SUMMARY OF 2019 FINANCIAL RESULTS
Aon is a leading global professional services firm providing a broad range of risk, retirement, and health solutions underpinned by proprietary data and analytics. Management continues to lead its set of initiatives designed to strengthen Aon and unite the firm with one portfolio of capability enabled by proprietary data and analytics and one operating model to deliver additional insight, connectivity, and efficiency.
Financial Results
In the first quarter of 2019, Aon adopted new accounting guidance related to the treatment of leases that was applied using the modified retrospective approach. Under this approach, prior periods were not restated. Refer to Note 2 “Summary of Significant Accounting Principles and Practices” of the Notes to Consolidated Financial Statements in Part II, Item 8 of this report for further information surrounding the quantitative and qualitative impacts of adopting the new accounting guidance.
The following is a summary of our 2019 financial results from continuing operations:
| • | Revenue increased $243 million, or 2%, to $11,013 million in 2019 compared to 2018, reflecting 6% organic revenue growth, partially offset by a 3% unfavorable impact if we were to translate prior year period results using current period foreign exchange rates (“foreign currency translation”) and a 1% unfavorable impact from divestitures, net of acquisitions. Organic revenue growth for the year was highlighted by each of the five solution lines contributing similar or improved growth compared to the prior year. |
| • | Operating expenses decreased $382 million, or 4%, to $8,844 million in 2019 compared to 2018 due primarily to a $238 million favorable impact from foreign currency translation, a $176 million decrease from a non-cash impairment charge related to certain assets and liabilities that were classified as held for sale in the prior year period, $169 million of incremental savings from restructuring and other operational improvement initiatives, an $81 million decrease in expenses related to divestitures, net of acquisitions, a $62 million net decrease in expense related to legacy litigation, and a $34 million decrease in restructuring charges, partially offset by an increase in expense associated with 6% organic revenue growth and investments supporting long-term growth initiatives. |
| • | Operating margin increased to 19.7% in 2019 from 14.3% in 2018. The increase in operating margin from the prior year is primarily driven by organic revenue growth of 6% and strong operational improvement. |
| • | Due to the factors set forth above, net income from continuing operations was $1,574 million in 2019, an increase of $474 million, or 43%, from 2018. |
| • | Diluted earnings per share from continuing operations was $6.37 per share during the twelve months of 2019 compared to $4.29 per share for the prior year period. |
| • | Cash flows provided by operating activities was $1,835 million in 2019, an increase of $149 million, or 9%, from $1,686 million in 2018. The current year period includes approximately $130 million of net cash payments related to certain litigation settlements. The prior year comparable period included an $80 million accelerated pension contribution. |
We focus on four key non-GAAP metrics that we communicate to shareholders: organic revenue growth, adjusted operating margins, adjusted diluted earnings per share, and free cash flows. These non-GAAP metrics should be viewed in addition to, not instead of, our Consolidated Financial Statements and Notes thereto (the “Consolidated Financial Statements”). The following is our measure of performance against these four metrics from continuing operations for 2019:
| • | Organic revenue growth, a non-GAAP measure defined under the caption “Review of Consolidated Results — Organic Revenue Growth,” was 6% in 2019, compared to 5% organic growth in the prior year. Organic revenue growth was driven by growth across every major revenue line, with particular strength in Reinsurance Solutions and Commercial Risk Solutions. |
| • | Adjusted operating margin, a non-GAAP measure defined under the caption “Review of Consolidated Results — Adjusted Operating Margin,” was 27.5% in 2019, compared to 25.0% in the prior year. The increase in adjusted operating margin primarily reflects organic revenue growth of 6%, operational improvement, and $169 million of incremental savings related to restructuring and other operational improvement initiatives. |
| • | Adjusted diluted earnings per share from continuing operations, a non-GAAP measure defined under the caption “Review of Consolidated Results — Adjusted Diluted Earnings per Share,” was $9.17 per share in 2019, an increase of $1.01 per share, or 12%, from $8.16 per share in 2018. The increase in adjusted diluted earnings per share primarily reflects strong operational performance and effective capital management, highlighted by $2.0 billion of share repurchase during 2019, partially offset by an unfavorable impact from foreign currency translation. |
| • | Free cash flow, a non-GAAP measure defined under the caption “Review of Consolidated Results — Free Cash Flow,” was $1,610 million in 2019, an increase of $164 million, or 11%, from $1,446 million in 2018, driven by an increase of $149 million in cash flows in operations and a $15 million decrease in capital expenditures. |
PROPOSED REORGANIZATION
In October 2019, we announced the proposed Reorganization, which would result in an Irish public limited company serving as our new publicly traded parent company by means of a scheme of arrangement under English law. The Reorganization would effectively change the jurisdiction of incorporation of the publicly traded parent company of Aon from the U.K. to Ireland.
The Reorganization requires shareholder approval, which was obtained on February 4, 2020. We are also required to make an application to the High Court of Justice of England and Wales to seek approval of the Reorganization. This application is expected to be heard, and we currently anticipate that the Reorganization will be completed, on March 31, 2020. This expected date depends on a number of factors. If this expected date is changed, we will give adequate notice of such change by issuing an announcement that will be made available at our website.
Upon completion of the Reorganization, each shareholder will own the same number of Class A Ordinary Shares of the new Irish parent company that such shareholder owned immediately prior to completion of the Reorganization, and each shareholder’s proportionate ownership and relative voting rights will remain unchanged. We will continue to report earnings and other financial statements in accordance with SEC regulations, including U.S. dollar denominated financial statements. We expect that the shares of the new Irish parent company will be listed on the NYSE under the symbol “AON,” the same symbol under which our Class A Ordinary Shares are currently listed.
We believe the Reorganization will have no material impact on the day-to-day conduct of the various operating companies within Aon, the strategy of Aon, or the dividend policy of the new Irish parent company. The location of our future operations will depend on the needs of our business, independent of legal domicile, as per our practice prior to the Reorganization.
REVIEW OF CONSOLIDATED RESULTS
Summary of Results
In the first quarter of 2019, Aon adopted new accounting guidance related to the treatment of leases that was applied using the prospective approach. Under this approach, prior periods were not restated. Refer to Note 2 “Summary of Significant Accounting Principles and Practices” of the Notes to Consolidated Financial Statements in Part II, Item 8 of this report for further information surrounding the quantitative and qualitative impacts of adopting the new accounting guidance. In the first quarter of 2018, Aon adopted new accounting guidance related to the treatment of revenue from contracts with customers that was applied prospectively on the U.S. GAAP financial statements and therefore the 2017 comparable period has not been restated.
Our consolidated results are as follow:
| Years ended December 31 | ||||||||||||
| (millions) | 2019 | 2018 | 2017 | |||||||||
| Revenue | ||||||||||||
| Total revenue | $ | 11,013 | $ | 10,770 | $ | 9,998 | ||||||
| Expenses | ||||||||||||
| Compensation and benefits | 6,054 | 6,103 | 6,003 | |||||||||
| Information technology | 494 | 484 | 419 | |||||||||
| Premises | 339 | 370 | 348 | |||||||||
| Depreciation of fixed assets | 172 | 176 | 187 | |||||||||
| Amortization and impairment of intangible assets | 392 | 593 | 704 | |||||||||
| Other general expense | 1,393 | 1,500 | 1,272 | |||||||||
| Total operating expenses | 8,844 | 9,226 | 8,933 | |||||||||
| Operating income | 2,169 | 1,544 | 1,065 | |||||||||
| Interest income | 8 | 5 | 27 | |||||||||
| Interest expense | (307 | ) | (278 | ) | (282 | ) | ||||||
| Other income (expense) | 1 | (25 | ) | (125 | ) | |||||||
| Income from continuing operations before income taxes | 1,871 | 1,246 | 685 | |||||||||
| Income tax expense | 297 | 146 | 250 | |||||||||
| Net income from continuing operations | 1,574 | 1,100 | 435 | |||||||||
| Net income (loss) from discontinued operations | (1 | ) | 74 | 828 | ||||||||
| Net income | 1,573 | 1,174 | 1,263 | |||||||||
| Less: Net income attributable to noncontrolling interests | 41 | 40 | 37 | |||||||||
| Net income attributable to Aon shareholders | $ | 1,532 | $ | 1,134 | $ | 1,226 | ||||||
| Diluted net income per share attributable to Aon shareholders | ||||||||||||
| Continuing operations | $ | 6.37 | $ | 4.29 | $ | 1.53 | ||||||
| Discontinued operations | — | 0.30 | 3.17 | |||||||||
| Net income | $ | 6.37 | $ | 4.59 | $ | 4.70 | ||||||
| Weighted average ordinary shares outstanding - diluted | 240.6 | 247.0 | 260.7 |
Consolidated Results for 2019 Compared to 2018
Revenue
Total revenue increased $243 million, or 2%, to $11,013 million in 2019, compared to $10,770 million in 2018. The increase was driven by 6% organic revenue growth, partially offset by a 3% unfavorable impact from foreign currency translation and a 1% unfavorable impact from divestitures, net of acquisitions. Organic revenue growth for the year was highlighted by each of the five solution lines contributing similar or improved growth compared to the prior year.
