AON

Business Context and Reporting Period

This Form 10-Q covers Aon Corporation for the quarterly period ended June 30, 1995. Aon is a diversified financial services company operating primarily in insurance brokerage, consulting, and various insurance lines (life, accident and health, specialty property and casualty). The financial statements are unaudited but include normal recurring adjustments.

Key Financial Metrics

Liquidity and Debt: Cash and short-term investments totaled $1,111.9 million ($268.4M cash + $843.5M short-term investments) as of June 30, 1995. Short-term borrowings were $227.0 million, and notes payable were $496.2 million. The company maintains adequate liquidity to meet foreseeable needs.

Material Changes vs. Prior Period

• Revenue Growth: Total revenue increased 11.2% in Q2 and 11.5% YTD compared to 1994. This was driven by a 17.4% increase in brokerage commissions and fees and a 10.3% increase in net investment income.
• Profitability: Net income rose 11.9% in Q2 and 12.1% YTD. Income before tax increased 13.6% in Q2, largely due to growth in the brokerage and consulting segment.
• Segment Performance:
  • Brokerage & Consulting: Revenue up 18.3% (Q2) and 21.1% (YTD), fueled by acquisitions (JFS, EII, HRS) and internal growth.
  • Specialty P&C: Revenue surged 26.2% (Q2) due to extended warranty growth, though income before tax was flat (-0.7% YTD) due to the phase-out of high-margin liability programs.
  • Life Insurance: Revenue up 5.8% (Q2), driven by capital accumulation products.
• Balance Sheet: Total assets increased $1.1 billion to $19.0 billion since year-end 1994, primarily due to growth in the investment portfolio. Stockholders' equity increased $345.4 million, aided by $238.8 million in net unrealized investment gains.

Guidance, Outlook, and Risks

• Outlook: Management anticipates the continuation of positive cash flow and the ability to access adequate short-term credit lines. No specific numerical guidance for the full year was provided in this filing.
• Market Conditions: The brokerage segment continues to face a "soft" domestic property and casualty market with highly competitive pricing. International brokerage revenue grew 35.3% in Q2.
• Investment Risks:
  • Interest Rate Risk: Assets and interest-sensitive liabilities are closely matched with a duration variance of less than one year. However, mortgage-backed securities (CMOs) are subject to prepayment risk in declining rate environments and duration extension risk in rising rate environments.
  • Derivatives: The company uses interest rate swaps to manage duration. As of June 30, 1995, open swap contracts had unrealized losses of approximately $22.6 million.
  • Credit Risk: 96.1% of the fixed maturity portfolio is investment grade. Reserves for mortgage loan losses and illiquid holdings were $33.5 million.
• Unusual Items: The company adopted SFAS 114 and 118 in Q1 1995 regarding loan impairment, with no material effect. A $30 million valuation allowance for tax credits on unrealized losses established in 1994 was reversed in Q1 1995 due to improved market performance.

Investor Verification Checklist

• Verify the sustainability of the 18.3% revenue growth in the brokerage segment given the noted "soft" domestic P&C market.
• Monitor the phase-out of specialty liability programs and its long-term impact on Specialty P&C margins.
• Review the $22.6 million unrealized loss on interest rate swaps and the company's hedging strategy against rising interest rates.
• Confirm the composition of the $2.3 billion CMO portfolio and exposure to prepayment risk in a low-interest-rate environment.
• Assess the impact of the $66.7 million in acquisition costs on future cash flows and integration synergies.