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WSH > SEC Filings for WSH > Form 10-K on 27-Feb-2014All Recent SEC Filings

Show all filings for WILLIS GROUP HOLDINGS PLC

Form 10-K for WILLIS GROUP HOLDINGS PLC


27-Feb-2014

Annual Report


Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations

This discussion includes references to non-GAAP financial measures as defined in Regulation G of the rules of the Securities and Exchange Commission ('SEC'). We present such non-GAAP financial measures, specifically, organic growth in commissions and fees, adjusted operating margin, adjusted operating income, adjusted net income from continuing operations and adjusted earnings per diluted share from continuing operations, as we believe such information is of interest to the investment community because it provides additional meaningful methods of evaluating certain aspects of the Company's operating performance from period to period on a basis that may not be otherwise apparent on a GAAP basis. Organic growth in commissions and fees excludes the impact of acquisitions and disposals, period over period movements in foreign currency , and investment and other income from growth in revenues. Adjusted operating income, adjusted operating margin, adjusted net income from continuing operations and adjusted earnings per diluted share from continuing operations are calculated by excluding the impact of certain specified items from operating income, net income or loss from continuing operations, and earnings per diluted share from continuing operations, respectively, the most directly comparable GAAP measures. Our methods of calculating these measures may differ from those used by other companies and therefore comparability may be limited. These financial measures should be viewed in addition to, not in lieu of, the consolidated financial statements for the year ended December 31, 2013.

This discussion includes forward-looking statements, including under the headings 'Executive Summary', 'Liquidity and Capital Resources', 'Critical Accounting Estimates' and 'Contractual Obligations'. Please see 'Forward-Looking Statements' for certain cautionary information regarding forward-looking statements and a list of factors that could cause actual results to differ materially from those predicted in those statements.

EXECUTIVE SUMMARY
Business Overview

We provide a broad range of insurance broking, risk management and consulting services to our clients worldwide and organize our business into three segments:
Global, North America and International.

Our Global business provides specialist brokerage and consulting services to clients worldwide arising from specific industries and activities including Aerospace; Energy; Marine; Construction, Property and Casualty; Financial and Executive Risks; Financial Solutions; Faber Global; Fine Art, Jewelry and Specie; Special Contingency Risks; Hughes-Gibbs; Willis Capital Markets & Advisory; Placement and Reinsurance.
North America and International comprise: our retail operations and provide services to small, medium and large corporations; and the Human Capital practice, our largest product-based practice group, provides health, welfare and human resources consulting and brokerage services.
In our capacity as advisor and insurance broker, we act as an intermediary between our clients and insurance carriers by advising our clients on their risk management requirements, helping clients determine the best means of managing risk, and negotiating and placing insurance with insurance carriers through our global distribution network.
We derive most of our revenues from commissions and fees for brokerage and consulting services and do not determine the insurance premiums on which our commissions are generally based. Commission levels generally follow the same trend as premium levels as they are derived from a percentage of the premiums paid by the insureds. Fluctuations in these premiums charged by the insurance carriers can therefore have a direct and potentially material impact on our results of operations.
Due to the cyclical nature of the insurance market and the impact of other market conditions on insurance premiums, commission revenues may vary widely between accounting periods. A period of low or declining premium rates, generally known as a 'soft' or 'softening' market, generally leads to downward pressure on commission revenues and can have a material adverse impact on our commission revenues and operating margin. A 'hard' or 'firming' market, during which premium rates rise, generally has a favorable impact on our commission revenues and operating margin. Rates, however, vary by geography, industry and client segment. As a result and due to the global and diverse nature of our business, we view rates holistically.