Commercial Risk Solutions revenue increased $21 million, or less than 1%, to $4,673 million in 2019, compared to $4,652 million in 2018. Organic revenue growth was 7% in 2019, reflecting growth across every major geography, highlighted by double-
digit growth across the U.S. and Latin America, driven by strong retention and management of the renewal book portfolio. On average globally, exposures and pricing were both modestly positive, resulting in a modestly positive market impact overall.
Reinsurance Solutions revenue increased $123 million, or 8%, to $1,686 million in 2019, compared to $1,563 million in 2018. Organic revenue growth was 10% in 2019 driven by strong net new business generation globally in treaty, as well as double-digit growth globally in facultative placements and in capital markets transactions. In addition, market impact was modestly positive on results.
Retirement Solutions revenue decreased $48 million, or 3%, to $1,817 million in 2019, compared to $1,865 million in 2018. Organic revenue growth was 2% in 2019 driven by solid growth in delegated investment management and in the Human Capital practice, partially offset by an unfavorable impact from certain businesses that were divested in the second quarter.
Health Solutions revenue increased $71 million, or 4%, to $1,667 million in 2019, compared to $1,596 million in 2018. Organic revenue growth was 5% in 2019 driven primarily by solid growth globally in health and benefits brokerage, highlighted by particular strength internationally.
Data & Analytic Services revenue increased $79 million, or 7%, to $1,184 million in 2019, compared to $1,105 million in 2018. Organic revenue growth was 4% in 2019 driven by growth globally across our Affinity business, with particular strength across both business and consumer solutions in the U.S.
Compensation and Benefits
Compensation and benefits decreased $49 million, or 1%, in 2019 compared to 2018. The decrease was primarily driven by a $173 million favorable impact from foreign currency translation, $144 million of incremental savings from restructuring and other operational improvement initiatives, and a $47 million decrease in expenses related to divestitures, net of acquisitions, partially offset by a $90 million increase in restructuring charges and an increase in expense associated with 6% organic revenue growth.
Information Technology
Information technology, which represents costs associated with supporting and maintaining our infrastructure, increased $10 million, or 2%, in 2019 compared to 2018. The increase was primarily driven by an increase in expense associated with 6% organic revenue growth and an increase in investments to support growth initiatives across the portfolio and enhance capabilities of our Aon Business Services organization, partially offset by a $9 million favorable impact from foreign currency translation, an $8 million decrease in restructuring charges, a $5 million decrease in expenses related to divestitures, net of acquisitions, and $4 million of incremental savings from restructuring and other operational improvement initiatives.
Premises
Premises, which represents the cost of occupying offices in various locations throughout the world, decreased $31 million, or 8%, in 2019 compared to 2018. The decrease was primarily driven by an $11 million favorable impact from foreign currency translation, $11 million of incremental savings from restructuring and other operational improvement initiatives, and a reduction of costs as we continue to optimize our global real estate footprint, partially offset by a $5 million increase in restructuring charges.
Depreciation of Fixed Assets
Depreciation of fixed assets primarily relates to software, leasehold improvements, furniture, fixtures and equipment, computer equipment, buildings, and automobiles. Depreciation of fixed assets decreased $4 million, or 2%, in 2019 compared to 2018. The decrease was primarily driven by a $3 million favorable impact from foreign currency translation.
Amortization and Impairment of Intangible Assets
Amortization and impairment of intangibles primarily relates to finite-lived tradenames and customer-related, contract-based, and technology assets. Amortization and impairment of intangibles decreased $201 million, or 34%, in 2019 compared to 2018. Included in 2018 was a $176 million non-cash impairment charge related to certain assets and liabilities that were classified as held for sale.
Other General Expenses
Other general expenses decreased $107 million, or 7%, in 2019 compared to 2018. The decrease was primarily driven by a $122 million decrease in restructuring charges, a $62 million net decrease in expense related to legacy litigation, a $36 million favorable impact from foreign currency translation, a $12 million decrease in expenses related to divestitures, net of acquisitions, and $11 million of incremental savings from restructuring and other operational improvement initiatives, partially offset by an increase in expense associated with 6% organic revenue growth and investments supporting long-term growth initiatives.
Interest Income
Interest income represents income earned on operating cash balances and other income-producing investments. It does not include interest earned on funds held on behalf of clients. Interest income was $8 million in 2019, an increase of $3 million, or 60%, from 2018, reflecting the currency composition of operating cash.
Interest Expense
Interest expense, which represents the cost of our debt obligations, was $307 million in 2019, an increase of $29 million, or 10%, from 2018. The increase was driven primarily by higher outstanding debt balances.
Other Income (Expense)
Total other income was $1 million in 2019, compared to other expense of $25 million in 2018. Other income in 2019 primarily includes $13 million in net gains on the disposition of businesses, a $9 million favorable impact of exchange rates on the remeasurement of assets and liabilities in non-functional currencies, $9 million of pension and other postretirement income, and $4 million of equity earnings, partially offset by $34 million of losses on certain financial instruments.
Income from Continuing Operations before Income Taxes
Due to factors discussed above, income from continuing operations before income taxes was $1,871 million in 2019, a 50% increase from $1,246 million in 2018.
Income Taxes from Continuing Operations
The effective tax rate on net income from continuing operations was 15.9% in 2019 and 11.7% in 2018. The primary driver of the 2019 tax rate is the geographical distribution of income, including restructuring charges, as well as net favorable discrete items, including the impact of share-based payments.
The 2018 tax rate was primarily driven by the geographical distribution of income including restructuring charges, legacy litigation, and the impairment of certain assets and liabilities classified as held for sale. The tax rate was also impacted by certain discrete items including the net tax benefit associated with the sale of the disposal group and the impact of share-based payments offset by the net tax expense from enactment date impacts of the Tax Cuts and Jobs Act of 2017 and changes in valuation allowances.
Net Income from Discontinued Operations
Net loss from discontinued operations was $1 million in the twelve months ended December 31, 2019, compared to net income from discontinued operations of $74 million in 2018.
Net Income Attributable to Aon Shareholders
Net income attributable to Aon shareholders increased to $1,532 million, or $6.37 per diluted share, in 2019, compared to $1,134 million, or $4.59 per diluted share, in 2018.
Consolidated Results for 2018 Compared to 2017
We have elected not to include a discussion of our consolidated results for 2018 compared to 2017 in this report in reliance upon Instruction 1 to Item 303(a) of Regulation S-K. This discussion can be found in our Annual Report on Form 10-K for the year ended December 31, 2018, which was filed with the SEC on February 19, 2019.
Non-GAAP Metrics
In our discussion of consolidated results, we sometimes refer to certain non-GAAP supplemental information derived from consolidated financial information specifically related to organic revenue growth, adjusted operating margin, adjusted diluted earnings per share, free cash flow, and the impact of foreign exchange rate fluctuations on operating results. This non-GAAP supplemental information should be viewed in addition to, not instead of, our Consolidated Financial Statements.
Organic Revenue Growth
We use supplemental information related to organic revenue growth to help us and our investors evaluate business growth from existing operations. Organic revenue growth is a non-GAAP measure that includes the impact of intercompany activity and excludes the impact of the adoption of the new revenue recognition standard, changes in foreign exchange rates, fiduciary investment income, acquisitions, divestitures, transfers between revenue lines, and gains or losses on derivatives accounted for as hedges. This supplemental information related to organic revenue growth represents a measure not in accordance with U.S. GAAP and should be viewed in addition to, not instead of, our Consolidated Financial Statements. Industry peers provide similar supplemental information about their revenue performance, although they may not make identical adjustments. A reconciliation of this non-GAAP measure to the reported Total revenue is as follows (in millions, except percentages):
| Twelve Months Ended | ||||||||||||||||||||||||||
| Dec 31, 2019 | Dec 31, 2018 | % Change | Revenue Recognition**(1)** | Less: Currency Impact**(2)** | Less: Fiduciary Investment Income**(3)** | Less: Acquisitions, Divestitures & Other | Organic Revenue Growth**(4)** | |||||||||||||||||||
| Commercial Risk Solutions | $ | 4,673 | $ | 4,652 | — | % | N/A | (3 | )% | — | % | (4 | )% | 7 | % | |||||||||||
| Reinsurance Solutions | 1,686 | 1,563 | 8 | N/A | (2 | ) | 1 | (1 | ) | 10 | ||||||||||||||||
| Retirement Solutions | 1,817 | 1,865 | (3 | ) | N/A | (2 | ) | — | (3 | ) | 2 | |||||||||||||||
| Health Solutions | 1,667 | 1,596 | 4 | N/A | (3 | ) | — | 2 | 5 | |||||||||||||||||
| Data & Analytic Services | 1,184 | 1,105 | 7 | N/A | (3 | ) | — | 6 | 4 | |||||||||||||||||
| Elimination | (14 | ) | (11 | ) | N/A | N/A | N/A | N/A | N/A | N/A | ||||||||||||||||
| Total revenue | $ | 11,013 | $ | 10,770 | 2 | % | — | % | (3 | )% | — | % | (1 | )% | 6 | % |
| Twelve Months Ended | ||||||||||||||||||||||||||
| Dec 31, 2018 | Dec 31, 2017 | % Change | Revenue Recognition**(1)** | Less: Currency Impact**(2)** | Less: Fiduciary Investment Income**(3)** | Less: Acquisitions, Divestitures & Other | Organic Revenue Growth**(4)** | |||||||||||||||||||
| Commercial Risk Solutions | $ | 4,652 | $ | 4,169 | 12 | % | — | % | 1 | % | — | % | 5 | % | 6 | % | ||||||||||
| Reinsurance Solutions | 1,563 | 1,429 | 9 | (1 | ) | 2 | 1 | — | 7 | |||||||||||||||||
| Retirement Solutions | 1,865 | 1,755 | 6 | — | 1 | — | 3 | 2 | ||||||||||||||||||
| Health Solutions | 1,596 | 1,515 | 5 | (1 | ) | — | — | 1 | 5 | |||||||||||||||||
| Data & Analytic Services | 1,105 | 1,140 | (3 | ) | — | — | — | (6 | ) | 3 | ||||||||||||||||
| Elimination | (11 | ) | (10 | ) | NA | NA | NA | NA | NA | NA | ||||||||||||||||
| Total revenue | $ | 10,770 | $ | 9,998 | 8 | % | — | % | 1 | % | — | % | 2 | % | 5 | % |
| (1) | Revenue recognition represents the impact of Aon’s adoption of the new revenue recognition standard, effective for Aon in the first quarter of 2018. |
| (2) | Currency impact is determined by translating prior period's revenue at this period's foreign exchange rates. |
| (3) | Fiduciary investment income for the years ended December 31, 2019, 2018, and 2017, respectively, was $74 million, $53 million, and $32 million. |
| (4) | Organic revenue growth includes the impact of intercompany activity and excludes the impact of the adoption of the new revenue recognition standard, changes in foreign exchange rates, fiduciary investment income, acquisitions, divestitures, transfers between revenue lines, and gains or losses on derivatives accounted for as hedges. |
Adjusted Operating Margin
We use adjusted operating margin as a non-GAAP measure of core operating performance of the Company. Adjusted operating margin excludes the impact of certain items, as listed below, because management does not believe these expenses reflect our core operating performance. This supplemental information related to adjusted operating margin represents a measure not in accordance with U.S. GAAP, and should be viewed in addition to, not instead of, our Consolidated Financial Statements.
