Aon DEF 14A 2007
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Statement Pursuant to Section 14(a) of
Notice of Annual Meeting of
President and Chief Executive Officer
To Our Stockholders:
We had many accomplishments in 2006, while undertaking a number of strategic actions focused on delivering distinctive value to our clients, attracting and retaining unmatched talent and delivering operational excellence.
Our most significant accomplishments included the following:
The results of 2006 are fully on track with the first year of our three-year improvement plan with significant progress in our three key financial metrics: organic revenue growth of 5%; adjusted pretax margin improvement of 150 basis points; and a 22% increase in adjusted net income per share from continuing operations.
We feel good about the progress we have made in our three key metrics. However, we want you to fully understand that we are far from reaching what this firm and the 43,000 Aon colleagues around the world are ultimately capable of achieving, as we focus on succeeding in all three key metrics simultaneously.
From our view, 2006 was a year to streamline the company and improve efficiencies, while also investing and strengthening the foundation with a consistent way to manage and generate future revenue growth.
Building Our Foundation
Aon has built an unparalleled global network of resources and capabilities, and we are working hard to fully integrate those resources and capabilities to better serve our clients.
We took several actions to simplify and focus our organization in 2006. During the year we split our Brokerage International group into two separate business units uniquely positioned to capitalize on their leading geographic positions. Europe, Middle East, and Africa (EMEA) is now under the leadership of Roelof Hendriks and Asia Pacific (APAC) is now under the leadership of Bernie Fung.
Our London broking strength is essential to serving many of our clients throughout the world. We have more closely aligned our London broking capability with our global network. Regional broking teams were established for the Americas, EMEA and APAC in London that will report directly to their respective geographies. A global specialty broking group in London will report to Aon Global, which will serve our clients' needs for more sophisticated risk placements.
While middle market clients continue to be a cornerstone of Aon's success, we continue to believe there is significant opportunity to further penetrate the large corporate segment. We recently combined all of our large corporate services into Aon Global, in order to provide world-class solutions to clients with complex and sophisticated needs. Aon Global encompasses all of our capabilities in a single unified service platform including the global large corporate business unit, captive management services and international risk management among others. We have established three centers of excellence in Chicago, London and Hong Kong to coordinate our efforts globally. Of the largest 1,500 clients that were identified, approximately two-thirds have an existing relationship with Aon and approximately 25% have a meaningful relationship, providing significant opportunity for future growth.
In order to ensure that we fully capture the opportunity to bring Aon's capabilities to more clients, we are approaching sales management with improved tools and processes, and with greater vigor. In 2006, we began implementation of a single centralized sales database that will replace 27 separate sales management systems around the world. We are more carefully measuring opportunity pipelines across all of our businesses and geographies. We are creating marketing campaigns that can be replicated and executed across the world, ensuring that our local market planning is the best in the industry. We believe these efforts will improve organic growth rates over time as we ensure that appropriate resources are directed to specific growth opportunities.
Investing In Our Future
While the resources within Aon today are impressive, we continue to invest to ensure that our people, our capabilities, and our technology remain industry-leading.
In 2006, we welcomed significant numbers of new colleagues to Aon, and we believe the industry's top talent increasingly looks to Aon as the destination of choice. In Brokerage, we added producers across our system while building office leadership in important markets such as Los Angeles, Phoenix and San Francisco in the U.S. and our specialty desks in London. In Reinsurance, we invested in leadership and additional capabilities around both treaty and facultative reinsurance, two markets which we believe also represent significant growth opportunity. In Consulting, we invested heavily in our Financial Advisory and Litigation (FALC) business unit, which is already delivering meaningful top-line contribution.
We are making investments to ensure that Aon is positioned to deliver distinctive client value across the globe. While all of our geographies are important, we will continue to invest in growing our resources in emerging markets such as Latin America, Asia, Eastern Europe and Africa, many of which experienced double-digit revenue growth in 2006.
We also made over $150 million of acquisitions in 2006 primarily in our Brokerage and Consulting segments. We added capability in our specialty markets including environmental and construction, and in early 2007, we added Footman James, a leading affinity provider in the U.K., to our already strong position in that market. In addition, our technology platform was strengthened in early 2007 through
the acquisition of Valley Oak Systems. We believe combining Valley Oak Systems with our own capabilities creates the only web-based comprehensive risk management platform in the market today. This acquisition follows our introduction of Risk Console, an innovative claims offering platform for our larger clients.
Innovation is critical to our long-term success. Clients come to Aon for the industry's most creative, most effective, and most sought-after products and services. We have been driving innovation for many years and one such example is in our industry-leading Reinsurance group, where we have invested several hundred million dollars over the last 10 years to develop sophisticated value-added capabilities, including catastrophe modeling, capital market solutions, and actuarial analytics.
Stimulating innovation will continue to be a driver of the investment we make in our most critical asset, our colleagues. During the year, our leadership model was introduced to define the five key behaviors essential for all high-performing colleaguesclient value, teamwork, innovation, business results and living our values. These are the criteria for a systematic approach to talent development, performance evaluation, succession planning, recruitment and training. A global organization needs a global workforce, and steps like these ensure that the great talent we already have can develop, grow and contribute to everything we are trying to accomplish.
Delivering Operational Excellence
In 2006, we strengthened our relationships and increased our ability to serve clients with investments in talent, acquisitions and innovative new offerings. While maintaining our commitment to investing for the long-term success of our company, we generated strong near-term results. We were pleased with the progress we made throughout 2006 on our three key metricsimproving organic growth, expanding our segment margins, and delivering higher levels of profitability to our shareholders. Our balance sheet is strong, and we returned more than $1.2 billion to stockholders through share repurchases and dividends, highlighting our commitment to maximizing total return for our stockholders and efficiently using our shareholders' capital.
Our efforts to pursue operational excellence are closely linked with driving value for our clients. It is not about arbitrary or unfocused cost-cutting. It is about efficiency and productivityinvesting in what delivers value to our clients and minimizing or eliminating those expenses that do not.
We continue to look at outsourcing and/or offshoring for certain activities performed in our company. In September 2006, we outsourced approximately 500 positions in the U.K. as part of our deal with Exchanging. In addition to outsourcing, certain non-client facing activities are more efficiently and effectively performed by Aon colleagues operating out of lower cost locations such as India and Romania.
The restructuring program we announced in November 2005 is ahead of our original expectations as we delivered more than $119 million of savings in 2006. We are pleased that we were able to raise our initial goals for this program, and are now on track to deliver $280 million of annual savings by 2008.
There have also been numerous day-to-day operating achievements and more systematic control in areas such as information technology expense, which declined from approximately $750 million in 2005 to approximately $660 million in 2006, and in other areas including real estate, purchasing and vendor management. Changes we made to our U.S. and U.K. defined benefit pension plans should result in more than $60 million of annual pension expense savings in 2007.
Looking Forward With Optimism
I continue to have virtually daily contact with Aon clients and colleagues from around the globe. There is a palpable sense of excitement within Aon. Through greater coordination and communication, we are increasingly delivering on what we have all known Aon is capable of, and that is gratifying to all of us. Clients are seeing the value in what Aon offers, and during 2006, less than 20 years after its founding, Aon is now the largest insurance intermediary in the world. That is a stunning tribute to what my colleagues have built over the past 20 years, and to what my Aon colleagues deliver to their clients every day throughout the world.
We are an asset-rich institution with the best talent and the broadest global network of resources and capabilities. We are in a position of strength as the leading intermediary of primary risk insurance and reinsurance, and we are making meaningful investments in our future. We are reinforcing a culture that is held accountable for performance and delivering distinctive client value. We are managing capital effectively and will continue to drive value creation for our stockholders. It is my pleasure to be a part of this great company and this extraordinary team. We still have much to do, but I am optimistic for continued success in 2007 and beyond.
NOTICE OF ANNUAL MEETING OF STOCKHOLDERS
To the Holders of Common Stock of Aon Corporation:
The 2007 Annual Meeting of Stockholders of Aon Corporation will be held on Friday, May 18, 2007, at 10:00 A.M (local time), at the Indiana Room, Aon Center, 200 East Randolph Street, Chicago, Illinois 60601, for the following purposes:
Only holders of common stock at the close of business on March 21, 2007 are entitled to notice of and to vote at the Annual Meeting and any adjournment or postponement thereof. A list of the stockholders entitled to vote at the Annual Meeting will be available for inspection, for any purpose germane to the Annual Meeting, both at the Annual Meeting and during normal business hours at our corporate offices for ten days prior to the Annual Meeting.
Your vote is important. Whether or not you plan to attend the Annual Meeting, please vote as promptly as possible by telephone, through the Internet or by completing and returning the enclosed proxy card.
Why did I receive these proxy materials?
We are providing this proxy statement in connection with the solicitation of proxies by the Board of Directors of Aon Corporation ("Aon," "we," "us" or "our"), a Delaware corporation, for use at the 2007 Annual Meeting of Stockholders to be held at the Indiana Room, Aon Center, 200 East Randolph Street, Chicago, Illinois 60601, at 10:00 a.m. (local time), on Friday, May 18, 2007, and at any adjournment or postponement thereof.
This proxy statement and the accompanying proxy card are first being mailed to stockholders on or about April 11, 2007.
What matters will be presented for consideration at the Annual Meeting?
Action will be taken at the Annual Meeting with respect to the following items:
Will any other matters be decided at the Annual Meeting?
At the date of this proxy statement, we did not know of any other matters to be raised at the Annual Meeting other than those described in this proxy statement. If any other matters are properly presented at the Annual Meeting for consideration, your signed proxy card gives authority to the persons named in your proxy card to vote on such matters in their discretion.
Who is entitled to vote at the Annual Meeting?
Holders of our common stock, par value $1.00 per share (the "Common Stock") as of the close of business on March 21, 2007, are entitled to vote at the Annual Meeting. As of that date, there were 293,938,655 shares of Common Stock outstanding and entitled to vote. Each share of Common Stock is entitled to one vote on each matter properly brought before the Annual Meeting.
What is the difference between holding shares of Common Stock as a stockholder of record and as a beneficial owner?
If your shares of Common Stock are registered directly in your name with Aon's transfer agent, Computershare Trust Company, N.A., you are considered, with respect to those shares of Common Stock, the stockholder of record, and these proxy materials are being sent directly to you by Aon.
If your shares of Common Stock are held in a stock brokerage account or by a bank or other nominee, you are considered the beneficial owner of shares held in street name, and these proxy materials are being forwarded to you by your broker, bank or other nominee who is considered, with respect to those shares, the stockholder of record. As the beneficial owner, you have the right to direct
your broker, bank or other nominee how to vote your shares of Common Stock by using the voting instruction card included in the mailing or by following their instructions for voting by telephone or through the Internet.
How do I vote?
If you are a stockholder of record, you may vote using any of the following methods:
Telephone and Internet voting facilities for stockholders of record will be available 24 hours a day. If you vote by telephone or through the Internet, your vote must be received by 11:59 p.m., Eastern Time, on Thursday, May 17, 2007, the day before the Annual Meeting. If you properly cast your vote by telephone, through the Internet or by executing and returning the enclosed proxy card, and your vote is not subsequently revoked, your Common Stock will be voted in accordance with your instructions. If you execute and return the enclosed proxy card but do not give instructions, your proxy will be voted as follows: FOR the election of all nominees for Director named below, FOR the ratification of the appointment of Ernst & Young LLP as our independent registered public accounting firm for the year 2007, and otherwise in accordance with the judgment of the person or persons voting the proxy on any other matter properly brought before the Annual Meeting.
If you are a beneficial owner, you should follow the voting directions provided by your broker, bank or other nominee. You may complete and mail a voting instruction card to your broker, bank or other nominee, or, in most cases, submit voting instructions by telephone or through the Internet to your broker, bank or other nominee.
We will distribute written ballots to anyone who wants to vote at the Annual Meeting. If you are a beneficial owner, you must obtain a legal proxy from your broker, bank or other nominee and present it to the inspectors of election with your ballot to be able to vote at the Annual Meeting.
What should I do if I receive more than one proxy card?
We have endeavored to consolidate all of your Common Stock on one proxy card; however, if you receive more than one proxy card, you should vote the Common Stock represented by each proxy card to ensure that all of your Common Stock is voted.
How is a quorum determined?
The presence of the holders of a majority of the shares of Common Stock issued and outstanding and entitled to vote at the Annual Meeting, present in person or represented by proxy, is necessary to constitute a quorum. Abstentions and broker non-votes will be counted as present and entitled to vote for purposes of determining a quorum at the Annual Meeting.
What is a broker non-vote?
A broker non-vote occurs when a nominee, such as a broker or bank, holding shares of Common Stock on behalf of a beneficial owner does not vote on a particular proposal because the nominee has
not received instructions from the beneficial owner and does not have discretionary voting power with respect to that proposal.
What are the voting requirements to elect Directors and approve each of the proposals?
Except as otherwise required by applicable law or our Second Amended and Restated Certificate of Incorporation, as amended, any proposal properly presented at a meeting in which a quorum is present will be decided by the affirmative vote of the holders of a majority of the Common Stock present in person or represented by proxy and entitled to vote on the proposal at that meeting. Accordingly, the election of fourteen Directors and the ratification of the appointment of our independent registered public accounting firm will be decided by the vote of the holders of a majority of the Common Stock present in person or represented by proxy and entitled to vote on these matters. For the election of Directors, a vote withheld for a nominee for Director will have the effect of a vote against that nominee. For the ratification of the appointment of our independent registered public accounting firm, a stockholder who submits a ballot or proxy is considered present and entitled to vote, so an abstention will have the effect of a vote against the proposal.
Under the rules of the New York Stock Exchange (the "NYSE"), if you are a beneficial owner, your broker, bank or other nominee has discretion to vote your shares of Common Stock on the election of Directors and the ratification of the appointment of our independent registered public accounting firm.
Can I change my vote?
If you are a stockholder of record, you can change your vote or revoke your proxy at any time before the Annual Meeting by:
If you are a beneficial owner of shares of Common Stock, you may submit new voting instructions by contacting your broker, bank or other nominee. You may also vote in person at the Annual Meeting if you obtain a legal proxy as described above under "How do I vote?"
All shares of Common Stock that have been properly voted and not revoked will be voted at the Annual Meeting. Attending the Annual Meeting without taking further action will not automatically revoke your prior telephone or Internet vote or your proxy.
Will the Annual Meeting be webcast?
You may listen to the Annual Meeting on the World Wide Web by logging on to our website at www.aon.com and following the on-screen instructions. We have included our website address in this proxy statement for reference purposes only. The information contained on our website is not incorporated by reference into this proxy statement.
Who can attend the Annual Meeting?
Stockholders as of the close of business on March 21, 2007, which is the record date for voting, may attend the Annual Meeting.
What do I need to do to attend the Annual Meeting?
If you are a stockholder of record, you do not need to take any additional action in order to attend the Annual Meeting. If you are a beneficial owner of shares of Common Stock and would like to attend the Annual Meeting, you will need to bring an account statement or other acceptable evidence of ownership of your Common Stock as of the close of business on March 21, 2007, which is the record date for voting. Alternatively, you may contact the broker, bank or other nominee in whose name your Common Stock is registered and obtain a proxy to bring to the Annual Meeting.
Who will pay the costs of this proxy solicitation?
We will pay the expenses of the preparation of proxy materials and the solicitation of proxies for the Annual Meeting. In addition to the solicitation of proxies by mail, solicitation may be made on our behalf by certain Directors, officers or employees of Aon and our subsidiaries telephonically, electronically or by other means of communication, and by Georgeson Shareholder Communications Inc., whom we have hired to assist in the solicitation and distribution of proxies. Directors, officers and employees of Aon and our subsidiaries will receive no additional compensation for such solicitation. Georgeson will receive a fee of $7,000 for its services. We will also reimburse banks, brokers and other nominees for costs incurred by them in mailing proxy materials to beneficial owners in accordance with applicable rules.
Who will count the vote?
Representatives of our transfer agent, Computershare Trust Company, N.A., will count the vote and serve as inspectors of election.
As of March 21, 2007, the beneficial owners of 5% or more of our Common Stock entitled to vote at the Annual Meeting and known to us were:
permitted by Rule 13d-4 of the Exchange Act, Southeastern disclaims beneficial ownership of the shares of Common Stock covered by the Schedule 13G.
Fourteen Directors are to be elected at the Annual Meeting of Stockholders. All of the current members of our Board of Directors (the "Board") are standing for election. The term of each Director expires at the next Annual Meeting of Stockholders, and each Director will continue in office until the election and qualification of his or her respective successor or until his or her earlier death, removal or resignation. The Board of Directors consists of a number of Directors as is fixed from time to time by resolution adopted by the Board of Directors as provided in our bylaws. The Board of Directors currently is authorized to have up to twenty-one members.
All nominees are currently Directors of Aon. All nominees for Director have consented to be named and have agreed to serve as Directors if elected. The Governance/Nominating Committee recommended to the full Board of Directors that each Director be nominated to serve for an additional term.
The fourteen Directors will be elected by the vote of the majority of the Common Stock present in person or represented by proxy at the Annual Meeting. Accordingly, since votes withheld will count as present at the Annual Meeting (and will therefore also count toward the establishment of a quorum), a vote withheld for a nominee will adversely affect that nominee's ability to secure the necessary majority of votes present at the Annual Meeting.
Unless a proxy directs to the contrary, it is intended that the proxies will be voted for the election of the fourteen nominees for Director named on the following pages, to hold office until the next Annual Meeting of Stockholders or until their respective successors are duly elected and qualified. We have no reason to believe that any of the nominees will not be available to serve as a Director. However, if any of them should become unavailable to serve for any reason, the proxies will be voted for such substitute nominees as may be designated by the Board of Directors.
Set forth on the following pages is biographical information concerning each nominee for election as a Director, the nominee's principal occupation and the period during which the nominee has served as a Director of Aon, including service as a Director or employee of Ryan Insurance Group, Inc. ("Ryan Group"), which merged with Aon in 1982. The information presented has been confirmed by each nominee for purposes of its inclusion in this proxy statement. Ages shown for all Directors are as of December 31, 2006.
OUR BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS THAT YOU VOTE "FOR" THE ELECTION OF ALL NOMINEES.
The following table sets forth the number of shares of Common Stock beneficially owned as of March 21, 2007 by each Director and nominee, by each of the named executive officers of Aon as set forth in the 2006 Summary Compensation Table in this proxy statement, and by all Directors, nominees and executive officers of Aon as a group. As used in this proxy statement, beneficially owned means a person has, or may have within 60 days, the sole or shared power to vote or direct the voting of a security and/or the sole or shared investment power with respect to a security (i.e., the power to dispose or direct the disposition of a security). Therefore, the table does not include the "phantom stock" shares held by or attributable to any individual under our benefit plans.
The Board of Directors has adopted Board Governance Guidelines (the "Governance Guidelines"), which, along with the Committee charters, the Code of Business Conduct, which provides minimum standards of conduct for employees, officers and Directors, the Code of Ethics, and the Code of Ethics for Senior Financial Officers, provide the framework for the governance of Aon. The Board provides oversight of Aon's overall performance, strategic direction, and executive management team performance. The Board also approves major initiatives and transactions and advises on key financial and business matters. The Board is kept apprised of Aon's progress on a regular basis through Board and Committee meetings, discussions with management, operating and financial reports provided by the Chief Executive Officer and Chief Financial Officer, and other material distributed to the Directors throughout the year.
The Governance Guidelines require that Aon have a majority of Directors who meet the categorical standards of independence adopted by the Board, which must meet or exceed the NYSE independence requirements. The Governance Guidelines further provide that each of the members of the Audit, Compliance, Governance/Nominating, Investment and Organization and Compensation Committees will be comprised entirely of independent Directors. The principal responsibilities of each Committee are described below.