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Willis Group Holdings plc

Market Conditions

Market conditions in our industry are generally defined by factors such as the strength of the economies in the various geographic regions in which we serve around the world, insurance rate movements, and insurance and reinsurance buying patterns of our clients.
The industry and market in general throughout 2011 and early 2012 experienced modest increase in catastrophe-exposed property insurance and reinsurance pricing levels driven by significant catastrophe losses including the Japanese earthquake and tsunami, the New Zealand earthquake and, late in 2012, Super Storm Sandy. Also during that period, direct carriers in North America, facing persistent low investment returns, started to modestly raise rates in certain products. This firming rate environment, however, generally did not extend beyond North America to impact our International retail business. Early in 2013 the reinsurance market was generally flat, however, as the year progressed we saw changing market sentiment driven by changes in the sources of capital and increases in capital supply in the reinsurance market, most notably within the North American catastrophe-exposed property market. The influx of third party capital coupled with changes to reinsurance buying patterns and regulatory complexity is leading to growing complexity in the reinsurance market and a softening of prices.
This pattern of new capacity and market entrants coupled with strong underwriting performance in 2013, due to the absence of natural and man-made catastrophes, means that the trend of price softening is continuing as we enter 2014 and is extending to other lines of business, not just catastrophe exposed property.
The outlook for our business, operating results and financial condition continues to be challenging due to the global economic condition. There are signs of improving conditions both in the US, and within certain European Union countries, including a return to sustained GDP growth in certain countries. If conditions in the Global economy, including the US, the UK and the Eurozone deteriorate, there will likely be a negative effect on our business as well as the businesses of our clients.
In the face of this challenging economic environment we have adopted a strategy to invest selectively in growth areas, defined by geography, industry sector and client segment, and to better align our three segments so as to, among other things, bring our clients greater access to the Company's specialty areas and analytical capabilities. Our growth strategy also involves increasing our investment in, and deployment of, our analytical capabilities.

Financial Performance
Consolidated Financial Performance
2013 compared to 2012

Total revenues in 2013 of $3,655 million increased by $175 million, or 5.0 percent, compared to 2012. This included organic growth in commissions and fees of 4.9 percent, and 0.5 percent growth from acquisitions and disposals. Organic growth was achieved in all three of our operating segments led by Global with 5.6 percent. Our North America operations reported organic growth of 4.9 percent, which included a $5 million positive revenue recognition adjustment. Our International operations achieved organic growth of 4.1 percent despite recognizing a $15 million negative revenue recognition adjustment. Foreign currency movements had a negative $12 million or 0.3 percent impact on commissions and fees in 2013.

Total expenses for 2013 of $2,970 million were $719 million or 19.5 percent lower compared to 2012.
The 2013 total expenses included $46 million related to the Expense Reduction Initiative (see 'Expense Reduction Initiative' section below) conducted earlier in the year. The 2012 total expenses included a $492 million non-cash goodwill impairment charge related to our North American reporting unit, a $200 million write-off of unamortized cash retention awards following the decision to eliminate the repayment requirement of past awards, and a $252 million expense related to the accrual for 2012 cash bonuses paid in 2013. Foreign currency movements had a $9 million positive impact on total expenses in 2013. Excluding the items noted above, total expenses in 2013 were $188 million, or 6.8 percent, higher than in 2012. The largest driver of this was the increase in salaries and benefits due to annual salary reviews, higher charges for share-based compensation and new hires and investments in targeted businesses and geographies. In addition to these, we recorded higher incentives as a result of growth in commissions and fees, and the change in remuneration policy. Other operating expenses also increased due to travel, accommodation and client entertaining costs to support business development, marketing costs, strategic review charges and higher professional fees.


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Business discussion

The Company incurred a loss on extinguishment of debt of $60 million from the refinancing that was completed during 2013.
The tax rate for the full year was affected by an incremental US tax expense of $9 million recorded after taking into account the impact of adjustments to the valuation allowance placed against our US deferred tax assets.
Earnings from associates were down $5 million, net of tax, mainly due to costs of a reorganization program in our principal associate, Gras Savoye. Net income attributable to Willis shareholders from continuing operations was $365 million or $2.04 per diluted share in 2013 compared to a loss of $446 million or $2.58 per diluted share in 2012. The $811 million increase in net income compared to 2012 can be attributed primarily to the non-recurrence of the 2012 items discussed above and growth in commissions and fees partially offset by growth in expenses.
2012 compared to 2011

Total revenues in 2012 of $3,480 million increased by $33 million, or 1.0 percent, compared to 2011, including a $59 million or 1.7 percent negative impact from movements in foreign exchange. Organic growth in commissions and fees of 3.1 percent was driven by our International and Global operations. Our North America operations reported a decline of 0.6 percent in commissions and fees, due to lower revenues generated by Loan Protector, a specialty business acquired as part of the HRH business, and the continued adverse impact of difficult economic conditions in the US.

