AON

Business Context and Reporting Period

Company: Aon Corporation (Aon Plc)

Filing Type: Form 10-K (Annual Report)

Period Ended: December 31, 2003

Aon operates through three primary segments: Risk and Insurance Brokerage Services (58% of revenue), Consulting (12% of revenue), and Insurance Underwriting (30% of revenue). The company serves corporations, governments, and individuals globally with approximately 54,000 employees in over 125 countries. In 2003, Aon executed a "back-to-basics" strategy, placing certain non-core accident and health operations in run-off and selling its automotive finance servicing business, which was classified as a discontinued operation.

Key Financial Metrics

Segment Performance (Pretax Income):

• Risk and Insurance Brokerage Services: $829 million (Margin: 14.6%)
• Consulting: $108 million (Margin: 9.1%)
• Insurance Underwriting: $196 million (Margin: 6.8%)

Material Changes vs. Prior Period

• Revenue Growth: Consolidated revenue increased 11% to $9.8 billion, driven by solid demand, favorable foreign exchange rates, and growth in brokerage commissions and premiums. Organic revenue growth was 6%.
• Profitability: Pretax income from continuing operations rose $286 million (35%) to $1.1 billion. The overall pretax margin improved by 190 basis points to 11.3%, largely due to a $105 million increase in investment income from Endurance Specialty Holdings stock and warrants.
• Investment Income: Increased 26% to $317 million. This included an $80 million non-cash gain on Endurance warrants and $46 million in equity earnings, offset by lower impairment write-downs ($36 million in 2003 vs. $130 million in 2002).
• Discontinued Operations: The automotive finance servicing business was sold in Q4 2003, resulting in a $35 million after-tax loss for the year, compared to a $20 million loss in 2002.
• Debt Reduction: The company paid down over $300 million of long-term debt, reducing the debt-to-total-capitalization ratio from 40% to 33%.

Guidance, Outlook, Risks, and Unusual Items

Management Commentary & Outlook:

• Management is focused on improving margins through cost discipline, strategic divestitures of non-core businesses (e.g., claims services), and leveraging purchasing power.
• Pension Obligations: Defined benefit pension expenses are projected to increase by approximately $40 million in 2004. Cash contributions for 2004 are estimated at $195 million, though potential U.S. legislative relief could reduce this to $170 million.
• Dividends: The company paid $0.60 per share in dividends in 2003, a reduction from $0.825 in 2002.

Unusual Items:

• World Trade Center: A net $14 million credit was recorded in 2003, combining a $60 million gain from a final insurance settlement and a $46 million expense for temporary office space assignments.
• Endurance Investment: A significant non-cash gain of $80 million was recognized on the fair value of warrants held in Endurance Specialty Holdings.

Risks and Contingencies:

• Credit Ratings: Standard & Poor's revised its outlook on Aon's senior debt to "negative" in August 2003. A further downgrade could increase borrowing costs and trigger funding obligations of up to $75 million for premium finance securitizations.
• Reserve Adequacy: The company faces uncertainty regarding insurance reserves, particularly related to the National Program Services (NPS) run-off program, which incurred $65 million in additional losses and reserve strengthening in 2003.
• Legal Proceedings: Significant litigation includes the Unicover Occupational Accident Reinsurance Pool disputes and pension mis-selling claims in the U.K. Management believes reserves are adequate but notes potential for material impact on future periods.

Investor Verification Checklist

• Pension Funding: Verify the impact of the projected $195 million cash contribution requirement for 2004 and the sensitivity of pension expense to discount rate changes.
• Endurance Valuation: Assess the sustainability of the $80 million non-cash gain on Endurance warrants and the volatility of this investment income source.
• Credit Rating Impact: Monitor credit rating agency actions (S&P negative outlook) and potential triggers for increased interest rates or funding obligations on securitizations.
• Run-off Reserves: Review the adequacy of reserves for the NPS run-off program and other discontinued underwriting operations, given the $65 million charge in 2003.
• Debt Structure: Confirm the classification of the $726 million subordinated debt following the deconsolidation of Aon Capital A under FIN 46.