A reconciliation of this non-GAAP measure to reported operating margins is as follows (in millions, except percentages):
| Years ended December 31 | ||||||||||||
| 2019 | 2018 | 2017 | ||||||||||
| Revenue from continuing operations | $ | 11,013 | $ | 10,770 | $ | 9,998 | ||||||
| Operating income from continuing operations | $ | 2,169 | $ | 1,544 | $ | 1,065 | ||||||
| Restructuring | 451 | 485 | 497 | |||||||||
| Amortization and impairment of intangible assets (1) | 392 | 593 | 704 | |||||||||
| Legacy litigation (2) | 13 | 75 | — | |||||||||
| Regulatory and compliance matters | — | — | 28 | |||||||||
| Operating income from continuing operations - as adjusted | $ | 3,025 | $ | 2,697 | $ | 2,294 | ||||||
| Operating margin from continuing operations | 19.7 | % | 14.3 | % | 10.7 | % | ||||||
| Operating margin from continuing operations - as adjusted | 27.5 | % | 25.0 | % | 22.9 | % |
| (1) | Included in the twelve months ended December 30, 2018 was a $176 million non-cash impairment charge taken on certain assets and liabilities held for sale. Included in the twelve months ended December 31, 2017 was a $380 million non-cash impairment charge taken on indefinite-lived tradenames. |
| (2) | During the fourth quarter of 2019 we settled legacy litigation that had been reported in a prior year as an adjustment to GAAP earnings. In connection with the settlement, we recorded a $13 million charge in the quarter, which represents the difference between the amount accrued in the prior year and the final settlement amount of the legacy litigation. |
Adjusted Diluted Earnings per Share
We use adjusted diluted earnings per share as a non-GAAP measure of our core operating performance. Adjusted diluted earnings per share excludes the items identified above, along with pension settlements and related income taxes, because management does not believe these expenses are representative of our core earnings. This supplemental information related to adjusted diluted earnings per share represents a measure not in accordance with U.S. GAAP and should be viewed in addition to, not instead of, our Consolidated Financial Statements.
A reconciliation of this non-GAAP measure to reported diluted earnings per share is as follows (in millions, except per share data and percentages):
| Year Ended December 31, 2019 | ||||||||||||
| (millions, except per share data) | U.S. GAAP | Adjustments | Non-GAAP Adjusted | |||||||||
| Operating income from continuing operations | $ | 2,169 | $ | 856 | $ | 3,025 | ||||||
| Interest income | 8 | — | 8 | |||||||||
| Interest expense | (307 | ) | — | (307 | ) | |||||||
| Other income (expense) (1) | 1 | — | 1 | |||||||||
| Income before income taxes from continuing operations | 1,871 | 856 | 2,727 | |||||||||
| Income tax expense (2) | 297 | 181 | 478 | |||||||||
| Net income from continuing operations | 1,574 | 675 | 2,249 | |||||||||
| Net income (loss) from discontinued operations (3) | (1 | ) | — | (1 | ) | |||||||
| Net income | 1,573 | 675 | 2,248 | |||||||||
| Less: Net income attributable to noncontrolling interests | 41 | — | 41 | |||||||||
| Net income attributable to Aon shareholders | $ | 1,532 | $ | 675 | $ | 2,207 | ||||||
| Diluted net income per share attributable to Aon shareholders | ||||||||||||
| Continuing operations | $ | 6.37 | $ | 2.80 | $ | 9.17 | ||||||
| Discontinued operations | — | — | — | |||||||||
| Net income | $ | 6.37 | $ | 2.80 | $ | 9.17 | ||||||
| Weighted average ordinary shares outstanding — diluted | 240.6 | — | 240.6 | |||||||||
| Effective tax rates (3) | ||||||||||||
| Continuing operations | 15.9 | % | 17.5 | % | ||||||||
| Discontinued operations | 47.4 | % | 47.4 | % |
| Year Ended December 31, 2018 | ||||||||||||
| (millions, except per share data) | U.S. GAAP | Adjustments | Non-GAAP Adjusted | |||||||||
| Operating income from continuing operations | $ | 1,544 | $ | 1,153 | $ | 2,697 | ||||||
| Interest income | 5 | — | 5 | |||||||||
| Interest expense | (278 | ) | — | (278 | ) | |||||||
| Other income (expense) (1) | (25 | ) | 37 | 12 | ||||||||
| Income before income taxes from continuing operations | 1,246 | 1,190 | 2,436 | |||||||||
| Income tax expense (2) | 146 | 233 | 379 | |||||||||
| Net income from continuing operations | 1,100 | 957 | 2,057 | |||||||||
| Net income (loss) from discontinued operations (3) | 74 | (82 | ) | (8 | ) | |||||||
| Net income | 1,174 | 875 | 2,049 | |||||||||
| Less: Net income attributable to noncontrolling interests | 40 | — | 40 | |||||||||
| Net income attributable to Aon shareholders | $ | 1,134 | $ | 875 | $ | 2,009 | ||||||
| Diluted net income (loss) per share attributable to Aon shareholders | ||||||||||||
| Continuing operations | $ | 4.29 | $ | 3.87 | $ | 8.16 | ||||||
| Discontinued operations | 0.30 | (0.33 | ) | (0.03 | ) | |||||||
| Net income | $ | 4.59 | $ | 3.54 | $ | 8.13 | ||||||
| Weighted average ordinary shares outstanding — diluted | 247.0 | — | 247.0 | |||||||||
| Effective tax rates (3) | ||||||||||||
| Continuing operations | 11.7 | % | 15.6 | % | ||||||||
| Discontinued operations | 15,949.3 | % | 29.7 | % |
| Year Ended December 31, 2017 | ||||||||||||
| (millions, except per share data) | U.S. GAAP | Adjustments | Non-GAAP Adjusted | |||||||||
| Operating income from continuing operations | $ | 1,065 | $ | 1,229 | $ | 2,294 | ||||||
| Interest income | 27 | — | 27 | |||||||||
| Interest expense | (282 | ) | — | (282 | ) | |||||||
| Other income (expense) (1) | (125 | ) | 128 | 3 | ||||||||
| Income before income taxes from continuing operations | 685 | 1,357 | 2,042 | |||||||||
| Income tax expense (2) | 250 | 55 | 305 | |||||||||
| Net income from continuing operations | 435 | 1,302 | 1,737 | |||||||||
| Net income (loss) from discontinued operations (3) | 828 | (772 | ) | 56 | ||||||||
| Net income | 1,263 | 530 | 1,793 | |||||||||
| Less: Net income attributable to noncontrolling interests | 37 | — | 37 | |||||||||
| Net income attributable to Aon shareholders | $ | 1,226 | $ | 530 | $ | 1,756 | ||||||
| Diluted net income (loss) per share attributable to Aon shareholders | ||||||||||||
| Continuing operations | $ | 1.53 | $ | 4.99 | $ | 6.52 | ||||||
| Discontinued operations | 3.17 | (2.95 | ) | 0.22 | ||||||||
| Net income | $ | 4.70 | $ | 2.04 | $ | 6.74 | ||||||
| Weighted average ordinary shares outstanding — diluted | 260.7 | — | 260.7 | |||||||||
| Effective tax rates (3) | ||||||||||||
| Continuing operations | 36.5 | % | 14.9 | % | ||||||||
| Discontinued operations | 58.9 | % | 11.7 | % |
| (1) | Adjusted Other income (expense) excludes pension settlement charges of $37 million and $128 million, for the years ended 2018, and 2017, respectively. |
| (2) | Adjusted items are generally taxed at the estimated annual effective tax rate, except for the applicable tax impact associated with estimated Restructuring Plan expenses, legacy litigation, accelerated tradename amortization, impairment charges and non-cash pension settlement charges, which are adjusted at the related jurisdictional rates. In addition, tax expense excludes the tax impacts of the sale of the disposal group and enactment date impacts of the Tax Cuts and Jobs Act of 2017. |
| (3) | Adjusted Net income (loss) from discontinued operations excludes the gain on sale of discontinued operations of $82 million and $779 million for the years ended 2018, and 2017, respectively. Adjusted net income from discontinued operations excludes intangible asset amortization of $11 million for the twelve months ended December 31, 2017. The effective tax rate was further adjusted for the applicable tax impact associated with the gain on sale and intangible asset amortization, as applicable. |
Free Cash Flow
We use free cash flow, defined as cash flow provided by operations minus capital expenditures, as a non-GAAP measure of our core operating performance and cash generating capabilities of our business operations. This supplemental information related to free cash flow represents a measure not in accordance with U.S. GAAP and should be viewed in addition to, not instead of, the Consolidated Financial Statements. The use of this non-GAAP measure does not imply or represent the residual cash flow for discretionary expenditures. A reconciliation of this non-GAAP measure to cash flow provided by operations is as follows (in millions):
| Years Ended December 31 | 2019 | 2018 | 2017 | |||||||||
| Cash provided by continuing operating activities | $ | 1,835 | $ | 1,686 | $ | 669 | ||||||
| Capital expenditures used for continuing operations | (225 | ) | (240 | ) | (183 | ) | ||||||
| Free cash flow provided by continuing operations | $ | 1,610 | $ | 1,446 | $ | 486 |
Impact of Foreign Currency Exchange Rate Fluctuations
Because we conduct business in more than 120 countries and sovereignties, foreign currency exchange rate fluctuations have a significant impact on our business. Foreign currency exchange rate movements may be significant and may distort true period-to-period comparisons of changes in revenue or pretax income. Therefore, to give financial statement users meaningful information about our operations, we have provided an illustration of the impact of foreign currency exchange rate fluctuations on our financial
results. The methodology used to calculate this impact isolates the impact of the change in currencies between periods by translating the prior year’s revenue, expenses, and net income using the current year’s foreign currency exchange rates.