Total expenses in 2012 of $3,689 million increased $808 million compared to 2011, primarily due to the recognition of a $492 million non-cash goodwill impairment charge related to our North American reporting unit, a $200 million write-off of unamortized cash retention awards following the decision to eliminate the repayment requirement of past awards, and a $252 million expense related to the accrual for 2012 cash bonuses paid in 2013.

Excluding these expenses, total operating expenses declined $136 million, or 4.7 percent, principally due to $180 million expense recognized in 2011 related to the Operational Review and favorable movements in foreign exchange partially offset by increases in salary and benefits expenses linked to annual pay reviews, new hires and investments in targeted businesses and geographies.

Net loss attributable to Willis shareholders from continuing operations was $446 million or a loss of $2.58 per diluted share in 2012 compared to a profit of $203 million or $1.15 per diluted share in 2011. The $649 million decrease in net income compared to 2011 primarily reflects the increase in total expenses described above and the $113 million charge to establish a valuation allowance against deferred tax assets in our US operations, partially offset by the non-recurrence of the $131 million post-tax cost in 2011 relating to the make-whole amounts on the repurchase and redemption of $500 million of our senior debt and the write-off of related unamortized debt issuance costs and by the revenue growth achieved during the year. Net income in 2012 was also adversely impacted by a $7 million reduction in interest in earnings of associates, net of tax, mainly due to declining performance in our principal associate, Gras Savoye.


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Willis Group Holdings plc

Adjusted Operating Income, Adjusted Net Income from Continuing Operations and Adjusted Earnings per Diluted Share from Continuing Operations Our non-GAAP measures of adjusted operating income, adjusted net income from continuing operations and adjusted earnings per diluted share from continuing operations are calculated by excluding the impact of certain items (as detailed below) from operating income (loss), net income (loss) from continuing operations, and earnings per diluted share from continuing operations, respectively, the most directly comparable GAAP measures.

The following items are excluded from operating income (loss) and net income
(loss) from continuing operations as applicable:

(i) the additional incentive accrual recognized following the replacement of annual cash retention awards with annual cash bonuses which will not feature a repayment requirement;

(ii) write-off of unamortized cash retention awards following the decision to eliminate the repayment requirement on past awards;

(iii) goodwill impairment charge;

(iv) valuation allowance against deferred tax assets;

(v) write-off of uncollectible accounts receivable balance and associated legal fees arising in Chicago due to fraudulent overstatement of commissions and fees;

(vi) costs associated with the 2011 Operational Review;

(vii) significant legal and regulatory settlements which are managed centrally;

(viii) gains and losses on the disposal of operations;

(ix) insurance recoveries;

(x) make-whole amounts on repurchase and redemption of senior notes and write-off of unamortized debt issuance costs;

(xi) loss and fees related to the extinguishment of debt; and

(xii) costs associated with the Expense Reduction Initiative.

We believe that excluding these items, as applicable, from operating income
(loss), net income (loss) from continuing operations and earnings per diluted share from continuing operations provides a more complete and consistent comparative analysis of our results of operations. We use these and other measures to establish Group performance targets and evaluate the performance of our operations.

As set out in the tables below, adjusted operating margin at 20.0 percent in 2013, was down 160 basis points compared to 2012, while adjusted net income from continuing operations at $472 million was $18 million higher than in 2012. Adjusted earnings per diluted share from continuing operations was $2.64 in 2013, compared to $2.58 in 2012.


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Business discussion

A reconciliation of reported operating income or loss, the most directly comparable GAAP measure, to adjusted operating income is as follows (in millions, except percentages):

                                                                 Year Ended December 31,
                                                               2013         2012        2011
Operating income (loss), GAAP basis                         $   685       $ (209 )    $  566
Excluding:
Additional incentive accrual for change in remuneration
policy (a)                                                        -          252           -
Write-off of unamortized cash retention awards (b)                -          200           -
Goodwill impairment charge (c)                                    -          492           -
India JV settlement (d)                                           -           11           -
Insurance recovery (e)                                            -          (10 )         -
Write-off of uncollectible accounts receivable balance (f)        -           13          22
Net (gain) loss on disposal of operations                        (2 )          3          (4 )
2011 Operational Review (g)                                       -            -         180
FSA regulatory settlement (h)                                     -            -          11
Expense Reduction Initiative (i)                                 46            -           -
Fees related to the extinguishment of debt                        1            -           -
Adjusted operating income                                   $   730       $  752      $  775
Operating margin, GAAP basis, or operating income (loss) as
a percentage of total revenues                                 18.7 %       (6.0 )%     16.4 %
Adjusted operating margin, or adjusted operating income as
a percentage of total revenues                                 20.0 %       21.6  %     22.5 %


