AON

Aon Plc (Aon Corporation) Q1 2006 10-Q Summary

Business Context and Reporting Period

This report covers the quarterly period ended March 31, 2006. Aon Corporation operates globally in three primary segments: Risk and Insurance Brokerage Services, Consulting, and Insurance Underwriting. The company is a large accelerated filer with 318.7 million shares of common stock outstanding as of the period end.

Key Financial Metrics

Margins: Pretax margin for continuing operations was 12% in Q1 2006, down from 13% in Q1 2005.

Material Changes vs. Prior Period

• Revenue: Increased 2% year-over-year. Brokerage commissions decreased 1% due to foreign exchange headwinds ($56 million impact) and reduced contingent commissions. Underwriting premiums increased 7% driven by growth in supplemental health and warranty products.
• Expenses: Total expenses rose 3% to $2,219 million. Compensation and benefits increased 1%, largely due to $25 million in restructuring charges and $20 million in increased stock-based compensation expense. Absent these items, staff costs would have decreased.
• Investment Income: Increased 21% to $110 million. This was driven by a $35 million gain on the contribution of Scandent preferred stock to a U.K. pension plan and higher interest rates, partially offset by a $17 million decrease in the fair value of Endurance warrants.
• Accounting Change: Aon adopted FASB Statement No. 123(R) on January 1, 2006, requiring fair value recognition for share-based payments. This resulted in a $41 million stock-based compensation expense in Q1 2006, compared to $21 million in Q1 2005.

Guidance, Outlook, and Risks

• Restructuring: The 2005 restructuring plan is expected to result in cumulative pretax charges of approximately $290 million through 2007. $191 million has been incurred to date, with $33 million recognized in Q1 2006. The company anticipates annualized pre-tax savings of at least $190 million by 2008.
• Stock Repurchases: Under a $1 billion authorization, Aon repurchased 6.2 million shares for $247 million in Q1 2006. Approximately $728 million remains available under the program.
• Pension Contributions: Aon plans to contribute approximately $350 million to major international defined benefit pension plans in 2006. $227 million was contributed in Q1 2006, including non-cash assets (Endurance warrants and PEPS I notes).
• Legal Contingencies: Significant pending matters include:
  • State Settlements: A $190 million settlement with New York and other states regarding broker compensation practices.
  • BP Litigation: A U.K. court judgment finding Aon liable for a shortfall in BP's offshore energy insurance claims; damages estimated at $96 million, subject to appeal.
  • Lloyds Litigation: Lloyds has sued Aon for alleged losses of approximately $569 million related to reinsurance placement for the New Central Fund.
• Forward-Looking Risks: Management cites risks related to foreign exchange fluctuations, interest rate changes, credit rating downgrades, and the outcome of ongoing legal proceedings.

Investor Verification Checklist

• Restructuring Progress: Verify the timeline and cost realization of the $290 million restructuring plan and the expected $190 million in annualized savings.
• Legal Exposure: Monitor the status of the BP and Lloyds litigation, as potential liabilities could materially impact future earnings.
• Foreign Exchange Impact: Assess the sensitivity of revenue and earnings to currency fluctuations, particularly the British Pound and Euro, which negatively impacted Q1 results.
• Stock-Based Compensation: Review the ongoing impact of FASB 123(R) adoption on future expense recognition and EPS.
• Pension Funding: Track the remaining $123 million of planned 2006 pension contributions and their impact on cash flow.