Translating prior year results at current year foreign currency exchange rates, currency fluctuations had a $0.19 unfavorable impact on net income per diluted share during the year ended December 31, 2019. Currency fluctuations had a $0.08 favorable impact on net income per diluted share during the year ended December 31, 2018, when 2017 results were translated at 2018 rates. Currency fluctuations had a $0.12 favorable impact on net income per diluted share during the year ended December 31, 2017, when 2016 results were translated at 2017 rates.
Translating prior year results at current year foreign currency exchange rates, currency fluctuations had a $0.23 unfavorable impact on adjusted net income per diluted share during the year ended December 31, 2019. Currency fluctuations had a $0.09 favorable impact on adjusted net income per diluted share during the year ended December 31, 2018, when 2017 results were translated at 2018 rates. Currency fluctuations had a $0.08 favorable impact on adjusted net income per diluted share during the year ended December 31, 2017, when 2016 results were translated at 2017 rates. These translations are performed for comparative purposes only and do not impact the accounting policies or practices for amounts included in the Consolidated Financial Statements.
LIQUIDITY AND FINANCIAL CONDITION
Liquidity
Executive Summary
We believe that our balance sheet and strong cash flow provide us with adequate liquidity. Our primary sources of liquidity are cash flows provided by operations, available cash reserves, and debt capacity available under our credit facilities. Our primary uses of liquidity are operating expenses and investments, restructuring activities, capital expenditures, acquisitions, share repurchases, pension obligations, and shareholder dividends. We believe that cash flows from operations, available credit facilities, and the capital markets will be sufficient to meet our liquidity needs, including principal and interest payments on debt obligations, capital expenditures, pension contributions, and anticipated working capital requirements, for the foreseeable future.
Cash on our balance sheet includes funds available for general corporate purposes, as well as amounts restricted as to their use. Funds held on behalf of clients in a fiduciary capacity are segregated and shown together with uncollected insurance premiums and claims in Fiduciary assets in the Consolidated Statements of Financial Position, with a corresponding amount in Fiduciary liabilities.
In our capacity as an insurance broker or agent, we collect premiums from insureds and, after deducting our commission, remit the premiums to the respective insurance underwriters. We also collect claims or refunds from underwriters on behalf of insureds, which are then returned to the insureds. Unremitted insurance premiums and claims are held by us in a fiduciary capacity. The levels of fiduciary assets and liabilities can fluctuate significantly depending on when we collect the premiums, claims, and refunds, make payments to underwriters and insureds, and collect funds from clients and make payments on their behalf, and upon the impact of foreign currency movements. Fiduciary assets, because of their nature, are generally invested in very liquid securities with highly rated, credit-worthy financial institutions. Our Fiduciary assets included cash and short-term investments of $5.2 billion and $3.9 billion at December 31, 2019 and 2018, respectively, and fiduciary receivables of $6.7 billion and $6.3 billion at December 31, 2019 and 2018, respectively. While we earn investment income on the fiduciary assets held in cash and investments, the cash and investments cannot be used for general corporate purposes.
We maintain multi-currency cash pools with third-party banks in which various Aon entities participate. Individual Aon entities are permitted to overdraw on their individual accounts provided the overall global balance does not fall below zero. At December 31, 2019, non-U.S. cash balances of one or more entities were negative; however, the overall balance was positive.
The following table summarizes our Cash and cash equivalents, Short-term investments, and Fiduciary assets as of December 31, 2019 (in millions):
| Statement of Financial Position Classification | |||||||||||||||
| Asset Type | Cash and Cash Equivalents | Short-Term Investments | Fiduciary Assets | Total | |||||||||||
| Certificates of deposit, bank deposits or time deposits | $ | 790 | $ | — | $ | 3,285 | $ | 4,075 | |||||||
| Money market funds | — | 138 | 1,869 | 2,007 | |||||||||||
| Cash and short-term investments | 790 | 138 | 5,154 | 6,082 | |||||||||||
| Fiduciary receivables | — | — | 6,680 | 6,680 | |||||||||||
| Total | $ | 790 | $ | 138 | $ | 11,834 | $ | 12,762 |
Cash and cash equivalents increased $134 million in 2019 compared to 2018. A summary of our cash flows provided by and used for continuing operations from operating, investing, and financing activities is as follows (in millions):
| Years Ended December 31 | ||||||||||||
| 2019 | 2018 | 2017 | ||||||||||
| Cash provided by operating activities | $ | 1,835 | $ | 1,686 | $ | 669 | ||||||
| Cash provided by (used for) investing activities | $ | (229 | ) | $ | 31 | $ | 2,806 | |||||
| Cash used for financing activities | $ | (1,493 | ) | $ | (1,699 | ) | $ | (3,265 | ) | |||
| Effect of exchange rates changes on cash and cash equivalents | $ | 21 | $ | (118 | ) | $ | 69 |
Operating Activities
Net cash provided by operating activities during the twelve months ended December 31, 2019 increased $149 million, or 9%, from the prior year to $1,835 million. This amount represents net income reported, as adjusted for gains or losses on sales of businesses, share-based compensation expense, depreciation expense, amortization and impairments, and other non-cash income and expenses, as well as changes in working capital that relate primarily to the timing of payments of accounts payable and accrued liabilities and the collection of receivables.
Pension Contributions
Pension contributions were $135 million for the twelve months ended December 31, 2019, as compared to $252 million for the twelve months ended December 31, 2018. In 2020, we expect to contribute approximately $123 million in cash to our pension plans, including contributions to non-U.S. pension plans, which are subject to changes in foreign exchange rates.
Restructuring Plan
In 2017, Aon initiated the Restructuring Plan in connection with the sale of the Divested Business. The Restructuring Plan was intended to streamline operations across the organization and deliver greater efficiency, insight, and connectivity. The Company has incurred all remaining costs for the Restructuring Plan and the plan was closed in the fourth quarter of 2019.
The Restructuring Plan resulted in cumulative charges of $1,433 million, consisting of $619 million in workforce reduction, $119 million in technology rationalization costs, $69 million in lease consolidation costs, $53 million in non-cash asset impairments, and $573 million in other costs, including certain separation costs associated with the sale of the Divested Business. These charges are included in Compensation and benefits, Information technology, Premises, Depreciation of fixed assets, and Other general expense in the accompanying Consolidated Statements of Income. Before any potential reinvestment of savings, the Restructuring Plan delivered annual cumulative expense savings of $529 million in 2019 and is expected to deliver run-rate savings of $580 million annually in 2020. The Company eliminated 5,832 positions under the Restructuring Plan.
