Business Context and Reporting Period
This Form 10-Q covers Aon Corporation for the quarterly period ended June 30, 2002. The filing includes unaudited condensed consolidated financial statements that have been restated to reflect resolutions of SEC comments regarding a disputed reinsurance recoverable related to World Trade Center benefits and the timing of other-than-temporary impairment charges. The company operates through three primary segments: Insurance Brokerage and Other Services, Consulting, and Insurance Underwriting, alongside a Corporate and Other segment.
Key Financial Metrics
| Metric | Q2 2002 | Q2 2001 | 6 Months 2002 | 6 Months 2001 |
|---|---|---|---|---|
| Total Revenue ($ millions) | $2,122 | $1,917 | $4,210 | $3,728 |
| Net Income ($ millions) | $0 | $29 | $160 | $48 |
| Diluted EPS ($) | $0.00 | $0.11 | $0.57 | $0.17 |
| Operating Cash Flow ($ millions) | N/A | N/A | $605 | $296 |
| Total Assets ($ millions) | $24,591 | N/A | N/A | N/A |
| Total Liabilities ($ millions) | $20,050 | N/A | N/A | N/A |
| Stockholders' Equity ($ millions) | $3,691 | N/A | N/A | N/A |
Debt and Liquidity: Short-term borrowings were $292 million and notes payable were $1,816 million as of June 30, 2002. Cash and cash equivalents totaled $761 million. The company maintains back-up lines of credit to support its commercial paper program.
Material Changes Versus Prior Period
- Revenue Growth: Total revenue increased 11% in Q2 2002 and 13% for the six-month period compared to 2001, driven by growth in brokerage commissions and premiums.
- Profitability Decline in Q2: Q2 2002 net income dropped to breakeven ($0) from $29 million in Q2 2001. This was primarily due to a $101 million charge for other-than-temporary investment impairments (including a $56 million cumulative adjustment for prior periods) and higher investment losses.
- Year-to-Date Improvement: Despite the Q2 drag, six-month net income rose significantly to $160 million from $48 million in 2001, aided by the elimination of goodwill amortization under FAS 142 and strong operating cash flow.
- Expense Management: Total expenses increased 14% in Q2 and 8% for the six months. However, excluding one-time business transformation charges recorded in 2001, underlying expenses rose more sharply due to business growth and higher costs in U.S. retail brokerage.
Guidance, Outlook, Risks, and Unusual Items
- SEC Restatements: The company restated Q4 2001 and Q1 2002 results to record a $90 million pretax allowance for a reinsurance recoverable related to World Trade Center benefits in Q4 2001 rather than Q1 2002. Additionally, a $56 million impairment charge was recognized in Q2 2002 for prior period investment impairments.
- Divestiture Plans: Aon is investigating alternative options for its Insurance Underwriting segment (Combined Specialty Group), including a sale or partial spin-off, as current market conditions are not conducive to raising the equity capital originally planned for a full spin-off.
- Business Transformation: The company recorded a $6 million credit in Q2 2002 reversing previously accrued termination benefits as the transformation plan neared completion. Total plan costs since inception are approximately $294 million.
- National Program Services (NPS) Issue: A significant risk involves the managing general agent NPS, which ceased operations. Aon recorded a $6 million allowance for receivables and a $21 million increase in loss ratios. Litigation is ongoing to recover uncollected premiums.
- Credit Rating Downgrades: In early August 2002, Aon's commercial paper and senior debt were downgraded by rating agencies, leading to increased interest rates on floating rate notes and potential increases on fixed rate notes if registration rights are not met.
- Contingencies: The company faces various lawsuits, including a putative class action regarding securities violations and ongoing litigation related to the Unicover reinsurance matter and Mississippi insurance practices.
Investor Verification Checklist
- Verify the impact of the $56 million cumulative investment impairment adjustment on future earnings and the company's revised impairment recognition policy.
- Monitor the resolution of the NPS (National Program Services) litigation and the potential for further loss reserves or receivable write-downs.
- Track the status of the Combined Specialty Group divestiture and the company's ability to raise capital or execute a sale in the current market.
- Assess the financial impact of recent credit rating downgrades on borrowing costs and liquidity.
- Review the progress of the Business Transformation Plan and the realization of expected cost savings versus the $294 million already incurred.