Pursuant to the NYSE corporate governance rules, the Board has adopted categorical independence standards to provide assistance in the determination of Director independence. The categorical standards are set forth below and provide that a Director will not qualify as an independent Director if:
For purposes of the categorical standards, immediate family member includes a Director's spouse, parents, children, siblings, mothers and fathers-in-law, sons and daughters-in-law, brothers and sisters-in-law, and anyone (other than domestic employees) who shares the Director's home.
The Board engages in an annual review of director independence. As part of that review, the Board considered transactions and relationships between each Director and any member of the Director's immediate family and the Company.
In determining that each of the non-employee Directors is independent, the Board also considered the following relationships that it deemed were immaterial to such Director's independence.
With respect to Mr. Jannotta, Mr. Martin, Mr. Notebaert, Mr. McKenna, Mr. Rogers and Ms. Santona, the Board considered that, in the ordinary course of business, Aon has sold services to, or purchased services from, a company (or other entity) at which these Directors is a senior or executive officer (or, in the case of Mr. Martin, is counsel), and in each case the amount paid to or received from one of these entities in any of the previous three fiscal years was below one percent (1%) of Aon's or the other company's annual revenue.
With respect to each non-management Director, the Board considered that, in the ordinary course of business, Aon has sold services to, or purchased services from, a company (or other entity) at which each non-management Director serves as a Director.
With respect to Mr. Knight, the Board considered personal investments made by Mr. Ryan, Mr. Jannotta, Mr. McKenna and Mr. O'Halleran, and by the Aon Pension Fund, in a privately held fund managed by Mr. Knight. The Board determined that the investments were immaterial and did not impact any Director's independence.
The Board considered that Mr. Knight, Mr. Martin, Mr. McKenna and Mr. Rogers serve on the boards of one for-profit and various not-for-profit entities with executive officers of Aon.
With respect to Mr. Janotta, Mr. Kalff, Mr. Knight, Mr. Martin, Mr. McKenna, Mr. Morrison, Mr. Notebaert, Mr. Rogers, Ms. Santona and Dr. Woo, the Board considered that Aon has made charitable contributions in 2006 to organizations in which the Director or an immediate family member of the Director is an officer, director or trustee. No such charitable contribution exceeded the greater of $100,000 or 1% of such organization's revenue in 2006.
After a thorough review of all such relationships, using the categorical standards adopted by the Board, the Board affirmatively determined that none of the outside Directors has a material relationship with the Company. The Board of Directors determined that each of Mr. Jannotta, Mr. Kalff, Mr. Knight, Mr. Losh, Mr. Martin, Mr. McKenna, Mr. Morrison, General Myers, Mr. Notebaert, Mr. Rogers, Ms. Santona and Dr. Woo is an independent Director. Mr. Case is considered a management Director because of his position as President and Chief Executive Officer of
Aon. Mr. Ryan is considered a management Director because of his position as Executive Chairman of Aon. In making its determination, the Board of Directors considered all relevant facts and circumstances, including commercial, industrial, banking, consulting, legal, accounting, charitable and familial relationships and considered the issue not merely from the standpoint of a Director, but also from that of persons or organizations with which the Director has an affiliation.
The Board met seven times in 2006. All incumbent Directors attended at least seventy-five (75%) of the meetings of the Board and all committees of the Board on which they served.
Meetings of Non-Management Directors
In accordance with NYSE rules and the Governance Guidelines, non-management Directors meet regularly in executive session without management. In 2006, Aon's non-management Directors met four times in executive session. Andrew J. McKenna, Chairman of the Governance/Nominating Committee and Aon's lead independent Director (the "Lead Independent Director"), chaired these executive sessions.
Stock Ownership Guidelines for Non-Management Directors
In July 2006, the Board of Directors adopted Stock Ownership Guidelines for Non-Management Directors. The Guidelines require each non-management Director to hold an investment position in Common Stock (including vested deferred stock units) equal to three times the annual Director retainer. The Guidelines provide a transition period of five years for non-management Directors to achieve the ownership guidelines level, however, notwithstanding that, each new non-management Director is expected to hold 1,000 shares within the first year of joining the Board or transitioning from a management Director to a non-management Director.
Attendance at Annual Meeting
The Governance Guidelines provide that Directors are expected to attend the Annual Meeting of Shareholders. All of our Board members attended the 2006 Annual Meeting of Stockholders held on May 19, 2006.
Communications with the Board of Directors
Stockholders and other interested parties may communicate with the Board of Directors by contacting the non-management Directors of Aon Corporation c/o Office of the Corporate Secretary, 200 East Randolph Street, Chicago, IL 60601. Alternatively, stockholders and other interested parties may communicate with Aon's non-management Directors via electronic mail to the following address: firstname.lastname@example.org.
The non-management Directors have established procedures for handling communications from stockholders and other interested parties. Communications are distributed to the Chairman of the Governance/Nominating Committee, the full Board of Directors, the non-management Directors or to any individual Director or Directors as appropriate, depending on the facts and circumstances outlined in the communication. Solicitations, spam, junk mail and mass mailings, resumes and other forms of job inquiries, business solicitations or advertisements and frivolous or inappropriate communications will not be forwarded, but will be made available to any non-management Director upon request.
The Board has adopted a code of ethics regarding business conduct that applies to our Directors, officers and employees. This Code of Ethics can be found on our web site at http://www.aon.com/about/corp_governance/code_of_ethics.jsp and is available in print copy to any stockholder who makes a written request to our Corporate Secretary.
In addition, the Board has adopted a Code of Ethics for Senior Financial Officers that applies to the principal executive officer and the senior financial officers of Aon and our subsidiaries. The Code of Ethics for Senior Financial Officers can be found on our web site at http://www.aon.com/about/corp_governance/sfo_code.jsp.
We intend to disclose future amendments to, or waivers from, certain provisions of both the Code of Ethics and the Code of Ethics for Senior Financial Officers on our website promptly following the date of such amendment or waiver.
The Board of Directors has appointed standing committees, including Executive, Audit, Compliance, Governance/Nominating, Investment and Organization and Compensation Committees. The charters of the Audit, Compliance, Governance/Nominating, Investment and Organization and Compensation Committees are available on the corporate governance section of our website at http://www.aon.com/about/corp_governance/board_charter. Membership on the committees since the last Annual Meeting of the Board in 2006 has been as follows:
When the Board of Directors is not in session, the Executive Committee is empowered to exercise the power and authority in the management of the business and affairs of Aon as would be exercised by the Board of Directors, subject to certain exceptions. The Executive Committee acted by unanimous written consent twice in 2006.
In 2006, the Audit Committee met eight times. The Board of Directors has determined that each of the members of the Audit Committee is independent as defined by the rules of the NYSE. All of the Committee members are financially literate. The Board of Directors has determined that each of John W. Rogers, Jr., the Chairman of our Audit Committee, Robert S. Morrison and Richard C. Notebaert is an "audit committee financial expert" within the meaning of rules promulgated by the SEC. The primary purposes of the Audit Committee are to assist the Board with the oversight of: (i) the integrity of Aon's financial statements; (ii) Aon's compliance with legal and regulatory requirements and ethics programs established by management and the Board; (iii) the independent auditor's qualifications and independence; and (iv) the performance of Aon's internal audit function and independent auditor. In discharging this role, the Audit Committee is authorized to retain outside counsel or other experts as it deems appropriate to carry out its duties and responsibilities.
Additional information regarding the Audit Committee's responsibilities may be found in the section under the heading "Report of the Audit Committee."
The Compliance Committee oversees Aon's policies, programs and procedures to ensure compliance with relevant laws, Aon's Code of Conduct, and other relevant standards. The Compliance Committee also monitors Aon's efforts to implement legal obligations arising from settlement agreements and other similar documents and performs other duties as directed by Aon's Board of
Directors. Each member of the Compliance Committee is independent as defined by the NYSE listing standards. The Compliance Committee met three times during 2006.
The Governance/Nominating Committee identifies and recommends to the Board of Directors candidates for service on the Board, reviews and recommends the renomination of incumbent Directors, reviews and recommends committee appointments and leads the annual performance review of the Board of Directors. In addition, the Governance/Nominating Committee reviews and recommends governance guidelines for Aon to the Board of Directors and reviews related party transactions. Each member of the Governance/Nominating Committee is independent as defined by the NYSE listing standards. The Governance/Nominating Committee met five times during 2006.
The Governance/Nominating Committee considers recommendations for Director candidates from Aon's Directors, executive officers and stockholders. Although the Governance/Nominating Committee does not specifically solicit suggestions from stockholders regarding possible Director candidates, the Governance/Nominating Committee will consider stockholders' recommendations. Recommendations, together with the name and address of the stockholder making the recommendation, relevant biographical information regarding the proposed candidate and a description of any arrangement or understanding between the stockholder and the proposed nominee, should be sent to our Corporate Secretary. Consistent with the Governance Guidelines, the Governance/Nominating Committee considers a number of criteria in evaluating Director candidates, including professional background, expertise, reputation for integrity, business experience, leadership capabilities and potential contributions to the Board of Directors and Aon's management. The Governance/Nominating Committee also considers whether a potential nominee would satisfy the independence standards of the NYSE.
When a vacancy exists on the Board of Directors due to the expansion of the size of the Board of Directors or the resignation or retirement of an existing Director, the Governance/Nominating Committee identifies and evaluates potential Director nominees. The Governance/Nominating Committee has sole authority to retain and terminate any search firm to be used to identify Director candidates and sole authority to approve such search firm's fees and other retention terms.
Candidates for Director are evaluated using the criteria discussed above and the existing composition of the Board of Directors, including its size, structure, backgrounds and areas of expertise of existing Directors and the number of independent and management Directors. The Governance/Nominating Committee also considers the specific needs of the various Board committees. The Governance/Nominating Committee recommends potential Director candidates to the full Board of Directors, which is responsible for final approval of any Director candidate. This process is the same for Director candidates who are recommended by our stockholders.
Recommendations for Director candidates to stand for election at the 2008 Annual Meeting of Stockholders must be submitted in writing to the Corporate Secretary of Aon, 200 East Randolph Street, Chicago, IL 60601. Recommendations will be forwarded to the Chairman of the Governance/ Nominating Committee for review and consideration.
The Investment Committee is responsible for overseeing the investments of our underwriting segment, reviewing all private placement investments for business units outside the underwriting
segment and monitoring the investment performance of our benefit plans. The Investment Committee met three times during 2006.
Organization and Compensation Committee
The Organization and Compensation Committee annually reviews and determines the compensation of Aon's executive officers, including Aon's Executive Chairman and Chief Executive Officer subject to the approval of the independent members of the Board. The Organization and Compensation Committee consults with the Chief Executive Officer on, and directly approves, the compensation of other executive officers. The Organization and Compensation Committee administers the Aon Stock Incentive Plan (and its predecessor plans), including granting stock options and stock awards (other than awards to the Chief Executive Officer or Executive Chairman, which awards must be approved by the independent members of the Board) and interpreting the plan, and has general administrative responsibility with respect to Aon's other U.S. employee benefit programs. In addition, the Organization and Compensation Committee makes recommendations to the Board concerning Director compensation and certain amendments to U.S. employee benefit plans or equity plans. The Organization and Compensation Committee may delegate its authority to sub-committees when appropriate. The Organization and Compensation Committee met five times during 2006. The Organization and Compensation Committee charter can be found on the corporate governance section of our website at http://www.aon.com/about/corp_governance/board_charters/org_comp_charter.jsp
The role of Aon management is to assist the Committee in managing the Company's executive and Director compensation programs. Direct responsibilities of management include, but are not limited to:
Since 2005, the Organization and Compensation Committee has retained Frederic W. Cook & Co. ("F.W. Cook") as the Committee's independent compensation consultant. F.W. Cook provides independent third party advice and expertise to the Organization & Compensation Committee on a wide array of executive and director compensation matters.
Compensation Committee Interlocks and Insider Participation
During 2006, the Organization and Compensation Committee was composed of Richard C. Notebaert (Chairman), Edgar D. Jannotta, Lester B. Knight, J. Michael Losh, Andrew J. McKenna, Robert S. Morrison and Richard B. Myers. General Myers commenced service on the Organization and Compensation Committee on May 19, 2006. No member of the Organization and Compensation Committee was, during 2006 or previously, an officer or employee of Aon or any of its subsidiaries. In addition, during 2006, there were no compensation committee interlocks required to be disclosed.
Based on the New York Stock Exchange listing standards, the Board of Directors has determined that each member of the Audit Committee is an independent Director. In addition, the Board of Directors has determined that each of John W. Rogers, Jr., Robert S. Morrison and Richard C. Notebaert is an "audit committee financial expert," as defined by the SEC rules. The Audit Committee operates pursuant to a charter that was last amended and restated by the Board on March 16, 2007.
The Audit Committee oversees Aon's financial reporting process on behalf of the Board of Directors. Management has the primary responsibility for establishing and maintaining adequate internal financial controls, for preparing the financial statements and for the reporting process.
Ernst & Young LLP ("E&Y"), Aon's independent registered public accounting firm for 2006, is responsible for expressing opinions on the conformity of Aon's audited financial statements with generally accepted accounting principles, management's assessment of the effectiveness of Aon's internal control over financial reporting and the effectiveness of Aon's internal control over financial reporting.
In this context, the Audit Committee reviewed and discussed with management and E&Y the audited financial statements for the year ended December 31, 2006, as well as management's assessment of the effectiveness of Aon's internal control over financial reporting and E&Y's evaluation of Aon's internal control over financial reporting. The Audit Committee has discussed with E&Y the matters that are required to be discussed by Statement on Auditing Standards No. 61 (Communication With Audit Committees), as may be amended or supplemented.
In addition, the Audit Committee has discussed with E&Y the independence of that firm from Aon and its management, including the matters in the written disclosures required by Independence Standards Board Standard No. 1 (Independence Discussions with Audit Committees), as may be amended or supplemented. The Audit Committee has also considered whether E&Y's provision of non-audit services to Aon is compatible with maintaining E&Y's independence. The Audit Committee has concluded that E&Y is independent from Aon and its management.
The Audit Committee discussed with Aon's internal auditors and E&Y the overall scope and plans for their respective audits. The Audit Committee meets with the internal and independent auditors, with and without management present, to discuss the results of their examinations, their evaluations of Aon's internal controls, and the overall quality of Aon's financial reporting.
The members of the Audit Committee are not professionally engaged in the practice of auditing or accounting and are not experts in the fields of accounting or auditing, including in respect of auditor independence. Members of the Audit Committee rely without independent verification on the information provided to them and on the representations made by management, E&Y, and the internal auditors.
In reliance on the reviews and discussions referred to above, and subject to the limitations on the role and responsibilities of the Audit Committee referred to above, the Audit Committee recommended to the Board of Directors (and the Board has approved) that the audited financial statements be included in the Annual Report on Form 10-K for the year ended December 31, 2006 for filing with the
SEC. The Audit Committee has approved, and the Board of Directors has requested that stockholders ratify, the selection of E&Y as our independent auditor for the year 2007.
The Audit Committee has appointed Ernst & Young LLP ("E&Y") as Aon's independent registered public accounting firm for the year 2007, subject to ratification by our stockholders. E&Y was first retained as Aon's independent registered public accounting firm in February 1986. Although this appointment is not required to be submitted to a vote of the stockholders, the Board of Directors believes it appropriate as a matter of policy to request that the stockholders ratify the appointment of the independent registered public accounting firm for the year 2007. In the event a majority of the votes cast at the meeting are not voted in favor of this proposal, the Audit Committee will reconsider the appointment, but may decide to maintain its appointment of E&Y.
We anticipate that a representative of E&Y will be present at the Annual Meeting. The representative will be given the opportunity to make a statement if he or she desires to do so, and is expected to be available to respond to any appropriate questions that may be submitted by stockholders at the Annual Meeting.
OUR BOARD OF DIRECTORS AND AUDIT COMMITTEE UNANIMOUSLY RECOMMEND THAT YOU VOTE "FOR" THE RATIFICATION OF THE APPOINTMENT OF ERNST & YOUNG LLP AS OUR INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM FOR 2007.
Audit Fees. Fees for audit services totaled approximately $18.1 million in 2006 and $18.9 million in 2005. For both years, audit fees included services associated with the annual audit, including fees related to Sarbanes-Oxley Section 404, the reviews of Aon's documents filed with the SEC, and statutory audits required domestically and internationally. Fees for required statutory audits and attestation reports in various domestic and foreign jurisdictions were approximately $8.3 million in 2006 and $9.1 million in 2005, respectively.
Audit-Related Fees. Fees for audit-related services totaled approximately $1.4 million in 2006. There were no individual projects that exceeded $250,000. In 2005, fees for audit-related services totaled approximately $0.9 million. There were no individual projects that exceeded $250,000. Audit-related fees include services such as employee benefit plan audits, other attestation services, due diligence in connection with acquisitions and accounting consultations not included in audit fees.
Tax Fees. Fees for tax services, including tax compliance, tax advice and tax planning totaled approximately $1.8 million in 2006 and $1.3 million in 2005.
All Other Fees. Fees for all other services not included above totaled approximately $0.1 million in 2006. In 2005, fees for all other services not included above totaled approximately $0.2 million.
Audit Committee's Pre-Approval Policies and Procedures
The Audit Committee pre-approves all audit and permissible non-audit services provided by the independent registered public accounting firm. These services may include audit services, audit-related services, tax services and other services. Each pre-approval provides details regarding the particular service or category of service to be provided and is subject to a specific engagement authorization. The Audit Committee requires that the independent registered public accounting firm and management report on the actual fees charged by the independent registered public accounting firm for each category of service at Audit Committee meetings held during the year.
The Audit Committee acknowledges that circumstances may arise throughout the year that require the engagement of the independent registered public accounting firm to provide additional services not contemplated in the initial pre-approval. In those circumstances, the Audit Committee requires that specific pre-approval be obtained before engaging the independent registered public accounting firm. The Audit Committee has delegated pre-approval authority to the Chairman of the Audit Committee for those instances when pre-approval is needed prior to a scheduled Audit Committee meeting. Such pre-approvals are reported to the Audit Committee at the next scheduled Audit Committee meeting.
All audit and non-audit services provided by the independent registered public accounting firm during 2006 were pre-approved.
Introduction. This section provides an overview of Aon's executive compensation program, a description of the program elements and an analysis of the key policies and practices underlying our program during 2006.
Objectives of Our Compensation Program. Under the direction of our Board's Organization and Compensation Committee (the "Committee"), the compensation program is fundamentally designed to align the financial interests of our executives with those of our stockholders, both in the short and long term. To that end, we have established an executive compensation program that supports Aon's key business imperatives of: (a) delivering distinctive client value; (b) achieving operational excellence; and (c) strengthening our talent and capability.
Elements of Our Compensation Program.
Overview. The three major elements of our compensation program are base salary, annual bonus and long-term equity awards. To a lesser extent, other forms of compensation are also provided under the program, including participation in Aon's benefit programs, perquisites and post-employment compensation.
Base Salary. We choose to provide base salary as a component of total compensation to provide a stream of income to our executive officers during the year. In the first quarter of each year, we review the base salaries of our executive officers and make any necessary adjustments. In determining individual salaries, we consider the scope of job responsibilities, individual contributions to company-wide and business unit performance and competitive levels for comparable positions in the marketplace, as described more fully below under the heading "Our Use of Benchmarking." Our philosophy and practice is to place a greater emphasis on the incentive components of compensation, and base salaries of executive officers are therefore adjusted only occasionally. The 2006 base salaries of our named executive officers are set forth in the 2006 Summary Compensation Table on page 40 under the column labeled "Salary." Our rationale for 2006 base salary adjustments is set forth below under the heading "Policies Underlying Our 2006 Compensation Program for Named Executive Officers."