The following table summarizes restructuring and separation costs by type that were incurred through the end of the Restructuring Plan (in millions):
| 2019 | 2018 | 2017 | Completed Plan Total | |||||||||||||
| Workforce reduction | $ | 205 | $ | 115 | $ | 299 | $ | 619 | ||||||||
| Technology rationalization (1) | 39 | 47 | 33 | 119 | ||||||||||||
| Lease consolidation (1) | 33 | 28 | 8 | 69 | ||||||||||||
| Asset impairments | 14 | 13 | 26 | 53 | ||||||||||||
| Other costs associated with restructuring and separation (1) (2) | 160 | 282 | 131 | 573 | ||||||||||||
| Total restructuring and related expenses | $ | 451 | $ | 485 | $ | 497 | $ | 1,433 |
| (1) | Total contract termination costs incurred under the Restructuring Plan associated with technology rationalizations, lease consolidations, and other costs associated with restructuring and separation for the twelve months ended December 31, 2019 were $0 million, $33 million, and $13 million, respectively; for the twelve months ended December 31, 2018 were $5 million, $25 million, and $85 million, respectively; and for the twelve months ended December 31, 2017 were $1 million, $8 million, and $3 million, respectively. |
| (2) | Other costs associated with the Restructuring Plan include those to separate the Divested Business, as well as moving costs, and consulting and legal fees. These costs are typically recognized when incurred. |
The changes in the Company’s liabilities for the Restructuring Plan as of December 31, 2019 are as follows (in millions):
| Restructuring Plan | ||||
| Balance at December 31, 2018 | $ | 201 | ||
| Expensed | 418 | |||
| Cash payments | (415 | ) | ||
| Foreign currency translation and other | — | |||
| Balance at December 31, 2019 | $ | 204 |
The Company’s unpaid liabilities for the Restructuring Plan are included in both Accounts payable and accrued liabilities and Other non-current liabilities in the Consolidated Statement of Financial Position. Of the remaining liabilities as of December 31, 2019, we expect approximately $180 million to be paid in 2020.
Investing Activities
Cash flows used for investing activities in continuing operations during the twelve months ended December 31, 2019 were $229 million, a decrease of $260 million compared to prior year. Generally, the primary drivers of cash flows used for investing activities are acquisition of businesses, purchases of short-term investments, capital expenditures, and payments for investments. Generally, the primary drivers of cash flows provided by investing activities are sales of businesses, sales of short-term investments, and proceeds from investments. The gains and losses corresponding to cash flows provided by proceeds from investments and used for payments for investments are primarily recognized in Other income (expense) in the Consolidated Statements of Income.
Short-term Investments
Short-term investments decreased $34 million at December 31, 2019 as compared to December 31, 2018. As disclosed in Note 16 “Fair Value Measurements and Financial Instruments” of the Notes to Consolidated Financial Statements contained in Part II, Item 8 of this report, the majority of our investments carried at fair value are money market funds. These money market funds are held throughout the world with various financial institutions. We are not aware of any market liquidity issues that would materially impact the fair value of these investments.
Acquisitions and Dispositions of Businesses
During 2019, the Company completed the acquisition of three businesses for consideration of $39 million, net of cash acquired, and the disposition of eight businesses for a $52 million cash inflow, net of cash sold.
During 2018, the Company completed the acquisition of eight businesses for consideration of $58 million, net of cash acquired, and the disposition of four businesses for a $10 million cash outflow, net of cash sold.
Capital Expenditures
The Company’s additions to fixed assets, including capitalized software, which amounted to $225 million in 2019 and $240 million in 2018, primarily related to computer equipment purchases, the refurbishing and modernizing of office facilities, and software development costs.
Financing Activities
Cash flows used for financing activities in continuing operations during the twelve months ended December 31, 2019 were $1,493 million, a decrease of $206 million compared to prior year. Generally, the primary drivers of cash flows used for financing activities are share repurchases, issuances of debt, net of repayments, dividends paid to shareholders, issuances of shares for employee benefit plans, transactions with noncontrolling interests, and other financing activities, such as collection of or payments for deferred consideration in connection with prior-year business acquisitions and divestitures.
Share Repurchase Program
Aon has a share repurchase program authorized by the Company’s Board of Directors. The Repurchase Program was established in April 2012 with $5.0 billion in authorized repurchases, and was increased by $5.0 billion in authorized repurchases in each of November 2014 and June 2017, for a total of $15.0 billion in repurchase authorizations.
The following table summarizes the Company’s Share Repurchase activity (in millions, except per share data):
| Twelve months ended December 31 | ||||||||
| 2019 | 2018 | |||||||
| Shares repurchased | 10.5 | 10.0 | ||||||
| Average price per share | $ | 186.33 | $ | 143.94 | ||||
| Costs recorded to retained earnings | ||||||||
| Total repurchase cost | $ | 1,950 | $ | 1,447 | ||||
| Additional associated costs | 10 | 7 | ||||||
| Total costs recorded to retained earnings | $ | 1,960 | $ | 1,454 |
At December 31, 2019, the remaining authorized amount for share repurchase under the Repurchase Program was approximately $2.0 billion. Under the Repurchase Program, we have repurchased a total of 128.7 million shares for an aggregate cost of approximately $13.0 billion.
Borrowings
Total debt at December 31, 2019 was $7.3 billion, an increase of $1.1 billion compared to December 31, 2018. Commercial paper activity during the years ended December 31, 2019 and 2018 is as follows (in millions):
| Twelve months ended December 31 | |||||||
| 2019 | 2018 | ||||||
| Total issuances(1) | $ | 4,812 | $ | 5,400 | |||
| Total repayments | (4,941 | ) | (5,118 | ) | |||
| Net issuances | $ | (129 | ) | $ | 282 |
(1) The proceeds of the commercial paper issuances were used primarily for short-term working capital needs.
On November 15, 2019, Aon Corporation issued $500 million 2.20% Senior Notes due November 2022. The Company used the net proceeds of the offering to pay down a portion of outstanding commercial paper and for general corporate purposes.
In September 2019, the Company’s $600 million 5.00% Senior Notes due September 2020 were classified as Short-term debt and current portion of long-term debt in the Consolidated Statement of Financial Position as the date of maturity is in less than one year.
On May 2, 2019, Aon Corporation issued $750 million 3.75% Senior Notes due May 2029. The Company used the net proceeds of the offering to pay down a portion of outstanding commercial paper and for general corporate purposes.
On December 3, 2018, Aon Corporation issued $350 million 4.50% Senior Notes due December 2028. The Company used the net proceeds of the offering to pay down a portion of outstanding commercial paper and for general corporate purposes.
Other Liquidity Matters
Distributable Reserves
As a company incorporated in England and Wales, we are required under U.K. law to have available “Distributable Reserves” to make share repurchases or pay dividends to shareholders. Distributable Reserves are created through the earnings of the U.K. parent company and, among other methods, through a reduction in share capital approved by the High Court of Justice in England. Distributable Reserves are not linked to a U.S. GAAP reported amount (e.g., retained earnings). As of December 31, 2019 and 2018, we had Distributable Reserves in excess of $32.4 billion and $2.2 billion, respectively. On July 16, 2019, we completed a reduction in share capital to create additional Distributable Reserves of $31 billion to support the payment of possible future dividends or future share repurchases, if and to the extent declared by the directors in compliance with their duties under U.K. law. We believe that we will have sufficient Distributable Reserves to fund shareholder dividends and make share repurchases for the foreseeable future. Additionally, following the Reorganization, we would be required under Irish law to have available “Distributable Profits” (the equivalent to Distributable Reserves under U.K. law) to make share repurchases or pay dividends to shareholders.
Credit Facilities
We expect cash generated by operations for 2019 to be sufficient to service our debt and contractual obligations, finance capital expenditures, continue purchases of shares under the Repurchase Program, and continue to pay dividends to our shareholders. Although cash from operations is expected to be sufficient to service these activities, we have the ability to access the commercial paper markets or borrow under our credit facilities to accommodate any timing differences in cash flows. Additionally, under current market conditions, we believe that we could access capital markets to obtain debt financing for longer-term funding, if needed.
As of December 31, 2019, we had two primary committed credit facilities outstanding: our $900 million multi-currency U.S. credit facility expiring in February 2022 and our $400 million multi-currency U.S. credit facility expiring in October 2023.
Each of these facilities includes customary representations, warranties, and covenants, including financial covenants that require us to maintain specified ratios of adjusted consolidated EBITDA to consolidated interest expense and consolidated debt to adjusted consolidated EBITDA, in each case, tested quarterly. At December 31, 2019, we did not have borrowings under either facility, and we were in compliance with the financial covenants and all other covenants contained therein during the twelve months ended December 31, 2019.
Shelf Registration Statement
On September 25, 2018, we filed a shelf registration statement with the SEC, registering the offer and sale from time to time of an indeterminate amount of, among other securities, debt securities, preference shares, Class A Ordinary Shares, and convertible securities. Our ability to access the market as a source of liquidity is dependent on investor demand, market conditions, and other factors.
