AON

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 1998, for Aon Corporation (Delaware). The company operates primarily in insurance brokerage, consulting services, and insurance underwriting. The financial statements are unaudited but include normal recurring adjustments. The company adopted FASB Statement No. 130 regarding comprehensive income effective January 1, 1998, though this had no impact on net income or equity.

Key Financial Metrics

Segment Performance: Insurance brokerage and consulting revenue grew 18.1% to $1,040.2 million. Insurance underwriting revenue grew 6.6% to $475.0 million. Corporate and other revenue increased 64.2% to $46.3 million, driven by investment income.

Material Changes vs. Prior Period

• Profitability Surge: Net income increased dramatically from $0.7 million to $138.3 million. This is primarily attributable to a $145 million special charge recorded in Q1 1997 related to the restructuring of brokerage operations following the Alexander & Alexander (A&A) acquisition. No comparable special charges were recorded in Q1 1998.
• Revenue Growth: Total revenue increased 15.3% ($207.2 million). Brokerage commissions and fees rose 18.4%, driven by acquisitions including Gil y Carvajal (Spain) and Jauch & Hubener (Germany).
• Expense Management: Total expenses decreased 1.2% year-over-year due to the absence of the 1997 special charges. Excluding those charges, operating expenses increased 10.9%.
• Cash Flow: Operating cash flow decreased $51.6 million to $256.2 million, attributed to the timing of receivable settlements and payments on prior restructuring charges. Investing activities used $364.9 million, largely for the $96.1 million acquisition of Gil y Carvajal.

Outlook, Risks, and Management Commentary

• Acquisition Strategy: Management anticipates continued revenue growth from recent acquisitions. In April 1998, Aon acquired LeBlanc de Nicolay (France), subject to regulatory approval.
• Market Conditions: The brokerage segment faces a soft property and casualty market, particularly in reinsurance. However, cost savings from consolidating 1997 acquisitions are improving pretax margins.
• Liquidity: The company maintains adequate liquidity with substantial positive cash flow from operating subsidiaries. Short-term borrowings decreased by $88.6 million compared to year-end 1997.
• Investment Portfolio: Fixed maturity investments total $3.04 billion, with 96.6% held in investment-grade securities. The portfolio fair value is 104.6% of amortized cost.
• Legal Contingencies: Aon faces numerous lawsuits, including those inherited from the A&A acquisition. Management believes the possibility of material loss from these exposures is remote based on current facts and insurance coverage.

Investor Verification Checklist

• Special Charges Impact: Verify the comparability of Q1 1998 results against Q1 1997, noting the $145 million one-time restructuring charge in the prior year that skewed the baseline.
• Acquisition Integration: Monitor the integration and financial contribution of Gil y Carvajal and Jauch & Hubener to ensure projected revenue growth materializes.
• Underwriting Margins: Review trends in the extended warranty and direct sales lines, as international pretax income in underwriting decreased 7.9% due to expense comparisons.
• Legal Exposure: Assess the status of ongoing litigation related to the A&A acquisition and the adequacy of indemnity reserves ($152 million net liability).
• Debt Servicing: Confirm the company's ability to service its $800 million mandatorily redeemable preferred capital securities and other debt obligations given the reliance on operating cash flow.