Annual Bonus Plan. We choose to provide annual bonus eligibility as a component of our compensation program to provide our executive officers with short-term incentive to achieve the chosen performance goals. We believe it is important to provide incentives to executives in the short-term as well as the long-term to keep them consistently focused on achieving Aon's key business imperatives. In the first quarter of each year, we determine the annual bonus eligibility of our executive officers for the current fiscal year under Aon's incentive plan. We also determine at that time whether our executive officers are eligible for bonuses for the prior calendar year and, if so, we determine the actual bonus awards payable. In setting individual bonus eligibility for the current calendar year, we consider the scope of job responsibilities, our expectations regarding the executive's contributions to company-wide and business unit performance and competitive bonus levels for comparable positions in the marketplace, as described more fully below under the heading "Our Use of Benchmarking."
We also take into consideration the fact that annual bonuses might not be deductible by Aon for certain executive officers unless the bonuses meet specific criteria set forth in our stockholder-approved
bonus plan known as the "Senior Officer Incentive Compensation Plan" (the "Executive Bonus Plan"). For 2006, annual bonus eligibility for any executive officer was capped at $5 million under the Executive Bonus Plan. Within the framework of the Executive Bonus Plan, we set bonus eligibility for our named executive officers as follows: the target amount of each executive's bonus was 100% (125% for Mr. Case and Mr. Ryan) of the executive's base salary; the bonus range was capped at 200% (250% for Mr. Case and Mr. Ryan) of the executive's base salary; the determination of the actual bonus amount payable was determined based, among other things, on Aon's performance overall and the performance of the executive's business unit and personal performance; bonuses for the executives were determined through the Committee's exercise of its discretion to adjust the bonuses downward, but only after the Committee determined that Aon had achieved its specified performance target. Factoring individual performance into the analysis allows us to differentiate among executives and emphasize the link between individual performance and compensation.
All annual incentive compensation for this group was tied to the achievement of a minimum threshold level of 85% of planned pre-tax income from continuing operations, adjusted for unusual items such as gains or losses from the sale of a business or asset. All such adjustments were individually approved by the Committee and met the adjustment criteria established by the Committee within the first 90 days of 2006. We chose this measure to emphasize performance of Aon as a whole and directly link executives' awards to Aon's key business initiatives of delivering distinctive client value and achieving operational excellence. The bonuses of less senior Aon employees were tied to the achievement of a lower minimum threshold level, 70%, of targeted pre-tax pre-incentive net income of their business units, below which level incentives are capped at 25% of the target pool.
The annual bonuses of executive officers are payable pursuant to Aon's "incentive stock program." Under the program generally all annual bonuses of $50,000 or greater are payable 80% in cash and 20% in restricted stock units with a 10% equity enhancement as described below under the heading "Equity CompensationRestricted Stock Units." The primary goals of the program are to further focus the employees' attention on the longer-term performance of the Company as a whole, and to further promote employee retention.
The 2006 annual bonus of each named executive officer is shown in the 2006 Summary Compensation Table on page 40 under the column labeled "Non-Equity Incentive Plan Compensation." Our rationale for awarding the 2006 bonuses to the named executive officers is set forth below under the heading "Policies Underlying Our 2006 Compensation Program for Named Executive Officers."
Overview. We choose to provide equity compensation to executive officers as a key component of our compensation program to align the interests of our executives with our stockholders on a long-term basis; to focus the executives' efforts on achieving Aon's overall business imperatives of delivering distinctive client value and achieving operational excellence, because such achievements are expected to result in our increased long-term value; and to encourage executive retention through the vesting provisions that are typically connected with our equity awards. Overall, we believe equity compensation is effective for rewarding the creation of stockholder value and encouraging the ownership of Aon stock. Annually, the Committee approves individual equity awards for executive officers. We determine the amount of each individual's grant based upon the executive's performance, market data and our expectations regarding the executive's future contribution to Aon. All awards are granted pursuant to the stockholder-approved Aon Stock Incentive Plan (the "Stock Plan"). The Stock Plan allows for the grant of a variety of equity compensation awards, including performance awards, stock options and
restricted stock unitsthe three forms of equity compensation granted to our named executive officers in 2006.
Performance Awards. In the first quarter of 2006 we granted "performance shares" to our executive officers pursuant to our "leadership performance program" ("LPP"), a sub-plan of the Stock Plan that is intended to further strengthen the relationship between executive capital accumulation and long-term company financial performance and stockholder value. The performance shares were granted in the form of units payable in Aon shares, and the performance shares were valued on the date of grant based on that day's average of the high and low trading prices of Common Stock, in accordance with the terms of the Stock Plan. The units will be earned and settled in a range of 0 to 150% of target based on performance results over a three-year performance period. The performance period began January 1, 2006 and will end on December 31, 2008, and the performance results will be measured against the specified cumulative earnings per share target for the 2006-2008 period, which ranges from $7.02 to $8.74. These targets represent annual average growth rates of 8% ($7.02) up to 20% ($8.74) as compared to an adjusted 2005 base year EPS of $2.00. In the future, we may award performance shares that have performance results that differ from those performance shares awarded for 2006-2008.
In addition to the broad-based multi-year performance awards under our LPP, we also grant individual performance-based equity awards to executive officers when we seek to encourage specific performance results from a business unit or operating division. Details regarding, and our rationale for awarding, the 2006 individual performance-based equity awards to certain named executive officers is set forth below under the heading "Policies Underlying Our 2006 Compensation Program for Named Executive Officers." The estimated future payouts related to performance awards granted to our named executive officers in 2006 are set forth in 2006 Grants of Plan-Based Awards on page 43.
Stock Options. Under the LPP, we also granted stock options to our executive officers. The exercise price of the options is the average of the high and low trading prices of Common Stock on the date of grant, pursuant to the terms of the Stock Plan. The options will vest in three equal annual installments and have a six-year term. The number of securities underlying, and the exercise price of, the stock options awarded to our named executive officers in 2006 are set forth in 2006 Grants of Plan-Based Awards on page 43. Our rationale for awarding the stock options to our named executive officers is set forth below under the heading "Policies Underlying Our 2006 Compensation Program for Named Executive Officers."
Restricted Stock Units. In the first quarter of 2007 we granted time-vested restricted stock units to certain executive officers in connection with the "incentive stock program" (briefly described above under the heading "Annual Bonus Plan") pursuant to which the executives received a portion of their 2006 annual bonus in the form of equity compensation. The restricted stock units vest ratably over a three-year period and are generally payable in shares of Common Stock along with ongoing dividend equivalents. In addition, we provided a 10% enhancement to the entire incentive award in the form of additional restricted stock units that become fully vested after the third year. For bonuses to be earned in 2007 and payable in 2008, all executive officers will receive 65% of their bonus in cash and 35% in restricted stock units pursuant to Aon's incentive stock program. The additional 10% stock enhancement will be eliminated for all executive officers for incentives paid for 2007 and beyond.
Pursuant to their employment arrangements, Mr. O'Halleran and Mr. Rice were each awarded restricted stock units in 2006. Mr. Rice's employment agreement provided for a one-time grant of 27,500 restricted stock units. Mr. O'Halleran's employment agreement provided for an annual grant of 22,500 time-vested restricted stock units, and he received such grant in early 2006. Mr. O'Halleran's
employment agreement was amended in May of 2006 to provide that Aon's obligation set forth therein to make annual grants of 22,500 restricted stock units ceased effective January 1, 2007.
The number of restricted stock units granted to our named executive officers in 2006 are set forth in 2006 Grants of Plan-Based Awards on page 43.
Practices Regarding the Grant of Equity Awards. On February 9, 2007 the Audit Committee of Aon's Board of Directors engaged a national law firm, which engaged a national public accounting firm (together, the "Audit Committee Team"), to perform an analysis of Aon's stock grant practices and related accounting for 1994 through 2006. The Audit Committee Team reviewed the available facts and circumstances surrounding stock option grants made during 1994-2006. Based upon this review, the Audit Committee Team, management and the Audit Committee determined that Aon's procedures relating to option grants caused incorrect measurement dates to be used for accounting purposes. The Audit Committee found that the practice of "delegated grants," as well as grants involving administrative errors, led to unrecognized compensation expense during the relevant period. Based on its review, the Audit Committee found no misconduct by current or former management or Directors. The review did reveal a limited number of instances in which options were granted as of a prior date, for example, to honor employment or other previously made contractual commitments. The Audit Committee examined grants made after 2000 and found only inconsequential accounting adjustments. On March 1, 2007, Aon restated in an Annual Report on Form 10-K its consolidated prior year financial statements arising from errors made in the measurement of equity compensation. Additional details regarding the findings of the Audit Committee are set forth in that filing.
During 2006, all equity awards granted in connection with our incentive stock program or pursuant to the LPP (other than awards to our Executive Chairman and Chief Executive Officer) were awarded by the Committee at its regularly scheduled meetings and valued at such dates. The stock options and restricted stock units awarded to our Executive Chairman and Chief Executive Officer were approved by the independent members of our Board at its regularly scheduled meetings, which typically occur the day following the meeting of the Committee, and the grants were effective and valued as of such Board meeting dates. In addition, during 2006 all other equity awards to executive officers (including awards made pursuant to employment agreements or granted for retentive purposes) were approved and granted by the Committee at its regularly scheduled meetings.
Pursuant to our Stock Plan, stock options granted in 2006 bear the strike price of the average of the high and low trading prices for Common Stock on the date of grant. Mr. Case is granted limited authority under the plan's guidelines to grant equity awards between meetings of the Committee. He may grant up to a maximum of 50,000 shares to any individual other than an individual who is covered by Section 16(b) of the Securities Exchange Act of 1934, as amended.
Perquisites. We provide perquisites and personal benefits to our executives as a component of their total compensation. These perquisites can include memberships in social and professional clubs, car allowances, mortgage subsidies, fuel allowances, the payment of professional services fees, and personal use of corporate aircraft. In some cases, for instance in connection with the use of corporate aircraft, we provide these perquisites to make our executives more efficient, which benefits Aon. With regard to other forms of perquisites, such as car allowances and mortgage subsidies, they are typically provided by our competitors to their executives in the countries in which they live, and we feel we must provide the perquisites to our executives to attract and retain the best talent.
Overall, the value of perquisites provided in 2006 was a small percentage of each executive's total compensation. The value of significant perquisites provided to our named executive officers in 2006 is
set forth in the Summary Compensation Table under the column labeled "All Other Compensation." Additional information regarding our rationale for providing certain perquisites to our named executive officers is set forth below under the heading "Policies Underlying Our 2006 Compensation Program for Named Executive Officers."
Deferred Compensation Program. We maintain a Deferred Compensation Plan ("DCP") that allows certain employees, including our executive officers, to defer receipt of their salary and/or annual incentive payments into Common Stock or accounts that mirror several different investment funds. Participants may defer up to 75% of salary and up to 100% of their annual bonus until the date(s) they have specified in accordance with the DCP's distribution provisions. We do not credit above-market interest on deferred compensation. We are not required to make any contributions to the DCP. We do not fund the DCP, and participants have an unsecured contractual commitment by Aon to pay the amounts due under the DCP. When such payments are due, the distributions will be made from our general assets. We have purchased corporate-owned life insurance to offset a portion of this liability. Information regarding the named executive officers' DCP benefits is set forth in the Nonqualified Deferred Compensation Table in Fiscal 2006 on page 54.
Overview. We believe that the provision of change-in-control severance agreements and other transitional compensation arrangements are critical to recruit talented employees and to secure the continued employment and dedication of our existing employees. All or nearly all of the companies with which we compete for talent have similar arrangements in place for their executive officers.
Severance Agreements regarding Change in Control. We have entered into change-in-control severance agreements with certain of our key executive officers, including Messrs. Case, Bolger, O'Halleran and Rice. The agreements are intended to secure the continued service and to ensure the dedication and objectivity of these executives in the event of an actual or threatened change in control of Aon. The agreements provide that covered executives receive certain severance benefits upon qualifying terminations of employment in connection with or within two years following a change in control of Aon. Thus, the agreements require a "double trigger"a qualifying termination of the executive's employment and a qualifying change in control of Aonin order for severance benefits to become payable. If these conditions are met, the following severance benefits are payable: (a) the executive's base salary through the date of termination and a pro rated bonus based upon the executive's average annual bonus for the preceding three years; (b) for key executive officers other than Mr. Case, three times the executive's highest annual base salary in effect during the twelve-month period prior to the date of termination (with regard to Mr. Case, three times the sum of (i) his highest annual base salary in effect during the twelve-month period prior to the date of termination and (ii) his target annual bonus for the fiscal year in which the date of termination occurs); (c) the amount forfeited by the executive under any qualified defined contribution plan as a result of the executive's termination; and (d) the executive's accrued benefits under Aon's nonqualified benefit plans, which shall vest and be payable with three additional years of plan contributions.
The agreements for executives also require us to maintain medical, dental and life insurance on behalf of the executive for three years, or until the executive becomes eligible for substantially equivalent benefits from another employer. In addition, all stock options and other equity awards will become fully vested and, if permissible, each option will remain exercisable until the expiration of its term. The agreements for executives not based in the United States were adjusted to conform to local benefit practices and to comply with local laws. As a condition to the receipt of payments and benefits
pursuant to the agreements for executives, the executive is required to enter into an agreement with Aon providing that the executive will not compete with us or solicit our employees or customers for a two-year period and will not use or disclose any of our confidential information. Additional details regarding the terms and conditions of the severance agreements are set forth in this proxy statement under the heading "Severance Agreements" in the "Potential Payments on Termination or Change-in-Control" section beginning on page 61. Utilizing certain assumptions, we have calculated and set forth the estimated values of the severance benefits payable to the named executive officers in the same section.
Letter Agreement with Mr. Ryan. Mr. Ryan is not party to a change-in-control severance agreement. In 2005 we entered into a letter agreement with Mr. Ryan in connection with his continued service as Aon's Executive Chairman. The agreement provides certain supplemental benefits to Mr. Ryan in consideration for his agreement to continue to serve as our Executive Chairman. The agreement addresses certain benefits to be provided to him, including: (i) accelerated vesting of stock options; (ii) health care coverage; and (iii) supplemental pension benefits. Additional details regarding the letter agreement are set forth in this proxy statement under the heading "Employment and Severance AgreementsSeverance Agreements." Utilizing certain assumptions, we have calculated and set forth the estimated value of the supplemental benefits payable to Mr. Ryan in the "Potential Payments on Termination or Change-in-Control" section on page 69.
Severance Benefits Pursuant to Employment Agreements. We have entered into agreements with certain executive officers that provide for post-employment severance benefits and transitional compensation if the officer's employment terminates for a qualifying event or circumstance unrelated to a change in control of Aon, such as being terminated without "cause" as such term is defined in the operative agreement. Additional details regarding the terms and conditions of such agreements are set forth in this proxy statement under the heading "Employment and Severance AgreementsSeverance Agreements." Utilizing certain assumptions, we have calculated and set forth the estimated values of the severance benefits payable to the named executive officers in the "Potential Payments on Termination or Change-in-Control" section on pages 66-73.
Overview. We generally provide employee benefits that are consistent with local practices and competitive markets. We maintain a tax-qualified, defined benefit pension plan and a supplemental pension program for U.S. employees hired on or before December 31, 2003. The present value of accumulated benefits under the plans for each of our named executive officers (other than Mr. Case, who was hired in 2005 and is not eligible for participation in the plans) is set forth in Pension Benefits in Fiscal 2006 on page 51.
U.S. Pension Plan. In 2006 and prior thereto, our U.S. pension plan (the "Pension Plan") generally provided benefits under a basic formula sometimes referred to as a "final average pay formula." Effective January 1, 2007, we amended the plan to provide benefits pursuant to a "career average pay formula." This change resulted in a reduction of future benefit accruals for the majority of plan participants, including our participating named executive officers.
U.S. Supplemental Pension Program. The supplemental pension program is a non-qualified, deferred compensation plan that provides eligible U.S. employees, including executives hired on or before December 31, 2003, with the opportunity to receive contributions that could not be credited under the qualified pension plan because of tax limitations and the specific provisions of such plan.
Our ability to offer participation in the plan has helped us attract and retain our top talent. For certain key executives, including Messrs. Ryan, Bolger and Rice, we have granted additional service credits to be applied in determining their supplemental pension benefits, particularly where a new executive has lost similar supplemental pension benefits in connection with his or her previous employer upon joining Aon. The plan contains limitations on compensation and benefits in order to strike a balance between the retentive effects of the plan and the expense of the plan. In addition, there are minimum age and service requirements (attainment of age 50 and 10 years of benefit accrual service) and for years after 2001 and prior to 2006, earnings in excess of $500,000 were not included in the calculation of basic benefits.
Effective January 1, 2006, the plan was amended to provide an alternative formula such that an employee would receive the greatest of (i) the benefits calculated under the existing formula, (ii) accrued benefits as of December 31, 2005, or (iii) 1% of uncapped final average pay times years of service (subject to a maximum gross pension of $500,000). Because of its nonqualified tax status, no trust fund exists to formally fund the plan and plan benefits are paid on a pay-as-you-go basis from corporate cash flow. Prior to January 1, 2007, the plan generally provided benefits under a basic formula sometimes referred to as a "final average pay formula." Effective January 1, 2007, we amended the plan in a manner similar to qualified Pension Plan to provide benefits pursuant to a "career average pay formula." This change resulted in a reduction of future benefit accruals under this plan for the majority of plan participants, including our named executive officers.
U.S. Savings Plan. Aon maintains a tax-qualified 401(k) plan (the "Savings Plan") for its U.S. employees. The vast majority of Aon's U.S. employees are eligible to participate in the plan and may contribute portions of their salary and bonus to the plan in accordance with the guidelines set forth in the U.S. Internal Revenue Code. Aon provides a basic matching contribution to the plan equal to 50% of the employee's contributions of up to 6% of pay, capped at a maximum matching contribution of $6,600, and Aon also provides a discretionary matching contribution for certain employees. For 2006, Aon made a discretionary matching contribution of an additional 2% of plan- eligible compensation for employees that (i) contributed in the aggregate at least 6% of their compensation on a before-tax basis to the plan, (ii) remained active employees on December 15, 2006; and (iii) received compensation of less than $220,000 for 2006. Each named executive officer's contribution to the plan, and Aon's contributions to the plan on behalf of the executive, are reflected in the 2006 Summary Compensation Table on page 40 under column (i) "All Other Compensation."
U.S. Supplemental Savings Plan. The Supplemental Savings Plan is a non-qualified, deferred compensation plan that provides eligible employees, including executives, with the opportunity to receive contributions that could not be credited under the Savings Plan because of tax limitations and the specific provisions of such plan. Information about the named executive officers' benefits under the Supplemental Savings Plan is set forth in the Nonqualified Deferred Compensation Table in Fiscal 2006 on page 54.
Stock Ownership Guidelines. In the first quarter of 2006 our Board's Governance/Nominating Committee adopted stock ownership guidelines applicable to members of Aon's Policy Committee. The guidelines are designed to increase executives' equity stakes in Aon and to align executives' interests more closely with those of our stockholders. The guidelines provide that the Chief Executive Officer should attain an investment position in Common Stock equal to four times annual base salary and each other executive officer should attain an investment position in Common Stock equal to two times
annual base salary. These investment levels should be achieved within five years. Shares counted toward these guidelines include: any shares owned outright; shares held through the Savings Plan; shares held through our employee stock purchase plan; "phantom" stock held under the DCP, if such distribution is paid in stock; and "phantom" stock held under the Supplemental Savings Plan.