Rating Agency Ratings
The major rating agencies’ ratings of our debt at February 14, 2020 appear in the table below.
| Ratings | |||||
| Senior Long-term Debt | Commercial Paper | Outlook | |||
| Standard & Poor’s | A- | A-2 | Stable | ||
| Moody’s Investor Services | Baa2 | P-2 | Stable | ||
| Fitch, Inc. | BBB+ | F-2 | Stable |
A downgrade in the credit ratings of our senior debt and commercial paper could increase our borrowing costs, reduce or eliminate our access to debt capital, reduce our financial flexibility, or restrict our access to the commercial paper market altogether, and/or impact future pension contribution requirements.
Guarantees in Connection with the Sale of the Divested Business
In connection with the sale of the Divested Business, we guaranteed future operating lease commitments related to certain facilities assumed by the Buyer. We are obligated to perform under the guarantees if the Divested Business defaults on the leases at any time during the remainder of the lease agreements, which expire on various dates through 2025. As of December 31, 2019, the undiscounted maximum potential future payments under the lease guarantee were $70 million, with an estimated fair value of $12 million. No cash payments were made in connection to the lease commitments during the year ended December 31, 2019.
Additionally, we are subject to performance guarantee requirements under certain client arrangements that were assumed by the Buyer. Should the Divested Business fail to perform as required by the terms of the arrangements, we would be required to fulfill the remaining contract terms, which expire on various dates through 2023. As of December 31, 2019, the undiscounted maximum potential future payments under the performance guarantees were $151 million, with an estimated fair value of $1 million. No cash payments were made in connection to the performance guarantees during the year ended December 31, 2019.
Letters of Credit and Other Guarantees
We have entered into a number of arrangements whereby our performance on certain obligations is guaranteed by a third party through the issuance of a letter of credit (“LOC”). We had total LOCs outstanding of approximately $73 million at December 31, 2019, compared to $83 million at December 31, 2018. These LOCs cover the beneficiaries related to certain of our U.S. and Canadian non-qualified pension plan schemes and secure deductible retentions for our own workers’ compensation program. We also have obtained LOCs to cover contingent payments for taxes and other business obligations to third parties, and other guarantees for miscellaneous purposes at our international subsidiaries.
We have certain contractual contingent guarantees for premium payments owed by clients to certain insurance companies. The maximum exposure with respect to such contractual contingent guarantees was approximately $110 million at December 31, 2019, compared to $103 million at December 31, 2018.
Off-Balance Sheet Arrangements
Apart from commitments, guarantees, and contingencies, as disclosed herein and Note 17 “Claims, Lawsuits, and Other Contingencies” of the Notes to Consolidated Financial Statements in Part II, Item 8 of this report, the Company had no off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on the Company’s financial condition, results of operations, or liquidity. Our cash flows from operations, borrowing availability, and overall liquidity are subject to risks and uncertainties. See “Information Concerning Forward-Looking Statements” in Part I, Item I of this report.
Contractual Obligations
Summarized in the table below are our contractual obligations and commitments as of December 31, 2019. Payments by year due are estimated as follows (in millions):
| Payments due by | |||||||||||||||||||
| 2020 | 2021-2022 | 2023-2024 | After 2024 | Total | |||||||||||||||
| Principal payments on debt | $ | 712 | $ | 900 | $ | 950 | $ | 4,882 | $ | 7,444 | |||||||||
| Interest payments on debt | 302 | 528 | 498 | 2,137 | 3,465 | ||||||||||||||
| Operating leases | 208 | 379 | 254 | 432 | 1,273 | ||||||||||||||
| Pension and other postretirement benefit plans | 128 | 288 | 246 | 265 | 927 | ||||||||||||||
| Purchase obligations | 156 | 129 | 63 | 48 | 396 | ||||||||||||||
| Total | $ | 1,506 | $ | 2,224 | $ | 2,011 | $ | 7,764 | $ | 13,505 |
Pension and other postretirement benefit plan obligations include estimates of our minimum funding requirements pursuant to the Employee Retirement Income Security Act and other regulations, as well as minimum funding requirements agreed with the trustees of our U.K. pension plans. Additional amounts may be agreed to with, or required by, the U.K. pension plan trustees. Nonqualified pension and other postretirement benefit obligations are based on estimated future benefit payments. We may make additional discretionary contributions.
In 2019, our principal U.K. subsidiary agreed with the trustees of one of the U.K. plans to contribute £1.2 million ($2 million at December 31, 2019 exchange rates) per annum to facilitate de-risking. The trustees of the plan have certain rights to request that our U.K. subsidiary advance an amount equal to an actuarially determined winding-up deficit. As of December 31, 2019, the estimated winding-up deficit was £64 million ($83 million at December 31, 2019 exchange rates). The trustees of the plan have accepted in practice the agreed-upon schedule of contributions detailed above and have not requested the winding-up deficit be paid.
Purchase obligations are defined as agreements to purchase goods and services that are enforceable and legally binding on us, and that specifies all significant terms, including the goods to be purchased or services to be rendered, the price at which the goods or services are to be rendered, and the timing of the transactions. Most of our purchase obligations are related to purchases of information technology services or other service contracts. Purchase obligations exclude $299 million of liabilities for uncertain tax positions due to our inability to reasonably estimate the periods when potential cash settlements will be made.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Consolidated Financial Statements have been prepared in accordance with U.S. GAAP. To prepare these financial statements, we make estimates, assumptions, and judgments that affect what we report as our assets and liabilities, what we disclose as contingent assets and liabilities at the date of the Consolidated Financial Statements, and the reported amounts of revenues and expenses during the periods presented.
In accordance with our policies, we regularly evaluate our estimates, assumptions, and judgments, including, but not limited to, those concerning revenue recognition, restructuring, pensions, goodwill and other intangible assets, contingencies, share-based payments, and income taxes, and base our estimates, assumptions, and judgments on our historical experience and on factors we believe reasonable under the circumstances. The results involve judgments about the carrying values of assets and liabilities not readily apparent from other sources. If our assumptions or conditions change, the actual results we report may differ from these estimates. We believe the following critical accounting policies affect the more significant estimates, assumptions, and judgments we use to prepare these Consolidated Financial Statements.
Revenue Recognition
The Company recognizes revenue when control of the promised services is transferred to the customer in the amount that best reflects the consideration to which the Company expects to be entitled in exchange for those services. For arrangements where control is transferred over time, an input or output method is applied that represents a faithful depiction of the progress towards completion of the performance obligation. For arrangements that include variable consideration, the Company assesses whether any amounts should be constrained. For arrangements that include multiple performance obligations, the Company allocates consideration based on their relative fair values.
Costs incurred by the Company in obtaining a contract are capitalized and amortized on a systematic basis that is consistent with the transfer of control of the services to which the asset relates, considering anticipated renewals when applicable. Certain contract related costs, including pre-placement brokerage costs, are capitalized as a cost to fulfill and are amortized on a systematic basis consistent with the transfer of control of the services to which the asset relates, which is generally less than one year.
Commercial Risk Solutions includes retail brokerage, cyber solutions, global risk consulting, and captives. Revenue primarily includes insurance commissions and fees for services rendered. Revenue is predominantly recognized at a point in time upon the effective date of the underlying policy (or policies), or for a limited number of arrangements, over the term of the arrangement using output measures to depict the transfer of control of the services to customers in an amount that reflects the consideration to which the Company expects to be entitled in exchange for those services. For arrangements recognized over time, various output measures, including units transferred and time elapsed, are utilized to provide a faithful depiction of the progress towards completion of the performance obligation. Revenue is recorded net of allowances for estimated policy cancellations, which are determined based on an evaluation of historical and current cancellation data. Commissions and fees for brokerage services may be invoiced near the effective date of the underlying policy or over the term of the arrangement in installments during the policy period.
Reinsurance Solutions includes treaty and facultative reinsurance brokerage and capital markets. Revenue primarily includes reinsurance commissions and fees for services rendered. Revenue is predominantly recognized at a point in time upon the effective date of the underlying policy (or policies), or for a limited number of arrangements, over the term of the arrangement using output measures to depict the transfer of control of the services to customers in an amount that reflects the consideration to which the Company expects to be entitled in exchange for those services. For arrangements recognized over time, various output measures, including units delivered and time elapsed, are utilized to provide a faithful depiction of the progress towards completion of the performance obligation. Commissions and fees for brokerage services may be invoiced at the inception of the reinsurance period for certain reinsurance brokerage, or more commonly, over the term of the arrangement in installments based on deposit or minimum premiums for most treaty reinsurance arrangements.
Retirement Solutions includes core retirement, investment consulting, and human capital. Revenue consists primarily of fees paid by customers for consulting services. Revenue recognized for these arrangements is predominantly recognized over the term of the arrangement using input or output measures to depict the transfer of control of the services to customers in an amount that reflects the consideration to which the Company expects to be entitled in exchange for those services, or for certain arrangements, at a point in time upon completion of the services. For consulting arrangements recognized over time, revenue will be recognized based on a measure of progress that depicts the transfer of control of the services to the customer, utilizing an appropriate input or output measure to provide a reasonable assessment of the progress towards completion of the performance obligation including units delivered or time elapsed. Fees paid by customers for consulting services are typically charged on an hourly, project or fixed-fee basis, and revenue for these arrangements is typically recognized based on time incurred, days elapsed, or reports delivered. Revenue from time-and-materials or cost-plus arrangements are recognized as services are performed using input or output measures to provide a reasonable assessment of the progress towards completion of the performance obligation including hours worked, and revenue for these arrangements is typically recognized based on time and materials incurred. Reimbursements received for out-of-pocket expenses are recorded as a component of revenue. Payment terms vary but are typically over the contract term in installments.