_________________


(a) Additional incentive accrual recognized following the replacement of annual cash retention awards with annual cash bonuses which will not feature a repayment requirement.

(b) Write-off of unamortized cash retention awards following the decision to eliminate the repayment requirement on past awards.

(c) Non-cash charge recognized related to the impairment of the carrying value of the North America reporting unit's goodwill.

(d) $11 million settlement with former partners related to the termination of a joint venture arrangement in India. In addition, a $1 million loss on disposal of operations was recorded related to the termination.

(e) Insurance recovery related to the previously disclosed fraudulent activity in Chicago. See 'Correction of Commissions and Fees Overstatement Relating to 2011 and Prior Periods', below.

(f) Write-off of uncollectible accounts receivable balance relating to periods prior to January 1, 2011, see 'Correction of Commissions and Fees Overstatement Relating to 2011 and Prior Periods', below.

(g) Charge relating to the 2011 Operational Review, including $98 million of severance costs related to the elimination of approximately 1,200 positions for the full year 2011.

(h) Regulatory settlement with the UK Financial Services Authority (FSA), now the Financial Conduct Authority (FCA).

(i) Charge related to the assessment of the Company's organizational design. See 'Expense Reduction Initiative' section below.


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Willis Group Holdings plc


A reconciliation of reported net income or loss from continuing operations and
reported earnings per diluted share from continuing operations, the most
directly comparable GAAP measures, to adjusted net income from continuing
operations and adjusted earnings per diluted share from continuing operations is
as follows (in millions, except per share data):
                                                         Year Ended                    Per diluted share
                                                        December 31,                Year Ended December 31,
                                                 2013       2012      2011        2013        2012        2011
Net income (loss) from continuing operations,
GAAP basis                                      $ 365     $ (446 )   $ 203     $   2.04     $ (2.58 )   $ 1.15
Excluding:
Additional incentive accrual for change in
remuneration policy, net of tax ($nil, $77,
$nil) (a)                                           -        175         -            -        0.99          -
Write-off of unamortized cash retention awards,
net of tax ($nil, $62, $nil) (b)                    -        138         -            -        0.78          -
Goodwill impairment charge, net of tax ($nil,
$34, $nil) (c)                                      -        458         -            -        2.60          -
India JV settlement, net of tax ($nil, $nil,
$nil) (d)                                           -         11         -            -        0.06          -
Insurance recovery, net of tax ($nil, $4,
$nil) (e)                                           -         (6 )       -            -       (0.03 )        -
Write-off of uncollectible accounts receivable
balance, net of tax ($nil, $5, $9) (f)              -          8        13            -        0.05       0.08
Net (gain) loss on disposal of operations, net
of tax ($1, $nil, $nil)                            (1 )        3        (4 )      (0.01 )      0.02      (0.02 )
2011 Operational Review, net of tax ($nil,
$nil, $52) (g)                                      -          -       128            -           -       0.73
FSA regulatory settlement, net of tax ($nil,
$nil, $nil) (h)                                     -          -        11            -           -       0.06
Make-whole amounts on repurchase and redemption
of Senior Notes and write-off of unamortized
debt issuance costs, net of tax ($nil, $nil,
$50)                                                -          -       131            -           -       0.74
Expense Reduction Initiative, net of tax ($8,
$nil, $nil) (i)                                    38          -         -         0.21           -          -
Fees related to the extinguishment of debt, net
of tax ($nil, $nil, $nil)                           1          -         -         0.01           -          -
Loss on extinguishment of debt, net of tax
($nil, $nil, $nil)                                 60          -         -         0.34           -          -
Impact of US valuation allowance                    9        113         -         0.05        0.64          -
Dilutive impact of potentially issuable shares
(j)                                                 -          -         -            -        0.05          -
Adjusted net income from continuing operations  $ 472     $  454     $ 482     $   2.64     $  2.58     $ 2.74
Average diluted shares outstanding, GAAP basis
(j)                                               179        173       176


_________________

(a) Additional incentive accrual recognized following the replacement of annual cash retention awards with annual cash bonuses which will not feature a repayment requirement.