Policies Underlying Our 2006 Compensation Program for Named Executive Officers.
Our Use of Benchmarking. We seek to set executive compensation at levels that are appropriate and competitive, for professional services companies both within Aon's market sector and the general-industry marketplace, in major metropolitan areas. For this purpose, we annually review the levels of executive officer compensation from global pay surveys provided by Hewitt Associates, Inc. Comparisons of an individual executive's compensation are also made to selected peer companies (the "Compensation Comparison Group") where job descriptions are sufficiently similar to the executive's. Each executive's Compensation Comparison Group is generally comprised of companies that are included in the "Peer Group Index" used for the Stock Performance Graph (included in Aon's annual report to stockholders for 2006) as well as additional companies, either in our industry or outside, that are generally similar to Aon in size and with whom we believe we compete for executive talent and financial capital. For 2006, Mr. Case's Compensation Comparison Group was comprised of the following companies: American Express Company; The Allstate Corporation; Marsh & McLennan Companies, Inc.; Chubb; The Progressive Corporation; Lincoln National Corporation; Mellon Financial Corporation; Principal Financial Group, Inc.; The Hartford Financial Services Group, Inc.; Ace Limited; AFLAC Incorporated; Travelers Insurance Group Holdings Inc.; Safeco Corporation; Genworth Financial, Inc.; BearingPoint, Inc.; Willis Group Holdings Limited; CNA Financial Corporation; UnumProvident Corporation; Arthur J. Gallagher & Co.; Hub International; Hewitt Associates, Inc.; Hilb Rogal & Hobbs Company; Watson Wyatt & Company Holdings; Benfield Group Ltd.; and Brown & Brown, Inc.
Given the infrequency of executive chairmen roles among Aon's industry peers, Mr. Ryan's Compensation Comparison Group was comprised of the following companies where the chief executive officers transitioned to the role of executive chairmen: Ace Limited; Advanced Micro Devices, Inc.; AGCO Corporation; Altria Group, Inc.; Anheuser-Busch Companies, Inc.; Apache Corporation; Applied Materials, Inc.; Barnes & Noble, Inc.; Bed, Bath & Beyond Inc.; Best Buy Co., Inc.; Citigroup Inc.; Clear Channel Communications, Inc.; Coca-Cola Enterprises Inc.; Consolidated Edison, Inc.; Corning Incorporated; Hughes Supply Inc.; Johnson Controls, Inc.; Jones Apparel Group, Inc.; Navistar International; Nike, Inc.; Rite Aid Corporation; Texas Instruments Incorporated; Tribune Company; and Walgreens Co. Mr. Bolger's Compensation Comparison Group was comprised of the same companies as Mr. Case's group but for the exclusion of the following companies due to the fact that compensation information about each company's chief financial officer was not publicly available: Marsh & McLennan Companies, Inc.; Mellon Financial Corporation; Genworth Financial, Inc.; Hewitt Associates, Inc.; and Brown & Brown, Inc.
How We Determine Total Compensation. Market data is helpful in determining the competitive level of certain elements of our compensation program; however, Aon does not generally have a target for the "total compensation" that will be delivered to each NEO from year to year, target a certain percentile with regard to the benchmark, or use a specific formula to set pay either in relation to market data or otherwise. For 2006, we generally targeted a competitive level of total compensation value and mix of elements, as described herein. This was not a mechanical process. Rather, we used our judgment and business experience. Overall, our intent is to manage the various elements of total
compensation together so that the focus is on variable compensation, such as short-term and long-term incentives that fluctuate based on the performance of Aon, and not on base salary, benefits and perquisites. These latter elements are not performance-based and, therefore, are adjusted only rarely and will diminish in their proportion of total compensation over time.
For certain named executive officers, the actual value of 2006 total compensation varied above the targeted competitive range based on the overall Aon, business unit, and individual performance. Specifically, Mr. Case's total compensation reflected two strong years of performance since his arrival, as well as the caliber of his background and experience. Mr. Ryan's total compensation reflects his continued active role in Aon, the successful transition of his responsibilities as Chief Executive Officer to Mr. Case and his unique position in our industry. Mr. Bolger's total compensation reflects his larger role as Chief Administrative Officer which has included a broad range of other administrative functions over the last four years. It also reflects his previous experience and background as an executive officer of a major financial institution prior to joining Aon. The total compensation of Messrs. O'Halleran and Rice reflect their business unit performance, their many years of industry-leading experience and their substantial market presence, as well as their overall contributions to Aon's success.
Our Use of Tally Sheets and Other Analytical Tools. The independent non-employee Directors met in the first quarter of 2006 to evaluate the performance, and review the compensation, of the Executive Chairman and Chief Executive Officer. The Committee evaluated the performance, and reviewed the compensation, of all other named executive officers. In connection with each of these reviews, the Directors reviewed compensation tally sheets detailing all aspects of total compensation. The tally sheets affixed dollar amounts to all components of the executives' 2006 compensation, including current base salary and bonus, deferred compensation, outstanding equity awards, benefits (including supplemental pension benefits), perquisites and potential change-in-control severance payments.
The tally sheets were provided to Committee members to ensure the members were aware of all compensation elements and the value of such elements. The Committee reviewed these various elements for each of the executive officers. They noted nothing unusual in these analyses that would cause them to vary awards from those recommended by Mr. Case and approved by the Committee for the named executive officers. The Committee also reviewed the analyses for Messrs. Case and Ryan prior to determining their elements of compensation. The tally sheets for the executive officers were updated prior to the Committee's reviews of executive officer compensation in early 2006 and again in early 2007.
Involvement of Mr. Case in the Compensation Process. The Committee approves each element of Aon executive officers' compensation; however, the Chief Executive Officer recommends to the committee the total compensation levels and the base salary adjustment, target cash bonus and target equity award for the executive officers that report directly to him because he has substantially greater knowledge of the contributions made by those executive officers to Aon. The Committee has the discretion to modify any such recommended compensation adjustment, bonus or equity award.
2006 Adjustments to Base Salaries. Based on our compensation review for each of the named executive officers, we chose to adjust the base salary of Mr. Rice exclusively. Mr. Rice's base salary was increased from $700,000 to $800,000, effective January 1, 2006, because Mr. Rice is an executive officer who has spent his career at Aon and his base salary had fallen behind the level of more recently hired executive officers. For all other named executive officers, we determined that their current base salaries were consistent with Aon's compensation philosophy and their personal contributions.
Determination of 2006 Annual Bonus Awards. During the first quarter of 2007, the Committee determined that the corporate performance goal under the Executive Bonus Plan was exceeded. The Committee determined the actual bonuses payable to the executives for 2006, taking into consideration the fact that the named executive officers' major business units or operating divisions substantially achieved or exceeded their performance goal and each of the named executive officers achieved or exceeded his individual performance goals. The 2006 bonuses for Mr. Ryan and Mr. Case were approved by the independent Directors of our Board. The 2006 results for Aon overall exceeded aggressive performance goals set at the beginning of the year, as adjusted for non-controllable, extraordinary or unusual items such as gain or loss on the sale of businesses or assets. The Committee determined that it was, therefore, appropriate to grant bonuses at above target levels for most executive officers. The bonuses of the named executive officers are reflected in the 2006 Summary Compensation Table on page 40 under column (g) "Non-Equity Incentive Plan Compensation."
Determination of 2006 Equity Awards. In determining the March 2006 grant of stock options and performance units under our LPP to executive officers, the Committee reviewed market data by employee level to determine the appropriate long-term value of such equity awards. The Committee took into account that this was the first year of a new performance-based program. This program varies from previous practice as it has no elements of time-vested restricted stock, and is therefore entirely performance-driven, with option gains reflecting market performance and performance shares only vesting if performance targets are met. The Committee agreed that awards in this first performance period would be on the higher end of the market range for most named executive officers, with the exception of Mr. Case. As previously described, the largest element of these awards (75%) is performance shares which are earned based on the achievement of the three-year cumulative earnings per share target. The remaining portion (25%) consists of stock options converted on a 3:1 basis. The Committee determined that both forms of awards provide the requisite incentive for the executives to enhance the value of Aon's stock, while the performance units also provide an additional incentive to achieve specific corporate performance goals. The three-year performance period was selected to provide the award recipients a reasonable period of time within which to achieve and sustain challenging growth goals.
With regard to Mr. Ryan's LPP award, the Committee factored in his successful management of the leadership succession process and Aon's desire to encourage Mr. Ryan to remain in the executive chairman role and to contribute to the future success of Aon. Mr. Rice's lower LPP award, as compared to Messrs. Bolger and O'Halleran, reflects his impending retirement in December 2007.
In March of 2006 we determined that Mr. Rice had satisfied the performance criteria associated with a grant of 35,000 restricted stock units awarded to him in March of 2005, the vesting of which was fully contingent upon ARS-US' achievement of a specified 2005 net operating income target. We determined that ARS-US had achieved 110% of the targeted 2005 net operating income, and that therefore the 35,000 restricted stock units were fully vested.
In March of 2006, we granted a performance award to Mr. Rice to encourage him, among other things, to strengthen and transition the leadership of Aon Risk Services Americas ("ARSA") to its new chief executive officer through December 31, 2007, which is expected to be Mr. Rice's retirement date. Upon the successful completion of these goals, Aon will award Mr. Rice in March of 2008 Common Stock having an aggregate value of $1 million.
In May of 2006 we granted performance shares to Mr. O'Halleran to encourage him to focus on the long-term performance of our global reinsurance business. The performance shares were granted in
the form of units payable in Aon shares. The units will be earned and settled in a range of 0 to 150% of target based on global reinsurance performance results over a multi-year performance period that began on April 1, 2006 and will end on December 31, 2008. The cumulative performance results will be measured against the specific segment pre-tax income from ongoing operations target for the period, and a cumulative margin target. Mr. O'Halleran's employment agreement was amended in May of 2006 to provide that the individual performance share award will replace, effective January 1, 2007, the annual awards of 22,500 time-vested restricted stock units that he would otherwise be entitled to receive pursuant to the agreement. The Committee believes that this change is advantageous to Aon because it substitutes performance-based equity compensation for future equity awards that would have been subject only to time-vesting requirements. In addition to these specific business unit related awards, the Committee also granted Messrs. Rice and O'Halleran awards under the LPP. These awards reward performance and contribution at the broader Aon level and we believe that they are appropriate recognition for the considerable role that they both play in driving Aon's overall performance.
Selection of Performance Measures. The performance goals chosen for the annual bonus typically differ from the goals selected for Aon's long-term incentive programs and are selected to focus the executives' efforts on incremental growth targets for Aon while maintaining Aon's long-term growth objectives. For 2006, annual bonuses were tied to Aon's achievement of planned pre-tax income from continuing operations. The 2006 LPP awards are tied to the achievement of the specified cumulative earnings per share target for the 2006-2008 performance period. We believe that this focus on both pre-tax income and earnings per share appropriately balances executive perspective.
With regard to the performance target under the annual bonus plan, we set the pre-tax income target at a level that was substantially in excess of Aon's 2005 actual pre-tax income after adjustments. We believe that the 2006 target was a reasonable "stretch" goal. Eligibility for bonuses was dependent upon the achievement of at least 85% of the specified target, subject to appropriate adjustments. We set the minimum threshold at 85% because we believed performance below that level should not result in incentive compensation awards.
In November of 2006, Aon sold the Aon Warranty Group and its worldwide operations (including Virginia Surety Company). We have begun, and expect to continue, to use a portion of the sales proceeds to repurchase additional shares of Common Stock under our $2 billion share repurchase program. We have analyzed the impact of the sale of the warranty business and the stock repurchases on the performance goals under the LPP (i.e. earnings per share targets), and we do not believe that the sale of the income-generating business and use of the proceeds to repurchase stock is accretive to the earnings per share target. Although the arrangement has the result of reducing the number of shares outstanding, it also reduces pre-tax net income. Thus, the net result does not dissuade us from using earnings per share targets for future awards under our LPP.
With regard to the performance targets associated with the individual performance award granted to Mr. O'Halleran in 2006, we set the performance targets at a level that will require substantial growth in net operating income during the performance period as well as a minimum margin requirement. The award granted to Mr. Rice in 2005 was based on performance that significantly exceeded planned net operating income for his business unit for the year. The 2006 award has more subjective criteria that reflect the need to ensure a successful transition of the business sector to new management in advance of Mr. Rice's retirement in 2007. We believe that the goals present a reasonable challenge because they are expected to stretch performance for these critical business sectors and allow for the orderly transition of management.
Approval of, or adjustments to, 2006 Perquisites. We do not emphasize perquisites in our executive compensation practices, and the level of such items is moderate. There are no standard auto, private club or financial planning benefits. Messrs. Case, Ryan and Bolger did not receive any perquisites in 2006, other than Mr. Ryan's personal use of the Company aircraft. We believe that this benefit is appropriate given his intense travel schedule and the efficiency and security that such benefit brings. Aon provides Messrs. Rice and O'Halleran auto and private club benefits pursuant to their employment agreements. Mr. O'Halleran also receives financial planning advice pursuant to his employment agreement. In 2006, he also used the Company aircraft for personal travel, and received reimbursement for legal fees incurred, and a gross-up for taxes due on such reimbursement, in connection with the amendment to his employment agreement.
2007 Compensation Decisions Relevant to the Discussion of Aon's Compensation Philosophy. In January of 2007, in recognition of Mr. Rice's years of employment with the Ryan Insurance Group prior to the date such entity was acquired by Aon, the Committee agreed to award Mr. Rice an additional 14 years of service for purposes of calculating Mr. Rice's benefits under Aon's nonqualified pension program. Mr. Ryan's eligibility for similar past service credit related to his years of employment with the Ryan Insurance Group is set forth in the 2005 letter agreement between Aon and Mr. Ryan described herein.
Tax Matters. Section 162(m) of the U.S. Internal Revenue Code provides that a public corporation may take a deduction for compensation in excess of $1 million for its chief executive officer or any of its four other highest paid executive officers only if certain specific and detailed criteria are satisfied. Other sections of the Code could result in adverse tax consequences to Aon and/or the executive related to certain change-in-control payments or the receipt of deferred compensation. Among other factors, we consider the company deductibility of compensation paid to the named executive officers.
We recognize that the deductibility of some types of compensation payments can depend upon the timing of an executive's vesting or exercise of previously granted rights. Interpretations of and changes in applicable tax laws and regulations as well as other factors beyond our control also can affect deductibility of compensation. Also, in some circumstances, factors other than tax deductibility are more important in determining the forms and levels of executive compensation most appropriate and in the best interests of Aon and its stockholders. For these and other reasons, we have determined that we will make a reasonable effort to administer Aon's compensation program in a tax-effective manner; however, we have from time to time approved elements of compensation for certain executive officers that are not fully deductible or result in adverse tax consequences to the executive and we reserve the right to do so in the future, when appropriate. For 2006, non-deductible compensation included the portion of Mr. Case's and Mr. Ryan's base salary that exceeded $1,000,000 as shown in the 2006 Summary Compensation Table on page 40. Stock option exercise income generally is not included in the Section 162(m) limitation, but time vested restricted stock units that do not qualify as performance-based compensation are included when they vest.
Accounting Matters. Changes to accounting practices did not drive changes in compensation philosophy at Aon. However, the Committee evaluates the effect of such changes to accounting practices on an ongoing basis and will make appropriate adjustments to Aon's compensation philosophy where appropriate.
Compensation Consultant. The Committee has retained F.W. Cook as independent outside compensation consultant to provide expertise on various matters coming before the Committee. F.W.
Cook is engaged by, and reports directly to, the Committee. F.W. Cook neither advises Aon's management nor receives other compensation from Aon. A representative of F.W. Cook typically participates in all meetings of the Committee during which executive compensation matters are discussed. With the Committee's support, management periodically retains Hewitt & Associates to provide pay survey data.
Summary. We believe that Aon's compensation program was administered in 2006 in a manner consistent with its objectives.
The Organization and Compensation Committee of the Board of Directors of Aon has reviewed and discussed with management the Compensation Discussion and Analysis required by Item 402(b) of Regulation S-K and set forth in this proxy statement.
Based on its review and discussions with management, the Organization and Compensation Committee recommended to the Board of Directors that the Compensation Discussion and Analysis be included in this proxy statement and Aon's Annual Report on Form 10-K.
This Report is provided by the Organization and Compensation Committee, which is composed entirely of the following independent Directors:
2006 Summary Compensation Table
The following table discloses the total compensation of Aon's Principal Executive Officer and Principal Financial Officer during the fiscal year ended December 31, 2006, as well as Aon's three other most highly compensated executive officers. We refer to these individuals collectively in this proxy statement as the "named executive officers" of Aon.
The following table provides information on non-equity incentive plan awards, stock options, restricted stock unit awards and performance share unit awards granted in 2006 to each of the named executive officers.
Employment Agreements and Other Compensation Arrangements
Each of Messrs. Case, Bolger, O'Halleran and Rice has entered into an employment agreement with Aon. Mr. Ryan is a party to a letter agreement with Aon in connection with his continued service as Executive Chairman. Each of the employment agreements with Messrs. Case, Bolger, O'Halleran and Rice, as well as the letter agreement with Mr. Ryan, addresses the payments and benefits these individuals will receive under various termination scenarios. These payments and benefits are described in the section entitled "Potential Payments on Termination or Change-in-Control" set forth in this proxy statement. Non-competition and non-solicitation covenants apply to each of Messrs. Case, Bolger, O'Halleran and Rice for a period of two years following the termination of his employment without regard to the reason for such termination.
In addition to the employment agreements, each of Messrs. Case, Bolger, O'Halleran and Rice has entered into a severance agreement with Aon. Please see the section entitled "Potential Payments on Termination or Change-in-Control" of this proxy statement for a description of these agreements.
Aon has entered into an Employment Agreement with Gregory C. Case, our President and Chief Executive Officer, dated April 4, 2005, which commenced April 4, 2005 and will expire April 3, 2010 unless terminated earlier. The agreement provides Mr. Case will be employed as Aon's President and Chief Executive Officer. The agreement also provides that Mr. Case will be appointed to Aon's Board of Directors, and will be nominated for election as a Director at each subsequent annual meeting of stockholders during the period of his employment.
The agreement provides for a base salary of $1,500,000, subject to adjustment at the discretion of the Board of Directors, and an annual incentive bonus of up to 250% of his base salary, with a targeted annual incentive bonus of not less than 125% of his base salary.
Pursuant to the agreement, upon commencement of his employment, Mr. Case received: (i) a restricted stock unit award of 125,000 shares of Common Stock, which will vest in four installments of 12,500 shares on each of the first through fourth anniversaries of the date of grant and in a final installment of 75,000 shares on the fifth anniversary of the date of grant; and (ii) a nonqualified stock option award to purchase 1,000,000 shares of Common Stock, which will vest in three equal annual installments on each of the second through fourth anniversaries of the date of grant. The restricted stock unit award and the portion of the stock option award related to 325,000 shares were granted outside of the Stock Plan. The agreement provides that, during the term of his employment, Mr. Case is also eligible to receive an annual option grant with a Black-Scholes value of not less than $1,800,000; however, Mr. Case has waived his entitlement to receive such option grants in 2006-2009 as consideration for his participation in Aon's LPP. In addition, the agreement provides that Mr. Case will be provided with life insurance coverage in the amount of $5,000,000 during the term of the agreement.