Health Solutions includes health and benefits brokerage and health care exchanges. Revenue primarily includes insurance commissions and fees for services rendered. For brokerage commissions, revenue is predominantly recognized at the effective date of the underlying policy (or policies), or for a limited number of arrangements, over the term of the arrangement to depict the transfer of control of the services to customers in an amount that reflects the consideration to which the Company expects to be entitled in exchange for those services using input or output measures, including units delivered or time elapsed, to provide a faithful depiction of the progress towards completion of the performance obligation. Revenue from health care exchange arrangements are typically recognized upon successful enrollment of participants, net of a reserve for estimated cancellations. Commissions and fees for brokerage services may be invoiced at the effective date of the underlying policy or over the term of the arrangement in installments during the policy period. Payment terms for other services vary but are typically over the contract term in installments.
Data & Analytic Services includes Affinity, Aon InPoint, and ReView. Revenue consists primarily of fees for services rendered and is generally recognized over the term of the arrangement to depict the transfer of control of the services to customers in an amount that reflects the consideration to which the Company expects to be entitled in exchange for those services. Payment terms vary but are typically over the contract term in installments. For arrangements recognized over time, revenue will be recognized based on a measure of progress that depicts the transfer of control of the services to the customer, utilizing an appropriate input or output measure to provide a faithful depiction of the progress towards completion of the performance obligation, including units delivered or time elapsed. Input and output measures utilized vary based on the arrangement but typically include reports provided or days elapsed.
Restructuring
Workforce reduction costs
The method used to account for workforce reduction costs depends on whether the costs result from an ongoing severance plan, which represents the majority of these costs, or are considered one-time costs related to exit and disposal activities, which are less frequent. We account for relevant expenses as severance costs when we have an established severance policy, statutory requirements dictate the severance amounts, or we have an established pattern of paying by a specific formula. We recognize these costs when the likelihood of future settlement is probable and the amount of the related benefit is reasonably estimable, or on a straight-line basis over the remaining service period, if applicable.
Although less frequent than costs subject to our established severance policy, when applicable, we estimate our one-time workforce reduction costs related to exit and disposal activities not resulting from an ongoing severance plan based on the benefits available to the employees being terminated. We recognize these costs when we identify the specific classification (or functions) and locations of the employees being terminated, notify the employees who might be included in the termination, and expect to terminate employees within the legally required notification period. When employees are receiving incentives to stay beyond the legally required notification period, we record the cost of their severance over the remaining service period.
Lease consolidation costs
In the first quarter of 2019, Aon adopted new accounting guidance related to the treatment of leases that was applied using the modified retrospective approach. Under this approach, prior periods were not restated. Refer to Note 2 “Summary of Significant Accounting Principles and Practices” of the Notes to Consolidated Financial Statements in Part II, Item 8 of this report for further information surrounding the quantitative and qualitative impacts of adopting the new accounting guidance.
Where we have provided notice of cancellation pursuant to a lease agreement, we remove the associated right-of-use (“ROU”) asset and the related lease liability, including any additional termination penalties incurred that were not previously included within the liability. To the extent that the associated ROU assets and lease liabilities are removed, a corresponding gain or loss is recorded.
For properties where we plan to permanently cease use of a space and have the intent and ability to sublease the property, we will test the ROU asset for impairment to determine if a loss has occurred. The test for impairment will adjust the book value of the asset based on the net present value of the future cash flows expected from a sublease agreement using current market quotes for similar properties. When we finalize definitive agreements with the sublessee, we may record an additional impairment to reflect actual outcomes.
For properties where we plan to permanently cease use of a space and have no intention of reoccupying or subleasing the property, the amortization related to the ROU asset will be accelerated and recognized on a straight-line basis from the date that we commit to a plan to abandon the space through the date we permanently exit the property.
Additionally, a loss will also be recognized for lease related costs that are not reflected within the lease liability, such as operating expenses, taxes, and insurance that we are obligated to pay to the landlord after we have permanently exited the property.
Fair value concepts of one-time workforce reduction costs and lease losses
Accounting guidance requires that our exit and disposal accruals reflect the fair value of the liability. Where material, we discount the lease loss calculations to arrive at their net present value. Most workforce reductions happen over a short span of time, so no discounting is necessary.
For the remaining lease term, we decrease the liability for payments and increase the liability for accretion of the discount, if material. The discount reflects our incremental borrowing rate, which matches the lifetime of the liability. Significant changes in the discount rate selected or the estimations of sublease income in the case of leases could impact the amounts recorded.
Asset impairments
Asset impairments relate to fixed assets and are accounted for in the period when they become known. Furthermore, we record impairments by reducing the book value to the net present value of future cash flows (in situations where the asset had an identifiable cash flow stream) or accelerating the depreciation to reflect the revised useful life.
Other associated costs of exit and disposal activities
We recognize other costs associated with exit and disposal activities as they are incurred, including separation costs, moving costs, and consulting and legal fees.
Pensions
We sponsor defined benefit pension plans throughout the world. Our most significant plans are located in the U.S., the U.K., the Netherlands, and Canada, which are closed to new entrants. We have ceased crediting future benefits relating to salary and services for our U.S., U.K., Netherlands, and Canada plans to the extent statutorily permitted.
The service cost component of net periodic benefit cost is reported in Compensation and benefits and all other components are reported in Other income (expense). We used a full-yield curve approach in the estimation of the service and interest cost components of net periodic pension and postretirement benefit cost for our major pension and other postretirement benefit plans; this was obtained by applying the specific spot rates along the yield curve used in the determination of the benefit obligation to the relevant projected cash flows.
Recognition of gains and losses and prior service
Certain changes in the value of the obligation and in the value of plan assets, which may occur due to various factors such as changes in the discount rate and actuarial assumptions, actual demographic experience, and/or plan asset performance are not immediately recognized in net income. Such changes are recognized in Other comprehensive income and are amortized into net income as part of the net periodic benefit cost.
Unrecognized gains and losses that have been deferred in Other comprehensive income, as previously described, are amortized into expense as a component of periodic pension expense based on the average life expectancy of the U.S., U.K., Netherlands, and Canada plan members. We amortize any prior service expense or credits that arise as a result of plan changes over a period consistent with the amortization of gains and losses.
As of December 31, 2019, our pension plans have deferred losses that have not yet been recognized through income in the Consolidated Financial Statements. We amortize unrecognized actuarial losses outside of a corridor, which is defined as 10% of the greater of market-related value of plan assets or projected benefit obligation. To the extent not offset by future gains, incremental amortization as calculated above will continue to affect future pension expense similarly until fully amortized.
The following table discloses our unrecognized actuarial gains and losses, the number of years over which we are amortizing the experience loss, and the estimated 2020 amortization of loss by country (in millions, except amortization period):
| U.K. | U.S. | Other | |||||||||
| Unrecognized actuarial gains and losses | $ | 1,244 | $ | 1,763 | $ | 454 | |||||
| Amortization period | 8 to 27 years | 7 to 23 years | 13 to 38 years | ||||||||
| Estimated 2020 amortization of loss | $ | 32 | $ | 68 | $ | 12 |
The unrecognized prior service cost (credit) at December 31, 2019 was $1 million, $40 million, and $(6) million for the U.S., U.K. and other plans, respectively.
For the U.S. pension plans, we use a market-related valuation of assets approach to determine the expected return on assets, which is a component of net periodic benefit cost recognized in the Consolidated Statements of Income. This approach recognizes 20% of any gains or losses in the current year’s value of market-related assets, with the remaining 80% spread over the next four years. As this approach recognizes gains or losses over a five-year period, the future value of assets and therefore, our net periodic benefit cost will be impacted as previously deferred gains or losses are recorded. As of December 31, 2019, the market-related value of assets was $2.0 billion. We do not use the market-related valuation approach to determine the funded status of the U.S. plans recorded in the Consolidated Statements of Financial Position. Instead, we record and present the funded status in the Consolidated Statements of Financial Position based on the fair value of the plan assets. As of December 31, 2019, the fair value of plan assets was $2.1 billion. Our non-U.S. plans use fair value to determine expected return on assets.
Rate of return on plan assets and asset allocation
The following table summarizes the expected long-term rate of return on plan assets for future pension expense as of December 31, 2019:
| U.K. | U.S. | Other | |||
| Expected return on plan assets, net of administration expenses | 2.74% | 3.30 - 7.04% | 2.10 - 3.10% |
In determining the expected rate of return for the plan assets, we analyze investment community forecasts and current market conditions to develop expected returns for each of the asset classes used by the plans. In particular, we surveyed multiple third-party financial institutions and consultants to obtain long-term expected returns on each asset class, considered historical performance data by asset class over long periods, and weighted the expected returns for each asset class by target asset allocations of the plans.
The U.S. pension plan asset allocation is based on approved allocations following adopted investment guidelines. The investment policy for U.K. and other non-U.S. pension plans is generally determined by the plans’ trustees. Because there are several pension plans maintained in the U.K. and other non-U.S. categories, our target allocation presents a range of the target allocation of each plan. Target allocations are subject to change.