(b) Write-off of unamortized cash retention awards debtor following the decision to eliminate the repayment requirement on past awards.

(c) Non-cash charge recognized related to the impairment of the carrying value of the North America reporting unit's goodwill.

(d) $11 million settlement with former partners related to the termination of a joint venture arrangement in India. In addition, a $1 million loss on disposal of operations was recorded related to the termination.

(e) Insurance recovery related to the previously disclosed fraudulent activity in Chicago. See 'Correction of Commissions and Fees Overstatement Relating to 2011 and Prior Periods', below.

(f) Write-off of uncollectible accounts receivable balance relating to periods prior to January 1, 2011, see 'Correction of Commissions and Fees Overstatement Relating to 2011 and Prior Periods', below.

(g) Charge relating to the 2011 Operational Review, including $98 million pre-tax of severance costs related to the elimination of approximately 1,200 positions for the full year 2011.

(h) Regulatory settlement with the UK Financial Services Authority (FSA), now the Financial Conduct Authority (FCA).

(i) Charge related to the assessment of the Company's organizational design. See 'Expense Reduction Initiative' section below.

(j) Potentially issuable shares were not included in the calculation of diluted earnings per share, GAAP basis, because the Company's net loss from continuing operations rendered their impact anti-dilutive.


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Business discussion

Goodwill Impairment
Our annual goodwill impairment analysis is performed each year at October 1. At October 1, 2013 our analysis showed the estimated fair value of each reporting unit was in excess of the carrying value, and therefore did not result in an impairment charge (2012: $492 million; 2011: $nil).
In 2012 an impairment charge for the North America reporting unit was required and amounted to $492 million. There was no impairment for the Global and International reporting units, as the fair values of these units were significantly in excess of their carrying value.
Correction of Commissions and Fees Overstatement Relating to 2011 and Prior Periods
As previously disclosed, in early 2012 we identified through our internal financial control process and a subsequent internal investigation an uncollectible accounts receivable balance of approximately $40 million in Chicago from the fraudulent overstatement of Commissions and fees from the years 2005 to 2011.
We concluded that the total $40 million of overstatement did not materially affect our previously issued financial statements for any of the prior periods and we corrected the misstatement by recognizing a charge to Other operating expenses to write off the uncollectible receivable (a) of $13 million (including legal expenses) in the first quarter of 2012 and (b) of $22 million in the fourth quarter of 2011. In the fourth quarter 2011 we also reversed a $6 million balance of Commissions and fees which had been recorded during 2011 and $2 million of Salaries and benefits expense representing an over-accrual of production bonuses relating to the overstated revenue. During 2012, we recorded within Other operating expenses a $10 million insurance settlement from insurers in respect of our claim under Group insurance policies, for compensation paid out in the years 2005 to 2010 on the fraudulently overstated revenues discussed above.
The employees in question, who have been terminated, were not members of Willis executive management nor did they play a significant role in internal control over financial reporting. Based on the results of our investigation, which has now been completed, we do not believe that any client or carrier funds were misappropriated or that any other business units were affected. We have enhanced our internal controls in relation to the business unit in question, including enhanced procedures over receipt of checks and application of cash, increased segregation of duties between the operating unit and the accounting and settlement function, and additional central sign off requirement on revenue recognition.
Expense Reduction Initiative
The Company recorded a pre-tax charge of $46 million in the first quarter of 2013 related to the previously announced assessment of the Company's organizational design. In connection with this assessment, we incurred the following pre-tax charges:
$29 million of severance and other staff related costs towards the elimination of 207 positions; and

$17 million of Other operating expenses and Depreciation resulting from the rationalization of property and systems.

The Company did not incur any further charges related to this review. The actions taken resulted in total cost savings of approximately $20 million exclusive of the costs incurred in 2013. It is also anticipated that we will achieve prospective annualized cost savings of approximately $25 million to $30 million. . . .

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