Aon has entered into an Employment Agreement with David P. Bolger, our Chief Financial Officer, Chief Administrative Officer and Executive Vice President, dated January 1, 2003, which commenced January 8, 2003 and will expire December 31, 2009 unless terminated earlier. The agreement provides for a base salary of $750,000, subject to adjustment but not below $750,000; and an annual incentive bonus of up to 150% of his base salary. The Organization and Compensation Committee waived this cap on his annual incentive bonus in 2006. In addition, the agreement provides that Mr. Bolger will receive a supplemental pension benefit equal to his actual years of service with Aon plus ten years. This supplemental pension benefit will be paid to Mr. Bolger at age 65, or upon termination of employment, if later.
Aon has entered into a letter agreement with Patrick G. Ryan, our Executive Chairman, dated December 9, 2005. The agreement provides certain supplemental benefits to Mr. Ryan in consideration for his agreement to continue to serve as Aon's Executive Chairman. The agreement addresses certain benefits to be provided to Mr. Ryan by Aon, including: (i) accelerated vesting of stock options upon any termination of employment; (ii) health care coverage for Mr. Ryan and his eligible family members for life; and (iii) supplemental pension benefits equal to his actual years of service plus fifteen years.
Aon has entered into an Employment Agreement dated January 1, 2001, as amended pursuant to amendments dated September 29, 2004 and May 18, 2006, with Michael D. O'Halleran, who currently serves as Senior Executive Vice President. As amended, the agreement will expire on January 1, 2013 unless terminated earlier. The agreement provides for a base salary of $1,000,000 per year subject to increase as determined by the Board; an annual incentive bonus target of 100% of base salary and a maximum of not less than 200% of base salary; and stock options at the discretion of the Organization and Compensation Committee of the Board of Directors with the advice of the Chairman and Chief Executive Officer. The agreement also provides for a grant of performance shares to Mr. O'Halleran, which will be earned and settled in shares of Common Stock based on global reinsurance performance results.
Aon has entered into an Employment Agreement with Michael D. Rice, who currently serves as Chairman of Aon Risk Services Americas. The agreement will expire on December 31, 2007 unless terminated earlier. The agreement may be renewed by Aon upon ninety (90) days notice prior to the end of the original term or any renewal, subject to written acceptance thereof by Mr. Rice. The agreement provides for a base salary of $800,000 per year, and participation by Mr. Rice in all of Aon's annual incentive compensation and equity compensation programs appropriate to his position.
Pursuant to a supplemental agreement, Mr. Rice also received a grant of 27,500 restricted stock units that will vest in full on: (i) December 31, 2007, provided that Mr. Rice is either still employed by Aon on that date, or has been terminated by Aon without cause prior to that date; (ii) the death of Mr. Rice; or (iii) the disability of Mr. Rice.
In addition, Mr. Rice received a grant with a target level of 27,309 performance share units pursuant to Aon's LPP that will be earned and settled in Common Stock based upon Aon's performance relative to a cumulative earnings per share target over the period beginning January 1, 2006 and ending December 31, 2008. The total performance score can range from a minimum of 0% to a maximum of 150% of target. These performance share units will become fully vested upon the termination of Mr. Rice's employment provided that Mr. Rice successfully strengthens and transitions the leadership team to the Chief Executive Officer of Aon Risk Services Americas. If Mr. Rice remains employed by Aon Risk Services Americas through December 31, 2007, or an earlier date determined by Aon's Chief Executive Officer, and Mr. Rice has successfully strengthened and transitioned the leadership team to the Chief Executive Officer of Aon Risk Services Americas, Mr. Rice will receive
shares of Common Stock having a value of $1,000,000. In the event of Mr. Rice's death prior to the termination of his employment, Aon will provide his estate with a lump sum cash payment of $1,000,000 in lieu of the restricted stock unit award.
Aon has also entered into a supplemental pension agreement dated as of January 18, 2007 with Mr. Rice. The agreement provides that Mr. Rice will receive a supplemental pension benefit equal to his actual years of service with Aon plus fourteen years. The supplemental pension benefit will be paid to Mr. Rice upon termination of employment in installments over a five-year period beginning on the first day of the seventh month following the date of termination of employment. In the event of Mr. Rice's death prior to termination of employment, Mr. Rice's spouse will be entitled to receive a survivor annuity payable as of the date of death.
For additional information regarding the Executive Bonus Plan and the LPP, see the "Compensation Discussion and Analysis" section beginning on page 26 of this proxy statement.
The following table sets forth information regarding exercisable and unexercisable stock options, unvested restricted stock units and unvested performance share units held by each of the named executive officers on December 31, 2006.
The following table sets forth the number of shares of Common Stock acquired during 2006 upon the vesting of restricted stock unit awards and the value realized on vesting. None of Aon's named executive officers exercised any stock options during the fiscal year ended December 31, 2006.
The following table sets forth certain information regarding the benefits expected to be paid from Aon's defined benefit plans, as well as supplemental contractual arrangements. The terms of each such plan and arrangement are described below the table.
The present value of the accumulated benefit shown above is based on the pension benefit earned from service and compensation through December 31, 2006. The discount rate used to determine the present value is 5.88% and the retirement age is assumed to be the later of age 65 or the current age.
Prior to January 1, 2007, a participant's final average compensation used for the Aon Pension Plan and the Aon Excess Benefit Plan is the average of his or her base salary and certain eligible bonus payments for the five consecutive calendar plan years during the last ten years of the participant's career for which the average is the highest or, in the case of a participant who has been employed for less than five full years, the period of his or her employment with Aon and our subsidiaries. Due to the number of acquisitions by Aon and resulting pension plan assumptions and mergers, the formula used to determine pension benefits for service prior to January 1, 1998 is complex. The pension formula for service after January 1, 1998, is 1.15% of final average compensation times years of service, plus 0.45% of final average earnings in excess of Social Security Covered Compensation times years of service (maximum of 35 years). Covered Compensation is the average of the Social Security Taxable Wage Base for the 35-year period prior to the participant's normal retirement age.
The Internal Revenue Code places limits on compensation and pension benefits for qualified defined benefit programs such as the Aon Pension Plan. For example, in 2007, compensation in excess of $225,000 cannot be used to determine pension benefits from the Aon Pension Plan. Because of these limitations Aon, like other companies, has established a non-qualified supplemental defined benefit pension program to restore, or partially restore, pension benefits not otherwise payable to an executive under the qualified plan. Aon's ability to offer participation in the Aon Excess Benefit Plan has helped Aon attract and retain our top talent. For certain key executives, the company has granted additional service credits to be applied in determining supplemental pension benefits, particularly where a new executive loses similar supplemental pension benefits in connection with his or her previous employer upon joining Aon or where prior service is not recognized under the Aon Pension Plan or the Aon Excess Benefit Plan due to merger and acquisition agreements. Nonetheless, the Aon Excess Benefit Plan contains limitations on compensation and benefits in order to strike a balance between the retentive effects of the plan and the expense of the plan. In addition, minimum age and service requirements exist (attainment of age 50 and 10 years of benefit accrual service) that must be completed before an executive will be entitled to any benefits from the Aon Excess Benefit Plan. Because of its non-qualified tax status, no trust fund exists to formally fund the Aon Excess Benefit Plan and plan benefits are paid on a pay-as-you-go basis from corporate cash flow. As of December 31, 2006, there were 414 active employees who had met the age and service requirements for the Aon Excess Benefit Plan.
To limit Aon's expense under the Aon Excess Benefit Plan, Aon's Board of Directors approved an amendment to the plan that provides, for years after 2001, earnings in excess of $500,000 will not be included in the calculation of basic benefits. During 2005, Aon's Board of Directors reexamined this change and determined that, for more highly compensated and longer service executives, the compensation limitation could result in a decreasing total pension benefit over time and had the unintended result of encouraging the executive to depart Aon during his or her high earnings years. As a result, effective January 1, 2006, Aon's Board of Directors approved an alternative pension formula that provides a benefit of 1% of final average compensation (without limitation) times total years of service subject to a maximum annual pension benefit of $500,000, subject to certain exceptions. Upon retirement a participant will receive the greater of the pension from the basic formula (1.15%/0.45%) or the 1% formula.
Effective January 1, 2007, the compensation used to determine benefits under the Aon Pension Plan and Aon Excess Benefit Plan changed. Beginning January 1, 2007, future pension benefits are earned each calendar year based on the compensation paid in such calendar year. Pension benefits earned prior to 2007 cannot be reduced but pension benefits in the future are earned under this career average pay method rather then the prior final average pay method. The definition of compensation was not changed. The basic pension formula (1.15%/0.45%) and the alternative formula (1%) remain the same but are applied on a future annual career average basis. The plan change has no effect on employees over age 65 as of December 31, 2006 but generally reduces projected pension benefits at normal retirement for those under age 65. Further, no executive can get a larger pension benefit under the revised plan than under the plan prior to the change.
Estimated pensionable earnings in 2006, estimated years of service at age 65, and the estimated projected total annual pension benefit at age 65 (or current age if later) for the named executive officers covered by the Aon Pension Plan and the Aon Excess Benefit Plan are:
(a) for Mr. Bolger, estimated pensionable earnings of $2,100,000 (base salary of $750,000 and bonus paid in 2006 of $1,350,000, 30 years of service (20 standard years plus 10 additional years of
service granted pursuant to his employment agreement dated January 1, 2003) and estimated projected total annual pension benefits of $467,607;
(b) for Mr. Ryan, estimated pensionable earnings of $3,150,000 (base salary of $1,125,000 plus bonus paid in 2006 of $2,025,000) and 42 years of service (27 standard years plus 15 additional years pursuant to the letter agreement between Aon and Mr. Ryan dated December 9, 2005) and estimated total annual pension benefit of $1,200,107;
(c) for Mr. O'Halleran, estimated pensionable earnings of $2,200,000 (base salary of $1,000,000 plus bonus paid in 2006 of $1,200,000, 27 years of service and estimated total annual pension benefit of $460,695; and
(d) for Mr. Rice, estimated pensionable earnings of $2,000,000 (base salary of $800,000 plus bonus paid in 2006 of $1,200,000), 42 years of service (28 standard years plus 14 additional years pursuant to the letter agreement between Aon and Mr. Rice dated January 18, 2007) and estimated total annual pension benefit of $574,363.
Mr. Case does not participate in the Aon Pension Plan or the Aon Excess Benefit Plan because participation under both plans was closed to employees hired after December 31, 2003. Instead, like all employees hired in 2004 or later, Mr. Case participates at his election in the Aon Savings Plan, a defined contribution 401(k) plan, and in a sub-account under such plan (the Aon Retirement Account) to which Aon may make a discretionary annual contribution for employees hired on or after December 31, 2003. Mr. Case also participates in a non-qualified defined contribution plan (the Aon Supplemental Savings Plan) for executives hired after December 31, 2003. The Aon Supplemental Savings Plan provides for a company allocation as a percentage of compensation in excess of the IRS limit ($225,000 in 2007). Compensation is limited to $500,000 for the Aon Supplemental Savings Plan. The percentage allocation varies by length of service but in the first five years of employment the allocation percentage is 3% and increases to 7% after 30 years of service. For Mr. Case, the company contribution for 2006 to his Aon Retirement Account under the Aon Savings Plan was $6,600, and the company allocation on his behalf to the Aon Supplemental Savings Plan was $8,400.
The following table shows the executive contributions, Aon contributions, earnings, withdrawals and account balances for the named executive officers in the Aon Deferred Compensation Plan (the "Deferred Compensation Plan"), as well as the Aon Supplemental Savings Plan (the "Supplemental Savings Plan"), the Aon Supplemental Employee Stock Ownership Plan (the "Supplemental ESOP") and the Supplemental Aon Retirement Account (the "Supplemental Profit Sharing Plan"), each of which is a non-qualified savings plan. Information regarding each of these plans is set forth below the table.
The Deferred Compensation Plan is an unfunded, unsecured deferred compensation program that allows participants to defer:
The Company does not make any Company contributions to the Deferred Compensation Plan. The aggregate balances shown above represent amounts that the named executive officers earned but elected to defer, plus earnings or losses. Deferrals may be allocated among a choice of fourteen (14) valuation funds, including a fund that tracks Common Stock, that are used to determine investment gains or losses credited to the accumulated account balance. Participants can change their investment selections on a going-forward basis by contacting the Plan's trustee.
When participants elect to defer amounts into the Deferred Compensation Plan, they must also select when the amounts ultimately will be distributed to them. Distributions may either be made in a specific year, whether or not employment has then ended, or after the executive's retirement or termination.
Participants who elect to have distributions made in a specific year must choose a payout date that is at least three years after the date of the first deferral election, and can elect to receive a single, lump-sum payment or up to five annual installments. Distributions begin as soon as practicable after February 28 of the elected calendar year. Participants who elect to have distributions made at retirement or termination can elect to receive a single, lump-sum payment or up to ten annual installments. Payments commence as soon as practicable after February 28 of the year following termination of employment.
The Supplemental Aon Retirement Account, a subplan of the Supplemental Savings Plan, was established for employees eligible for the Aon Retirement Account of the Aon Savings Plan and whose regular contributions were limited due to Internal Revenue Code compensation limits. Employees are eligible for the Supplemental Aon Retirement Account if they are eligible to participate in the regular Aon Retirement Account (criteria include hired after January 1, 2004, paid 1,000 or more hours per year and did not accrue a benefit under the Aon Pension Plan) and plan eligible compensation exceeds the Internal Revenue Code qualified plan limit. The Board will determine the allocation to be paid in each particular year.
Prior to 1989, Mr. Ryan and Mr. Rice participated in the Combined International Corporation Staff Employees Profit Sharing Plan ("CIC Profit Sharing Plan") which eventually became the Aon Savings Plan. A Supplemental Profit Sharing Plan was established to provide company allocations similar to those that participants would have received had the Internal Revenue Code limits not restricted contributions in the CIC Profit Sharing Plan. No company allocations were made to the Supplemental Profit Sharing Plan after 1988. Distributions from the Supplemental Profit Sharing Plan are made in cash after actual retirement.
In 1989, Aon established tax qualified retirement plans, the Aon Savings Plan ("Savings Plan") and the Aon Employee Stock Ownership Plan ("ESOP"). The ESOP was merged into the Savings Plan in 2002. The Aon Supplemental Savings Plan and Supplemental ESOP were created to provide matching and other company allocations similar to those that participants in the Savings Plan and ESOP would have received had the Internal Revenue Code limits not restricted contributions under the Savings Plan and ESOP. As of January 1, 2004, no further matching allocations or other company allocations were made to the Supplemental Savings Plan or Supplemental ESOP, subject to very limited exceptions for employees of a specific practice group of Aon Consulting. Distributions from the Supplemental ESOP are made in the form of Common Stock. Distributions from the Supplemental Savings Plan and Supplemental ESOP must begin at the earlier of retirement or age 65.
The table below summarizes Director compensation for the fiscal year ended December 31, 2006. All non-employee Directors are referred to in this proxy statement as "outside Directors" or "non-management Directors."
Director, including additional share units credited as a result of the reinvestment of dividend equivalents:
Outside Director Compensation2006 Modifications
On March 17, 2006, Aon's Board of Directors approved changes to the form and amount of compensation paid to Aon's outside Directors. The modifications were recommended to the Board by its Organization & Compensation Committee (the "Committee") after the Committee undertook a careful review of market practices and, based upon advice from the Committee's outside compensation consultant, found that the outside Directors' compensation programs provided compensation that was significantly below the competitive level relative to non-employee Directors at companies in Aon's peer group. The modifications were effective January 1, 2006.
Aon provides its outside Directors with the following cash compensation:
Aon also pays or reimburses Directors for reasonable travel, lodging and related expenses in connection with their attendance at Board, committee or Company business meetings and for other reasonable expenses related to Board service such as continuing education.
Grant of Deferred Stock Units
In addition, under the Aon Corporation Non-Employee Directors' Deferred Stock Unit Plan, effective January 1, 2006, a subplan of the Stock Plan, each outside Director received an annual grant of deferred stock units with a value of $85,000 on May 19, 2006, the date of Aon's annual meeting of stockholders. The deferred stock units vest over the course of a year, and will convert to shares of Common Stock upon the earlier of: (a) the third anniversary of the date of grant; or (b) the outside Director's termination of service from the Board, unless the Director makes a timely election to defer receipt of the grant in compliance with Section 409A of the Internal Revenue Code of 1986, as amended, and deferral procedures established by Aon. The number of deferred stock units to be granted will be determined by dividing $85,000 by the fair market value of a share of Common Stock on the date of grant. Dividend equivalents will be credited on the deferred stock units and the dividend equivalents will be reinvested in additional deferred stock units.
An outside Director newly elected or appointed to the Board on or after January 1, 2006, will receive an additional grant of deferred stock units as of his or her first day of service on the Board. The deferred stock units will be subject to the same rules described directly above and will be valued at $85,000 for a Director elected or appointed to service on the Board at Aon's annual meeting of stockholders. General Myers received an additional grant of deferred stock units following his election to the Board on May 19, 2006.
Matching Charitable Contributions
During 2006, Aon Foundation matched up to $10,000 of charitable contributions made to a qualified organization by any Director.
Pursuant to the Aon Corporation Outside Director Deferred Compensation Plan, effective January 1, 2003 (the "Deferred Plan") and the Aon Corporation Outside Director Stock Award and Retirement Plan, as amended and restated effective January 1, 2003 (the "Award Plan") (as subplans of the Stock Plan) (the "Deferred Plan"), and pursuant to the Award Plan, outside Directors have the ability to defer receipt of cash compensation and shares of Common Stock until, generally, retirement from the Board.
Under the Deferred Plan, outside Directors elect that a portion of the annual retainer (referred to as "Fees") be credited to either a cash account, the earnings of which are based on six-month Treasury bills, or a stock account. Both accounts are maintained for bookkeeping purposes only and no amounts are actually invested or set aside for the outside Directors' benefit. The outside Directors' stock accounts are credited with the number of shares that could have been purchased with the Fees at the average of the high and low prices of the shares of Common Stock on the date the Fees are earned. As dividends are declared and paid on shares of Common Stock, each outside Director's stock account, for
bookkeeping purposes, is credited with the amount of shares of Common Stock that could have been purchased had such dividends been reinvested in shares of Common Stock. Distributions generally commence upon termination of Director status or retirement of the outside Director from the Board. With regard to the deferred Fees, distributions may be made in cash or in shares of Common Stock, at the election of the Director.
Under the Award Plan, outside Directors may also elect to defer receipt of the annual award of shares of Common Stock issued prior to January 1, 2006. For Directors who elect to defer, we maintain accounts for bookkeeping purposes that are credited with the number of shares of Common Stock that could have been purchased with the annual award if shares were priced at the average price of shares of Common Stock during the first three months of the year the annual award is made. As dividends are declared and paid on shares of Common Stock, each outside Director's account, for bookkeeping purposes, is credited with the amount of shares of Common Stock that could have been purchased had such dividends been reinvested in shares of Common Stock. Distributions are made in shares of Common Stock.
In addition, under the Award Plan, for periods prior to January 1, 2006, outside Directors were also entitled to certain deferred benefits when they retired from the Board. The Award Plan provided for $20,000 to be credited to an account on behalf of each outside Director for Board service for each year of service. Upon retirement from the Board, or upon death or disability, the vested value accumulated in the account as to a particular outside Director will be distributed in ten installments consisting of shares of Common Stock.
Although the retirement benefit has been discontinued, existing retirement benefits will continue to vest and will remain subject to the terms and conditions of the Award Plan, as it may be amended from time to time.