Impact of changing economic assumptions
Changes in the discount rate and expected return on assets can have a material impact on pension obligations and pension expense.
Holding all other assumptions constant, the following table reflects what a 25 basis point (“bps”) increase and decrease in our discount rate would have on our projected benefit obligation at December 31, 2019 (in millions):
| Increase (decrease) in projected benefit obligation (1) | 25 bps Change in Discount Rate | ||||||
| Increase | Decrease | ||||||
| U.K. plans | $ | (211 | ) | $ | 193 | ||
| U.S. plans | $ | (92 | ) | $ | 98 | ||
| Other plans | $ | (61 | ) | $ | 65 |
| (1) | Increases to the projected benefit obligation reflect increases to our pension obligations, while decreases in the projected benefit obligation are recoveries toward fully-funded status. A change in the discount rate has an inverse relationship to the projected benefit obligation. |
Holding all other assumptions constant, the following table reflects what a 25 bps increase and decrease in our discount rate would have on our estimated 2020 pension expense (in millions):
| 25 bps Change in Discount Rate | |||||||
| Increase (decrease) in expense | Increase | Decrease | |||||
| U.K. plans | $ | (2 | ) | $ | — | ||
| U.S. plans | $ | 1 | $ | (1 | ) | ||
| Other plans | $ | 1 | $ | (1 | ) |
Holding all other assumptions constant, the following table reflects what a 25 bps increase and decrease in our long-term rate of return on plan assets would have on our estimated 2020 pension expense (in millions):
| 25 bps Change in Long-Term Rate of Return on Plan Assets | |||||||
| Increase (decrease) in expense | Increase | Decrease | |||||
| U.K. plans | $ | (15 | ) | $ | 15 | ||
| U.S. plans | $ | (5 | ) | $ | 5 | ||
| Other plans | $ | (3 | ) | $ | 3 |
Estimated future contributions
We estimate cash contributions of approximately $123 million to our pension plans in 2020 as compared with cash contributions of $135 million in 2019.
Goodwill and Other Intangible Assets
Goodwill represents the excess of cost over the fair market value of the net assets acquired. We classify our intangible assets acquired as either tradenames, customer-related and contract-based, or technology and other.
Goodwill is not amortized, but rather tested for impairment at least annually in the fourth quarter. We test more frequently if there are indicators of impairment or whenever business circumstances suggest that the carrying value of goodwill may not be recoverable. These indicators may include a sustained significant decline in our share price and market capitalization, a decline in our expected future cash flows, or a significant adverse change in legal factors or in the business climate, among others. No events occurred during 2019 that indicate the existence of an impairment with respect to our reported goodwill.
We perform impairment reviews at the reporting unit level. A reporting unit is an operating segment or one level below an operating segment (referred to as a “component”). A component of an operating segment is a reporting unit if the component constitutes a business for which discrete financial information is available and segment management regularly reviews the operating results of that component. An operating segment shall be deemed to be a reporting unit if all of its components are similar, if none of its components are a reporting unit, or if the segment comprises only a single component.
When evaluating these assets for impairment, we may first perform a qualitative assessment to determine whether it is more likely than not that a reporting unit is impaired. If we do not perform a qualitative assessment, or if we determine that it is not more likely than not that the fair value of the reporting unit exceeds its carrying amount, then the goodwill impairment test becomes a two-step analysis. Step 1 requires the fair value of each reporting unit to be compared to its book value. Management must apply judgment in determining the estimated fair value of the reporting units. If the fair value of a reporting unit is determined to be greater than the carrying value of the reporting unit, goodwill is deemed not to be impaired and no further testing is necessary. If the fair value of a reporting unit is less than the carrying value, we perform Step 2. Step 2 uses the calculated fair value of the reporting unit to perform a hypothetical purchase price allocation to the fair value of the assets and liabilities of the reporting unit. The difference between the fair value of the reporting unit calculated in Step 1 and the fair value of the underlying assets and liabilities of the reporting unit is the implied fair value of the reporting unit’s goodwill. A charge is recorded in the financial statements if the carrying value of the reporting unit’s goodwill is greater than its implied fair value.
In determining the fair value of our reporting units, we use a discounted cash flow (“DCF”) model based on our most current forecasts. We discount the related cash flow forecasts using the weighted-average cost of capital method at the date of evaluation. Preparation of forecasts and selection of the discount rate for use in the DCF model involve significant judgments, and changes in these estimates could affect the estimated fair value of one or more of our reporting units and could result in a goodwill impairment charge in a future period. We also use market multiples which are obtained from quoted prices of comparable companies to corroborate our DCF model results. The combined estimated fair value of our reporting units from our DCF model often results in a premium over our market capitalization, commonly referred to as a control premium. We believe the implied control premium determined by our impairment analysis is reasonable based upon historic data of premiums paid on actual transactions within our industry. Based on tests performed in both 2019 and 2018, there was no indication of goodwill impairment, and no further testing was required.
We review intangible assets that are being amortized for impairment whenever events or changes in circumstance indicate that their carrying amount may not be recoverable. There were no indications that the carrying values of amortizable intangible assets were impaired as of December 31, 2019. If we are required to record impairment charges in the future, they could materially impact our results of operations.
Contingencies
We define a contingency as an existing condition that involves a degree of uncertainty as to a possible gain or loss that will ultimately be resolved when one or more future events occur or fail to occur. Under U.S. GAAP, we are required to establish reserves for loss contingencies when the loss is probable and we can reasonably estimate its financial impact. We are required to assess the likelihood of material adverse judgments or outcomes, as well as potential ranges or probability of losses. We determine the amount of reserves required, if any, for contingencies after carefully analyzing each individual item. The required reserves may change due to new developments in each issue. We do not recognize gain contingencies until the contingency is resolved and amounts due are probable of collection.
Share-Based Payments
Share-based compensation expense is measured based on the grant date fair value and recognized over the requisite service period for awards that we ultimately expect to vest. We estimate forfeitures at the time of grant based on our actual experience to date and revise our estimates, if necessary, in subsequent periods if actual forfeitures differ from those estimates.
Restricted Share Units
Restricted share units (“RSUs”) are service-based awards for which we recognize the associated compensation cost on a straight-line basis over the requisite service period. We estimate the fair value of the awards based on the market price of the underlying share on the date of grant, reduced by the present value of estimated dividends foregone during the vesting period where applicable.
Performance Share Awards
Performance share awards (“PSAs”) are performance-based awards for which vesting is dependent on the achievement of certain objectives. Such objectives may be made on a personal, group or company level. We estimate the fair value of the awards based on the market price of the underlying share on the date of grant, reduced by the present value of estimated dividends foregone during the vesting period.
Compensation expense is recognized over the performance period. The number of shares issued on the vesting date will vary depending on the actual performance objectives achieved, which are based on a fixed number of potential outcomes. We make assessments of future performance using subjective estimates, such as long-term plans. As a result, changes in the underlying assumptions could have a material impact on the compensation expense recognized.
The largest plan is the Leadership Performance Plan (“LPP”), which has a three-year performance period. As the percent of expected performance increases or decreases, the potential change in expense can go from 0% to 200% of the targeted total expense. The 2017 to 2019 performance period ended on December 31, 2019, the 2016 to 2018 performance period ended on December 31, 2018, and the 2015 to 2017 performance period ended on December 31, 2017. The LPP currently has two open performance periods: 2018 to 2020 and 2019 to 2021. A 10% upward adjustment in our estimated performance achievement percentage for both open performance periods would have increased our 2019 expense by approximately $7.5 million, while a 10% downward adjustment would have decreased our expense by approximately $7.5 million.
Income Taxes
We earn income in numerous countries and this income is subject to the laws of taxing jurisdictions within those countries.
The carrying values of deferred income tax assets and liabilities reflect the application of our income tax accounting policies and are based on management’s assumptions and estimates about future operating results and levels of taxable income, and judgments regarding the interpretation of the provisions of current accounting principles.
Deferred tax assets are reduced by valuation allowances if, based on the consideration of all available evidence, it is more likely than not that some portion of the deferred tax asset will not be realized. Considerations with respect to the realizability of deferred tax assets include the period of expiration of the deferred tax asset, historical earnings and projected future taxable income by jurisdiction as well as tax liabilities for the tax jurisdiction to which the tax asset relates. Significant management judgment is required in determining the assumptions and estimates related to the amount and timing of future taxable income. Valuation allowances are evaluated periodically and will be subject to change in each future reporting period as a result of changes in various factors.
We assess carryforwards and tax credits for realization as a reduction of future taxable income by using a “more likely than not” determination.
We base the carrying values of liabilities and assets for income taxes currently payable and receivable on management’s interpretation of applicable tax laws and incorporate management’s assumptions and judgments about using tax planning strategies in various taxing jurisdictions. Using different estimates, assumptions, and judgments in accounting for income taxes, especially those that deploy tax planning strategies, may result in materially different carrying values of income tax assets and liabilities and changes in our results of operations.
NEW ACCOUNTING PRONOUNCEMENTS
Note 2 “Summary of Significant Accounting Principles and Practices” of the Notes to Consolidated Financial Statements in Part II, Item 8 of this report contains a summary of our significant accounting policies, including a discussion of recently issued accounting pronouncements and their impact or future potential impact on our financial results, if determinable.
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