Broking giant Aon had its fair share of trials and tribulations in 2005, but far from sticking its head in the sand it is obviating any future issues through reform and restructuring, reports Helen Yates
Last year was anything but a quiet year for the world's second largest insurance broker. One avenue of pressure was the residual and ongoing investigations into the broking industry by New York attorney general Eliot Spitzer and the knock-on affect that had, in particular the $190m settlement reached in March 2005 and lower revenues, partly due to the termination of contingent commission arrangements. Aon's decision in mid-2005 to implement a three-year restructuring plan beginning with significant changes to its UK operations provided an additional burden. Add to this mix a new CEO, the sale of certain businesses and an extremely active hurricane season, and it seems an understatement to say that Aon has had a challenging time. "The challenges of the industry were the challenges of Aon to a certain extent," explains Michael O'Halleran, chairman and chief executive officer of Aon Re Global. "The investigation by the attorneys general was probably challenge number one. Challenge two of course was the aftermath of the hurricanes in the US and clearly that demanded significant involvement of our people for our clients - not only helping them deal with the enormity of the situation, but trying to collect billions of dollars of claims on their behalf."
And yet despite all of this Aon remains relatively unscathed. Revenues for 2005 were at $9,837m, down just 1% - or $94m - compared to 2004, while brokerage commissions and fees decreased to $6,646m, down by 3% from the 2004 figure. Organic revenue growth (revenue growth after foreign exchange and other adjustments) was flat at 1%. Aon was quick to identify the main causes for this, including a loss of around $100m as a result of lost contingent commission revenue in 2004 and the absence of $212m of claim services revenue which would have come from claims business Cambridge Integrated Services, which was sold in late 2004. In addition, Aon's decision in 2004 to sell virtually all of its investment in Endurance common stock reduced 2005 pre-tax income by $75m. "Over time the absence of contingent commissions will have less and less impact on the year over year comparisons," said David Bolger, Aon Corp chief financial officer, at a press briefing following the release of Aon's first quarter results. "But for the first quarter of 2006 we recorded $6m less, or a penny per share, in contingent commissions relating to amounts earned prior to 1 October 2004."
Income from Aon's continuing operations were $956m for 2005, up by $134m on 2004 income. One of the reasons for this was higher expenses incurred in 2004, relating to the Spitzer settlement and the Daniel v Aon class action lawsuit, which together accounted for $220m of expenses in 2004. Only $5m of the total $190m settlement was absorbed into the 2005 balance sheet. Income from discontinued operations included a $239m pre-tax gain resulting from the fourth quarter sale of US wholesale brokerage business Swett & Crawford. Investment income for the year was up by $22m, or 7%, at $343m, while investment plans for 2006 so far include a $2bn shelf registration of debt and equity securities.
Across its operating segments - brokerage, consulting and insurance underwriting - pre-tax income increased for each business, however, total revenues for risk and insurance brokerage were $5,400m for the year, down by $97m on 2004. This was attributed to a softer market in 2005, in particular declining property/casualty premium, which resulted in decreased commission revenues. In particular, growth in reinsurance has been a challenge. According to O'Halleran, "The 2005 numbers really were a factor of several things. Mostly in 2005 the market was softening quite a bit across all lines and therefore our portfolios of renewals were going down. But despite the fact that revenue growth was hard to come by we did in fact have a very positive result in terms of our overall performance."
O'Halleran points out that while premium rates have hardened for hurricane-exposed lines in 2006, this has been offset by softening on casualty lines of business and in reinsurance markets outside the US. The trend of increased risk retention by many insurers and the growing popularity of alternatives to reinsurance also holds potential for the broker. "We are the leading provider of creation of catastrophe bonds, side-car deals and any other alternative that you'd like to discuss," says O'Halleran. "We are very busy working on a lot of different alternatives for our clients, some of which will definitely enhance our revenue lines for 2006."
In August 2005, Aon announced it was reviewing the revenue potential and cost structure of its brokerage, consulting and insurance underwriting businesses. Its three-year restructuring initiative is currently expected to cost a total of $290m before tax (an increased figure from its end of year estimate of $262m due to newly identified IT initiatives), of which $191m had been spent over the course of 2005 and in the first quarter of 2006. Expected restructuring costs include redundancies and lease consolidation costs, asset impairments and other expenses. Aon anticipates the restructure will lead to yearly cost savings of around $180m by the end of 2007. In total the restructure is expected to include 1,800 job cuts and a number of office closures.
Taking the brunt of the restructure is Aon UK (see figure 1), which announced last year it would be making 750 redundancies over 24 months. "The old ways of doing business are changing forever and our business needs to reflect this," said Dennis Mahoney, chairman and CEO of Aon UK. "2006 will be a watershed year for Aon as we strive to meet the challenge of a profoundly changed marketplace. By realigning our activities still further around clients we will continue to improve our service to them." The company has since shelved its plans to relocate from its London city headquarters to Canary Wharf, but other elements of the restructure are continuing.
Few heavyweights of the broking world escaped Spitzer's scrutiny in 2004 and 2005, and Aon wasn't one of them, although it arguably reacted in a more proactive manner by terminating contingent commission agreements in October 2004, when it was speculated that Aon could be Spitzer's next target after Marsh & McLennan. Aon was also quick to resolve allegations of fraud and anti-competitive practices with attorneys general in three states - New York, Connecticut and Illinois - through a multi-million dollar settlement in March 2005 and a promise to implement sweeping reforms. Under the terms of the settlement Aon agreed to pay $190m over a 30-month period for restitution to policyholders and to adopt a new business model designed to avoid conflicts of interest. "The underlying complaint in this case shows that improper conduct was pervasive at Aon," said Spitzer at the time. "To its credit, however, the company has acknowledged the problems, has agreed to compensate policyholders and has adopted reforms that will provide greater accountability in the future." As far as O'Halleran is concerned it was the right approach to take. "I believe Aon entered into an agreement with the attorneys general that we're satisfied with, that we're adhering to and that we changed our business model to respond to."
Confirming that the broker is back on track was the announcement by rating agency Standard & Poor's in December 2005 that it had revised its outlook on Aon from stable to positive and affirmed its "BBB+" credit and debt ratings. The outlook revision reflected S&P's confidence that "through the continuation of its expense reduction initiatives and, prospectively, increased success in leveraging its competitive position" it would continue to improve its operating performance. According to S&P, Aon has also successfully addressed the loss of elimination of contingent commission revenue, but added that "ongoing competitive and financial uncertainties resulting from the allegations of fraud and anticompetitive actions disclosed in the settlement with various legal entities, though materially diminished, continue to represent a potential negative to the rating."
"We are totally committed to transparency and we believe that Aon in a transparent world will survive extremely well," O'Halleran emphasises. With its bid to instil better business practices through its new business model and gain new efficiencies through the group restructure, it is a time for change, but not just for the broker. O'Halleran believes the current initiatives at Aon are a necessary step if it is to maintain its competitive edge in an evolving industry. "We can take the industry to a whole different level of efficiency," he explains. "And I believe that we are in a very strong position to lead that change in every one of our disciplines. We're absolutely adamant that we're going to get to an industry that's recognised as one of the most efficient in the financial services sector."
- Helen Yates is deputy editor of Global Reinsurance.