Outside Directors elected or appointed to serve on the Board before January 1, 2006, remain eligible to participate in the outside Directors' lifetime charitable bequest program (the "Bequest Plan"), established by Aon in 1994. Outside Directors elected or appointed to serve on the Board on or after January 1, 2006, are not eligible to participate in the Bequest Plan. As a result, General Myers is not eligible to participate in the Bequest Plan. The Bequest Plan was closed to future participants in connection with the modifications to outside Director compensation that were effective January 1, 2006.
The Bequest Plan was established to acknowledge the service of outside Directors, to recognize the mutual interest of Aon and our outside Directors in supporting worthy charitable institutions and to assist us in attracting and retaining outside Directors of the highest caliber. Aon funds the Bequest Plan generally through the maintenance of life insurance policies on our outside Directors. Individual outside Directors derive no financial benefit from the Bequest Plan since any and all insurance proceeds and tax-deductible charitable donations accrue solely to us. Charitable donations by Aon will be directed to charitable institutions designated by the eligible outside Directors. Each eligible outside Director is permitted to recommend total charitable donations of up to $1,000,000 and to designate up to five tax qualified institutions to receive a portion of such bequest (subject to a $100,000 minimum per institution). The bequest will be contributed in 10 annual installments to the designated tax qualified institutions following the death of that outside Director or any outside Director with whom he or she is paired for purposes of the Bequest Plan.
Stock Ownership Guidelines
Aon adopted stock ownership guidelines for its non-management Directors effective July 21, 2006. The guidelines require that: (i) a target ownership level of Aon common stock equal to three times the annual Director retainer be achieved by each outside Director within five years of joining the Board; and (ii) each new outside Director achieve a target ownership level of 1,000 shares of Common Stock within the first year of joining the Board or transitioning from a management Director to a non-management Director. Shares held by the outside Directors in deferred accounts will be included when determining if the target ownership level has been achieved.
Aon has entered into severance agreements with certain of its key executive officers, including Messrs. Case, Bolger, O'Halleran and Rice ("Tier 1 executives"). Mr. Ryan is not party to a severance agreement.
The severance agreements are intended to secure the continued service and to ensure the dedication and objectivity of these executives in the event of an actual or threatened change in control of Aon.
The agreements provide that covered executives receive the following severance benefits upon qualifying terminations of employment in connection with or within two years following a change in control of Aon: (a) the executive's base salary through the date of termination, a pro rated bonus based upon the executive's average annual cash incentive for the preceding three years and any accrued vacation pay; (b) for key executive officers other than Mr. Case, three times the executive's highest annual base salary in effect during the 12-month period prior to the date of termination (with regard to Mr. Case, three times the sum of (i) his highest annual base salary in effect during the twelve-month period prior to the date of termination and (ii) his target annual incentive bonus for the fiscal year in which the date of termination occurs); (c) the amount forfeited by the executive under any qualified defined contribution plan as a result of the executive's termination; and (d) the executive's accrued benefits under Aon's nonqualified benefit plans, which shall vest and be payable with three additional years of age and service credit and, in the case of the supplemental savings plan, three additional years of plan contributions. Qualifying terminations consist of termination by Aon other than for cause (as defined in the agreements) or by the executive for good reason (as defined in the agreements), in each case in connection with or within two years following a change in control.
The agreements for executives also require that Aon maintain medical, dental and life insurance on behalf of the executive for three years, or until the executive becomes eligible for substantially equivalent benefits from another employer. In addition, all stock options and other equity awards will become fully vested and each option will remain exercisable until the expiration of its term. The agreements for executives not based in the United States were modified to conform to local benefit practices and to comply with local laws.
A "change in control" for purposes of the agreements generally consists of any of the following: (a) an acquisition of 30% or more of either outstanding common stock or the combined voting power of the outstanding securities entitled to vote; (b) a change in the majority of the current Board; (c) a reorganization, merger or consolidation or sale or other disposition of all or substantially all of the assets of Aon (unless (i) the existing stockholders receive more than 60% of the outstanding common stock and the combined voting power of the surviving company, as the case may be, (ii) no person or group owns 30% or more of the outstanding common stock or combined voting power of the surviving company and (iii) there is no change in the majority of the Board); and (d) a liquidation or dissolution of Aon.
As a condition to the receipt of payments and benefits pursuant to the agreements for executives, the executive is required to enter into an agreement with Aon providing that the executive will not compete with Aon or solicit employees or customers of Aon for a two-year period and will not use or disclose any confidential information of Aon.
If an executive is entitled under the agreements for Tier 1 executives to severance payments and benefits or the vesting of equity awards, and any payment or distribution to the executive pursuant to such agreements are, or would otherwise be, subject to the excise tax imposed by Section 4999 of the Internal Revenue Code of 1986, as amended, then the executive is entitled to a grossed-up payment from the Company sufficient to pay the amount of such excise tax.
The Board may terminate the agreements for executives, other than Mr. Case, upon 120 days notice to an executive, provided that no termination may occur if the Board has knowledge of an action to effect a change in control or if there has been a change in control. Mr. Case's agreement may not, without his consent, be amended or terminated during the term of his employment agreement. In any event, the agreements for executives will terminate upon the first to occur of the executive's death and the termination of the employment relationship of the executive prior to a change in control.
As noted in the narrative captioned "Employment Agreements and Other Compensation Arrangements" following 2006 Grants of Plan-Based Awards on page 43 of this proxy statement, each of Messrs. Case, Bolger, O'Halleran and Rice has entered into an employment agreement with Aon. In addition, Mr. Ryan is a party to a letter agreement with Aon in connection with his continued service as Executive Chairman.
Mr. Case's employment agreement provides that, in the event of Mr. Case's death during the term of the agreement, his heirs, executors or the administrators of his estate will receive: (i) his accrued base salary through and including his date of death; (ii) any annual incentive bonus earned and payable but not yet paid for the bonus year prior to the year in which termination of employment occurs; (iii) a prorated annual incentive bonus through and including his date of death; (iv) other employee benefits to which he was entitled at the time of his death in accordance with the terms of the plans and programs of Aon; and (v) continued vesting of the stock options and awards granted to him pursuant to the agreement. If Mr. Case's employment is terminated due to his incapacity or disability, he will receive the payments and benefits set forth in items (i) through (v) of the immediately preceding sentence.
Mr. Case's employment agreement also provides that if Aon terminates Mr. Case's employment for cause (as defined in the agreement) as determined by a majority of the members of the Board of Directors (excluding Mr. Case), Mr. Case will be entitled to receive: (i) his accrued base salary through and including his date of termination; (ii) any annual incentive bonus earned and payable but not yet paid for the bonus year prior to the year in which termination of employment occurs; (iii) a prorated annual incentive bonus through and including his date of termination; and (iv) other employee benefits to which he was entitled at the time of his termination in accordance with the terms of the plans and programs of Aon. In the event of a termination for cause, Mr. Case must immediately resign from the Board of Directors.
If Aon terminates his employment for any other reason (other than for cause as defined in the agreement), Mr. Case will be entitled to receive: (i) his accrued base salary through and including his date of termination; (ii) any annual incentive bonus earned and payable but not yet paid for the bonus year prior to the year in which termination of employment occurs; (iii) a prorated annual incentive bonus through and including his date of termination; (iv) other employee benefits to which he was entitled at the time of his termination in accordance with the terms of the plans and programs of Aon;
provided that Aon shall continue to provide medical, dental and vision benefits to Mr. Case, his spouse and dependent children for a period of 24 months following the date of termination, followed with immediate eligibility for coverage under Aon's retiree medical program until Mr. Case, his spouse and dependent children become covered by the plan of another employer providing comparable benefits; (v) accelerated vesting of the restricted stock unit award and continued vesting of the stock option awards granted to him pursuant to the agreement; and (vi) a lump sum cash payment equal to two times the sum of Mr. Case's base salary and his target annual incentive bonus for the bonus year in which his employment terminates, provided that for purposes of this calculation, Mr. Case's base salary and target annual bonus will be no less than his initial base salary and initial target bonus. If Mr. Case voluntarily terminates his employment with good reason (as defined in the agreement), he will be entitled to receive the payments and benefits set forth in items (i) through (vi) of the immediately preceding sentence. In addition, if Mr. Case's employment is terminated for any reason other than by Aon for cause (as defined in the agreement) after Mr. Case has attained at least age 50 and completed at least 10 years of continuous employment, Mr. Case, his spouse and his dependent children will be eligible for coverage under Aon's retiree medical program.
Non-competition and non-solicitation covenants apply to Mr. Case for a period of two years following the termination of his employment without regard to the reason for such termination.
Mr. Bolger's employment agreement provides that, in the event of Mr. Bolger's death during the term of the agreement, his executor or the administrator of his estate will receive a lump sum cash amount equal to his salary at the rate in effect at the time of his death to which he would have been entitled from the date of his death through the original term of the agreement, subject to reduction for benefits paid to him under any individual or group life insurance policy maintained by us for the benefit of Mr. Bolger. If Mr. Bolger's employment is terminated due to his disability or incapacity, he will receive his base salary, at the rate in effect at the date of such termination of employment, until January 8, 2011, subject to reduction for benefits paid to him under any disability insurance policy maintained by us for his benefit. If Aon terminates Mr. Bolger's employment due to his failure to perform the duties under the agreement to the satisfaction of the majority of the members of the Governance/Nominating Committee of the Board of Directors, Mr. Bolger will be entitled to receive his base salary in effect at the date of such termination for a period of two years following such termination. If Aon terminates his employment agreement for any other reason (other than for cause as defined in the agreement), Mr. Bolger will be entitled to receive his base salary in effect at the date of such termination through the original term of the agreement.
Non-competition and non-solicitation covenants apply to Mr. Bolger for a period of two years following the termination of his employment without regard to the reason for such termination.
The letter agreement with Mr. Ryan provides that all of Mr. Ryan's unvested options will immediately vest as of the date he ceases to be employed by Aon. The agreement also extends the expiration date of Mr. Ryan's options until the later of: (a) the 15th day of the third month following the date the exercise period would have expired; and (b) December 31 of the calendar year during which the exercise period would otherwise have expired. In addition, upon cessation of Mr. Ryan's employment, he and his eligible family members are entitled to continue participation in Aon-sponsored group health plans for life. Finally, subject to certain qualifications, the agreement
provides that Mr. Ryan shall receive a supplemental pension benefit calculated based upon his actual years of service with Aon plus fifteen years, the latter representing his years of service with Ryan Insurance Group prior to the date such entity was acquired by Aon that would not otherwise be considered in determining Mr. Ryan's pension benefits.
Mr. O'Halleran's agreement provides that if Mr. O'Halleran's employment is terminated due to his disability or incapacity, he will receive his salary through January 1, 2009, subject to reduction for benefits paid to him under any disability insurance policy maintained by us. If Aon terminates Mr. O'Halleran's employment due to his failure to perform the duties under the agreement to the satisfaction of the majority of the members of the Organization and Compensation Committee of the Board of Directors, Mr. O'Halleran will be entitled, among other things, to receive his base salary and annual stock award for two years after the termination. If Aon terminates his employment for any other reason (other than for cause as defined in the agreement), Mr. O'Halleran will be entitled to receive his base salary through January 1, 2009. In addition, under those circumstances, his previous stock awards will vest as permitted by the applicable plan and his stock options will become exercisable in full and the Board is also obligated to consider whether it should also make a grant of stock options that it determines to be equitable in light of other stock option grants made to Mr. O'Halleran.
Non-competition and non-solicitation covenants apply for two years after termination of employment without regard to the reason for the termination of employment.
Mr. Rice's agreement provides that if Mr. Rice's employment is terminated due to his disability or incapacity, he will receive his base salary through December 31, 2007, subject to reduction for benefits paid to him under any disability insurance policy maintained by us. If Aon terminates his employment for any other reason (other than for cause as defined in the agreement), Mr. Rice will be entitled to receive his base salary through the original term of the agreement, or, if the agreement is renewed, through any renewal period. In addition, Aon will pay Mr. Rice all accrued but unpaid benefits as of the date of termination.
Mr. Rice's agreement further provides that all stock awards and stock options granted to Mr. Rice will continue to vest upon the termination of Mr. Rice's employment, provided that Mr. Rice continue to make himself available to Aon as a consultant, and that Mr. Rice comply with the non-competition and non-solicitation covenants contained in the agreement.
Non-competition and non-solicitation covenants apply to Mr. Rice for a period of two years following the termination of employment without regard to the reason for such termination.
Pursuant to a supplemental agreement, Mr. Rice also received a grant of 27,500 restricted stock units that will vest in full on: (i) December 31, 2007, provided that Mr. Rice is either still employed by Aon on that date, or has been terminated by Aon without cause prior to that date; (ii) the death of Mr. Rice; or (iii) the disability of Mr. Rice.
In addition, Mr. Rice received a grant with a target level of 27,309 performance share units pursuant to Aon's LPP that will be earned and settled in Common Stock based upon Aon's performance relative to a cumulative earnings per share target over the period beginning January 1, 2006 and ending December 31, 2008. The total performance score can range from a minimum of 0% to a maximum of 150% of target. These performance share units will become fully vested upon the
termination of Mr. Rice's employment provided that Mr. Rice successfully strengthens and transitions the leadership team to the Chief Executive Officer of Aon Risk Services Americas. Further, if Mr. Rice remains employed by Aon Risk Services Americas through December 31, 2007, or an earlier date determined by Aon's Chief Executive Officer, and Mr. Rice has successfully strengthened and transitioned the leadership team to the Chief Executive Officer of Aon Risk Services Americas, Mr. Rice will receive a grant of fully vested restricted stock units having a value of $1,000,000. In the event of Mr. Rice's death prior to the termination of his employment, Aon will provide his estate with a lump sum cash payment of $1,000,000 in lieu of the restricted stock unit award.
Aon has also entered into a supplemental pension agreement dated as of January 18, 2007 with Mr. Rice. The agreement provides that Mr. Rice will receive a supplemental pension benefit equal to his actual years of service with Aon plus fourteen years. The supplemental pension benefit will be paid to Mr. Rice upon termination of employment in installments over a five-year period beginning on the first day of the seventh month following the date of termination of employment. In the event of Mr. Rice's death prior to termination of employment, Mr. Rice's spouse will be entitled to receive a survivor annuity payable as of the date of death.
Termination and Change-in-Control Tables
The tables below outline the potential payments to the named executive officers upon the occurrence of various termination events, including, without limitation, a termination upon a change in control of Aon. The following assumptions apply with respect to the tables below and any termination of employment of a named executive officer:
immediately vest, all restricted stock unit awards granted pursuant to the ISP will continue to vest in accordance with their terms, and a pro-rated portion of all equity grants made after July 1, 2004, will immediately vest. Under "Qualifying TerminationChange-in-Control," all outstanding unvested restricted stock unit awards and all unvested stock options become fully vested and each option will remain exercisable until the expiration of its terms.
awards granted pursuant to Mr. O'Halleran's employment agreement will immediately vest and all outstanding unvested stock options granted pursuant to Mr. O'Halleran's employment agreement will continue to vest in accordance with their terms, all restricted stock unit awards granted pursuant to the ISP will continue to vest in accordance with their terms, and a pro-rated portion of all equity grants made after July 1, 2004, will immediately vest. Under "Qualifying TerminationChange-in-Control," all outstanding unvested restricted stock unit awards and all unvested stock options become fully vested and each option will remain exercisable until the expiration of its terms.
issued under the LPP will become immediately vested at the greater of the target level or the number of shares of Common Stock that would have resulted from the growth rate achieved during the period up to the closing date of the change in control transaction.
Review and Approval of Related Party Transactions
Aon has adopted procedures governing the review and approval of related party transactions. The terms of these procedures provide that the Governance/Nominating Committee will review transactions in which: (i) Aon is a party, participant, or has a direct or indirect material interest; (ii) the amount involved exceeds $120,000; and (iii) any Director, executive officer or holder of five percent (5%) or more of Aon's voting securities, or an immediate family member of any such person, has a direct or indirect material interest. To facilitate the review and approval of related party transactions, Aon's Directors and executive officers complete an annual D&O questionnaire and disclose all potential related person transactions involving themselves and their immediate family members. Throughout the year, Directors and executive officers are required to notify Aon's General Counsel of any potential related person transactions of which they become aware, and Aon's General Counsel reports these transactions to the Governance/Nominating Committee. The Governance/Nominating Committee considers all relevant facts of any related party transactions to determine whether to approve or ratify the transaction.
Related Party Transactions
Aon has made contractual arrangements to provide ready access to aircraft for executives of Aon and our subsidiaries for business purposes. These arrangements include two dry leases entered into with two aircraft leasing companies affiliated with Patrick G. Ryan, Globe Leasing, Inc. and 17AN Leasing LLC. In addition, Aon provides hangar space and related operating support to Globe Leasing, Inc. and 17AN Leasing LLC in return for negotiated fees. In 2006, Aon and our subsidiaries paid Globe Leasing, Inc. and 17AN Leasing LLC $739,700 and $900,460, respectively, for usage of aircraft. Globe and 17AN paid Aon $198,527 and $195,648, respectively, for hangar space and operating support. These amounts are presented on an accrual basis. We believe that all of these arrangements are more favorable to us than would have been obtained by negotiating similar transactions with unrelated third parties. The payments represented in excess of 5% of each of Globe's and 17AN's consolidated gross revenues in 2006 and are expected to do so again in 2007. In addition, Globe and 17AN paid us $68,535 and $66,435, respectively, as annual insurance premiums for aircraft liability including bodily injury, property damage and hull physical damage (including war risk). Patrick G. Ryan owns 100% of Globe and serves as a Director, Chairman of the Board and treasurer; he also indirectly holds 50% of 17AN and serves as a Director, Chairman of the Board and Chief Executive Officer.
Resource Automotive, Inc. ("RA") a subsidiary of Aon Warranty Group, entered into a Vendor Agreement (the "Vendor Agreement") with Incisent Technologies LLC, formerly known as First Look, LLC ("Incisent") effective November 4, 2005. The Vendor Agreement replaced a Marketing and Distribution Agreement between the same parties that became effective March 18, 2004 and terminated as of November 4, 2005. Patrick G. Ryan, Jr., the son of Patrick G. Ryan, is the Chief Executive Officer of Incisent. The Vendor Agreement granted to RA a non-exclusive right to offer to RA's franchised automobile dealer customers certain proprietary technology and services developed by Incisent, and provided that RA is obligated to compensate Incisent only when RA's customers actually enroll in RA's Variable Income Partners program. RA entered into this agreement because it believed that its ability to offer its customers the Incisent technology and services helped RA differentiate itself from its competitors in an increasingly competitive marketplace. RA further believed that the Vendor Agreement did not contain terms that would not have been arrived at in arms-length negotiations with Incisent, because Incisent's products are superior to those offered by other potential suppliers and the
pricing offered by Incisent was less than, or equal to, what RA could obtain from others. The Vendor Agreement terminated on December 31, 2006. Total payments to Incisent in 2006 were $1,812,851.
On January 1, 2005 one of our subsidiaries entered into a five-year consulting agreement with Raymond I. Skilling, who served as Executive Vice President and Chief Counsel of Aon until August 2003. Mrs. Raymond I. Skilling and Mrs. Patrick G. Ryan are sisters. Under the terms of the agreement, Mr. Skilling performs services related to the subsidiary's professional liability brokerage business. The company pays him an annual fee of $250,000, provides office support services, and continues to vest the stock options and stock awards granted to him while he was an employee. During 2006, 4,500 stock awards with a market value of $185,085, and 50,500 options vested. The agreement may be terminated after an initial term of two years by either party upon 180 days' notice.
In 2006, Ryan Enterprises Group LLC ("REG"), of which Patrick G. Ryan is a Director and officer, paid Aon $116,993 representing insurance costs, pilot fees and consulting fees.
In 2006, Patrick G. Ryan and Shirley Ryan paid Aon the following amounts: (i) $130,000 for pilot services in connection with the use of personal aircraft; (ii) $126 for the reimbursement of personal charges at a company paid social club; and (iii) $240,387 for insurance premiums paid to insurers related to brokerage services provided by subsidiaries of Aon and (iv) $270 for medicare tax.
In March 1997, an interest-free loan in the amount of £478,189 was made to Dennis L. Mahoney by a subsidiary of Aon in connection with the implementation of a long-term incentive plan. The loan was repayable only if Mr. Mahoney left the employment of Aon prior to December 31, 2006. As long as Mr. Mahoney remained employed by Aon, the terms of the loan provided that twenty percent (20%) of the loan would be forgiven on December 31 of each of 2002 through 2006. The remaining balance on the loan was forgiven in the first quarter 2007.
On January 1, 2003, one of our subsidiaries entered into an employment agreement with Michael D. Rice, II, the son of Michael D. Rice. The agreement will terminate on March 31, 2011. In 2006, Michael D. Rice, II received aggregate cash compensation of $1,287,839. In addition, Michael D. Rice, Jr. received equity compensation consisting of 9,778 restricted stock units, options to purchase 18,206 shares of Common Stock and a grant with a target level of 18,206 performance share units. In addition, Matthew Rice, the son of Michael D. Rice, is employed by one of our subsidiaries. In 2006, Matthew Rice received aggregate cash compensation of $175,849. Neither of the sons of Mr. Rice reports to Mr. Rice, nor does Mr. Rice determine their compensation.
Beginning in 2004, a number of actions were filed against certain current and former Directors and officers of Aon. These actions include: (1) putative class actions, pending in the Northern District of Illinois, making allegations under the Employee Retirement Security Act of 1974 ("ERISA") that certain Directors, officers and retirement plan ("Plan") fiduciaries knew or should have known that alleged business improprieties at Aon, including contingent commission arrangements, steering and leveraging of alleged insurance placements, made Aon stock an imprudent investment alternative for the Plan and breached their fiduciary duties to Plan participants; (2) putative federal securities class actions brought in the Northern District of Illinois, alleging that certain current and former officers and Directors failed adequately to disclose that Aon was engaged in allegedly illegal contingent commission agreements, steering and leveraging of insurance placements, and that these activities resulted in Aon having overstated its revenues; and (3) shareholders' derivative complaints filed in the Circuit Court of Cook County, Illinois, alleging that Aon's Directors breached their fiduciary duties to the Company by approving and implementing a business plan that included the receipt of allegedly unlawful payments from insurance carriers, or alternatively, by failing to be aware of and take steps to alter this business plan. Pursuant to the indemnification provision contained in our Second Amended and Restated Certificate of Incorporation, as amended, Aon will advance expenses (including attorneys' fees) incurred by these current and former Directors and officers in defending against these actions.
Section 16(a) of the Exchange Act requires that each of our Directors and executive officers, and any other person who owns more than ten percent of our Common Stock, file with the SEC initial reports of ownership and reports of changes in ownership of our Common Stock. Such Directors, executive officers and stockholders are required by regulation to furnish us with copies of such reports. Based solely upon our review of these reports, as well as written representations to the effect that no such other reports were required to be filed, Aon believes that all such SEC filing requirements were met during 2006.
Stockholders who, in accordance with the SEC's Rule 14a-8, wish to present proposals for inclusion in the proxy materials to be distributed by us in connection with our 2007 Annual Meeting of Stockholders must submit their proposals to the Office of the Corporate Secretary of Aon at 200 East Randolph Street, Chicago, Illinois 60601, on or before December 13, 2007. As the rules of the SEC make clear, simply submitting a proposal does not guarantee its inclusion in our proxy statement.
In accordance with our by-laws, in order to nominate a candidate for election as a Director or properly bring other business before the 2008 Annual Meeting of Stockholders, a stockholder's notice of the matter the stockholder wishes to present must be delivered to the Office of the Corporate Secretary of Aon at 200 East Randolph Street, Chicago, Illinois 60601, not less than 75 nor more than 100 days prior to the first anniversary of the date of this year's Annual Meeting. As a result, any notice given by or on behalf of a stockholder pursuant to these provisions of our by-laws (and not pursuant to the SEC's Rule 14a-8) must be received no earlier than February 8, 2008 and no later than March 4, 2008.
We will furnish without charge to each person whose proxy is being solicited, upon such person's request, a copy of our Annual Report on Form 10-K for the fiscal year ended December 31, 2006, including the financial statements and schedules thereto, but excluding exhibits. Requests for copies of such report should be directed to the Office of the Corporate Secretary of Aon, 200 East Randolph Street, Chicago, IL 60601. Our Annual Report on Form 10-K will also be available free of charge through our web site (http://www.aon.com).
Appendix A to this proxy statement contains our 2006 Annual Financial Report, including our consolidated financial statements and management's discussion and analysis of financial condition and results of operations, as well as certain other financial and other information required by the rules and regulations of the SEC. To the extent that this proxy statement is incorporated by reference into any other filing by Aon with the SEC under the Securities Act of 1933, as amended (the "Securities Act"), or the Exchange Act, the information contained in Appendix A and the sections of this proxy statement entitled "Report of the Audit Committee" (to the extent permitted by the rules of the SEC) will not be deemed incorporated, unless specifically provided otherwise in such filing. The information contained in the Compensation Committee Report will not be deemed to be incorporated by reference into any filing under the Securities Act of the Exchange Act, other than Aon's Annual Report on Form 10-K, except to the extent specifically provided otherwise in such filing.
The Board of Directors is not aware of any business to be acted upon at the Annual Meeting other than that described in this proxy statement. If any other business comes before the Annual Meeting, the proxy holders (as indicated on the accompanying proxy card or cards) will vote the proxies according to their best judgment with respect to such matters.
2006 ANNUAL FINANCIAL REPORT
The following information has been adjusted to reflect the restatement of our financial results, which is described in the "Explanatory Note Regarding Restatement Related to Stock Option Expense" on page A-47, and which preceded Item 1 of Aon's Annual Report on Form 10-K, and in Note 2 to the consolidated financial statements, "Restatement of Consolidated Financial Statements". The net of tax impact of the adjustments, which amounted to $1 million in 2006, was recorded by the Company in its fourth quarter of 2006. The net of tax impact of the restatements on the Company's results of operations amounted to $2 million and $3 million in 2005 and 2004, respectively. The impact of these adjustments was not significant to the Company's operating results, trends, or liquidity for the annual or quarterly periods in 2006, 2005, and 2004.
This Management's Discussion and Analysis is organized as follows:
Key Drivers of Financial Performance
The key drivers of financial performance vary among our operating segments.
Risk and Insurance Brokerage Services. Brokerage segment results are affected by several key drivers, including:
Consulting. Consulting segment results are principally affected by:
Insurance Underwriting. Underwriting segment results are affected by:
Liquidity is derived from cash flows from our businesses, excluding funds held on behalf of clients, and from financing. We use liquidity for capital expenditures, to repay debt, to fund acquisitions and pension obligations, to repurchase shares, and to pay dividends to our stockholders. Because we are a holding company, our subsidiaries may not have available cash to pay us dividends; in the case of the insurance underwriting subsidiaries, this ability is limited by regulatory and rating agency
considerations. Our access to cash generated from operations outside the U.S. may be affected by tax considerations and by pension funding requirements in our international pension plans.
Executive Summary of 2006 Financial Results
Below is a summary of our 2006 financial results. Refer to our detailed discussion below for further details.
In managing our cash and investments during the year, we:
We also repaid $250 million of notes payable in January 2007.
All of Aon's financial information reflects the application of critical accounting policies, estimates, assumptions and judgments, as discussed below under "Critical Accounting Policies and Estimates."
These items are discussed further in the remainder of this Management's Discussion and Analysis.
Sale of Businesses and Disposal of Operations
We fundamentally changed the composition of our underwriting segment in 2006 by selling our AWG and CPG operations in two separate, but related, transactions. Virginia Surety Company, Inc. ("VSC"), our principal underwriter for both AWG and CPG, was sold to the buyer of AWG. We received approximately $800 million in gross cash proceeds and realized a pretax gain of $43 million on these sales. On an after-tax basis, the transactions generated a gain of $9 million. The operating results of AWG and CPG and the impact of the sales transactions are included in discontinued operations for all periods presented.
Over the last three years, we also sold the following businesses that are included in discontinued operations:
Results of these businesses are as follows:
In November 2004, we sold our Cambridge claims administration business to Scandent Holdings Mauritius Limited ("SHM") for $90 million in cash plus convertible preferred stock in SHM, valued at $15 million. Because of our convertible preferred stock holding and other factors, we included Cambridge's results before the sale's effective date, as well as a pretax gain on the sale of $15 million, in income from continuing operations. In 2006, we contributed the preferred stock to one of our U.K. pension plans.
See Note 6 to the consolidated financial statements, "Disposal of Operations," for further information.
Third Quarter Underwriting Reserve Adjustments
We continually review the adequacy of our policy liabilities. During the third quarter 2006, in connection with the sales of AWG and CPG, we completed a detailed review of all our property and casualty reserves. Based on the results of this review, we increased our property and casualty reserves by approximately $102 million, reflecting adverse development, refined assumptions and additional claim information relating to programs to be disposed of through sale or runoff. We recorded $81 million of this adjustment in continuing operations, of which the majority related to National Program Services, an independent managing general underwriter which wrote habitational risk on behalf of VSC. The remaining $21 million related to CPG and was recorded in discontinued operations.
Restructuring and Other Business Reorganization Initiatives
In 2005, we began executing a broad restructuring initiative to reduce our fixed cost base and increase efficiency. This three-year plan has evolved as new opportunities have been identified and existing initiatives have been finalized. We expect the remaining portion to cost $40 million during 2007, which is in addition to the $325 million already expensed. Restructuring costs include workforce reductions, lease consolidation costs, asset impairments, and other expenses. In 2006, we estimate restructuring benefits were approximately $119 million. These initiatives are expected to lead to annualized cost savings of approximately $280 million by 2008.
We estimate 3,600 positions will be eliminated as a result of this initiative. As of December 31, 2006, approximately 2,500 of these eliminations had already occurred. Further, office closures require that we recognize losses on subleases or lease buy-outs, and may also trigger asset impairments.
The following chart details the restructuring and related expenses we incurred through 2006 and our estimates for 2007 by geographic region:
The following chart summarizes the restructuring costs incurred through 2006 and our estimated expenses by type for 2007.
Stock Repurchase Program
In November 2005, our Board of Directors authorized the repurchase of up to $1 billion of Aon's common stock, and in November 2006, the Board increased that amount to $2 billion. Any repurchased common stock will be available for employee stock plans and for other corporate purposes. From time to time, we may purchase shares through the open market or in privately negotiated transactions based on prevailing market conditions, which will be funded from available capital. During 2006, we repurchased 28.4 million shares for $1,048 million.
Aon's consolidated financial statements have been prepared according to U.S. generally accepted accounting principles ("GAAP"). To prepare these financial statements, we made estimates, assumptions and judgments that affect:
In accordance with our policies, we:
The results involve judgments about the carrying values of assets and liabilities not readily apparent from other sources. If our assumptions or conditions change, the actual results we report may differ from these estimates.
We believe the following critical accounting policies affect the more significant estimates, assumptions and judgments we used to prepare these consolidated financial statements.
Our U.S. pension plans are closed to new entrants, and effective January 1, 2007, we will determine future pension benefits using a "career average pay" formula rather than the prior "final average pay" formula.
As of year-end 2006:
Gains and losses on pension obligations arise from such things as changes in the discount rate and demographic changes in employee data. Unrecognized gains and losses are deferred and amortized as a component of pension expense over several years, based on the average expected future service of active employees in the plans, which is currently estimated to be eight years.
As of December 31, 2006, the pension plans have a deferred loss of $485 million (comprised of unrecognized asset gains of $36 million and unrecognized actuarial losses of $521 million) that has not yet been recognized through income in the financial statements. We amortize the actuarial losses of $521 million outside of a corridor, over approximately eight years; this corridor is defined as 10% of the greater of market-related value of plan assets or PBO. For 2007, we estimate that this expense amortization will be approximately $43 million. To the extent not offset by future gains, incremental amortization as calculated above will continue to affect future pension expense similarly until fully amortized.
To determine future pension expense, we currently assume a long-term rate of return of approximately 8.6%. We base this expected long-term return on capital market expectations for various asset classes (see following table). U.S. equities and fixed income expectations are estimated using a theoretical Capital Asset Pricing ("CAP") Model. The CAP Model for equities included three factors:
The 5.8% fixed income expectation factor included the then current 10-year U.S. Treasury Note yields and simulations of future yields based on expected inflation and other factors. We based:
We then weighted the expected returns for each asset class by the plan's target allocation.
This table shows the result of our calculation based on target asset allocation for year-end 2006. The actual return for the 2006 calendar year (15.3%) was in excess of the assumed return.
Several assumptions affect the actuarial calculation of pension obligations, and in turn, net periodic pension expense. The most significant of these assumptions are:
We use the same assumptions for our pension plans and postretirement benefit plans where applicable. Changes in these assumptions can have a material impact on pension obligations and pension expense. For example, holding all other assumptions constant, a one percentage point:
Similarly, holding other assumptions constant, a one percentage point:
Required cash contributions are also sensitive to assumptions; however, we rarely change the assumptions we use to determine contributions to the plan. We anticipate minimum cash funding requirements of $36 million in 2007. Under the new funding rules of the Pension Protection Act, we anticipate funding requirements of $67 million in 2008.
Major U.K. Plans
Our U.K. pension plans are closed to new entrants, and in November 2006, we proposed ceasing future benefit accruals relating to salary and service in the U.K. plans, subject to trustee approval and member consultation. Proposed changes would take effect in the first half of 2007, and future retirement benefits would be provided in a defined contribution segment of a pension scheme.
As of December 31, 2006, our U.K. pension plans have a combined unrecognized loss (from asset and liability experience) of $1,541 million that has not yet been recognized through income in the financial statements. We amortize the unrecognized loss outside of a corridor over 16 years; this corridor is defined as 10% of the greater of fair value of plan assets or PBO. For 2007, we estimate that this expense amortization will be approximately $71 million. To the extent not offset by future gains, incremental amortization as calculated above will continue to affect future pension expense similarly until fully amortized.
To calculate pension expense, we use the fair market value of plan assets. Generally, the U.K. plans' trustees determine the investment policy for each plan. In total, at the end of the 2006 valuation year, the plans were invested 63% in equities, 32% in fixed income securities, and 5% in real estate, with a fair value of $3,665 million.
In determining the expected rate of return, we analyzed investment community forecasts and current market conditions to develop expected returns for each of the asset classes used by the plans. We:
As a result, we assume a rate of return of 7.2% to determine future pension expense.
The table below shows the result of our calculation based on target asset allocation for year-end 2006. Because there are eight pension plans maintained in the U.K., the target allocation represents a
weighted average of the target allocation of each plan. Further, target allocations are subject to change. The actual return for the 2006 calendar year (9.4%) was in excess of the assumed return.
With respect to U.K. pension liabilities, a one-percentage point:
Similarly, a one-percentage point:
Cash flow requirements are also sensitive to assumptions; however, we rarely change the assumptions we use for funding the U.K. plans. Under current rules and assumptions, we anticipate U.K. funding requirements of $182 million in both 2007 and 2008. These contributions reflect minimum funding requirements plus other amounts agreed with U.K. plan trustees.
To calculate pension expense, we use the fair market value of plan assets. As of December 31, 2006, the Dutch pension plan had a combined unrecognized loss of $80 million that has not yet been recognized through income in the financial statements. We amortize the unrecognized loss outside of a corridor over 12 years; this corridor is defined as 10% of the greater of fair value of plan assets or PBO. For 2007, we estimate that this amortization will be approximately $3 million. To the extent not offset by future gains, incremental amortization as calculated above will continue to affect future pension expense similarly until fully amortized.
The target asset allocation is 28% global equities, 65% fixed income securities, and 7% real estate, with an allowed deviation of 5%. At year-end 2006, actual asset allocation was consistent with target allocation. The expected long-term rate of return on assets is 6%, which results from:
With respect to Dutch pension liabilities, a one percentage point:
A one percentage point:
In addition to the critical assumptions described above, all plans use certain assumptions about the life expectancy of plan participants and surviving spouses. Periodic revision of those assumptions can materially change the present value of future benefits, and therefore the funded status of the plans and the resulting periodic pension expense.
We define a contingency as any material condition that involves a degree of uncertainty that will ultimately be resolved. Under GAAP, we are required to establish reserves for contingencies when a loss is probable and we can reasonably estimate its financial impact. We do not recognize gain contingencies until the contingency is resolved.
We are required to assess the likelihood of material adverse judgments or outcomes as well as potential ranges or probability of losses. We determine the amount of reserves required, if any, for contingencies after carefully analyzing each individual issue. The required reserves may change due to new developments in each issue, or changes in approach, such as changing our settlement strategy.
Through our insurance underwriting operations, we collect premiums from policyholders, and we establish liabilities (reserves) to pay benefits to policyholders. The liabilities for policy benefits, claims, and unearned premiums:
If these liabilities prove inadequate, we would be required to increase the reserves, which could hurt our results and financial condition.
Accident & Health and Life
To establish policy liabilities, we develop estimates of reported and anticipated claims, based on our historical experience, other actuarial data, and assumptions on investment yields. The actuarial data reflects our best estimates of future expectations regarding claim frequency, claim severity, and the length of time that a customer is insured. Morbidity and mortality patterns may change over time due to many factors including:
We base interest rate assumptions on factors such as market conditions and expected investment returns.
Although mortality, morbidity, persistency, and interest rate assumptions are set when we issue new insurance policies, we may need to provide for additional losses on a product by:
Since estimating and establishing policy and contract liabilities is inherently uncertain, the actual ultimate cost of a claim may vary materially from the estimated amount reserved.
Liabilities for incurred but unpaid claims include estimated costs relating to reported claims, and incurred, but not reported, claims. We base the liability for unpaid claims on the estimated ultimate cost of settling claims using best estimates from past experience. These estimates incorporate current trends and any other factors that influence historical data. Actual experience, however, may vary from our estimates, due to changes in claim reporting, processing patterns, and variations from historic averages for the amount paid per claim. Variations from historic patterns and averages could result in additional changes that increase or decrease unpaid claim liabilities. As of December 31, 2006, there were no known changes in reporting or processing patterns.
Except for products that meet the definition of FASB Statement No. 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments, we accrue a liability for future policy benefits relating to long-duration contracts when we recognize premium revenue. The liability represents the present value of future benefits to be paid to policyholders less the present value of future premiums; we estimate this liability using methods that include estimates of expected investment yields, mortality, morbidity, and policy persistency.
Actual experience may vary from our estimates due to emerging trends in morbidity, mortality, persistency, and asset yieldsand some of these trends can fluctuate significantly over time. As we realize the actual experience, we take into account the financial impacts of these variations from our original assumptions. When current estimates of the present value of future benefits and expenses exceed the present value of future premiums for a product line, we recognize all excess amounts as a loss.
We account for long-duration contracts meeting the definition of Statement No. 97, such as universal life type products, the same way we account for interest-bearing or other financial instruments. We do not report payments received on those contracts as revenue and, correspondingly, we do not establish a policy benefit reserve. The liability for policy benefits is equal to:
Reserves for claim liabilities were $506 million, $428 million and $422 million as of December 31, 2006, 2005 and 2004, respectively. A 1% increase in the assumed medical cost trends would reduce pretax income by approximately $3 million.
Future Policy Benefits
Reserves for future policy benefits were $1,784 million, $1,671 million and $1,542 million as of December 31, 2006, 2005 and 2004, respectively. If a 1% unfavorable change were to occur in the mortality and morbidity assumptions for both the accident & health and life books of business, pretax income would be decreased by approximately $8 million.
Property & Casualty
Loss reserves reflect our estimated liability for unpaid claims and claims adjustment expenses and for reported and unreported losses incurred as of the end of each accounting period. Because setting loss reserve levels is inherently uncertain, we cannot guarantee that our current reserves will prove adequate in light of subsequent events.
Since we cannot calculate estimated liabilities exactly, reserves represent our best estimate of what we expect the ultimate settlement and administration of claims will cost, given our informed judgments based on:
Many of these factors are not quantifiable in advance, and both internal and external events, such as changes in claims handling procedures, inflation, judicial and legal developments, and legislative changes, can cause our estimates to vary. The inherent uncertainty of estimating reserves is greater for certain types of liabilities, where the variables affecting the claims are subject to change and long periods of time may elapse before we can definitively determine liability. We:
We estimate loss reserves for all property and casualty lines of business by accident year using several standard actuarial techniques, which include, but are not limited to:
We project ultimate losses on a direct, assumed, ceded and net basis, and deduct paid losses from the selected ultimate losses to arrive at the total indicated reserve. The total reserve includes case reserves and incurred but not reported reserves.
Factors influencing loss reserve estimates include the consistency of the results from actuarial techniques and our knowledge of emerging loss trends and rate or benefit changes.
Valuation of Investments
We periodically review securities with unrealized losses and evaluate them for other-than-temporary impairment. We analyze various risk factors and determine if any specific asset impairment exists. If there is a specific asset impairment, we recognize a realized loss and adjust the cost basis of the impaired asset to its fair value.
We review invested assets with unrealized losses separated into two categories:
Assets with unrealized losses due to issuer-specific events
At least quarterly, we review the following types of information, depending on the type of security:
We recognize an other-than-temporary impairment loss when appropriate for these investments with continuous unrealized losses due to issuer-specific events. We base our decision on the facts and circumstances for each investment.
Assets with unrealized losses due to market conditions or industry-related events
Invested assets with unrealized losses due to market conditions or industry-related events include those affected by increasing U.S. Treasury or local sovereign interest rates; corporate and asset-backed credit spread widening; common stock price volatility due to conditions in the overall market or a particular industry; and illiquid market conditions.
In certain circumstances, we assume that a decline in value below cost is temporary for fixed-maturity investments, with unrealized losses due to market conditions or industry-related events from which the market is expected to recover; and we can hold the investment until maturity or the market recovers, which is a decisive factor when considering an impairment loss. If we conclude that we do not have the intent or ability to hold an investment to maturity, we will reevaluate that investment for other-than-temporary impairment.
We evaluate other-than-temporary impairment for preferred and common stock and other investments with continuous unrealized losses for two consecutive quarters due to market conditions or industry-related events. We recognize an other-than-temporary impairment loss based upon each investment's facts and circumstances. We continue to monitor these securities quarterly to ensure that unrealized losses are not the result of issuer-specific events.
Note 7 to the consolidated financial statements provides additional information about our investments, including unrealized losses segregated by type and period of continuous unrealized loss at December 31, 2006.
Intangible assets represent the excess of cost over the value of net tangible assets of acquired businesses. We classify our intangible assets as either goodwill, client lists, non-compete agreements, future profits of purchased books of business of the insurance underwriting subsidiaries, or other purchased intangibles.
Although goodwill is not amortized, we test it for impairment at least annually. We test more frequently if there are indicators of impairment or whenever business circumstances suggest that the carrying value of goodwill may not be recoverable. We perform impairment reviews at the reporting unit level. If the fair value of a reporting unit is determined to be less than the carrying value of the reporting unit, we complete further analysis to determine whether there was an impairment loss. No further analysis was required in 2006 or 2005. We determine fair value based on estimates and assumptions related to the amount and timing of future cash flows and future interest rates. Different estimates or assumptions could produce different results.
As discussed in the Explanatory Note, certain stock options granted in prior years were not accounted for correctly. All options granted in prior years were evaluated and, with respect to approximately 85% of the grants, revised measurement dates were derived based upon contemporaneous written evidence of approval. For the remainder, system entry date information was used to determine the measurement date. Absent better approval date information, the system entry date represented the latest date when the terms of the options to individual recipients were known with finality and provided a reasonable and reliable measurement date. Of the cumulative $43 million adjustment, approximately $7 million was attributable to use of the system entry date. Although the system entry date may have been subsequent to the actual approval date for some grants, based on the assessment of the processes in place and a sensitivity analysis of the potential price variance, the impact of any alternative revised measurement dates would be immaterial, cumulatively or in any restated period.
On January 1, 2006, Aon adopted FASB Statement No. 123 (revised 2004), Share-Based Payment ("Statement No. 123(R)"), which requires that we measure and recognize compensation expense for all
share-based payments to employees, including grants of employee stock options and awards as well as employee stock purchases related to the Employee Stock Purchase Plan, based on estimated fair values. Aon adopted Statement No. 123(R) using the modified prospective transition method. Our consolidated financial statements as of and for the year ended December 31, 2006, reflect the impact of Statement No. 123(R). In accordance with the modified prospective transition method, we have not restated the Company's consolidated financial statements for prior periods due to the adoption of Statement No. 123(R).
Stock-based compensation expense recognized during the period is based on the value of the portion of share-based payment awards that we ultimately expect to vest during that period. Stock-based compensation expense recognized in our consolidated statements of income for the year ended December 31, 2006 includes compensation expense for share-based payment awards granted:
As the stock-based compensation expense we recognize is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. Statement No. 123(R) requires that we estimate forfeitures at the time of grant and revise our estimates, if necessary, in subsequent periods if actual forfeitures differ from those estimates. In Aon's pro forma information required under Statement No. 123 for periods prior to 2006, we accounted for forfeitures on restricted stock units (RSUs) as they occurred, but estimated forfeitures on stock options. When the terms of an award require no additional service, the award is fully expensed at the grant date. When awards are modified, the incremental shares are accounted for at the fair market value at the date of modification. Expense recognition begins on the date the service period begins, which can precede or be after the grant date, depending on the provisions of the award.
Before 2006, Aon was subject to Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations in accounting for its stock-based compensation plans. Under APB No. 25, no compensation expense was recognized for stock options when the exercise price of the options equaled the market price of the stock at the date of grant. During 2006, we discovered certain errors in relation to measurement dates in options granted prior to 2001. See Note 2 to our consolidated financial statements for further details.
Following adoption of Statement No. 123(R), we have also changed our method of valuation for stock options granted: in 2006, we moved to a lattice-binomial option-pricing model from the Black-Scholes option-pricing model, which we previously used for our pro forma information required under Statement No. 123. Lattice-based option valuation models:
The expected life of employee stock options represents the weighted-average period stock options are expected to remain outstanding, which is a derived output of the lattice-binomial model.
During 2006, we recognized $25 million of expense related to stock options.
Service-Based RSU Awards
Prior to 2006, RSUs granted to employees were generally service-based and accounted for by expensing the total award value over the service period. The total award value was calculated by multiplying the total number of shares to be delivered by the quoted market value on the date of grant. Beginning in 2006, we adopted the provisions of Statement No. 123(R), requiring that we apply forfeitures as well as dividend discounts, if appropriate, when determining the fair value of the award to be expensed over the service period.
Beginning with awards granted in 2006, awards to executives and key employees may also consist of performance-based awards, which ultimately result in the receipt of RSUs if the employee achieves his or her objective. Such objectives may be made on a personal or group level. Generally, our performance awards are fixed, which means we determine the fair value of the award at the grant date and recognize the expense over the performance or vesting period, whichever is longer.
To expense performance-based awards, we:
These estimates take into account performance to date as well as the assessment of future performance. These assessments are made by management using subjective estimates, such as long-term plans. As a result, changes in the underlying assumptions could have a material impact on the expense recognized.
During 2006, we recognized $26 million of expense related to performance-based awards, including both individual and group awards. Based on estimates as of December 31, 2006, we will incur an additional $71 million of expense related to these awards between 2007 and 2012.
The largest performance-based stock plan is the Leadership Performance Plan ("LPP"), which substantially replaced fixed methods of stock compensation to ensure expense is recognized only if targets are achieved. We currently expect to recognize $61 million of expense for the LPP plan over the 3 year performance period (2006-2008), of which $19 million was expensed in 2006. A 10% upward or
downward adjustment in our estimated performance targets would increase or decrease expense by approximately $2 million. As the percent of expected performance increases or decreases, the potential change in expense can go from 0% to 150% of the targeted total expense.
Awards that have either an indeterminate number of shares to be delivered or are required to be settled in cash are accounted for as liabilities. These liabilities are marked-to-market at the end of each reporting period at the then fair market value of our stock.
We earn income in numerous foreign countries and are subject to the laws of taxing jurisdictions within those countries, as well as U.S. federal and state tax laws. At December 31, 2006, the Company has a $627 million net deferred income tax asset and $216 million income tax refund receivable.
The carrying values of deferred income tax assets and liabilities reflect the application of our income tax accounting policies in accordance with FASB Statement No. 109, Accounting for Income Taxes, and are based on management's:
We assess carryforwards and tax credits for realization as a reduction of future taxable income by using a "more likely than not" determination. We have not recognized a U.S. deferred tax liability for undistributed earnings of certain foreign subsidiaries because they are considered permanently reinvested. Distributions may be subject to additional U.S. income taxes if we either distribute these earnings, or are deemed to have distributed these earnings, according to the Internal Revenue Code.
The carrying values of liabilities for income taxes currently payable are based on management's interpretation of applicable tax laws, and incorporate management's assumptions and judgments regarding the use of tax planning strategies in various taxing jurisdictions. Using different estimates, assumptions and judgments in accounting for income taxes, especially those which deploy tax planning strategies, may result in materially different carrying values of income tax assets and liabilities and changes in our results of operations.
We operate in many foreign jurisdictions where tax laws relating to the insurance broking, consulting, and underwriting businesses are not well developed. In such jurisdictions, we obtain professional guidance and consider existing industry practices before using tax planning strategies and meeting our tax obligations. Tax returns are routinely subject to audit in most jurisdictions, and tax liabilities are frequently finalized through negotiations. While historically we have not experienced significant adjustments to previously recognized tax assets and liabilities as a result of finalizing tax returns, there can be no assurance that significant adjustments will not arise in the future. In addition, there are several factors that could increase the future level of uncertainty over our tax liabilities, including the following:
In July 2006, the FASB issued Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxesan Interpretation of FASB Statement No. 109. FIN 48 clarifies the accounting for uncertainty in income taxes which are recognized in a company's financial statements in accordance with Statement No. 109. FIN 48 prescribes a recognition threshold and measurement of a tax position taken, or expected to be taken, in a company's tax return. We are required to adopt FIN 48 in first quarter 2007 and are evaluating the impact FIN 48 will have, if any, on our consolidated financial statements.
In our discussion of operating results, we sometimes refer to supplemental information derived from consolidated financial information.
We use supplemental information related to organic revenue growth to help us and our investors evaluate business growth from existing operations. Organic revenue growth excludes from reported revenues the impact of foreign exchange rate changes, acquisitions, divestitures, transfers between business units, investment income, reimbursable expenses, and unusual items. Organic revenue growth for the underwriting segment is based on premiums written.
Supplemental organic revenue growth information should be viewed in addition to, not instead of, our consolidated statements of income. Industry peers provide similar supplemental information about their revenue performance, although they may not make identical adjustments.
Since we conduct business in more than 120 countries, foreign exchange rate fluctuations have a significant impact on our business. In comparison to the U.S. dollar, foreign exchange rate movements may be significant and may distort true period-to-period comparisons of changes in revenue or pretax income. Therefore, we have:
Some tables in the segment discussions reconcile organic revenue growth percentages to the reported revenue growth percentages for the segments and subsegments. We separately disclose the impact of foreign currency as well as the impact from acquisitions, divestitures, and transfers of business units, which represent the most significant reconciling items. In an "all other" category, we total other reconciling items that are not generally significant individually or in the aggregate. If there is a significant individual reconciling item within the "all other" category, we provide additional disclosure in a note.
Summary of Results for 2004 through 2006
The consolidated results of continuing operations follow:
Consolidated Results for 2006 Compared to 2005
During 2006, compared to the prior year:
Consolidated revenue by geographic area follows:
We attribute revenues to geographic areas based on the location of the resources producing the revenues.
Total expenses increased $346 million or 5% from 2005 for three primary reasons:
Income from Continuing Operations Before Provision for Income Tax
Income from continuing operations was $920 million compared to $808 million in 2005. The increase in income was driven by organic revenue growth across each segment along with estimated restructuring savings of $119 million, partially offset by increases in benefits to policyholders and higher compensation and benefits costs.
Provision for Income Taxes
The effective tax rate on income from continuing operations was 32.0% in 2006 and 29.7% in 2005.
Differences between the overall effective tax rate and the U.S. federal statutory rate are typically due to U.S. state income taxes and differences between U.S. and international tax rates. Changes in the mix between our U.S. and international pretax income directly affect our effective tax rates. In 2006 and 2005, our effective tax rate also reflects the favorable resolution of tax examination issues, adjustments, and tax credits. For a summary of these effects, please see the rate reconciliation provided in Note 9 to the consolidated financial statements.
Income from Continuing Operations
In 2006, compared to 2005:
To compute income per share in 2005, we have deducted dividends paid on the redeemable preferred stock from net income. The redeemable preferred stock was redeemed and retired in September 2005. To comply with Emerging Issues Task Force (EITF) No. 04-8, The Effect of Contingently Convertible Investments on Diluted Earnings per Share, we increased diluted shares outstanding by 14 million to reflect the possible conversion of Aon's 3.5% convertible debt securities. When calculating the diluted income per share, we added after-tax interest expense on these debt securities to income from continuing operations.
After-tax income from discontinued operations was:
Consolidated Results for 2005 Compared to 2004
In 2005, compared to the prior year:
Total expenses decreased $186 million or 2% from 2004 for three primary reasons:
These favorable impacts were partially offset by $158 million in restructuring related expenses.
Income from Continuing Operations Before Provision for Income Tax
Income from continuing operations before provision for income tax increased $75 million to $808 million; as previously discussed, this fluctuation reflects several significant items.
Provision for Income Taxes
Differences between the overall effective tax rate and the U.S. federal statutory rate are typically due to U.S. state income taxes and differences between U.S. and international tax rates. Changes in the mix between our U.S. and international pretax income directly affect our effective tax rates.
The effective tax rate on income from continuing operations was:
Income from Continuing Operations
In 2005, compared to 2004:
To compute income per share, we deducted dividends paid on the redeemable preferred stock from net income. To comply with EITF No. 04-8, we increased diluted shares outstanding by 14 million to reflect the possible conversion of Aon's 3.5% convertible debt securities. When calculating the diluted income per share, we added after-tax interest expense on these debt securities to income from continuing operations.
After-tax income from discontinued operations was:
Aon classifies its businesses into three operating segments: Risk and Insurance Brokerage Services, Consulting and Insurance Underwriting (see Note 17 to the consolidated financial statements for further information).
Aon's operating segments are identified as those that:
Segment revenue includes investment income generated by invested assets of that segment, as well as the impact of related derivatives. Investment characteristics mirror liability characteristics of the respective segments:
The following tables and commentary provide selected financial information on the operating segments.
Aon is a leader in many sectors of the insurance industry: globally, it is the largest insurance broker, the largest reinsurance broker, and the leading manager of captive insurance companies worldwide. These rankings are based on the most recent surveys compiled and reports printed by Business Insurance.
Changes in premiums have a direct and potentially material impact on the insurance brokerage industry, as commission revenues are generally based on a percentage of the premiums paid by insureds.
Insurance premiums are cyclical in nature and may vary widely based on market conditions. Heavier than anticipated loss experience or capital shortages can result in increasing premium rates, which is referred to as a "hard market." A hard market tends to favorably impact commission revenues. Conversely, increased competition for market share among insurance carriers or increased underwriting capacity can result in flat or reduced premium rates, or a "soft market." A soft market tends to put downward pressure on commission revenues. Hard and soft markets may be broad-based or more narrowly focused across certain product lines or geographic areas.
Risk and Insurance Brokerage Services generated approximately 63% of Aon's total operating segment revenues in 2006. Revenues are generated primarily through:
Our revenues vary from quarter to quarter throughout the year as a result of:
Our risk brokerage companies operate in a highly competitive industry and compete with many retail insurance brokerage and agency firms, as well as with individual brokers, agents, and direct writers of insurance coverage. Specifically, this segment:
We review our revenue results using the following subsegments:
enhance the risk/return characteristics of insurance policy portfolios
improve capital utilization
evaluate and mitigate catastrophic loss exposures worldwide.
This table details Risk and Insurance Brokerage Services revenue by subsegment:
In 2006, revenue increased $261 million or 5% from 2005 due to growth in our retail and reinsurance operation and higher investment income, partially offset by weakness in the U.K.
This table reconciles organic revenue growth to reported revenue growth in 2006 versus 2005:
Organic revenue growth for the entire segment was 2%.
The 8% reported growth in Americas reflects:
U.K. revenue fell 8%. Organic revenue decreased 2%, driven by revenue declines from soft pricing, low retention rates, and lower new business. In addition, 2005 revenue included $23 million resulting from refinement of the techniques we used to estimate revenues on installment contracts. This refinement has been excluded from our calculation of organic revenue growth.
Europe, Middle East & Africa revenue was up 2%, driven by acquisitions and organic revenue growth especially in Africa, the Middle East, Netherlands, Spain, and France, and partially offset by declines in Germany and the Nordic region.
Asia Pacific revenue rose 8%, driven by acquisitions and organic growth in emerging markets in Asia.
Reinsurance revenue improved 9%, due to higher investment income and organic revenue growth in most areas of the world.
This table shows Risk and Insurance Brokerage Services revenue by geographic area and total pretax income:
U.S. revenue rose 8% over 2005 as a result of organic revenue growth, increased investment income, including the gain on the contribution of a preferred stock, and the realignment of certain businesses from Consulting.
Americas other than U.S. revenue increased 11% due to growth in Latin America.
The decline in U.K. revenues reflect low retention rates, lower new businesses, and the restructuring of the U.K. insurance market.
Europe, Middle East & Africa and Asia Pacific revenue both rose 7%, due to acquisitions and organic revenue growth.
Income Before Income Tax
Pretax income increased $139 million or 20% from 2005 to $841 million. In 2006, pretax margins in this segment were 14.9%, up from 13.1% in 2005.
Our results improved primarily as a result of five factors:
Negative impacts to this year's income and margins included higher staff expense, driven principally by increased incentives and benefit costs.
Aon Consulting is one of the world's largest integrated human capital consulting organizations. Our consulting segment:
We review our revenue results using the following subsegments:
In 2006, revenues of $1,282 million were 2% over 2005. Revenue on an organic basis was up 4% from last year.
This table details Consulting revenue by subsegment.
This table reconciles organic revenue growth to reported revenue growth in 2006 versus 2005.
On a subsegment basis, Consulting services was up $8 million or 1%, resulting from:
This growth more than offset a decline in our health and welfare practice and the transfer of certain small units to the Risk and Insurance Brokerage Services segment.
Outsourcing revenue rose 7% during the year, due primarily to $13 million of fees we received from a client terminating an outsourcing contract, as well as from an acquisition made late in 2005.
This table shows Consulting revenue by geographic area and pretax income: