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Willis Group Holdings 10-K 2009

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549



FORM 10-K

(Mark One)    

ý

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2008

or

o

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 001-16503



WILLIS GROUP HOLDINGS LIMITED
(Exact name of Registrant as specified in its charter)

Bermuda
(Jurisdiction of incorporation or organization)
  98-0352587
(I.R.S. Employer Identification No.)

c/o Willis Group Limited
51 Lime Street, London EC3M 7DQ, England

(Address of principal executive offices)

(011) 44-20-3124-6000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:

Title of each Class
Common Shares of par value $0.000115

 

Name of each exchange on which registered
New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act:
None



Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ý    No o

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o    No ý

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý    No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant's knowledge, in definite proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definition of "large accelerated filer", "accelerated filer" and "smaller reporting company" in rule 12b-2 of the Exchange Act.

  Large accelerated filer ý   Accelerated filer o   Non-accelerated filer o   Smaller reporting company o
        (Do not check if a
smaller reporting company)
   

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o    No ý

As of February 17, 2009, the aggregate market value of the voting stock held by non-affiliates of the Registrant was approximately $4,344,584,605.

As of February 17, 2009, there were outstanding 166,850,684 shares of common stock, par value $0.000115 per share of the Registrant.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of Willis Group Holding Limited's 2009 Notice of Annual Meeting of Stockholders and Proxy Statement are incorporated by reference into Part III of this Form 10-K.



WILLIS GROUP HOLDINGS LIMITED

ANNUAL REPORT ON FORM 10-K

FOR THE YEAR ENDED DECEMBER 31, 2008

Certain Definitions

The following definitions apply throughout this annual report unless the context requires otherwise:

"Company" or "Group" or "Willis"

  Willis Group Holdings Limited and its subsidiaries.

"Companies Act"

  The Companies Act 1981 of Bermuda, as amended.

"Shares"

  The shares of common stock of Willis Group Holdings Limited, par value $0.000115 per share.

"Willis Group Holdings"

  Willis Group Holdings Limited.

"HRH"

  Hilb, Rogal & Hobbs Company.

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Table Of Contents

 
   
  Page
Information concerning forward-looking statements   4

PART I

 

6
    Item 1—Business   6
    Item 1A—Risk Factors   13
    Item 1B—Unresolved Staff Comments   21
    Item 2—Properties   22
    Item 3—Legal Proceedings   22
    Item 4—Submission of Matters to a Vote of Security Holders   25

PART II

 

26
    Item 5—Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities   26
    Item 6—Selected Financial Data   29
    Item 7—Management's Discussion and Analysis of Financial Condition and Results of Operations   31
    Item 7A—Quantitative and Qualitative Disclosures about Market Risk   59
    Item 8—Financial Statements and Supplementary Data   63
    Item 9—Changes in and Disagreements with Accountants on Accounting and Financial Disclosure   137
    Item 9A—Controls and Procedures   137
    Item 9B—Other Information   139

PART III

 

140
    Item 10—Directors and Executive Officers of the Registrant   140
    Item 11—Executive Compensation   141
    Item 12—Security Ownership of Certain Beneficial Owners and Management   142
    Item 13—Certain Relationships and Related Transactions   143
    Item 14—Principal Accountant Fees and Services   143

PART IV

 

144
    Item 15—Exhibits, Financial Statement Schedules   144

Schedule II—Valuation and Qualifying Accounts

 

S-1
Signatures    

3



INFORMATION CONCERNING FORWARD-LOOKING STATEMENTS

We have included in this document "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934, which are intended to be covered by the safe harbors created by those laws. These forward-looking statements include information about possible or assumed future results of our operations. All statements, other than statements of historical facts, included in this document that address activities, events or developments that we expect or anticipate may occur in the future, including such things as the potential benefits of the business combination transaction involving Willis and HRH, expected growth in commissions and fees, business strategies, competitive strengths, goals, the anticipated benefits of new initiatives, growth of our business and operations, plans and references to future successes are forward-looking statements. Also, when we use the words such as "anticipate", "believe", "estimate", "expect", "intend", "plan", "probably", or similar expressions, we are making forward-looking statements.

There are important uncertainties, events and factors that could cause our actual results or performance to differ materially from those in the forward-looking statements contained in this document, including regional, national or global political, economic, business, competitive, market and regulatory conditions and the following:

    our ability to achieve the expected cost savings, synergies and other strategic benefits as a result of the acquisition of HRH or the amount of time it may take to achieve such cost savings, synergies and benefits expected to be realized as a result of the integration of HRH with our operations;

    our ability to continue to manage our indebtedness;

    our ability to implement and realize anticipated benefits of the Shaping our Future initiative and other new initiatives;
    our ability to retain existing clients and attract new business, and our ability to retain key employees;

    changes in commercial property and casualty markets, or changes in premiums and availability of insurance products due to a catastrophic event such as a hurricane;

    volatility or declines in other insurance markets and the premiums on which our commissions are based;

    impact of competition;

    the impact of insolvencies of clients or insurance companies resulting from an economic downturn;

    the timing or ability to carry out share repurchases or take other steps to manage our capital and limitations in our long-term debt agreements that may restrict our ability to take these actions;

    a significant decline in the value of investments that fund our pension plans or changes in our pension plan funding obligations;

    fluctuations in exchange and interest rates that could affect expenses and revenue;

    rating agency actions that could inhibit ability to borrow funds or the pricing thereof;

    domestic and foreign legislative and regulatory changes affecting both our ability to operate and client demand;

    potential costs and difficulties in complying with a wide variety of foreign laws and regulations, given the global scope of our operations;

    the impact of current financial market conditions on our results of operations and financial condition;

    changes in the tax or accounting treatment of our operations;

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    our exposure to potential liabilities arising from errors and omissions claims against us;

    the results of regulatory investigations, legal proceedings and other contingencies; and

    the timing of any exercise of put and call arrangements with associated companies.

The foregoing list of factors is not exhaustive and new factors may emerge from time to time that could also affect actual performance and results.

Although we believe that the assumptions underlying our forward-looking statements are reasonable, any of these assumptions, and therefore also the forward-looking statements

based on these assumptions, could themselves prove to be inaccurate. In light of the significant uncertainties inherent in the forward-looking statements included in this document, our inclusion of this information is not a representation or guarantee by us that our objectives and plans will be achieved.

Our forward-looking statements speak only as of the date made and we will not update these forward-looking statements unless the securities laws require us to do so. In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this document may not occur, and we caution you against unduly relying on these forward-looking statements.

5



PART I

Item 1—Business

History and Development of the Company

Willis Group Holdings is the ultimate holding company for the Group. We trace our history to 1828 and are one of the largest insurance brokers in the world.

Willis Group Holdings was incorporated in Bermuda on February 8, 2001 as an exempted company under the Companies Act, for the sole purpose of redomiciling the ultimate parent company of the Willis Group from the United Kingdom to Bermuda.

For administrative convenience, we utilize the offices of a subsidiary company as our principal executive offices. The address is:

    Willis Group Holdings Limited
    c/o Willis Group Limited
    The Willis Building
    51 Lime Street
    London EC3M 7DQ
    England
    Tel: +44 203 124 6000

For several years, we have focused on our core retail and specialist broking operations. Prior to 2008, we made a number of smaller acquisitions around the world and increased our ownership in several of our associates and existing subsidiaries, which were not wholly-owned, where doing so strengthened our retail network and our specialty businesses.

On October 1, 2008, we completed the acquisition of HRH, the eighth largest insurance and risk management intermediary in the United States. The acquisition doubled our North America revenues and the combined Willis HRH operation has critical mass in key markets including California, Florida, Texas, Illinois, New York, Boston, New Jersey and Philadelphia.

Available Information

Willis Group Holdings files annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission (the "SEC"). You may read and copy any documents we file at the SEC's Public Reference Room at 100 F Street, NE

Washington, DC 20549. Please call the SEC at 1-800-SEC-0330 for information on the Public Reference Room. The SEC maintains a website that contains annual, quarterly and current reports, proxy statements and other information that issuers (including Willis Group Holdings) file electronically with the SEC. The SEC's website is www.sec.gov.

The Company makes available, free of charge through our website, www.willis.com, our annual report on Form 10-K, our quarterly reports on Form 10-Q, our proxy statement, current reports on Form 8-K and Forms 3, 4, and 5 filed on behalf of directors and executive officers, as well as any amendments to those reports filed or furnished pursuant to the Securities Exchange Act of 1934 (the "Exchange Act") as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC. Unless specifically incorporated by reference, information on our website is not a part of this Form 10-K.

The Company's Corporate Governance Guidelines, Audit Committee Charter, Compensation Committee Charter and Corporate Governance and Nominating Committee Charter are also available on our website, www.willis.com, in the Corporate Governance section, or upon written or verbal request. Requests for copies of these documents should be directed in writing to the Company Secretary at the above address.

General

We provide a broad range of insurance brokerage, reinsurance and risk management consulting services to our worldwide clients. We have significant market positions in the United States, in the United Kingdom and, directly and through our associates, in many other countries. We are a recognized leader in providing specialized risk management advisory and other services on a global basis to clients in various industries including the aerospace, marine, construction and energy industries.

In our capacity as an advisor and insurance broker, we act as an intermediary between our clients and insurance carriers by advising our

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clients on their risk management requirements, helping clients determine the best means of managing risk, and negotiating and placing insurance risk with insurance carriers through our global distribution network.

We assist clients in the assessment of their risks, advise on the best ways of transferring suitable risk to the global insurance and reinsurance markets and then execute the transactions at the most appropriate available price, terms and conditions for our clients. Our global distribution network enables us to place the risk in the most appropriate insurance or reinsurance market worldwide.

We also offer clients a broad range of services to help them to identify and control their risks. These services range from strategic risk consulting (including providing actuarial analyses), to a variety of due diligence services, to the provision of practical on-site risk control services (such as health and safety or property loss control consulting) as well as analytical and advisory services (such as hazard modeling and reinsurance optimization studies). We assist clients in planning how to manage incidents or crises when they occur. These services include contingency planning, security audits and product tampering plans. We are not an insurance company and therefore we do not underwrite insurable risks for our own account, with the exception of a small legacy HRH operation (which is immaterial to the Group) in Omaha that underwrites for college fraternities.

We and our associates serve a diverse base of clients located in approximately 190 countries. These clients include major multinational and middle-market companies in a variety of industries, as well as public institutions and individual clients. Many of our client relationships span decades. Including our associates, we have approximately 20,000 employees around the world and a network of about 400 offices in some 100 countries.

We believe we are one of only a few insurance brokers in the world possessing the global operating presence, broad product expertise and extensive distribution network necessary to meet effectively the global risk management needs of many of our clients.

Business Strategy—Shaping our Future

Shaping our Future, our strategy introduced in 2006, aims to deliver profitable growth over the next several years.

Our vision is that Willis will:

segment clients and deliver service consistent with their needs and target high growth businesses and geographies;

drive profitable growth through providing our clients with value and service above that provided by our competitors;

use our global scale to manage carrier relationships in the best interest of the clients and to deliver product innovation;

aim to deliver service to clients efficiently by streamlining our organization and utilizing industry leading technology. We expect to create the optimal platform by enhancing our service model, processes and technology; and

become the employer of choice by creating a clear path of career development for our people and a reward and recognition framework that recognizes team work.

Our Business

Insurance and reinsurance is a global business, and its participants are affected by global trends in capacity and pricing. Accordingly, we operate as one global business which ensures all clients' interests are handled efficiently and comprehensively, whatever their initial point of contact. We organize our business into three segments: North America and International, which together comprise our principal retail operations, and Global. For information regarding revenues, operating income and total assets per segment, see Note 22 of the Consolidated Financial Statements contained herein.

Global

Our Global business provides specialist brokerage and consulting services to clients worldwide for the risks arising from specific industrial and commercial activities. In these operations, we have extensive specialized

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experience handling diverse lines of coverage, including complex insurance programs, and acting as an intermediary between retail brokers and insurers. We increasingly provide consulting services on risk management with the objective of assisting clients to reduce the overall cost of risk. Our Global business serves clients in around 190 countries, primarily from offices in the United Kingdom, although we also serve clients from offices in the United States, Continental Europe and Asia.

The Global business is divided into:

Global Specialties;

Willis Re; and

Faber & Dumas

Faber & Dumas, our new wholesale brokerage division, was launched in October 2008 on completion of Willis' acquisition of HRH. Faber & Dumas comprises HRH's London-based operation Glencairn, together with our Fine Art, Jewelry and Specie; Special Contingency Risk and Hughes-Gibb units.

Global Specialties

Global Specialties has strong global positions in Aerospace, Energy, Marine, Construction, Financial and Executive Risks and several niche businesses.

Aerospace

We are highly experienced in the provision of insurance and reinsurance brokerage and risk management services to Aerospace clients, including aircraft manufacturers, air cargo handlers and shippers, airport managers and other general aviation companies. Advisory services provided by aerospace include claims recovery, contract and leasing risk management, safety services and market information. Aerospace's clients are spread throughout the world and include approximately 350 airlines and in excess of 30 percent of the top 30 of the world's leading insured non-American airports by passenger movement. Aerospace is also prominent in supplying the space industry through providing insurance and risk management services to approximately 40 companies.

Energy 

Our Energy practice provides insurance brokerage services including property damage, offshore construction, liability and control of well and pollution insurance to the energy industry. The Energy practice clients are worldwide. We are highly experienced in providing insurance brokerage for all aspects of the energy industry including exploration and production, refining and marketing, offshore construction and pipelines.

Marine 

Our marine unit provides marine insurance and reinsurance brokerage services, including hull, cargo and general marine liabilities. Marine's clients include ship owners, ship builders, logistics operators, port authorities, traders and shippers, other insurance intermediaries and insurance companies. Marine insurance brokerage is our oldest line of business dating back to our establishment in 1828.

Construction

Our Construction practice provides risk management advice and brokerage services for a wide range of UK and international construction activities. The clients of the construction practice include contractors, project owners, project managers, project financiers, professional consultants and insurers. We are the broker for many of the leading global construction firms.

Financial and Executive Risks 

Our Financial and Executive Risks unit specializes in broking directors' and officers' insurance as well as professional indemnity insurance for corporations and professional firms. It incorporates our political risk unit, as well as structured finance and credit teams. It also places structured crime and specialist liability insurance for clients across the broad spectrum of financial institutions as well as specializing in strategic risk assessment and transactional risk transfer solutions.

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Willis Re

We are one of the world's largest intermediaries for reinsurance and have a significant market share in the world's major markets, particularly marine and aviation. We operate this business on a global basis and our clients are both insurance and reinsurance companies.

We provide a complete range of transactional capabilities, including risk transfer via the capital markets, as well as analytical and advisory services including enterprise risk management, hazard modeling, financial and balance sheet analysis and reinsurance optimization studies.

Faber & Dumas

Faber & Dumas is our wholesale brokerage division and comprises Glencairn; Fine Art, Jewelry and Specie; Special Contingency Risk and Hughes-Gibb units.

Glencairn principally provides property, energy, casualty and personal accident insurance to independent wholesaler brokers worldwide who wish to access the London, European and Bermudan markets.

The Fine Art, Jewelry and Specie unit provides specialist risk management and insurance services to fine art, diamond and jewelry businesses and operators of armored cars. Coverage is also obtained for vault and bullion risks.

The Special Contingency Risks unit specializes in producing packages to protect corporations, groups and individuals against special contingencies such as kidnap and ransom, extortion, detention and political repatriation.

The Hughes-Gibb unit principally services the insurance and reinsurance needs of the horse racing and horse breeding industry.

Retail operations

Our North America and International retail operations provide services to small, medium and major corporate clients, accessing Global's specialist expertise when required.

North America

In October 2008, we completed the acquisition of HRH, a leading middle market US-based insurance broker with a large account portfolio. HRH generated $800 million of revenues in 2007, with $57 million from its international operations, which are based in London. The acquisition substantially improves our position in important areas in North America including California, Florida, Texas, Illinois, New York, Massachusetts, New Jersey and Pennsylvania, and in key business lines. In particular, it will more than double our North America revenues in Employee Benefits, an already strong area of expertise that we have targeted for further growth. In addition, it will further strengthen key practice areas including personal lines, real estate, health care, environmental, construction, complex property and executive risk.

Our North America business provides risk management, insurance brokerage, related risk services, and employee benefits brokerage and consulting to a wide array of industry and client segments in the United States and Canada. With around 95 retail locations, organized into 8 regions including Canada, Willis North America locally delivers our global and national resources and specialist expertise through this retail distribution network.

In addition to being organized geographically and by specialty, our North America business focuses on four client segments: global, large national/middle-market, small commercial, and private client, with service, marketing and sales platform support for each segment. Further, our North America Marketing Practice provides clients with efficient access to worldwide insurance capital.

North America Construction 

The largest industry practice group in North America is Construction which specializes in providing risk management, insurance brokerage, and surety bonding services to the construction industry. Willis Construction provides these services to around 25 percent of the Engineering News Record Top 400 contractors (a listing of the largest 400 North American contractors based on revenue). In addition, this practice group has expertise in

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owner controlled insurance programs for large projects and insurance for national homebuilders.

Other industry practice groups 

Other industry practice groups include Healthcare, serving the professional liability and other insurance and risk management needs of private and not-for-profit health systems, hospitals and physicians groups; Financial Institutions, serving the needs of large banks, insurers and other financial services firms; Mergers & Acquisitions, providing due diligence, and risk management and insurance brokerage services to private equity and merchant banking firms and their portfolio companies.

Employee Benefits 

Willis Employee Benefits, fully integrated into the North America platform, is our largest product-based practice group and provides health, welfare and human resources consulting, and brokerage services to all of our commercial client segments. This practice group's value lies in helping clients control employee benefit plan costs, reducing the amount of time human resources professionals spend administering their companies' benefit plans and educating and training employees on benefit plan issues.

Executive Risks 

Another industry-leading North America practice group is Willis Executive Risks, a national team of technical professionals who specialize in meeting the directors & officers, employment practices, fiduciary liability insurance risk management, and claims advocacy needs of public and private corporations and organizations. This practice group also has expertise in professional liability, especially internet risks.

Excess & Surplus 

The Excess and Surplus segment, based in Redondo Beach, California with offices operating in California, Texas, Florida and Illinois, is a wholesale broker providing access to excess and surplus lines markets for the domestic network of retail brokers.

CAPS 

The Captive, Actuarial, and Pooling Solutions (CAPS) practice has a national team of actuaries, certified public accountants, financial analysts and pooled insurance program experts who help large clients develop, implement and manage alternative risks financing vehicles.

Willis HRH Programs 

Willis HRH Programs, based in Portsmouth, New Hampshire with operations in Florida, Michigan, Utah, Colorado, Connecticut and Vermont, is a managing general agent/managing general underwriter and a leader in providing national insurance programs to niche industries including ski resorts, auto dealers, recycling, environmental, and specialty workers' compensation.

International

Our International unit consists of our retail operations in Eastern and Western Europe, the United Kingdom and Ireland, Asia/Pacific, Russia, the Middle East, South Africa and Latin America, with a presence in over 100 countries worldwide.

Our offices are there to grow our business locally around the world, making use of skills, industry knowledge and expertise available elsewhere in the Group.

The services provided are focused according to the characteristics of each market and are not identical in every office, but generally include direct risk management and insurance brokerage, specialist and reinsurance brokerage and employee benefits consulting.

We target both large accounts and middle market clients. Recent global market conditions have resulted in excellent opportunities to recruit talented teams and individuals from the competition with new and complementary skills and relationships. We have a dedicated team within International working on the implementation of our Shaping our Future strategy and initiatives, identifying opportunities for increased efficiency and growth.

We believe the combined total revenues of our International subsidiaries and associates provide

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an indication of the spread and capability of our International network. Our International segment generated close to 40 percent of total consolidated commissions and fees in 2008.

Emerging Markets

We have separately identified high growth markets across all International retail operations. This encompasses the fast-developing, high growth regions of Eastern Europe, Russia, Asia (excluding Japan), the Middle East and South Africa. We bring particular capabilities and scale in energy, construction, marine and aerospace to these regions.

Global Markets International 

Global Markets International works closely with Global to further develop access for our retail clients to global markets, and provide structuring and placing skills in the relevant areas of property, casualty, terrorism, accident & health, facultative and captives.

Strategic Investments 

As part of our on-going strategy, we are continually strengthening our International market share through acquisitions and strategic investments. We have acquired a controlling interest in a broad geographic spread of other brokers—a list of the significant International subsidiaries is included in Exhibit 21.1 to this document.

We have also invested in associate companies; our significant associates at December 31, 2008 were Gras Savoye & Cie ("Gras Savoye"), France (48 percent voting rights) and Al-Futtaim Willis Co. LLC, Dubai (49 percent holding). In connection with many of our investments, we retain the rights to increase our ownership percentage over time, typically to a majority or 100 percent ownership position. In addition, in certain instances our co-shareholders have a right, typically based on some price formula of revenues or earnings, to put some or all of their shares to us (see "Item 1a—Risk Factors—Put and Call Arrangements"). On January 2, 2008, we acquired an additional 4 percent of Gras Savoye and a further 5 percent on December 31, 2008, bringing our total current voting rights to 48 percent.

Customers

Our clients operate on a global and local scale in a multitude of businesses and industries throughout the world and generally range in size from major multinational corporations to middle-market companies. Further, many of our client relationships span decades, for instance our relationship with The Tokio Marine and Fire Insurance Company Limited dates back over 100 years. No one client accounted for more than 10 percent of revenues for fiscal year 2008. Additionally, we place insurance with over 5,000 insurance carriers, none of which individually accounted for more than 10 percent of the total premiums we placed on behalf of our clients in 2008.

Competition

We face competition in all fields in which we operate based on global capability, product breadth, innovation, quality of service and price. According to the Directory of Agents and Brokers published by Business Insurance in July 2008, the 140 largest commercial insurance brokers globally reported brokerage revenues totaling $37 billion in 2007, of which Marsh & McLennan Companies Inc. had approximately 31 percent, Aon Corporation had approximately 19 percent and Willis had approximately 7 percent.

We compete with Marsh & McLennan and Aon as well as with numerous specialist, regional and local firms. Although Marsh & McLennan and Aon, along with us, have agreed to implement certain business reforms, many specialist, regional and local firms have not agreed to those business reforms. These firms are continuing to accept contingent compensation and are not disclosing the compensation received in connection with providing policy placement services to the customer.

Insurance companies also compete with brokers by directly soliciting insureds without the assistance of an independent broker or agent.

Competition for business is intense in all our business lines and in every insurance market. Competition on premium rates has also exacerbated the pressures caused by a continuing reduction in demand in some classes of business.

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For example, insurers are currently retaining a greater proportion of their risk portfolios than previously. Industrial and commercial companies are increasingly relying upon captive insurance companies, self-insurance pools, risk retention groups, mutual insurance companies and other mechanisms for funding their risks, rather than buying insurance.

Additional competitive pressures arise from the entry of new market participants, such as banks, accounting firms and insurance carriers themselves, offering risk management or transfer services.

Regulation

Our business activities are subject to legal requirements and governmental and quasi-governmental regulatory supervision in virtually all countries in which we operate. Also, such regulations may require individual or company licensing to conduct our business activities. While these requirements may vary from location to location they are generally designed to protect our clients by establishing minimum standards of conduct and practice, particularly regarding the provision of advice and product information as well as financial criteria.

Our activities in connection with insurance brokerage services within the United States are subject to regulation and supervision by state authorities. Although the scope of regulation and form of supervision may vary from jurisdiction to jurisdiction, insurance laws in the United States are often complex and generally grant broad discretion to supervisory authorities in adopting regulations and supervising regulated activities. That supervision generally includes the licensing of insurance brokers and agents and the regulation of the handling and investment of client funds held in a fiduciary capacity. Our continuing ability to provide insurance brokerage in the jurisdictions in which we currently operate is dependent upon our compliance with the rules and regulations promulgated from time to time by the regulatory authorities in each of these jurisdictions.

The European Union Insurance Mediation Directive introduced rules to enable insurance

and reinsurance intermediaries to operate and provide services within each member state of the EU on a basis consistent with the EU single market and customer protection aims. Each EU member state, in which we operate, is required to ensure that the insurance and reinsurance intermediaries resident in their country are registered with a statutory body in that country and that each intermediary meets professional requirements in relation to their competence, good repute, professional indemnity cover and financial capacity. In the United Kingdom the statutory body is the Financial Services Authority.

The Financial Services Authority has prescribed the methods by which our insurance and reinsurance operations are to conduct business, and they generally conduct their regulatory functions through the establishment of net worth and other financial criteria. They also require the submission of reports and have investigative and disciplinary powers. Monitoring visits are carried out to assess our compliance with regulatory requirements.

Our failure, or that of our employees, to satisfy the regulators that we are in compliance with their requirements or the legal requirements governing our activities, can result in disciplinary action, fines, reputational damage and financial harm.

All companies carrying on similar activities in a given jurisdiction are subject to regulations which are not dissimilar to the requirements for our operations in the United States and United Kingdom. We do not consider that these regulatory requirements adversely affect our competitive position.

Employees

As of December 31, 2008 we had approximately 17,000 employees worldwide of whom approximately 3,500 were employed in the United Kingdom and 7,400 in the United States, with the balance being employed across the rest of the world. In addition, our associates had approximately 3,300 employees, all of whom were located outside the United Kingdom and the United States.

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Item 1A—Risk Factors

 

Risks Relating to our Business and the Insurance Industry

This section describes material risks affecting the Group's business. These risks could materially affect the Group's business, its revenues, operating income, net income, net assets, liquidity and capital resources and ability to achieve its financial targets and, accordingly should be read in conjunction with any forward-looking statements in this Annual Report on Form 10-K.

Competitive Risks

Our business may be adversely affected by an overall decline in economic activity.

Our business and operating results are materially affected by worldwide economic conditions. Current global economic conditions including the current credit crisis coupled with declining customer and business confidence, increasing energy prices, and other challenges, may have a significant negative impact on the buying behavior of some of our clients as their businesses suffer from these conditions. In particular, financial institutions, construction, aviation, and logistics businesses such as marine cargo are most likely to be affected. Further, the global economic downturn is also negatively affecting some of the international economies that have supported the strong growth in our International operations. Our employee benefits practice may also be adversely affected as businesses continue to downsize during this period of economic turmoil. In addition, a growing number of insolvencies associated with an economic downturn, especially insolvencies in the insurance industry, could adversely affect our brokerage business through the loss of clients or by hampering our ability to place insurance and reinsurance business. While it is difficult to predict consequences of any further deterioration in global economic conditions on our business, any significant reduction or delay by our clients in purchasing insurance or making payment of premiums could have a material adverse impact on our financial condition and results of operations.

We do not control the premiums on which our commissions are based, and volatility or declines in premiums may seriously undermine our profitability.

We derive most of our revenues from commissions and fees for brokerage and consulting services. We do not determine insurance premiums on which our commissions are generally based. Premiums are cyclical in nature and may vary widely based on market conditions. From the late 1980s through late 2000, insurance premium rates generally declined as a result of a number of factors, including the expanded underwriting capacity of insurance carriers; consolidation of both insurance intermediaries and insurance carriers; and increased competition among insurance carriers. During 2004, we saw a rapid transition from a "hard" market, with premium rates stable or increasing, to a "soft" market, with premium rates falling in most markets. Rates continued to decline in most sectors through 2005 and 2006, with the exception of catastrophe-exposed markets. In 2007, the market softened further with decreases in many of the market sectors in which we operated and this has continued into 2008 with further declines of between 5 and 15 percent in many territories.

In addition, as traditional risk-bearing insurance carriers continue to outsource the production of premium revenue to non-affiliated agents or brokers such as ourselves, those insurance carriers may seek to reduce further their expenses by reducing the commission rates payable to those insurance agents or brokers. The reduction of these commission rates, along with general volatility and/or declines in premiums, may significantly undermine our profitability.

Competition in our industry is intense, and if we are unable to compete effectively, we may lose market share and our business may be materially adversely affected.

We face competition in all fields in which we operate, based on global capability, product breadth, innovation, quality of service and price. We compete with Marsh & McLennan and Aon, the two other providers of global risk

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management services, as well as with numerous specialist, regional and local firms. Although Marsh & McLennan and Aon, along with us, have agreed to implement certain business reforms, many specialist, regional and local firms have not agreed to these business reforms. These firms are continuing to accept contingent compensation and are not disclosing the compensation received in connection with providing policy placement services to the customer. If we are unable to compete effectively against these competitors, we will suffer lower revenue, reduced operating margins and loss of market share. As a result of our acquisition of HRH, we must phase out the contingent compensation payable to HRH over 3 years. We are currently seeking to increase revenue through higher commissions and fees that we disclose to our clients, and to generate profitable revenue growth by focusing on the provision of value-added risk advisory services beyond traditional brokerage activities. We cannot be certain that such steps will generate the profitable revenue growth we are targeting.

Competition for business is intense in all our business lines and in every insurance market, and the other two providers of global risk management services have substantially greater market share than we do. Competition on premium rates has also exacerbated the pressures caused by a continuing reduction in demand in some classes of business. For example, rather than purchase additional insurance through brokers, many insureds have been retaining a greater proportion of their risk portfolios than previously. Industrial and commercial companies have been increasingly relying upon their own subsidiary insurance companies, known as captive insurance companies, self-insurance pools, risk retention groups, mutual insurance companies and other mechanisms for funding their risks, rather than buying insurance. Additional competitive pressures arise from the entry of new market participants, such as banks, accounting firms and insurance carriers themselves, offering risk management or transfer services.

Dependence on Key Personnel—The loss of our Chairman and Chief Executive Officer or a number of our senior management or a significant number of our brokers could significantly impede our financial plans, growth, marketing and other objectives.

The loss of our Chairman and Chief Executive Officer or a number of our senior management or a significant number of our brokers could significantly impede our financial plans, growth, marketing and other objectives. Our success depends to a substantial extent not only on the ability and experience of our Chairman and Chief Executive Officer, Joseph J. Plumeri and other members of our senior management, but also on the individual brokers and teams that service our clients and maintain client relationships. The insurance and reinsurance brokerage industry has in the past experienced intense competition for the services of leading individual brokers and brokerage teams, and we have lost key individuals and teams to competitors. We believe that our future success will depend in part on our ability to attract and retain additional highly skilled and qualified personnel and to expand, train and manage our employee base. We may not continue to be successful in doing so because the competition for qualified personnel in our industry is intense.

Legal and Regulatory Risks

We are subject to insurance industry regulation worldwide. If we fail to comply with regulatory requirements, we may not be able to conduct our business.

Many of our activities are subject to regulatory supervision in virtually all the countries in which we are based or our activities are undertaken. Failure to comply with some of these regulations could lead to disciplinary action, including requiring clients to be compensated for loss, the imposition of penalties and the revocation of our authorization to operate. In addition, changes in legislation or regulations and actions by regulators, including changes in administration and enforcement policies, could from time to time require operational improvements or modifications at various locations which could result in higher costs or hinder our ability to operate our business.

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We are subject to a number of legal proceedings concerning contingent compensation, other industry practices and certain conduct, which, if determined unfavorably to us, could adversely affect our financial results.

We have been subject to investigations by the departments of insurance or attorneys general of over 20 states, the District of Columbia, one US city, Canada and Australia concerning, among other things, arrangements pursuant to which insurers compensated insurance brokers for distribution and other services provided to insurers known as contingent compensation, bid rigging, tying and other possible violations of law, including violations of fiduciary duty, securities laws and antitrust laws. As more fully described in Note 17 to our consolidated financial statements included under Part II, Item 8 of this report, we are subject to a number of legal proceedings and other contingencies related to the subject of these investigations. If one or more of these matters is determined unfavorably to us it could have a material adverse effect on our business, results of operations or financial condition in any given quarterly or annual period. We intend to vigorously defend ourselves against these claims. The outcomes of these lawsuits, however, including any losses or other payments that may occur as a result, cannot be predicted at this time.

Our business, results of operations, financial condition or liquidity may be materially adversely affected by errors and omissions and the outcome of certain actual and potential claims, lawsuits and proceedings.

We are subject to various actual and potential claims, lawsuits and other proceedings relating principally to alleged errors and omissions in connection with the placement of insurance and reinsurance in the ordinary course of business. Because we often assist our clients with matters, including the placement of insurance coverage and the handling of related claims, involving substantial amounts of money, errors and omissions claims against us may arise which allege our potential liability for all or part of the amounts in question. Claimants can seek large damage awards and these claims can involve potentially significant defense costs. Such claims,

lawsuits and other proceedings could, for example, include allegations of damages for our employees or sub-agents improperly failing to place coverage or notify claims on behalf of clients, to provide insurance carriers with complete and accurate information relating to the risks being insured or to appropriately apply funds that we hold for our clients on a fiduciary basis. Errors and omissions claims, lawsuits and other proceedings arising in the ordinary course of business are covered in part by professional indemnity or other appropriate insurance. The terms of this insurance vary by policy year and self-insured risks have increased significantly in recent years. In respect of self-insured risks, we have established provisions against these items which we believe to be adequate in the light of current information and legal advice, and we adjust such provisions from time to time according to developments. Our business, results of operations, financial condition and liquidity may be adversely affected if in the future our insurance coverage proves to be inadequate or unavailable or there is an increase in liabilities for which we self-insure. Our ability to obtain professional indemnity insurance in the amounts and with the deductibles we desire in the future may be adversely impacted by general developments in the market for such insurance or our own claims experience. In addition, claims, lawsuits and other proceedings may harm our reputation or divert management resources away from operating our business.

The principal actual or potential claims, lawsuits and proceedings to which we are currently subject, including but not limited to errors and omissions claims, are: (1) the regulatory and other proceedings relating to contingent compensation arrangements referred to above; (2) potential claims arising out of various legal proceedings between reinsurers, reinsureds and their reinsurance brokers relating to personal accident excess of loss reinsurance placements for the years 1993 to 1998; (3) potential damages arising out of a court action, on behalf of a purported class of present and former female officer and officer equivalent employees for alleged discrimination against them on the basis of their gender; and (4) claims with respect to our placement of property and casualty insurance for a number of entities which were

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directly impacted by the September 11, 2001 destruction of New York's World Trade Center complex.

The ultimate outcome of all matters referred to above cannot be ascertained and liabilities in indeterminate amounts may be imposed on us. It is thus possible that future results of operations or cash flows for any particular quarterly or annual period could be materially affected by an unfavorable resolution of these matters. In addition, even if we do not experience significant monetary costs, there may be adverse publicity associated with these matters that will result in reputational harm to the insurance brokerage industry in general or to us in particular that may adversely affect our business.

Interruption or loss of our information processing systems or failure to maintain secure information systems could have a material adverse effect on our business.

Our business depends on highly available systems, secure information and the ability of our employees to process transactions. Our capacity to service our clients relies on storing, retrieving, processing and managing information. Interruption or loss of our information processing capabilities through loss of stored data, the failure of computer equipment or software systems, telecommunications failure or other disruption could have a material adverse effect on our business, financial condition and results of operations. Despite the business contingency plans we have in place, our ability to conduct business may be adversely affected by a disruption in the infrastructure that supports our business and the communities where we are located. This may include a disruption involving physical site access, terrorist activities, disease pandemics, electrical, communications or other services used by our company, our employees or third parties with whom we conduct business. Although we have certain disaster recovery procedures in place and insurance to protect against such contingencies, such procedures may not be effective and any insurance or recovery procedures may not continue to be available at reasonable prices and may not address all such losses or compensate us for the possible loss of clients occurring during any period that we are unable to provide services.

Furthermore, we depend on computer systems to store information about our clients, some of which is private. Database privacy, identity theft, and related computer and internet issues are matters of growing public concern and are subject to frequently changing rules and regulations. Our failure to adhere to or successfully implement processes in response to changing regulatory requirements in this area could result in legal liability or harm to our reputation. We have taken reasonable and appropriate security measures to prevent unauthorized access to information in our database. However, our technology may fail to adequately secure the private information we maintain in our databases and protect it from theft or inadvertent loss. In such circumstances, we may be held liable to our clients, which could result in litigation or adverse publicity that could have a material adverse effect on our business.

Financial Risks

The integration of the businesses and operations of HRH into our company involves risks and we may fail to realize all of the anticipated benefits of the acquisition of HRH.

The success of the acquisition of HRH completed in October 2008 will depend, in part, on our ability to achieve the anticipated cost synergies and other strategic benefits from combining the businesses of our company and HRH. We expect to benefit from operational synergies resulting from the consolidation of capabilities and elimination of redundancies as well as greater efficiencies from increased scale. We may face significant challenges in consolidating the functions of our company and HRH and their subsidiaries, integrating their technologies, organizations, procedures, policies and operations, addressing differences in the business cultures of the two companies, retaining key personnel and maintaining relationships with certain third parties. The integration process and other disruptions resulting from the acquisition may disrupt our ongoing businesses or cause inconsistencies in standards, controls, procedures and policies that adversely affect our relationships with clients and customers and with other market participants, employees, regulators and others with whom we have business or other dealings. If we are not able to successfully

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integrate the businesses, the anticipated cost synergies and other strategic benefits of the acquisition may not be realized fully or at all or may take longer to realize than expected.

Our incurrence of additional debt to pay a portion of the consideration related to the HRH acquisition significantly increased our interest expense, financial leverage and debt service requirements.

In October 2008, in connection with the acquisition of HRH, we incurred incremental borrowings of $1.525 billion which significantly increased our leverage. These borrowings were drawn down under new credit facilities consisting of a $700 million 5-year term loan facility, a $300 million revolving credit facility and a $1 billion interim credit facility. In February 2009, we entered into an agreement with Goldman Sachs Mezzanine Partners to issue notes in an aggregate principal amount of $500 million. We anticipate that the net proceeds of this issuance of approximately $480 million will be applied towards the balance of the interim credit facility. Although consummation of the issuance, which is subject to customary closing conditions, is expected to take place in March 2009, there is no certainty that the transaction will close. In addition, while the closing of the transaction would significantly extend the payment date for amounts otherwise due under the interim credit facility, the issuance of the notes will also result in a significant increase in our interest expense compared to that under the interim credit facility.

Although management believes that our cash flows will be more than adequate to service this debt, there may be circumstances in which required payments of principal and/or interest on this new debt could adversely affect our cash flows and this level of indebtedness may:

require us to dedicate a significant portion of our cash flow from operations to payments on our debt, thereby reducing the availability of cash flow to fund capital expenditures, to pursue other acquisitions or investments in new technologies, to pay dividends and for general corporate purposes;
increase our vulnerability to general adverse economic conditions, including increases in interest rates if the borrowings bear interest at variable rates;

limit our flexibility in planning for, or reacting to, changes or challenges relating to our business and industry; and

put us at a competitive disadvantage against competitors who have less indebtedness or are in a more favorable position to access additional capital resources.

The terms of the financing also include certain limitations on the amount and type of investments that may be made, the amount of dividends that may be declared, and the amount of shares that may be repurchased. In addition, any borrowings may be made at variable interest rates, making us vulnerable to increases in interest rates generally.

A failure to comply with the restrictions under our credit facilities and outstanding notes could result in a default under the financing obligations or could require us to obtain waivers from our lenders for failure to comply with these restrictions. The occurrence of a default that remains uncured or the inability to secure a necessary consent or waiver could cause our obligations with respect to our debt to be accelerated and have a material adverse effect on our business, financial condition or results of operations.

A downgrade in the credit ratings of our outstanding debt may adversely affect our borrowing costs and financial flexibility.

As of December 31, 2008, we had total consolidated debt outstanding of approximately $2.7 billion. A downgrade in the credit ratings of our debt would increase our borrowing costs and reduce our financial flexibility. In addition, certain downgrades would trigger a step-up in interest rates under the indenture for our 6.2% senior notes, which would increase our interest expense. If we need to raise capital in the future, any credit rating downgrade could negatively affect our financing costs or access to financing sources.

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If we are unable to repay or refinance the interim credit facility, it could have a significant negative effect on our financial condition.

In connection with the HRH acquisition we entered into an interim credit facility in an aggregate principal amount of $1 billion, of which approximately $750 million remains outstanding. Failure to repay or refinance the interim credit facility at or prior to maturity would constitute an event of default under the interim credit agreement and would trigger cross default provisions in our other debt instruments and agreements, potentially causing such other debt to become immediately due and payable. However, our access to capital is affected by prevailing conditions in the financial and capital markets and other factors beyond our control and, given the current uncertainty in the capital markets, we may not be able to obtain additional financing on favorable terms or at all. While we anticipate applying approximately $480 million of the proceeds of the March 2009 note issuance towards the outstanding balance of the interim credit facility, there is no assurance that the transaction will close. If we are not able to issue new debt to repay the interim credit facility, we may have to use other sources of cash such as drawing down on our current revolving credit facility, future cash flows or cash on hand. The use of our revolving credit facility and other cash resources would restrict our financial flexibility and our ability to use such cash for other purposes and could have a significant negative impact on our liquidity.

Our pension liabilities may increase which could require us to make additional cash contributions to our pension plans.

We have two principal defined benefit plans: one in the United Kingdom and the other in the United States. Cash contributions of approximately $55 million will be required in 2009 for our pension plans, although we may elect to contribute more. Total cash contributions to these defined benefit pension plans in 2008 were $148 million. Future estimates are based on certain assumptions, including discount rates, interest rates, fair value of assets and expected return on plan assets. Following changes to UK pension legislation in 2005, we are now required to agree to a funding strategy for our UK

defined benefit plan with the plan's trustees. In February 2009, we agreed to make full year contributions to the UK plan of $37 million for 2009 through 2012. However, if certain funding targets are not met at the beginning of 2010 and 2011, full year contributions for these years will increase to $74 million. We have taken actions to manage our pension liabilities, including closing our UK and US plans to new participants and restricting final pensionable salaries.

The determinations of pension expense and pension funding are based on a variety of rules and regulations. Changes in these rules and regulations could impact the calculation of pension plan liabilities and the valuation of pension plan assets. They may also result in higher pension costs, additional financial statement disclosure, and accelerate and increase the need to fully fund our pension plans. Our future required cash contributions to our US and UK defined benefit pension plans may increase based on the funding reform provisions that were enacted into law. Further, a significant decline in the value of investments that fund our pension plan, if not offset or mitigated by a decline in our liabilities, may significantly differ from or alter the values and actuarial assumptions used to calculate our future pension expense and we could be required to fund our plan with significant amounts of cash. In addition, if the Pension Benefit Guaranty Corporation requires additional contributions to such plans or if other actuarial assumptions are modified, our future required cash contributions could increase. The need to make these cash contributions may reduce the cash available to meet our other obligations, including the payment obligations under our credit facilities and other long-term debt, or to meet the needs of our business.

In addition to the critical assumptions described above, our 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. Changes in our pension benefit obligations and the related net periodic costs or credits may occur in the future due to any variance of actual results from our assumptions

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and changes in the number of participating employees. As a result, there can be no assurance that we will not experience future decreases in stockholders equity, net income, cash flow and liquidity or that we will not be required to make additional cash contributions in the future beyond those which have been estimated.

We have entered into significant put and call arrangements which require us to pay substantial amounts to purchase shares in one of our associates. Those payments would reduce our liquidity and short-term cash flow.

In connection with many of our investments in our associates, we retain rights to increase our ownership percentages over time and, in some cases, the existing owners also have a right to put their shares to us. The put arrangements in place for shares of our associate, Gras Savoye, require us to pay substantial amounts to purchase those shares, which could decrease our liquidity and short-term cash flow.

The rights under the put arrangement may be exercised through 2011. Under the put arrangement, we will be required to buy shares of Gras Savoye increasing our voting rights from the 48 percent we currently hold up to 100 percent if all shareholders put their shares under this arrangement, subject to the pre-emption provisions set out in the bye-laws of Gras Savoye.

Following our initial acquisition of shares, we acquired an additional 5 percent of Gras Savoye at a cost of $25 million under these arrangements in September 2006, another 4 percent at a cost of $31 million in January 2008 and another 5 percent at a cost of $41 million at the end of December 2008.

According to the put arrangement, the aggregate management shareholding may not fall below approximately 10% of Gras Savoye's share capital while the management shareholders remain general partners of the company. The current appointments of the relevant individuals will expire on December 31, 2009. Accordingly (and except in case of death, disability or retirement prior to such date), management shareholders will not have a general put right until January 1, 2011. Payments in connection

with management put rights would not have exceeded $67 million if those rights had been fully exercised at December 31, 2008. In addition, we have a call option to move to majority ownership under certain circumstances and in any event from December 2009. Once we exercise this call option, the remaining Gras Savoye shareholders will have a put option to require us to purchase their shares.

Subject to the pre-emption provisions set out in the bye-laws of Gras Savoye, the incremental 42 percent of Gras Savoye shares held by shareholders (excluding the 10 percent holding of management shareholders described above) may be put to us at a price determined by a contractual formula based on earnings and revenue, which at December 31, 2008 would have amounted to approximately $285 million. The shareholders may put their shares individually at any time during the put period and the amounts we may have to pay in connection with the put arrangements may significantly exceed this estimate. In each case, we would have 90 days from the date of a notification from a shareholder who wished to put his shares to us to acquire those shares. The timing of any exercise of these put and call arrangements could have a material affect on our results of operations or cash flows for a particular quarter or annual period.

We recently received a notification from one of the shareholders of Gras Savoye, namely AXA Corporate Solutions, informing us of its intention to put its shares in Gras Savoye to us, subject to the pre-emption provisions set out in bye-laws of Gras Savoye. The shares held by AXA represent approximately 4 percent of the share capital of Gras Savoye. Notwithstanding that we have received this notice from AXA we believe that it is likely that we will not be required to acquire all of the AXA shares in the immediate future or, in some circumstances, at all. We believe that either:-

Gras Savoye itself will buy back all the AXA shares on 23 March 2009 and as a result, we would not acquire any of them; or

AXA will agree to extend the date for payment of the amount due in respect of the AXA shares and that Gras Savoye itself will buy back all the AXA shares on the agreed

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    date for payment. In these circumstances we believe that Gras Savoye will buy back all the AXA shares and would agree to pay the amount due in respect of the shares into an escrow account to be paid to AXA upon completion of the acquisition of the shares. Again, as a result, we would not be required to acquire any of the shares; or

certain of the other shareholders of Gras Savoye will exercise their pre-emption rights to acquire a portion of the AXA shares. In these circumstances we believe that AXA would withdraw its notification in respect of the remaining shares held by it although we believe that it would then exercise its right to put those to us later in 2009.

In the event that none of the above occurred or an alternative arrangement was agreed, we would be required to acquire the AXA shares on 23 March 2009. The amount payable by us for the AXA shares would be approximately $25 million.

International Risks

Our significant non-US operations, particularly our London market operations, expose us to exchange rate fluctuations and various risks that could impact our business.

A significant portion of our operations is conducted outside the United States. Accordingly, we are subject to legal, economic and market risks associated with operating in foreign countries, including devaluations and fluctuations in currency exchange rates; imposition of limitations on conversion of foreign currencies into pounds sterling or dollars or remittance of dividends and other payments by foreign subsidiaries; hyperinflation in certain foreign countries; imposition or increase of investment and other restrictions by foreign governments; and the requirement of complying with a wide variety of foreign laws.

We report our operating results and financial condition in US dollars. Our US operations earn revenue and incur expenses primarily in US dollars. In our London market operations, however, we earn revenue in a number of different currencies, but expenses are almost

entirely incurred in pounds sterling. Outside the United States and our London market operations, we predominantly generate revenue and expenses in the local currency. The table gives an approximate analysis of revenues and expenses by currency in 2008, and includes full year HRH results on a proforma basis.

 
  US
Dollars
  Pounds
Sterling
  Euros   Other
currencies
 

Revenues

    60 %   11 %   14 %   15 %

Expenses

    53 %   26 %   9 %   12 %

Because of devaluations and fluctuations in currency exchange rates or the imposition of limitations on conversion of foreign currencies into US dollars, we are subject to currency translation exposure on the profits of our operations, in addition to economic exposure. Furthermore, the mismatch between pounds sterling revenues and expenses, together with any net sterling balance sheet position we hold in our US dollar denominated London market operations, creates an exchange exposure.

For example, as the pound sterling strengthens, the US dollars required to be translated into pounds sterling to cover the net sterling expenses increase, which then causes our results to be negatively impacted. Our results may also be adversely impacted if we are holding a net sterling position in our US dollar denominated London market operations: if the pound sterling weakens any net sterling asset we are holding will be less valuable when translated into US dollars. Given these facts, the relative strength of the pound sterling relative to the US dollar has in the past had a material negative impact on our reported results. This risk could have a material adverse effect on our business financial condition, cash flow and results of operations in the future.

Where possible, we hedge part of our exposure to exchange rate movements, for example:

to the extent that forecast pound sterling expenses exceed pound sterling revenues, we limit our exposure to this exchange rate risk by the use of forward contracts matched to specific, clearly identified cash outflows arising in the ordinary course of business; and

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to the extent the London market operations also earn significant revenues in Euros and Japanese Yen, we limit our exposure to changes in the exchange rate between the US dollar and these currencies by the use of forward contracts matched to a percentage of forecast cash inflows in specific currencies and periods.

Generally, it is our policy to hedge at least 25 percent of the next 12 months' exposure in significant currencies.

We do not hedge exposures beyond three years or exposures arising from items, such as our UK pension asset, which will not be reflected in our cash flows in the short term.

In conducting our businesses around the world, we are subject to political, economic, legal, operational and other risks that are inherent in operating in many countries.

In conducting our businesses and maintaining and supporting our global operations, we are subject to legal, economic and market risks. Our businesses and operations are increasingly expanding into new regions throughout the world, including emerging markets, and we expect this trend to continue. The possible effects of economic and financial disruptions throughout the world could have an adverse impact on our businesses. These risks include:

the general economic and political conditions in foreign countries;

the imposition of controls or limitations on the conversion of foreign currencies or remittance of dividends and other payments by foreign subsidiaries;

imposition of withholding and other taxes on remittances and other payments from subsidiaries;
imposition or increase of investment and other restrictions by foreign governments;

difficulties in controlling operations and monitoring employees in geographically dispersed locations; and

the requirement of complying with a wide variety of foreign laws as well as laws and regulations applicable to US business operations abroad, including rules relating to trade sanctions administered by the US Office of Foreign Assets Control, the EU and the UN, and the requirements of the US Foreign Corrupt Practices Act as well as other anti-bribery and corruption rules and requirements in the countries in which we operate.

We could incur substantial losses if one of the financial institutions we use in our operations would happen to fail.

The recent deterioration of the global credit and financial markets has created challenging conditions for financial institutions, including depositories. As the fallout from the credit crisis persists, the financial strength of these institutions may continue to decline. We maintain cash balances at various US depository institutions that are significantly in excess of the US Federal Deposit Insurance Corporation insurance limits. We also maintain cash balances in foreign financial institutions. If one or more of the institutions in which we maintain significant cash balances were to fail, our ability to access these funds might be temporarily or permanently limited, and we could face a material liquidity problem and potentially material financial losses.

Item 1B—Unresolved Staff Comments

The Company had no unresolved comments
from the SEC's staff.

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Item 2—Properties

 

We own and lease a number of properties for use as offices throughout the world and believe that our properties are generally suitable and adequate for the purposes for which they are used. The principal properties are located in the United Kingdom and the United States.

London

We moved into our new London headquarters in Lime Street in April 2008. This 491,000 sq ft development occupies a prime site comprising a 29 story tower and adjoining 10 story building. We have entered into a 25 year lease for this building.

On September 27, 2006, Willis Group Services Limited, a subsidiary of Willis Group Holdings Limited, completed the sale of Ten Trinity Square, the Company's London headquarters building. The building was then leased back at an annual rental of $13 million until the Company occupied its new London headquarters on Lime Street in April 2008.

New York

In New York, we occupy 200,000 sq ft of office space at One World Financial Center under a 20 year lease.

Item 3—Legal Proceedings

 

Claims, Lawsuits and Other Proceedings

The Company is subject to various actual and potential claims, lawsuits and other proceedings relating principally to alleged errors and omissions in connection with the placement of insurance and reinsurance in the ordinary course of business. Similar to other corporations, the Company is also subject to a variety of other claims, including those relating to the Company's employment practices. Some of the claims, lawsuits and other proceedings seek damages in amounts which could, if assessed, be significant.

Errors and omissions claims, lawsuits and other proceedings arising in the ordinary course of business are covered in part by professional indemnity or other appropriate insurance. The terms of this insurance vary by policy year and self-insured risks have increased significantly in recent years. In respect of self-insured risks, the Company has established provisions which are believed to be adequate in the light of current information and legal advice, and the Company adjusts such provisions from time to time according to developments.

On the basis of current information, the Company does not expect that the actual claims, lawsuits and other proceedings, to which the Company is subject, or potential claims, lawsuits and other proceedings relating to matters of which it is aware will ultimately have a material adverse effect on the Company's financial

condition, results of operations or liquidity. Nonetheless, given the large or indeterminate amounts sought in certain of these actions, and the inherent unpredictability of litigation, it is possible that an adverse outcome in certain matters could, from time to time, have a material adverse effect on the Company's results of operations or cash flows in particular quarterly or annual periods.

The most significant actual or potential claims, lawsuits and other proceedings, of which we are currently aware are:

Inquiries and Investigations

In connection with the investigation commenced by the New York State Attorney General in April 2004 concerning, among other things, contingent commissions paid by insurers to insurance brokers, in April 2005, the Company entered into an Assurance of Discontinuance ("NY AOD") with the New York State Attorney General and the Superintendent of the New York Insurance Department and paid $50 million to eligible customers. As part of the NY AOD the Company also agreed not to accept contingent compensation and to disclose to customers any compensation the Company will receive in connection with providing policy placement services to the customer. The Company also resolved similar investigations commenced by the Minnesota Attorney General, the Florida Attorney General, the Florida

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Department of Financial Services and the Florida Office of Insurance Regulation for amounts that were not material to the Company. Similarly, in August 2005 HRH, which the Company acquired in October 2008, entered into an agreement with the Attorney General of the State of Connecticut (the "CT Attorney General") and the Insurance Commissioner of the State of Connecticut to resolve all issues related to their investigations into certain insurance brokerage and insurance agency practices and to settle a lawsuit brought in August 2005 by the CT Attorney General alleging violations of the Connecticut Unfair Trade Practices Act and the Connecticut Unfair Insurance Practices Act. As part of this settlement, HRH agreed to take certain actions including establishing a $30 million national fund for distribution to certain clients, enhancing disclosure practices for agency and broker clients, and declining contingent compensation on brokerage business. The Company has co-operated fully with other similar investigations by the regulators and/or attorneys general of other jurisdictions, some of which have been concluded with no indication of any finding of wrongdoing.

The European Commission issued questionnaires pursuant to its Sector Inquiry or, in respect of Norway, the European Free Trade Association Surveillance Authority, related to insurance business practices, including compensation arrangements for brokers, to at least 150 European brokers including our operations in nine European countries. The Company responded to the European Commission questionnaires and has filed the European Free Trade Association Surveillance Authority for two of its Norwegian entities. The European Commission reported on a final basis on September 25, 2007, expressing concerns over potential conflicts of interest in the industry relating to remuneration and binding authorities when assuming a dual role for clients and insurers and also over the nature of the coinsurance market. The Company continues to co-operate with both the European Commission and the European Free Trade Association Surveillance Authority.

Since August 2004, the Company and HRH (along with various other brokers and insurers) have been named as defendants in purported class actions in various courts across the United States. All of these actions have been consolidated or are in the process of being consolidated into a single action in the U.S. District Court for the District of New Jersey ("MDL"). There are two amended complaints within the MDL, one that addresses employee benefits ("EB Complaint") and one that addresses all other lines of insurance ("Commercial Complaint"). HRH was a named defendant in the EB Complaint, but has since been voluntarily dismissed. HRH is a named defendant in the Commercial Complaint. The Company is a named defendant in both MDL Complaints. The EB Complaint and the Commercial Complaint seek monetary damages, including punitive damages, and equitable relief and make allegations regarding the practices and conduct that have been the subject of the investigation of state attorneys general and insurance commissioners, including allegations that the brokers have breached their duties to their clients by entering into contingent compensation agreements with either no disclosure or limited disclosure to clients and participated in other improper activities. The Complaints also allege the existence of a conspiracy among insurance carriers and brokers and allege violations of federal antitrust laws, the federal RICO statute and the Employee Retirement Income Security Act of 1974 ("ERISA"). In separate decisions issued in August and September 2007, the antitrust and RICO claims were dismissed with prejudice and the state claims were dismissed without prejudice from both Complaints. Plaintiffs have filed a notice of appeal regarding these dismissal rulings and oral arguments on this appeal are scheduled to be heard in April 2009. In January 2008, the Judge dismissed the ERISA claims with prejudice from the EB Complaint. Additional actions could be brought in the future by individual policyholders. The Company disputes the allegations in all of these suits and has been and intends to continue to defend itself vigorously against these actions. The outcomes of these lawsuits, however, including any losses

23


 

or other payments that may occur as a result, cannot be predicted at this time.

Reinsurance Market Dispute

Various legal proceedings are pending, have been concluded or may commence between reinsurers, reinsureds and in some cases their intermediaries, including reinsurance brokers, relating to personal accident excess of loss reinsurance for the years 1993 to 1998. The proceedings principally concern allegations by reinsurers that they have sustained substantial losses due to an alleged abnormal "spiral" in the market in which the reinsurance contracts were placed, the existence and nature of which, as well as other information, was not disclosed to them by the reinsureds or their reinsurance broker. A "spiral" is a market term for a situation in which reinsureds and reinsurers reinsure each other with the effect that the same loss or portion of that loss moves through the market multiple times.

The reinsurers concerned have taken the position that, despite their decisions to underwrite risks or a group of risks, they are no longer bound by their reinsurance contracts. As a result, they have stopped settling claims and are seeking to recover claims already paid. The Company also understands that there have been at least two arbitration awards in relation to a spiral, among other things, in which the reinsurer successfully argued that it was no longer bound by parts of its reinsurance program. Willis Limited, the Company's principal insurance brokerage subsidiary in the United Kingdom, acted as the reinsurance broker or otherwise as intermediary, but not as an underwriter, for numerous personal accident reinsurance contracts, including two contracts that were involved in one of the arbitrations. Due to the small number of reinsurance brokers generally, Willis Limited was one of a small number of brokers active in the market for this reinsurance during the relevant period. Willis Limited also utilized other brokers active in this market as sub-agents, including brokers who are parties to the legal proceedings described above, for certain contracts and may be responsible for any errors and omissions they may have made.

In July 2003, one of the reinsurers received a judgment in the English High Court against certain parties, including a sub-broker Willis Limited used to place two of the contracts involved in this trial. Although neither the Company nor any of its subsidiaries were a party to this proceeding or any arbitration, Willis Limited entered into tolling agreements with certain of the principals to the reinsurance contracts tolling the statute of limitations pending the outcome of proceedings between the reinsureds and reinsurers.

Two former clients of Willis Limited, American Reliable Insurance Company and one of its associated companies ("ARIC") and CNA Insurance Company Limited and two of its associated companies ("CNA") have each terminated their respective tolling agreements with Willis Limited and commenced litigation in September 2007 and January 2008, respectively, in the English Commercial Court against Willis Limited. ARIC has alleged conspiracy between a former Willis Limited employee and the ARIC underwriter as well as negligence and CNA has alleged deceit and negligence by the same Willis Limited employee both in connection with placements of personal accident reinsurance in the excess of loss market in London and elsewhere. The Company disputes these allegations and is vigorously defending itself in these actions. ARIC's asserted claim is approximately $257 million (plus unspecified interest and costs) and CNA's asserted claim is approximately $251 million (plus various unspecified claims for exemplary damages, interest and costs). Pleadings have been exchanged in both actions and the parties have been and continue to be engaged in extensive discovery prior to the trial which the Court has fixed on a preliminary basis for ten weeks commencing October 7, 2009. The Company cannot predict at this time what, if any, damages might result from these claims but has kept its errors and omissions insurance carriers fully informed of developments in the claims. The Company believes that any amounts required to resolve the claims will be covered by errors and omissions insurance.

24


 

Various arbitrations continue to be active and from time to time the principals request co-operation from the Company and suggest that claims may be asserted against the Company. Such claims may be made against the Company if reinsurers do not pay claims on policies issued by them. The Company cannot predict at this time whether any such claims will be made or the damages that may be alleged.

Gender Discrimination Class Action

In March 2008, the Company settled an action in the United States District Court for the Southern District of New York commenced against the Company in 2001 on behalf of an alleged nationwide class of present and former female officer and officer equivalent employees alleging that the Company discriminated against them on the basis of their gender and seeking injunctive relief, money damages, attorneys' fees and costs. Although the Court had denied plaintiffs' motions to certify a nationwide class or to grant nationwide discovery, it did certify a class of approximately 200 female officers and officer equivalent employees based in the Company's offices in New York, New Jersey and Massachusetts. The settlement agreement provides for injunctive relief and a monetary payment, including the amount of attorney fees plaintiffs' counsel are entitled to receive, which was not material to the Company. In December 2006, a former female employee, whose motion to intervene in the class action was denied, filed a purported class action in the United States District Court, Southern District of New York, with almost identical allegations as those contained in the suit that was settled in 2008, except seeking a class period of 1998 to the time of trial (the class period in the settled suit was 1998 to the end of 2001). The Company's motion to dismiss this suit was denied and the

Court did not grant the Company permission to immediately file an appeal from the denial of its motion to dismiss. The suit was recently amended to include two additional plaintiffs. The parties are in the discovery phase of the litigation. The Company cannot predict at this time what, if any, damages might result from this action.

World Trade Center

We acted as the insurance broker, but not as an underwriter, for the placement of both property and casualty insurance for a number of entities which were directly impacted by the September 11, 2001 destruction of the World Trade Center complex, including Silverstein Properties LLC, which acquired a 99-year leasehold interest in the twin towers and related facilities from the Port Authority of New York and New Jersey in July 2001. Although the World Trade Center complex insurance was bound at or before the July 2001 closing of the leasehold acquisition, consistent with standard industry practice, the final policy wording for the placements was still in the process of being finalized when the twin towers and other buildings in the complex were destroyed on September 11, 2001. There have been a number of lawsuits in the United States between the insured parties and the insurers for several placements and other disputes may arise in respect of insurance placed by us which could affect the Company including claims by one or more of the insureds that we made culpable errors or omissions in connection with our brokerage activities. However, we do not believe that our role as broker will lead to liabilities which in the aggregate would have a material adverse effect on our results of operations, financial condition or liquidity.

Item 4—Submission of Matters to a Vote of Security Holders

None.

25



PART II

Item 5—Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market Information

Our Shares have been traded on the New York Stock Exchange under the symbol "WSH" since June 11, 2001. The high and low sale prices of our Shares, as reported by the New York Stock Exchange, are set forth below for the periods indicated.

 
  Price Range
of Shares
 
 
  High   Low  

2007:

         

First Quarter

  $    41.94   $    38.62  

Second Quarter

  $    46.64   $    39.07  

Third Quarter

  $    44.67   $    37.88  

Fourth Quarter

  $    43.15   $    36.69  

2008:

         

First Quarter

  $    37.97   $    30.40  

Second Quarter

  $    37.35   $    31.33  

Third Quarter

  $    35.21   $    29.76  

Fourth Quarter

  $    33.59   $    19.53  

2009:

         

First Quarter (through February 17, 2009)

  $    26.32   $    21.71  

On February 17, 2009, the last reported sale price of our Shares as reported by the New York Stock Exchange was $23.97 per Share. As of February 17, 2009 there were approximately 2,600 shareholders of record of our Shares.

Dividends

We normally pay dividends on a quarterly basis to shareholders of record on March 31, June 30, September 30 and December 31. The dividend payment dates and amounts are as follows:

Payment Date
  $ Per Share  

January 15, 2007

  $ 0.235  

April 16, 2007

  $ 0.250  

July 16, 2007

  $ 0.250  

October 15, 2007

  $ 0.250  

January 14, 2008

  $ 0.250  

April 14, 2008

  $ 0.260  

July 14, 2008

  $ 0.260  

October 13, 2008

  $ 0.260  

January 16, 2009

  $ 0.260  

On February 11, 2009 our Board of Directors declared a regular quarterly cash dividend of $0.26 per share, which will be payable on April 13, 2009 to shareholders of record on March 31, 2009.

There are no governmental laws, decrees or regulations in Bermuda which will restrict the remittance of dividends or other payments to non-resident holders of the Company's common stock.

On the date of this document there is no Bermuda income, corporation or profits tax, withholding tax, capital gains tax, capital transfer tax, estate duty or inheritance tax payable by us or our shareholders, other than shareholders ordinarily resident in Bermuda.

Pursuant to the Exempted Undertakings Tax Protection Act 1966, as amended, we have received an undertaking from the Bermuda Ministry of Finance, that, in the event of there being enacted in Bermuda any legislation imposing withholding or other tax computed on profits or income, or computed on any capital assets, gain or appreciation or any tax in the nature of estate duty or inheritance tax, such tax shall not until March 28, 2016 be applicable to us or to any of our operations, or to our Shares, debentures or other obligations except and so far as such tax applies to persons ordinarily resident in Bermuda and holding such shares, debentures or other obligations or any land leased or let to us in Bermuda.

The gross amount of dividends paid to US shareholders will be treated as dividend income to such holders, to the extent paid out of current or accumulated earnings and profits, as determined under United States federal income tax principles. This income will be includable in the gross income of a US shareholder as ordinary income on the day received by the US shareholder. These dividends will not be eligible for the dividends received deduction allowed to corporations under the Internal Revenue Code of 1986, as amended.

With respect to non-corporate US shareholders, certain dividends received before January 1, 2009

26


from a qualified foreign corporation may be subject to reduced rates of taxation. A foreign corporation is treated as a qualified foreign corporation with respect to dividends received from that corporation on shares that are readily tradable on an established securities market in the United States, such as our shares. Non-corporate US shareholders that do not meet a minimum holding period requirement for our Shares during which they are not protected from the risk of loss or that elect to treat the dividend income as "investment income" pursuant to section 163(d)(4) of the Code will not be eligible for the reduced rates of taxation regardless of our status as a qualified foreign corporation. In addition, the rate reduction will not apply to dividends if the recipient of a dividend is obligated to make related payments with respect to positions in substantially similar or related property. This disallowance applies even if the minimum holding period has been met. Non-corporate US shareholders should consult their own tax advisors regarding the application of these rules given their particular circumstances.

Total Shareholder Return

The following graph demonstrates a five year comparison of cumulative total returns for the Company, the S&P 500 and a peer group comprised of the Company, Aon Corporation, Arthur J. Gallagher & Co., Brown & Brown Inc., and Marsh & McLennan Companies, Inc. The comparison charts the performance of $100 invested in the Company, the S&P 500 and the peer group on January 1, 2003, assuming full dividend reinvestment.

GRAPHIC

Unregistered Sales of Equity Securities and Use Of Proceeds

In addition to issuances disclosed in our quarterly filings throughout 2008 the Company issued a total of 71,989 shares of common stock, during the period from October 1, 2008 to December 31, 2008 without registration under the Securities Act of 1933, as amended, in reliance upon the exemption under Section 4(2) of such Act relating to sales by an issuer not involving a public offering, none of which involved the sale of more than 1 percent of the outstanding shares of common stock of the Company.

The following sales of shares related to partial consideration for the acquisition of interests in the following companies to their former shareholders, other than for the company last listed, which related to full consideration for the shares acquired:

Date of Sale
  Number
of Shares
  Acquisition

December 1, 2008

    24,887   Coyle Hamilton Willis Holdings Limited

December 20, 2008

    47,102   Heyerdahl Brokers AS

27


Issuer Purchases of Equity Securities

The following shares of the Company's common stock were repurchased by the Company during the fourth quarter on a trade date basis:

Period
  Total Number of Shares Purchased   Average Price per Share   Total Number of Shares Purchased as part of Publicly Announced Plans or Programs   Fees and Price Adjustments   Approximate Dollar Value of Shares that may yet be Purchased under the Plans or Programs  

October 1, to October 31, 2008

    7,342   $ 31.703     7,342   $ 232,763   $ 924,778,829  

November 1, to November 30, 2008

                  $ 924,778,829  

December 1, to December 31, 2008

                  $ 924,778,829  

Following the acquisition of HRH on October 1, 2008, certain HRH employees surrendered 7,342 shares to the Company in lieu of taxes payable on HRH restricted stock which vested immediately prior to the acquisition. There were no other repurchases of the Company's common stock during the quarter ended December 31, 2008.

On November 1, 2007, the Board of Directors authorized an open-ended plan to purchase, from time to time in the open market or

through negotiated trades with persons who are not affiliates of the Company, shares of the Company's common stock at an aggregate purchase price of up to $1 billion. This authorization replaced the $308 million remaining under the Company's previously announced $1 billion repurchase plan. In addition the board authorized in June 2008, the repurchase of up to the number of shares issued by the Company in connection with the acquisition of HRH.

28


Item 6—Selected Financial Data

Selected Historical Consolidated Financial Data

The selected consolidated financial data presented below should be read in conjunction with the audited consolidated financial statements of the Company and the related notes and Item 7—"Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this report.

The selected historical consolidated financial data presented below as of and for each of the five years ended December 31, 2008 have been derived from the audited consolidated financial statements of the Company, which have been prepared in accordance with accounting principles generally accepted in the United States of America ("US GAAP").

 
  Year ended December 31,  
 
  2004   2005   2006   2007   2008  
 
  (millions, except per share data)
 

Statement of Operations Data

                               

Total revenues

  $ 2,275   $ 2,267   $ 2,428   $ 2,578   $ 2,834  

Salaries and benefits (including share-based compensation of $20, $18, $18, $33, $40)

    (1,218 )   (1,384 )   (1,457 )   (1,448 )   (1,642 )

Other operating expenses

    (391 )   (405 )   (454 )   (460 )   (605 )

Regulatory settlements

        (51 )            

Depreciation expense

    (41 )   (43 )   (49 )   (52 )   (54 )

Amortization of intangible assets

    (6 )   (11 )   (14 )   (14 )   (36 )

Gain on disposal of London headquarters

            102     14     7  

Net gain (loss) on disposal of operations

    11     78     (4 )   2      
                       

Operating income

    630     451     552     620     504  

Interest expense

    (22 )   (30 )   (38 )   (66 )   (105 )

Premium on redemption of subordinated notes

    (17 )                
                       

Income before income taxes, interest in earnings of associates and minority interest

    591     421     514     554     399  

Income taxes

    (197 )   (143 )   (63 )   (144 )   (97 )

Interest in earnings of associates, net of tax

    15     14     16     16     22  

Minority interest, net of tax

    (7 )   (11 )   (18 )   (17 )   (21 )
                       

Net income

  $ 402   $ 281   $ 449   $ 409   $ 303  
                       

Earnings per share—basic

  $ 2.56   $ 1.75   $ 2.86   $ 2.82   $ 2.05  

Earnings per share—diluted

  $ 2.42   $ 1.72   $ 2.84   $ 2.78   $ 2.05  
                       

Average number of shares outstanding

                               

—basic

    157     161     157     145     148  

—diluted

    166     163     158     147     148  
                       

Balance Sheet Data (as of year end)

                               

Goodwill

  $ 1,491   $ 1,507   $ 1,564   $ 1,648   $ 3,275  

Other intangible assets

    60     77     92     78     682  

Total assets(i)

    11,641     12,194     13,378     12,969     16,402  

Net assets

    1,432     1,281     1,496     1,395     1,895  

Total long-term debt

    450     600     800     1,250     1,865  

Common shares and additional paid-in capital

    817     557     388     41     886  

Total stockholders' equity

    1,412     1,256     1,454     1,347     1,845  

29


 
  Year ended December 31,  
 
  2004   2005   2006   2007   2008  
 
  (millions, except per share data)
 

Other Financial Data

                               

Capital expenditures

  $ 49   $ 32   $ 55   $ 185   $ 94  

Cash dividends declared per common share

  $ 0.75   $ 0.86   $ 0.94   $ 1.00   $ 1.04  

(i)
As an intermediary, we hold funds in a fiduciary capacity for the account of third parties, typically as a result of premiums received from clients that are in transit to insurance carriers and claims due to clients that are in transit from insurance carriers. We report premiums, which are held on account of, or due from policyholders, as assets with a corresponding liability due to the insurance carriers. Claims held by, or due to, us which are due to clients are also shown as both assets and liabilities of ours. All those balances due or payable are included in accounts receivable and payable on the balance sheet. Investment income is earned on those funds during the time between the receipt of the cash and the time the cash is paid out. Fiduciary cash must be kept in certain regulated bank accounts subject to guidelines, which vary according to legal jurisdiction. These guidelines generally emphasize capital protection and liquidity. Fiduciary cash is not available to service our debt or for other corporate purposes.

30


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

This discussion includes references to non-GAAP financial measures as defined in Regulation G of SEC rules. We present such non-GAAP financial measures, as we believe such information is of interest to the investment community because it provides additional meaningful methods of evaluating certain aspects of the Company's operating performance from period to period on a basis that may not be otherwise apparent on a GAAP basis. These financial measures should be viewed in addition to, not in lieu of, the Company's consolidated financial statements for the year ended December 31, 2008.

This discussion includes forward-looking statements, including under the heading "Summary—2008 Expense Review," "—Market outlook" and "—Financial Targets". Please see "Information Concerning Forward-Looking Statements" for certain cautionary information regarding forward-looking statements and a list of factors that could cause actual results to differ materially from those predicted in the forward-looking statements.

BUSINESS OVERVIEW AND MARKET OUTLOOK

 

We provide a broad range of insurance brokerage and risk management consulting services to our worldwide clients. Our core businesses include Aerospace; Energy; Marine; Construction; Financial and Executive Risks; Fine Art, Jewelry and Specie; Special Contingency Risks; and Reinsurance.

In our capacity as an advisor and insurance broker, we act as an intermediary between our clients and insurance carriers by advising our clients on their risk management requirements, helping clients determine the best means of managing risk, and negotiating and placing insurance risk with insurance carriers through our global distribution network.

We derive most of our revenues from commissions and fees for brokerage and consulting services and we do not determine the insurance premiums on which our commissions are generally based. Fluctuations in these premiums charged by the insurance carriers have a direct and potentially material impact on our results of operations. Commission levels generally trend with such premium levels as they are derived from a percentage of the premiums paid by the insureds. Due to the cyclical nature and impact of other market conditions on insurance premiums, they may vary widely between accounting periods. Such variations can result in a reduction in premium rates leading to downward pressure on commission revenues (a "soft" market) which in turn can have a

potentially material impact on our commission revenues and operating margin.

A "hard" market occurs when premium uplifting factors, including a greater than anticipated loss experience or capital shortages, more than offset any downward pressures on premiums. This usually has a favorable impact on our commission revenues and operating margin.

From 2000 through 2003 we benefited from a hard market with premium rates stable or increasing. During 2004, we saw a rapid transition from a hard market to a soft market, with premium rates falling in most markets. The soft market continued through 2005 and 2006 with rates declining in most sectors, with the exception of catastrophe exposed markets.

In 2007, the market softened further and this has continued through 2008 with year on year premium rate decreases averaging approximately 10 percent across our market sectors during 2008.

It is possible that the market may harden in 2009 as insurers seek higher premiums to cover a combination of weak investment returns, significant losses in 2008 and three years of soft market underwriting. In the reinsurance market, we have seen stabilization in rates and early signs of market recovery going into 2009.

However, these potential benefits may be offset in whole or in part by potential changes in the

31


 

buying behavior of some of our clients as their businesses suffer from the current global market uncertainty. In particular, financial institutions, construction, aviation, and logistics businesses such as marine cargo are most likely to be affected. Further, the global economic activity is

also negatively affecting some of the international economies that have supported the strong growth in our International operations. Our employee benefits practice may also be adversely affected as businesses continue to downsize during this period of economic turmoil.

EXECUTIVE SUMMARY

 

Overview

Despite the difficult trading conditions in 2008, we reported 4 percent organic commissions and fee growth in 2008 compared with 2007, reflecting growth in our International and Global Specialties operations, partly offset by a 1 percent fall in North America organic commissions and fees.

Operating margin for full year 2008 was 18 percent compared with 24 percent for 2007, of which 4 percentage points were attributable to charges relating to our 2008 expense review and 2 percentage points were attributable to the impact of foreign exchange movements.

In October 2008, we completed the acquisition of HRH, the eighth largest insurance and risk intermediary in the United States. The acquisition doubled our North America revenues and the combined Willis HRH operation has critical mass in key markets including California, Florida, Texas, Illinois, New York, Boston, New Jersey and Philadelphia.

Results 2008 compared with 2007

Net income in 2008 was $303 million, or $2.05 per diluted share, compared with $409 million, or $2.78 per diluted share, in 2007. The benefits of good organic revenue growth, improved margins in our International and Global operations and a lower effective tax rate were more than offset by a $0.45 per diluted share impact of charges for the 2008 expense review and a $0.27 per diluted share year on year impact from foreign exchange, discussed in detail within "General and administrative expenses" below.

HRH's fourth quarter results, net of related funding costs and intangible amortization, contributed $0.04 per diluted share. New shares

issued as part consideration for the HRH acquisition had an $0.11 dilutive impact on full year diluted earnings per share.

Total revenues at $2,834 million were $256 million, or 10 percent, higher than in 2007. Organic revenue growth of 4 percent, a 7 percent benefit from net acquisitions and disposals primarily reflecting the HRH acquisition and a 1 percentage point benefit from foreign currency translation were partly offset by lower investment and other income. Organic revenue growth of 4 percent reflected net new business growth of 6 percent and a 2 percent negative impact from declining rates and other market factors. Net new business growth benefitted from a 1 percentage point improvement in client retention rate to 91 percent, compared with 90 percent in 2007.

Operating margin at 18 percent in 2008 was 6 percentage points lower than in 2007 with the decrease mainly reflecting:

the $92 million charge for the 2008 expense review, equivalent to 4 percentage points;

an adverse year on year impact from foreign currency translation, equivalent to approximately 2 percentage points;

a $22 million increase in intangibles amortization, of which $21 million related to HRH;

our continued investment in targeted new hires and Shaping our Future initiatives; and

lower investment and other income;

    partly offset by

increased productivity, with revenues per full time equivalent ("FTE") employee increasing to $190,000 in 2008 compared with $186,000 in 2007;

32


 

HRH's $38 million operating income in fourth quarter 2008, equivalent to 1 percentage point; and

good cost control, the realization of savings from last year's Shaping our Future initiatives and lower pension costs.

A combination of factors, including a reduction in the UK corporate tax rate and a change in our geographical mix of income, enabled us to reduce our effective underlying tax rate to 26 percent in 2008 compared with 30 percent in 2007. This underlying rate excludes the tax effects of the disposal of our London headquarters, gains and losses on disposal of operations and the benefit of the release of tax provisions relating to the resolution of prior period tax positions.

Results 2007 compared with 2006

Net income in 2007 was $409 million, or $2.78 per diluted share, compared with $449 million, or $2.84 per diluted share, in 2006 as the benefits of increased revenues and a 1 percent increase in margin were more than offset by the non-recurrence of a $71 million tax credit in fourth quarter 2006, primarily relating to the resolution of certain prior year tax matters.

Total revenues at $2,578 million were $150 million, or 6 percent, higher than in 2006 of which 2 percent related to foreign currency translation and 1 percent to net acquisitions and disposals. Organic revenue growth was 3 percent reflecting net new business growth of 4 percent and a 1 percent negative impact from declining rates and other market factors.

Operating margin at 24 percent was 1 percentage point higher than in 2006 mainly reflecting:

the $102 million gain on disposal of our London headquarters in 2006, equivalent to approximately a 4 percentage point decrease in margin;

the $105 million expenditure in 2006 to launch our Shaping our Future strategy, equivalent to approximately a 4 percentage point increase in margin;
the benefit of 2007 cost savings relating to our Shaping our Future strategy and lower charges for pensions and legal provisions; and

an adverse year on year impact from foreign currency translation, equivalent to approximately a 1 percentage point decrease in margin.

HRH acquisition

On October 1, 2008, we completed the acquisition of HRH, the eighth largest insurance and risk management intermediary in the United States.

We believe that the acquisition of HRH will:

substantially improve our position in key markets including California, Florida, Texas, Illinois, New York, Boston, New Jersey and Philadelphia;

greatly strengthen our position as a middle market broker and reinforce our large account presence; and

enable the combined Willis HRH operation to deliver enhanced value to clients through a more robust and diversified platform.

We also expect to achieve significant synergies by 2010 of approximately $140 million as we centralize HRH's dispersed back office processes and integrate these into Willis hubs, rationalize the combined office network and close down HRH's Richmond head office.

Assuming the acquisition had occurred on January 1, 2007, pro forma combined revenues for the Group for full year 2008 would have been $3,451 million (2007: $3,378 million), of which $1,546 million, or 45 percent (2007: $1,586 million, or 47 percent), would be attributable to North America operations.

Total consideration paid by Willis for HRH was approximately $1.8 billion, which comprised approximately 24.4 million shares of common stock valued at $792 million and $982 million of cash. The total purchase price of approximately $2.1 billion included the assumption of approximately $340 million of HRH existing debt. The funding of the HRH transaction is discussed in "Cash and financing" below.

33


 

On acquisition we recognized an intangible asset of $639 million comprising:

 
  October 1,
2008
 
 
  (millions)
 

Customer relationships

  $ 593  

Non-compete agreements

    36  

Trade names

    10  
       

  $ 639  
       

Customer relationships were identified as the key intangible asset as HRH has historically generated approximately 95 percent of its revenues from existing customers. The charge for HRH's intangible amortization was $21 million in fourth quarter 2008; we expect the full year 2009 charge relating to HRH's intangibles to be $82 million.

We recognized goodwill on the acquisition of $1.6 billion. However, we are still in the process of finalizing the valuation of certain assets and liabilities, thus the purchase price allocation is still subject to refinement.

HRH is being rapidly integrated into our North America segment. We complete our annual goodwill impairment review in the fourth quarter. Based on our forecasts of the combined Willis HRH's future revenue streams and anticipated synergies from the deal, we believe the combined goodwill for North America of $1,810 million was not impaired as of December 31, 2008. However, if we fail to recognize some or all of the strategic benefits and synergies expected from the HRH transaction, goodwill may be impaired in future periods.

Other acquisitions

Additionally in 2008, we acquired a further 10 percent of voting rights in Gras Savoye & Cie, our French associate at a cost of approximately $70 million, bringing our ownership share of voting rights to approximately 48 percent as at December 31, 2008.

2008 expense review

Our Shaping our Future strategy is a series of initiatives designed to deliver profitable growth. As previously announced, we decided:

to invest in further key hires and initiatives in 2008 and 2009;

and, in order to fund a portion of these initiatives,

to conduct a thorough review in 2008 of all businesses to identify additional opportunities to rationalize our expense base.

In 2008, we incurred a pre-tax charge of $92 million ($66 million net of tax, equivalent to $0.45 per diluted share) comprising:

$42 million to buy out remuneration packages that no longer align with the Group's overall remuneration strategy;

$24 million of severance costs relating to approximately 350 positions which have been eliminated; and

$26 million of other operating expenses, including property and systems rationalization costs.

In light of the current global economic uncertainty, we are vigorously reviewing our cost base and will continue our right-sizing initiatives in 2009. Our current right-sizing initiatives emphasize cost discipline including talent management, location optimization and aggressive reduction of discretionary spending. We now expect that the 2008 charges above, together with the benefits of the ongoing review, may lead to 2009 cost savings in excess of the $45 million to $55 million originally estimated.

Financial targets

In light of the current uncertainty in the global economy, we have suspended our practice of providing annual earnings guidance for the year ahead, as we cannot predict the potential impact of this uncertainty on insurance pricing or on potential changes in the buying decisions of clients with any degree of certainty.

In addition, our previously stated earnings per share targets should not be relied upon.

34


 

Cash and financing

Cash at December 31, 2008 was $176 million; $24 million lower than at December 31, 2007.

Net cash from operating activities of $211 million and net proceeds from the issuance of long and short-term debt totaling $1,669 million, together with a net $30 million benefit from other smaller cash flows less the impact of foreign exchange, were used to fund:

acquisitions of $978 million, of which $926 million related to HRH;

repayments of outstanding debt of $641 million, of which $341 million related to HRH debt assumed on the acquisition;

dividend payments of $146 million;

fixed asset additions of $94 million, of which $38 million related to our new London headquarters building; and

share buybacks of $75 million.

Total long-term debt at December 31, 2008 was $1,865 million (December 31, 2007: $1,250 million), total short-term debt was $785 million (December 31, 2007: nil) and total stockholders' equity was $1,845 million (December 31, 2007: $1,347 million) giving a capitalization ratio (total long-term and short-term debt to total long-term debt, short-term debt and stockholders' equity) of 59 percent at December 31, 2008 compared with 48 percent at December 31, 2007. The 11 percent increase in the capitalization ratio is mainly attributable to debt drawn down as part of the HRH acquisition, partly offset by the $792 million equity issued to fund the remainder of the transaction.

On October 1, 2008, we funded the HRH acquisition with $1 billion from an interim credit facility and $525 million from a $700 million 5-year term loan facility. In addition, we repaid the outstanding balance on our existing revolving credit facility and replaced this with a new 5-year $300 million line of credit.

During fourth quarter 2008, we repaid $250 million of the then outstanding $1 billion balance on the interim credit facility funded by

using free cash flow (cash flow from operating and investing activities excluding acquisitions, disposals and additional pension contributions) of $75 million together with the draw down of the remaining $175 million available under the 5-year term loan facility.

In February 2009, we entered into an agreement with Goldman Sachs Mezzanine Partners to issue 12.875 percent senior unsecured notes due 2016 in an aggregate principal amount of $500 million. The transaction is subject to customary closing conditions and is expected to close during March 2009. The net proceeds of the issue will be used to repay approximately $480 million of the interim credit facility. We expect to be able to repay the approximately $270 million remaining balance on this short-term facility over the next two quarters from free cash flow and proceeds from the sale of non-core businesses.

Over time, following full repayment of the interim credit facility, and subject to limitations in our debt facilities, we also plan to repurchase the majority of the shares issued in connection with the acquisition of HRH under our existing $1 billion buyback authorization.

Liquidity

We believe that existing cash and cash equivalents at December 31, 2008 of $176 million, the consummation of the agreement with Goldman Sachs Mezzanine Partners to issue $500 million of senior unsecured notes, availability under our $300 million revolving credit facility together with future generation of free cash flow and proceeds from the sale of non-core businesses should be adequate to meet our cash needs for at least the next 12 months. These sources of liquidity should also be adequate to finance full repayment of the $750 million outstanding balance on our interim credit facility, current portions of our long-term debt and other contractual obligations and presently known operating needs.

Long-term liquidity for debt service and other contractual obligations will be dependent on continued generation of free cash flow and,

35


 

given favorable market conditions, future borrowings or refinancing. However, our cash requirements could be materially affected by a deterioration in our results of operations, as well as various uncertainties discussed in this section and elsewhere in this document, which could require us to pursue other financing options, including, but not limited to, additional borrowings, debt refinancing, asset sales or other financing alternatives. With the current tightening in the credit markets, the amount and terms, if any, of these financing sources cannot be assured.

We continue to identify and implement further actions to control costs and enhance our operating performance, including cash flow. These actions include the rationalization of our cost base through the 2008 expense review and our ongoing right-sizing initiatives to achieve best fit within the current environment.

Share buybacks

On November 1, 2007, the Board authorized a new share buyback program for $1 billion. This replaced our previous $1 billion buyback program and its remaining $308 million

authorization. In addition the board authorized in June 2008, the repurchase of up to the number of shares issued by the Company in connection with the acquisition of HRH.

In first quarter 2008, we repurchased 2.3 million shares at a cost of $75 million under the new authorization of which $925 million is outstanding.

London headquarters

We completed the move from Ten Trinity Square into our new London headquarters on Lime Street in April 2008. We entered into an agreement to lease the Lime Street building in November 2004, and took control of the building in June 2007, under a 25 year lease. Annual rentals are approximately $35 million per year and we have subleased or agreed to sublease approximately 30 percent of the site under leases with terms up to 15 years. The outstanding contractual obligation for lease rentals at December 31, 2008 was $720 million and the amounts receivable from committed subleases were $106 million.

OPERATING RESULTS—GROUP

Revenues

2008 compared with 2007

 
   
   
   
  Change attributable to:  
 
  2008   2007   %
change
  Foreign
currency
translation
  Acquisitions
and
disposals
  Organic
revenue
growth(i)(ii)
 
 
  (millions)
   
   
   
   
 

Global

  $ 784   $ 750     5 %   0 %   3 %   2 %

North America

    912     751     21 %   0 %   22 %   (1 )%

International

    1,055     962     10 %   1 %   0 %   9 %
                           

Commissions and fees

  $ 2,751   $ 2,463     12 %   1 %   7 %   4 %
                                 

Investment income

    81     96     (16 )%                  

Other income

    2     19     (89 )%                  
                                 

Total revenues

  $ 2,834   $ 2,578     10 %                  
                                 

(i)
Organic revenue growth excludes the impact of foreign currency translation, the first twelve months of net commission and fee revenues generated from acquisitions, the net commission and fee revenues related to operations disposed of in each period presented, market remuneration, investment income and other income from reported revenues. Our method of calculating this measure may differ from that used by other companies and therefore comparability may be limited.

(ii)
Effective October 1, 2008, we changed how we calculate organic growth in commissions and fees. Previously, organic growth included growth from acquisitions from the date of acquisition. Under the new method, the first twelve months of commissions and fees generated from acquisitions are excluded from organic growth in commissions and fees.

36


 

Our 2008 total revenues at $2,834 million were $256 million, or 10 percent, higher than in 2007, reflecting a 7 percent benefit from net acquisitions and disposals principally attributable to HRH, organic commissions and fee growth of 4 percent and a 1 percentage point benefit from foreign currency translation, partly offset by lower investment and other income.

Our International and Global operations earn a significant portion of their revenues in currencies other than the US dollar. For the year ended December 31, 2008, reported revenues in International benefited from the year on year weakening of the US dollar against the euro, compared with 2007. However, in our Global operations the revenue line benefit of the stronger euro was offset by sterling weakening against the US dollar, compared with 2007.

Investment income was $81 million for 2008, $15 million lower than in 2007, with the decrease reflecting lower average interest rates in 2008. We expect investment income to decrease by approximately $20 million in 2009 compared with 2008 as interest rates have continued to experience sharp declines across the globe. This estimated decrease includes the mitigating effect of our forward hedging program, from which we expect to generate significant savings compared to LIBOR based rates.

Other income was $2 million for 2008, $17 million lower than in 2007 which benefited

from a higher than usual level of proceeds from the sale of books of business.

Organic growth in commissions and fees in 2008 was 4 percent compared with 2007, reflecting

net new business growth of 6 percent which comprised good growth in our International and Global Specialties businesses offset by lower revenues in North America and Reinsurance. Net new business growth also included the benefit of our Shaping our Future growth initiatives and a 1 percentage point improvement in client retention rates to 91 percent for 2008 compared with 90 percent for 2007;

partly offset by

a negative 2 percent impact from premium rates and other market factors in 2008. The impact of significant rate decreases in both periods has been tempered by the benefit of other market factors, including higher commission rates, client profitability analyses, higher insured values and changes in limits or exposures.

Organic revenue growth by segment is discussed further in "Operating Results—Segment Information" below.

37


2007 compared with 2006

 
   
   
   
  Change attributable to:  
 
  2007   2006   %
change
  Foreign
currency
translation
  Acquisitions
and
disposals
  Organic
revenue
growth(i)(ii)
 
 
  (millions)
   
   
   
   
 

Global

  $ 750   $ 737     2 %   1 %   1 %   0 %

North America

    751     744     1 %   0 %   0 %   1 %

International

    962     847     14 %   6 %   0 %   8 %
                           

Commissions and fees

  $ 2,463   $ 2,328     6 %   2 %   1 %   3 %
                                 

Investment income

    96     87     10 %                  

Other income

    19     13     46 %                  
                                 

Total revenues

  $ 2,578   $ 2,428     6 %                  
                                 

(i)
Organic revenue growth excludes the impact of foreign currency translation, the first twelve months of net commission and fee revenues generated from acquisitions, the net commission and fee revenues related to operations disposed of in each period presented, market remuneration, investment income and other income from reported revenues. Our method of calculating this measure may differ from that used by other companies and therefore comparability may be limited.

(ii)
Effective October 1, 2008, we changed how we calculate organic growth in commissions and fees. Previously, organic growth included growth from acquisitions from the date of acquisition. Under the new method, the first twelve months of commissions and fees generated from acquisitions are excluded from organic growth in commissions and fees.

 

Our 2007 total revenues of $2,578 million were $150 million, or 6 percent, higher than in 2006 of which 2 percent was attributable to foreign currency translation and 1 percent to net acquisitions and disposals.

For the year ended December 31, 2007, reported revenues in International benefited significantly from the year on year effect of foreign currency translation, in particular due to the weakening of the dollar against both sterling and the euro, compared with 2006.

Net acquisitions and disposals added a net 1 percent to total revenues in 2007 which was primarily attributable to the acquisitions of: InsuranceNoodle in Chicago; Burkart Risk Consulting and Partner in Switzerland; and Gras Savoye Re, a new venture with Gras Savoye & Cie.

Organic growth in commissions and fees in 2007 was 3 percent compared with 2006, reflecting

net new business growth of 4 percent, together with the benefit of maintaining client retention levels in excess of 90 percent;

partly offset by

a negative 1 percent impact from premium rates and other market factors, with the impact of the significant rate decreases largely offset by the benefit of other market factors, including higher commission rates, client profitability analyses, higher insured values and changes in limits or exposures.

Organic revenue growth by segment is discussed further in "Operating Results—Segment Information" below.

General and administrative expenses

 
  2008   2007   2006  
 
  (millions, except percentages)
 

Salaries and benefits

  $ 1,642   $ 1,448   $ 1,457  

Other

    605     460     454  
               

General and administrative expenses

  $ 2,247   $ 1,908   $ 1,911  
               

Salaries and benefits as a percentage of revenues

    58 %   56 %   60 %

Other as a percentage of revenues

    21 %   18 %   19 %

38


 

2008 compared with 2007

General and administrative expenses at $2,247 million for 2008 were $339 million, or 18 percent, higher than in 2007 of which:

$141 million, or 7 percentage points, was attributable to the fourth quarter acquisition of HRH;

$92 million, or 5 percentage points, was attributable to the charge for the 2008 expense review discussed above, of which $66 million related to salaries and benefits and $26 million to other expenses; and

a foreign exchange loss of $68 million, or 4 percentage points, including $34 million related to the revaluation of our UK pension benefits asset as discussed below together with $23 million relating to pound sterling purchases to fund the Company's contributions to the plan.

Salaries and benefits were 58 percent of 2008 revenues, compared with 56 percent in 2007, with the increase reflecting:

the $66 million charge relating to the 2008 expense review; and

continued hiring in targeted development areas including selected US regions; targeted International growth areas such as Spain, Italy, Denmark and Brazil; and a number of our London specialty businesses;

partly offset by

increased productivity: average revenues per FTE employee at constant exchange rates were approximately $190,000 in 2008 compared with $186,000 in 2007;

the benefits of cost controls and previous Shaping our Future initiatives; and

a $15 million reduction in pension charges. This decrease was mainly attributable to an increase in the expected return on assets in the UK pension plan reflecting higher opening asset levels due to the significant additional contributions we have made.

Net headcount on an FTE basis at December 31, 2008 was approximately 17,000 compared with approximately 13,000 at December 31, 2007, with the increase primarily reflecting the acquisition of HRH. The increase in average revenues per FTE employee discussed above reflected growth

across all business units, particularly driven by our International business which has continued its record of outstanding growth.

Other expenses were 21 percent of revenues in 2008 compared with 18 percent in 2007, with the increase reflecting:

$33 million additional other expenses in fourth quarter 2008 as a result of the HRH acquisition, equivalent to approximately 1 percentage point;

the $26 million charge relating to the 2008 expense review, equivalent to approximately 1 percentage point; and

a $34 million foreign exchange loss related to the revaluation of our UK pension benefits asset. This asset is a sterling denominated asset but a portion of the asset is held within our UK London market operations, which are US dollar denominated for accounting purposes. As the dollar strengthened significantly against sterling in 2008, the revaluation of the sterling pension benefits asset gave rise to a foreign exchange loss.

We have a program that hedges our sterling cash outflows from our London market operations, as part of which we hedge the sterling denominated cash contributions into the UK pension plan. However, we do not hedge against the pension benefits asset or liability recognized for accounting purposes.

The effects of the above increases were partly mitigated by the benefits of our continued focus on cost controls.

2007 compared with 2006

General and administrative expenses at $1,908 million for 2007 were $3 million lower than in 2006. This decrease was mainly attributable to:

the 2006 strategic initiative expenditure of $96 million relating to the launch of our Shaping our Future strategy, of which $59 million related to salaries and benefits and $37 million to other expenses; and

the benefits of our Shaping our Future initiatives;

39


 

partly offset by

a 4 percent adverse impact from foreign currency translation.

Salaries and benefits were 56 percent of 2007 revenues, compared with 60 percent in 2006, with the decrease reflecting:

the $59 million benefit as a result of 2006 strategic initiative expenditure, equivalent to approximately 2 percentage points;

the benefits of cost controls and our Shaping our Future initiatives; and

a $36 million reduction in pension charges, equivalent to approximately 1 percentage point. This decrease was mainly attributable to an increase in the expected return on assets in the UK plan reflecting higher asset levels due to the significant additional contributions we have made in 2007 and 2006;

partly offset by

an adverse impact from foreign currency translation, equivalent to approximately 4 percentage points; and

continued hiring in targeted development areas, including energy, construction, marine, financial institutions, reinsurance analytics and employee benefits.

Other expenses were 18 percent of revenues in 2007 compared with 19 percent in 2006, with the decrease reflecting:

the $37 million benefit as a result of 2006 strategic initiative expenditure, equivalent to approximately 2 percentage points;

a $22 million reduction in the net charge for legal provisions, reflecting both the favorable resolution of a small number of potentially significant claims and the benefit of a favorable trend in UK claims expense; and

the benefit of our continued focus on cost controls;

partly offset by

an adverse impact from foreign currency translation, equivalent to approximately 4 percentage points; and

a $17 million additional rental expense recognized in second half 2007, following practical completion of our new London headquarters in June 2007 which gave us control of the building.

Other expenses in 2007 also included $13 million of rent on our then existing London headquarters building, following its sale and leaseback in September 2006. We terminated this lease when we completed the move to our new London headquarters in April 2008. Of the $121 million pre-tax gain on the sale of the building, $22 million was deferred and subsquently recognized over the revised life of the lease, of which $14 million was recognized in 2007.

Depreciation and amortization

 

Depreciation and amortization of $90 million in 2008 was $24 million higher than in 2007 with the increase primarily attributable to a $21 million charge in fourth quarter 2008 in respect of intangible assets recognized on the HRH acquisition.

Depreciation and amortization was $66 million in 2007 compared to $63 million in 2006 with the increase mainly attributable to the initial depreciation of assets associated with World Financial Center, our new lease in New York.

Operating income and margin (operating income as a percentage of revenues)

 
  2008   2007   2006  
 
  (millions, except percentages)
 

Revenues

  $ 2,834   $ 2,578   $ 2,428  

Operating income

    504     620     552  

Operating margin or operating income as a percentage of revenues

    18 %   24 %   23 %

40


 

2008 compared with 2007

Operating margin was 18 percent in 2008 compared with 24 percent in 2007. This decrease reflected the impact of:

the $92 million charge for the 2008 expense review, equivalent to 4 percentage points;

a negative 2 percentage point impact from foreign exchange movements as discussed in "General and administrative expenses" above;

a $22 million increase in intangibles amortization, of which $21 million related to HRH;

our continued investments in targeted new hires and Shaping our Future initiatives; and

lower investment and other income;

partly offset by

increased productivity, with revenues at constant exchange rates per FTE employee increasing to $190,000 in 2008 compared with $186,000 in 2007;

a $38 million benefit from the operating income contribution of HRH in the fourth quarter; and

good cost control, the realization of savings from Shaping our Future initiatives and lower pension costs.

2007 compared with 2006

Operating margin was 24 percent in 2007 compared with 23 percent in 2006. This increase reflected the impact of:

the $105 million of expenditure in 2006 in support of the Shaping our Future strategic initiatives, equivalent to 4 percentage points; and

a 4 percentage point improvement in our retail margin, reflecting the increased margins in both North America and International as a result of our focus on productivity and profitable growth, together with the benefit of lower charges for pensions and legal provisions in our UK and US operations;

partly offset by

the $102 million pre-tax gain on the sale of our London headquarters, equivalent to 4 percentage points; and

a 2 percentage point reduction in Global's operating margin mainly reflecting the difficult reinsurance trading environment and an adverse impact from foreign exchange, partly offset by the benefit of our productivity initiatives and the benefit of lower charges for pensions and legal provisions.

Operating segment margins are discussed further in "Operating Results—Segment Information" below.

Interest expense

 

Interest expense in 2008 of $105 million was $39 million higher than in 2007 with the increase reflecting:

$18 million additional interest expense in 2008 relating to our new term loan and interim credit facilities connected with the HRH acquisition;

a $9 million charge for amortization of debt fees associated with the above facilities;

$9 million additional interest expense in 2008 due to fixed term $600 million senior notes issued in March 2007; and
increased interest relating to higher average drawings under our revolving credit facilities.

Interest expense was $66 million in 2007 compared with $38 million in 2006, with the increase due to higher average levels of debt at higher interest rates following the issuance of $600 million of senior notes in March 2007. Interest expense will increase in 2009 as a result of higher average levels of debt due to the HRH acquisition and higher rates of interest on the anticipated Goldman Sachs financing.

41


Income taxes

 
  2008   2007   2006  
 
  (millions, except percentages)
 

Income before taxes

  $ 399   $ 554   $ 514  

Income taxes

    97     144     63  

Effective tax rate

    24 %   26 %   12 %

 

2008 compared with 2007

The effective tax rate in 2008 was 24 percent compared with 26 percent in 2007, with the decrease in rate reflecting:

a change in the geographical mix of profits with a greater proportion of profits being earned outside the United States;

non-taxable exchange gains arising from the significant movement in the exchange rate between the US dollar and sterling; and

a decrease in the statutory rate of corporation tax in the UK from 30 percent in 2007 to an effective rate of 28.5 percent in 2008;

partly offset by

the benefit of a $10 million release of tax provisions in 2007 compared to a $2 million release in 2008. Both 2008 and 2007

    benefited from the release of tax provisions relating to prior tax periods following the resolution of tax issues surrounding prior debt refinancing; and

a one-off benefit of $4 million in 2007 relating to the restatement of the closing UK deferred tax liabilities to reflect the reduced rate of corporation tax applicable on the reversal of those liabilities.

2007 compared with 2006

The effective tax rate in 2007 was 26 percent compared with 12 percent in 2006. The lower effective tax rate in 2006 is primarily attributable to a $65 million tax credit in 2006 arising following the resolution of complex tax issues associated with the original KKR acquisition structure, together with a low tax rate on the gain on disposal of our previous London headquarters also in 2006.

Net income and diluted earnings per share

 
  2008   2007   2006  
 
  (millions, except per share data)
 

Net income

  $ 303   $ 409   $ 449  

Diluted earnings per share

  $ 2.05   $ 2.78   $ 2.84  

Average diluted number of shares outstanding

    148     147     158  

 

2008 compared with 2007

Net income for 2008 was $303 million, or $2.05 per diluted share, compared to $409 million, or $2.78 per diluted share, in 2007 with the decrease mainly reflecting the impact of:

the $66 million post-tax impact of charges associated with the 2008 expense review, equivalent to $0.45 per diluted share; and

a year on year accounting loss of $0.27 per diluted share primarily relating to the retranslation of our sterling denominated UK pension benefits asset as discussed in

    "General and administrative expenses" above;

partly offset by

strong organic revenue growth in 2008; and

a year on year benefit from a lower effective tax rate of $0.09 per diluted share.

HRH's fourth quarter results, net of related funding costs and intangible amortization, contributed $0.04 per diluted share.

Average diluted sharecount increased from 147 million in 2007 to 148 million in 2008 as the impact of the 11.5 million shares

42


 

repurchased under accelerated share repurchase programs in first half 2007 was more than offset by the additional 24.4 million shares issued on October 1, 2008 as part consideration for the HRH acquisition. The additional shares issued had a negative $0.11 cent impact on earnings per diluted share in 2008.

2007 compared with 2006

Net income for 2007 was $409 million, or $2.78 per diluted share, compared with $449 million, or $2.84 per diluted share, in 2006 with the decrease mainly reflecting the impact of:

the $94 million post-tax gain on the sale of our London headquarters in 2006, equivalent to $0.59 per diluted share;

the $71 million tax credit in 2006 as discussed above, equivalent to $0.45 per diluted share; and

a $20 million post-tax increase in interest expense in 2007 reflecting increased long-term borrowing to fund share buybacks and

    additional pension contributions, equivalent to $0.14 per diluted share;

partly offset by

the $74 million post-tax impact of expenditure in 2006 to launch our Shaping our Future strategic initiatives, equivalent to $0.47 per diluted share; and

increased revenues and the improved margin in 2007 as discussed above.

Foreign currency translation had a $0.06 negative year on year impact on diluted earnings per share in 2007.

Average diluted sharecount reduced from 158 million in 2006 to 147 million in 2007 primarily reflecting the impact of the 15 million shares repurchased under accelerated share repurchase programs in November 2006 and March 2007. After taking into account incremental funding costs, there was a $0.09 benefit to diluted earnings per share from these share buybacks for 2007.

43


OPERATING RESULTS—SEGMENT INFORMATION

We organize our business into three segments: Global, North America and International. Our Global business provides specialist brokerage and consulting services to clients worldwide for risks arising from specific industries and activities. North America and International

comprise our retail operations and provide services to small, medium and major corporates.

The following table is a summary of our operating results by segment for the three years ending December 31, 2008:

 
  2008(i)   2007(i)   2006(i)  
 
  Revenues   Operating
Income
  Operating
Margin
  Revenues   Operating
Income
  Operating
Margin
  Revenues   Operating
Income
  Operating
Margin
 
 
  (millions)
   
  (millions)
   
  (millions)
   
 

Global

  $ 814   $ 240     29 % $ 796   $ 224     28 % $ 780   $ 244     31 %

North America

   
929
   
143
   
15

%
 
786
   
152
   
19

%
 
777
   
134
   
17

%

International

    1,091     306     28 %   996     251     25 %   871     174     20 %
                                       

Total Retail

    2,020     449     22 %   1,782     403     23 %   1,648     308     19 %

Corporate & Other(ii)

        (185 )   n/a         (7 )   n/a             n/a  
                                       

Total Consolidated

  $ 2,834   $ 504     18 % $ 2,578   $ 620     24 % $ 2,428   $ 552     23 %
                                       

(i)
In 2008, the Company changed its basis of segmental allocation for central costs. All accounting adjustments for foreign exchange hedging activities and foreign exchange movements on the UK pension plan asset or liability are held at the Corporate level, together with legal costs that are managed centrally. As a result of this change, $nil in 2007 and $2 million net operating loss for full year 2006, previously allocated to the operating segments, has been reported within Corporate.

(ii)
Corporate and other includes the $92 million cost of the 2008 expense review (2007: $nil, 2006: $101 million of expenditure on second half 2006 Shaping our Future initiatives), foreign exchange hedging activities and foreign exchange on the UK pension plan asset of $47 million loss in 2008 (2007: $7 million, 2006: $10 million), amortization of intangible assets of $36 million (2007: $14 million, 2006: $12 million), net gains and losses on disposal of operations, certain legal costs, and in 2006 a $99 million gain on disposal of the Company's London headquarters net of leaseback costs.

44


Global

 

Our Global operations comprise Global Specialties and Reinsurance. The following table sets out revenues, organic revenue growth and

operating income and margin for the three years ended December 31, 2008:

 
  2008   2007   2006  
 
  (millions, except percentages)
 

Commissions and fees

  $ 784   $ 750   $ 737  

Investment income

    30     46     43  
               

Total revenues

  $ 814   $ 796   $ 780  
               

Operating income(i)

  $ 240   $ 224   $ 244  

Organic revenue growth(ii)(iii)

    2 %   0 %   10 %

Operating margin(i)

    29 %   28 %   31 %

(i)
In 2008, the Company changed its basis of segmental allocation for central costs. All accounting adjustments for foreign exchange hedging activities and foreign exchange movements on the UK pension plan asset or liability are held at the Corporate level, together with legal costs that are managed centrally. As a result of this change, $1 million net operating profit for full year 2007 and $10 million net operating loss for full year 2006, previously allocated to the Global segment, has been reported within Corporate.

(ii)
Organic revenue growth excludes the impact of foreign currency translation, the first twelve months of net commission and fee revenues generated from acquisitions, the net commission and fee revenues related to operations disposed of in each period presented, market remuneration, investment income and other income from reported revenues. Our method of calculating this measure may differ from that used by other companies and therefore comparability may be limited.

(iii)
Effective October 1, 2008, we changed how we calculate organic growth in commissions and fees. Previously, organic growth included growth from acquisitions from the date of acquisition. Under the new method, the first twelve months of commissions and fees generated from acquisitions are excluded from organic growth in commissions and fees.

 

Revenues: 2008 compared with 2007

Commissions and fees were $34 million, or 5 percent, higher in 2008 compared with 2007 of which 3 percent was attributable to the net impact of acquisitions and disposals, mainly due to HRH's UK-based specialty business. There was no net impact from foreign currency translation as a benefit from the euro strengthening year on year against the dollar was offset by a negative impact from sterling weakening against the dollar.

Organic revenue growth was 2 percent as the benefit of good growth in Global Specialties was partly offset by lower commissions and fees in Reinsurance.

Global Specialties revenue growth reflected the benefit of good growth in Marine, Financial Institutions, Bloodstock, Jewelry, Specie and Global Markets and was achieved despite significant rate reductions.

Organic revenues in Reinsurance in 2008 were adversely impacted by a combination of declining rates and a reduction in amounts reinsured. We continue to make investments in Reinsurance to strengthen capital markets and analytics capabilities throughout the soft market and are beginning to see the positive results of this investment as we move into 2009.

Client retention levels in Global improved to 90 percent in 2008 compared with 89 percent in 2007.

Revenues: 2007 compared with 2006

Commissions and fees were $13 million, or 2 percent, higher in 2007 compared with 2006 of which 1 percent was attributable to the net impact of acquisitions and disposals and 1 percent to foreign currency translation. Organic revenue growth was flat in 2007 with the benefit of a 6 percent increase in Global

45


 

Specialties offset by a 4 percent decrease in Reinsurance.

Global Specialties revenue growth reflected the benefit of one-time income from satellite launches and strong growth in Construction, especially in global infrastructure projects, together with good performances from Energy, Financial Institutions and Niche. This revenue growth was achieved despite significant rate reductions with rates decreasing in: Aerospace by some 15 to 20 percent year on year; Marine Hull by 15 to 20 percent; Marine cargo by 25 to 40 percent; and Financial Institutions, Energy and Niche by some 10 to 15 percent.

Organic revenues in Reinsurance declined in 2007 and were adversely impacted by a combination of declining rates, a reduction in amounts reinsured and other changes, including recent changes in Florida legislation which significantly increased capacity and reduced prices.

Operating margin: 2008 compared with 2007

Operating margin in our Global operations was 29 percent in 2008 compared with 28 percent in 2007, as the benefit of organic revenue growth in Global Specialties was partly offset by the impact of lower revenues in Reinsurance and an adverse impact from foreign exchange.

Operating margin in Global Specialties increased in 2008 compared with 2007 as the benefit from organic revenue growth, lower pension costs and our Shaping our Future initiatives more than offset further spend on targeted hires and strategic initiatives.

Operating margin in Reinsurance in 2008 was broadly in line with 2007 as the impact of lower

commissions and fees was largely offset by the benefits of Shaping our Future initiatives, lower pension costs and the positive results of our continued investments to strengthen capital markets and analytics capabilities throughout the soft market.

Operating margin: 2007 compared with 2006

Operating margin in our Global operations was 28 percent in 2007 compared with 31 percent in 2006. Revenues in our Global operations are largely US dollar denominated while our expense base is primarily sterling denominated. The weakening of average dollar rates against sterling generated a negative 2 percentage point impact on Global's margin.

Operating margin in Global Specialties decreased in 2007 compared with 2006 as the moderate revenue growth achieved against the backdrop of a very tough rate environment was more than offset by expense growth. The expense growth reflected an adverse impact from foreign exchange and continued hiring in targeted areas such as Construction, Energy and Financial Institutions, partly offset by the benefits of Shaping our Future initiatives, lower charges for pension costs and legal provisions and good cost control.

Reinsurance's operating margin in 2007 was broadly in line with 2006 as the decline in revenues, an adverse impact from foreign exchange and our continued investment in analytics were offset by the benefit of lower charges for pension costs and legal provisions, and good cost control.

46


North America

 
  2008   2007   2006  
 
  (millions, except percentages)
 

Commissions and fees

  $ 912   $ 751   $ 744  

Investment income

    15     18     21  

Other income(i)

    2     17     12  
               

Total revenues

  $ 929   $ 786   $ 777  
               

Operating income(ii)

  $ 143   $ 152   $ 134  

Organic revenue growth(iii)(iv)

    (1 )%   1 %   6 %

Operating margin(ii)

    15 %   19 %   17 %

(i)
Other income represents gains on disposals of intangible assets, including books of business. Prior to January 1, 2008 these gains were reported within total commissions and fees but were excluded from organic revenue growth with effect from April 1, 2007. As a result of this change, $17 million previously reported within North America's commissions and fees in 2007, has been transferred to other income (2006: $12 million).

(ii)
In 2008, the Company changed its basis of segmental allocation for central costs. All accounting adjustments for foreign exchange hedging activities and foreign exchange movements on the UK pension plan asset or liability are held at the Corporate level, together with legal costs that are managed centrally. As a result of this change, $nil in 2007 and $3 million net operating profit for full year 2006, previously allocated to the North America segment, has been reported within Corporate.

(iii)
Organic revenue growth excludes the impact of foreign currency translation, the first twelve months of net commission and fee revenues generated from acquisitions, the net commission and fee revenues related to operations disposed of in each period presented, market remuneration, investment income and other income from reported revenues. Our method of calculating this measure may differ from that used by other companies and therefore comparability may be limited.

(iv)
Effective October 1, 2008, we changed how we calculate organic growth in commissions and fees. Previously, organic growth included growth from acquisitions from the date of acquisition. Under the new method, the first twelve months of commissions and fees generated from acquisitions are excluded from organic growth in commissions and fees.

 

Revenues: 2008 compared with 2007

Commissions and fees in North America were $161 million, or 21 percent, higher in 2008 compared with 2007, of which $181 million was attributable to HRH's fourth quarter 2008 revenues. Excluding HRH, organic commissions and fees declined by 1 percent reflecting the soft market conditions.

Chicago, Georgia, Houston, Boston and Knoxville all generated growth in excess of 5 percent though several offices recorded significant declines in the difficult market conditions.

The integration of the HRH acquisition made good progress in fourth quarter 2008 with only 2 percent attrition of legacy HRH producers since the announcement of the HRH acquisition in June 2008.

Client retention levels improved to 91 percent in 2008, an increase of 3 percentage points from 2007, and productivity continued to improve with an approximately 2 percent rise in revenues per FTE employee in 2008 compared with 2007.

Revenues: 2007 compared with 2006

Commissions and fees in North America were $7 million, or 1 percent, higher in 2007 compared with 2006 which was attributable to organic growth. The organic revenue growth was achieved in the face of declining rates across most regions of the United States: MarketScout data for 2007 showed average property and casualty rate declines in the year of 13 percent. Despite the declining rates, we saw good growth in the Southeast, Central and New York regions and in our program business and employee benefits.

47


 

The rate of organic revenue growth moderated in 2007 compared to previous years as the focus was on profitable growth. From mid-2006 we moderated the pace of hiring and at the same time managed out under performers. Consequently, while there was a year on year decline in producers, revenue per FTE employee was 5 percent higher in 2007 compared with 2006.

Operating margin: 2008 compared with 2007

Operating margin in North America in 2008 was 15 percent compared with 19 percent in 2007. The decrease of 4 percentage points reflected:

lower commissions and fees, reflecting the soft market conditions;

a $15 million decrease in other income compared with 2007 which benefited from higher than usual proceeds from the sale of books of business; and
continued spend on targeted new hires and other initiatives;

partly offset by

the acquisition of HRH which contributed $38 million of operating income in fourth quarter 2008; and

the benefit of increased revenue per FTE employee and other cost savings.

Operating margin: 2007 compared with 2006

Operating margin in North America was 19 percent in 2007 compared with 17 percent in 2006 and reflected the benefit of the increased revenue per employee and effective expense control, together with a $5 million increase in proceeds from the sale of books of business. Margin improvement was most significant in our New York and Central regions.

International

 
  2008   2007   2006  
 
  (millions, except percentages)
 

Commissions and fees

  $ 1,055   $ 962   $ 847  

Investment income

    36     32     23  

Other income(i)

        2     1  
               

Total revenues

  $ 1,091   $ 996   $ 871  
               

Operating income(ii)

    306     251     174  

Organic revenue growth(iii)(iv)

    9 %   8 %   7 %

Operating margin(ii)

    28 %   25 %   20 %

(i)
Other income represents gains on disposals of intangible assets, including books of business. Prior to January 1, 2008 these gains were reported within total commissions and fees but were excluded from organic revenue growth with effect from April 1, 2007. As a result of this change, $2 million previously reported within International's commissions and fees in 2007, has been transferred to other income (2006: $1 million).

(ii)
In 2008, the Company changed its basis of segmental allocation for central costs. All accounting adjustments for foreign exchange hedging activities and foreign exchange movements on the UK pension plan asset or liability are held at the Corporate level, together with legal costs that are managed centrally. As a result of this change, $1 million net operating loss for full year 2007 and $5 million net operating loss for full year 2006, previously allocated to the International segment, has been reported within Corporate.

(iii)
Organic revenue growth excludes the impact of foreign currency translation, the first twelve months of net commission and fee revenues generated from acquisitions, the net commission and fee revenues related to operations disposed of in each period presented, market remuneration, investment income and other income from reported revenues. Our method of calculating this measure may differ from that used by other companies and therefore comparability may be limited.

(iv)
Effective October 1, 2008, we changed how we calculate organic growth in commissions and fees. Previously, organic growth included growth from acquisitions from the date of acquisition. Under the new method, the first twelve months of commissions and fees generated from acquisitions are excluded from organic growth in commissions and fees.

48


Revenues: 2008 compared with 2007

Commissions and fees in International were $93 million, or 10 percent, higher than in 2008 compared with 2007.

A significant part of International's revenues are earned in currencies other than the US dollar and foreign currency translation benefited 2008 revenues by 1 percent compared with 2007.

Organic revenue growth of 9 percent in 2008 was achieved despite declining rates in most countries.

We have seen consistent growth in our International business over the last three years, with all twelve quarters in this period showing growth of 5 percent or higher, with Spain, Denmark and Latin America continuing to contribute significantly.

Productivity in International continued to improve with revenues per FTE employee rising by 6 percent in 2008 compared with 2007 and average client retention levels remaining high at 91 percent.

Revenues: 2007 compared with 2006

Commissions and fees in International were $115 million, or 14 percent, higher in 2007 compared with 2006. Some 6 percent of this increase was attributable to foreign currency translation as a significant part of International's revenues are earned in currencies that have strengthened against the dollar on a year on year basis, in particular the euro. Organic growth of 8 percent was achieved despite declining rates in most countries, with decreases of between 5 and 20 percent.

Organic growth in 2008 was driven by the emerging markets, particularly Latin America, China and Asia, all of which continued to generate strong double-digit growth. The emerging market growth was complemented by good growth in mainland Europe, especially in the Nordic region, Spain, Italy and Eastern Europe. However, there was a modest decline in our UK and Irish operations revenues compared with 2006 primarily due to the declining rates environment, with decreases averaging between 15 and 20 percent.

Operating margin: 2008 compared with 2007

Operating margin in International was 28 percent in 2008 compared with 25 percent in 2007, with the 3 percentage point improvement reflecting the strong organic revenue growth, increased productivity and continued expense discipline partly offset by significant investment in targeted hires and the adverse impact of declining rates in most countries.

Operating margin: 2007 compared with 2006

Operating margin in International was 25 percent in 2007 compared with 20 percent in 2006, with the 5 percentage point improvement reflecting the strong organic revenue growth, particularly in the emerging markets, coupled with sustained cost control and a lower UK pension expense.

Significant operating margin improvement was reported across most areas of our International segment as the effect of strong organic revenue growth, our productivity efficiencies and joint focus more than offset the adverse impact of declining rates in most countries.

CRITICAL ACCOUNTING ESTIMATES

 

Our accounting policies are described in Note 2 to the Consolidated Financial Statements. Management considers that the following accounting estimates or assumptions are the most important to the presentation of our financial condition or operating performance. Management has discussed its critical accounting estimates and associated disclosures with our Audit Committee.

Pension expense

We maintain defined benefit pension plans that cover a majority of our employees in the United States and United Kingdom. Both these plans are now closed to new entrants. New entrants in the United Kingdom are offered the opportunity to join a defined contribution plan and in the United States are offered the opportunity to join a 401(k) plan. We also have smaller defined benefit schemes in Ireland, Germany, Denmark

49


 

and the Netherlands: these schemes have combined total assets of $89 million and a combined liability for pension benefits of $29 million as of December 31, 2008. Elsewhere, pension benefits are typically provided through defined contribution plans.

We make a number of assumptions when determining our pension liabilities and pension expense which are reviewed annually by senior management and changed where appropriate. The discount rate will be changed annually if underlying rates have moved whereas the expected long-term return on assets will be changed less frequently as longer term trends in asset returns emerge. Other material assumptions include rates of participant mortality, the expected long-term rate of compensation and pension increases and rates of employee termination.

We recorded a net pension credit on our UK and US defined benefit pension plans in 2008 of $25 million, compared to a net pension credit of $10 million in 2007, an increase of $15 million.

The UK plan increase was $17 million mainly reflecting an increase in the expected return on assets in the UK plan due to higher asset levels following significant additional contributions in 2007 and 2008 and increased member contributions in 2008. The US pension charge was $2 million higher in 2008 compared with 2007.

Based on December 31, 2008 assumptions, we expect the net pension credit in 2008 to decrease to a net pension expense in 2009 of between $50 to $60 million due to lower expected asset returns and increased amortization following the significant asset losses in the UK and US during 2008.

UK plan

 
  As disclosed
using
December 31,
2008
assumptions
  Impact of a
0.50 percentage
point increase
in the expected
rate of return
on assets(1)
  Impact of a
0.50 percentage
point increase
in the discount
rate(1)
  One year
increase in
mortality
assumption(1)(2)
 
 
  (millions)
 

Estimated 2009 expense

  $ 20   $ (7 ) $ (13 ) $ 5  

Projected benefit obligation at December 31, 2008

    1,386     n/a     (108 )   28  

(1)
With all other assumptions held constant.

(2)
Assumes all plan participants are one year younger.

Expected long-term rates of return on plan assets are developed from the expected future returns of the various asset classes using the target asset allocations. The expected long-term rate of return used for determining the net UK pension expense in 2008 remained unchanged at 7.75 percent, equivalent to an expected return in 2008 of $184 million. The expected and actual returns on UK plan assets for the three years ended December 31, 2008 were as follows:

 
  Expected
return on
plan
assets
  Actual
return on
plan
assets
 
 
  (millions)
 

2008

  $ 184   $ (509 )

2007

    182     99  

2006

    143     141  

During the latter half of 2008 the value of assets held by our pension plans has been significantly adversely affected by the turmoil in worldwide markets. The holdings of equity securities by our UK and US pension plans have been particularly affected.

Rates used to discount pension plan liabilities at December 31, 2008 were based on yields prevailing at that date of high quality corporate bonds of appropriate maturity. The selected rate used to discount UK plan liabilities was 6.5 percent compared with 5.9 percent at December 31, 2007 with the increase reflecting an increase in UK long-term bond rates in the latter part of 2008. The higher discount rate and reduced inflation assumption generated an actuarial gain of $248 million at December 31, 2008.

50


 

Mortality assumptions at December 31, 2008 were changed from December 31, 2007. The new mortality assumption is the 100 percent PNA00 table without an age adjustment. As an

indication of the longevity assumed, our calculations assume that a UK male retiree aged 65 at December 31, 2008 would have a life expectancy of 22 years.

US plan

 
  As disclosed
using
December 31,
2008
Assumptions
  Impact of a
0.50 percentage
point increase
in the expected
rate of return
on assets(1)
  Impact of a
0.50 percentage
point increase
in the discount
rate(1)
  One year
increase in
mortality
assumption(1)(2)
 
 
  (millions)
 

Estimated 2009 expense

  $ 39   $ (2 ) $ (7 ) $ 4  

Projected benefit obligation at December 31, 2008

    649     n/a     (41 )   17  

(1)
With all other assumptions held constant.

(2)
Assumes all plan participants are one year younger.

The expected long-term rate of return used for determining the net US pension scheme expense in 2008 was 8.0 percent, consistent with 2007. The rate used to discount US plan liabilities at December 31, 2008 was 6.3 percent, determined based on expected plan cash flows discounted using a corporate bond yield curve, an increase from 6.0 percent at December 31, 2007. The expected and actual returns on US plan assets for the three years ended December 31, 2008 were as follows:

 
  Expected
return on
plan assets
  Actual
return on
plan assets
 
 
  (millions)
 

2008

  $ 47   $ (142 )

2007

    44     46  

2006

    39     78  

The mortality assumption at December 31, 2008 is the RP-2000 Mortality Table (blended for annuitants and non-annuitants), projected to 2009 by Scale AA (December 31, 2007: projected to 2008 by Scale AA). As an indication of the longevity assumed, our calculations assume that a US male retiree aged 65 at December 31, 2008, would have a life expectancy of 18 years.

Intangible assets

Intangible assets represent the excess of cost over the value of net tangible assets of

businesses acquired. We classify our intangible assets into three categories:

Goodwill;

"Customer and Marketing related" includes client lists, client relationships and non-compete agreements; and

"Contract based, Technology and Other" includes all other purchased intangible assets.

Client relationships acquired on the HRH acquisition are amortized over twenty years in line with the pattern in which the economic benefits of the client relationships are expected to be consumed. Over 80 percent of the client relationships intangible will have been amortized after 10 years. Non-compete agreements acquired in connection with the HRH acquisition are amortized over two years on a straight line basis. Intangible assets acquired in connection with other acquisitions are amortized over their estimated useful lives on a straight line basis. Goodwill is not subject to amortization.

To determine the allocation of intangible assets between goodwill and other intangible assets and the estimated useful lives in respect of the HRH acquisition we considered a report produced by a qualified independent appraiser. The calculation of the allocation is subject to a number of estimates and assumptions. We base our allocation on assumptions we believe to be reasonable. However, changes in these estimates and assumptions could affect the allocation between goodwill and other intangible assets.

51


 

Impairment review

We review all our intangible assets for impairment periodically (at least annually) or whenever events or circumstances indicate impairment may have occurred. Application of the impairment test requires judgment, including:

the identification of reporting units;

assignment of assets, liabilities and goodwill to reporting units; and

determination of fair value of each reporting unit.

The fair value of each reporting unit is estimated using a discounted cash flow methodology and, in aggregate, validated against our market capitalization. This analysis requires significant judgments, including:

estimation of future cash flows which is dependent on internal forecasts;

estimation of the long-term rate of growth for our business;

the estimation of the useful life over which cash flows will occur; and

determination of our weighted average cost of capital.

We base our fair value estimates on assumptions we believe to be reasonable. However, changes in these estimates and assumptions could materially affect the determination of fair value and goodwill impairment for each reporting unit.

Our annual goodwill impairment analysis, which we performed during the fourth quarter of 2008, did not result in an impairment charge (2007: $nil, 2006: $nil).

Income taxes

We recognize deferred tax assets and liabilities for the estimated future tax consequences of events attributable to differences between the financial statements carrying amounts of existing assets and liabilities and their respective tax bases and operating and capital loss and tax credit carryforwards. We estimate deferred tax assets and liabilities and assess the need for any valuation allowances using enacted rates in effect for the year in which the differences are

expected to be recovered or settled taking into account our business plans and tax planning strategies.

At December 31, 2008, the Company had gross deferred tax assets of $362 million (2007: $184 million) against which a valuation allowance of $85 million (2007: $69 million) had been recognized. To the extent that:

the actual future taxable income in the periods during which the temporary differences are expected to reverse differs from current projections;

assumed prudent and feasible tax planning strategies fail to materialize;

new tax planning strategies are developed; or

material changes occur in actual tax rates or loss carry forward time limits,

the Company may adjust the deferred tax asset considered realizable in future periods. Such adjustments could result in a significant increase or decrease in the effective tax rate and have a material impact on our net income.

Positions taken in the Company's tax returns may be subject to challenge by the taxing authorities upon examination. The Company recognizes the benefit of uncertain tax positions in the financial statements when it is more likely than not that the position will be sustained on examination by the tax authorities. The benefit recognized is the largest amount of tax benefit that is greater than 50 percent likely of being realized on settlement with the tax authority, assuming full knowledge of the position and all relevant facts. The Company adjusts its recognition of these uncertain tax benefits in the period in which new information is available impacting either the recognition or measurement of its uncertain tax positions.

Commitments, contingencies and accrued liabilities

We purchase professional indemnity insurance for errors and insurance claims. The terms of this insurance vary by policy year and self-insured risks have increased significantly over recent years. We have established provisions against various actual and potential claims, lawsuits and other proceedings relating

52


 

principally to alleged errors and omissions in connection with the placement of insurance and reinsurance in the ordinary course of business. Such provisions cover claims that have been reported but not paid and also claims that have

been incurred but not reported. These provisions are established based on actuarial estimates together with individual case reviews and are believed to be adequate in the light of current information and legal advice.

NEW ACCOUNTING STANDARDS

New accounting standards issued during the year that would have a significant impact on the

Company's reporting are described in Note 2 to the Consolidated Financial Statements.

LIQUIDITY AND CAPITAL RESOURCES

On October 1, 2008, the Company completed the acquisition of HRH.

Under the terms of the definitive merger agreement, we acquired all of the outstanding shares of common stock of HRH for $46.00 per share, with approximately 55 percent of the total consideration being paid in cash and 45 percent being paid in our stock. The total purchase price of approximately $2.1 billion included the assumption of approximately $340 million of HRH existing debt.

We funded the transaction on October 1, 2008 from committed bank financing, with a $1 billion drawdown from an interim credit facility and a $525 million draw down from a $700 million 5-year term loan facility. In addition, we repaid approximately $340 million of HRH existing debt and the $170 million outstanding balance on our existing revolving credit facility, which has been replaced by a new $300 million facility, all of which remains available to draw at December 31, 2008.

During fourth quarter 2008, we repaid $250 million of the then outstanding $1 billion balance on the interim credit facility funded by using free cash flow of $75 million together with the drawdown of the remaining $175 million available under the 5-year term loan facility.

Total long term debt at December 31, 2008 was $1,865 million and total short term debt was $785 million. Included in total long-term debt is $250 million of 5.125% senior notes due 2010.

In February 2009, we entered into an agreement with Goldman Sachs Mezzanine Partners to issue 12.875 percent senior unsecured notes due 2016 in an aggregate principal amount of $500 million. The transaction is subject to customary closing conditions and is expected to

close during March 2009. The net proceeds of the issue will be used to repay approximately $480 million of the interim credit facility. We expect to be able to repay the approximately $270 million remaining balance on this short-term facility over the next two quarters from free cash flow and proceeds from the sale of non-core businesses.

Liquidity

We believe that existing cash and cash equivalents at December 31, 2008 of $176 million, the consummation of the agreement with Goldman Sachs Mezzanine Partners to issue $500 million of senior unsecured notes, availability under our $300 million revolving credit facility together with future generation of free cash flow and proceeds from the sale of non-core businesses should be adequate to meet our cash needs for at least the next 12 months. These sources of liquidity should also be adequate to finance full repayment of the interim credit facility, current portions of our long-term debt and other contractual obligations and presently known operating needs.

Long-term liquidity for debt service and other contractual obligations will be dependent on continued generation of free cash flow and, given favorable market conditions, future borrowings or refinancing. However, our cash requirements could be materially affected by a deterioration in our results of operations, as well as various uncertainties discussed in this section and elsewhere, which could require us to pursue other financing options, including, but not limited to, additional borrowings, debt refinancing, asset sales or other financing alternatives. With the current tightening in the

53


 

credit markets, the level, if any, of these financing sources cannot be assured.

We continue to identify and implement further actions to control costs and enhance our operating performance, including cash flow. These actions include the rationalization of our cost base through the 2008 expense review and our ongoing right-sizing initiatives to achieve best fit within the current environment.

On November 1, 2007, the Board authorized a new share buyback program for $1 billion. This replaced our previous $1 billion buyback program and its remaining $308 million authorization. In first quarter 2008, we repurchased 2.3 million shares at a cost of $75 million under the new authorization.

Over time, following full repayment of the interim credit facility, and subject to limitations in our debt facilities, we also plan to repurchase the majority of the shares issued in connection with the acquisition of HRH under our existing $1 billion buyback authorization.

Fiduciary funds

As an intermediary, we hold funds generally in a fiduciary capacity for the account of third parties, typically as the result of premiums received from clients that are in transit to insurers and claims due to clients that are in transit from insurers. We report premiums, which are held on account of, or due from, clients as assets with a corresponding liability due to the insurers. Claims held by, or due to, us which are due to clients are also shown as both assets and liabilities. All these balances due or payable are included in accounts receivable and accounts payable on the balance sheet. We earn interest on these funds during the time between the receipt of the cash and the time the cash is paid out. Fiduciary cash must be kept in certain regulated bank accounts subject to guidelines, which generally emphasize capital preservation and liquidity, and is not generally available to service our debt or for other corporate purposes.

Own funds

As of December 31, 2008, we had cash and cash equivalents of $176 million, compared with $200 million at December 31, 2007, and all of

our $300 million revolving credit facility remained available to draw.

Operating activities

Net cash provided by operations was $211 million in 2008 compared with $268 million in 2007 and $147 million in 2006. Net cash provided by operations has been significantly impacted by the accelerated funding of our pensions schemes over the last three years, with additional contributions of $107 million in 2008, $153 million in 2007 and $211 million in 2006.

Net cash from operations in 2008 was $57 million lower than in 2007, mainly reflecting:

an $81 million decrease in net income before gains relating to investment activities; and

a $65 million increase in cash payments for interest reflecting higher average debt levels, particularly following the funding of the HRH acquisition;

partly offset by

a $46 million reduction in additional contributions to our UK and US defined benefit pension plans;

the benefit of a $14 million reduction in taxes paid; and

the timing of cash collections and other working capital movements.

Net cash from operations in 2007 was $121 million higher than in 2006, mainly reflecting:

a $27 million increase in net income before gains relating to investment activities;

a $58 million reduction in additional contributions to our UK and US defined benefit pension plans; and

the benefit of a $13 million reduction in taxes paid.

Investing activities

Total net cash used in investing activities was $1,040 million in 2008 compared with $221 million in 2007 and an inflow of $67 million in 2006.

54


The net increase in cash used in investing activities of $819 million in 2008 compared with 2007 was attributable to:

an $896 million net increase in the cost of acquisitions, primarily reflecting $926 million attributable to the HRH acquisition; and

a reduction in proceeds from disposals of operations, investments and other assets of $14 million;

partly offset by

a reduction in fixed asset spend of $91 million, principally attributable to sharply reduced expenditure on our new London and US headquarters buildings following their completion.

The net increase in cash used in investing activities of $288 million in 2007 compared with 2006 was mainly attributable to:

a $130 million increased investment in fixed assets primarily relating to $106 million of expenditure on the fit-outs of our new US and UK headquarters buildings; and

cash proceeds on disposal of fixed and intangible assets of $27 million in 2007 compared with $205 million in 2006, primarily reflecting the $202 million proceeds on sale of our London headquarters in 2006.

In 2008 we completed the acquisition of HRH with approximately 55 percent of the total consideration being paid in cash, as described above. This payment for acquisitions of $926 million was in addition to a payment of $31 million to acquire an additional 4 percent of voting rights in Gras Savoye & Cie, our French associate. We also acquired a further 5.5 percent of Gras Savoye & Cie effective fourth quarter 2008 for which the $41 million in cash was paid in January 2009. The Gras Savoye acquisitions were pursuant to put arrangements, see "Contractual Obligations" below.

In 2007 we purchased an additional 17 percent of Coyle Hamilton Willis (since renamed Willis Risk Services Ireland Limited), our Irish subsidiary, for $33 million; and acquired InsuranceNoodle, a US internet distributor of small business property-casualty insurance for $29 million.

Financing activities

Cash provided by financing activities amounted to $828 million in 2008 compared with outflows of $146 million in 2007 and $129 million in 2006.

Long-term debt

In connection with the HRH acquisition on October 1, 2008, we drew down $1 billion from an interim credit facility and a further $525 million from a 5-year term loan facility. During fourth quarter 2008, we subsequently repaid $250 million of the outstanding balance on the interim credit facility using $175 million proceeds from an additional drawdown of the 5-year term loan facility together with $75 million from free cash flow.

As at December 31, 2008, total short-term debt was $785 million and total long-term debt was $1,865 million.

In February 2009, we entered into an agreement with Goldman Sachs Mezzanine Partners to issue 12.875 percent senior unsecured notes due 2016 in an aggregate principal amount of $500 million. The transaction is subject to customary closing conditions and is expected to close during March 2009. We expect the net proceeds of the issue to be used to repay approximately a further $480 million of the $750 million outstanding balance on the interim credit facility as at December 31, 2008.

In addition, we repaid the outstanding balance on our previously existing revolving credit facility and replaced it with a new 5-year $300 million line of credit.

We also repaid the previously existing HRH debt of $341 million assumed with the acquisition.

In March 2007, we issued $600 million of 10 year senior notes at 6.20 percent. We used the proceeds of the notes to fund share buybacks and to repay a net $150 million on our then existing revolving credit facility.

In 2006, we drew down $200 million on our then existing revolving credit facility primarily to fund our increased pension contributions.

55


 

Share buybacks

We repurchased 2.3 million shares for $75 million of cash in the first quarter of 2008 compared with 11.5 million shares for $480 million of cash in 2007 and 5.4 million shares for $211 million of cash in 2006.

Dividends

Cash dividends paid in 2008 were $146 million compared with $143 million in 2007 and $145 million in 2006. In February 2009, we declared a quarterly cash dividend of $0.26 per share, an annual rate of $1.04 per share.

CONTRACTUAL OBLIGATIONS

Our contractual obligations at December 31, 2008 were:

 
  Payments due by  
Obligations
  Total   2009   2010–
2011
  2012–
2013
  After 2013  
 
  (millions)
 
   

5.125% Senior notes due 2010

  $ 250   $   $ 250   $   $  
   

5.625% Senior notes due 2015

    350                 350  
   

6.200% Senior notes due 2017

    600                 600  
   

Interest on senior notes

    480     70     127     114     169  
   

Term loan expires 2013

    700     35     280     385      
   

Interest on term loan

    62     19     30     13      
   

Interim credit facility expires September 30, 2009

    750     750              
   

Interest on interim credit facility

    24     24              
                       

Total debt and related interest

    3,216     898     687     512     1,119  

Operating leases(i)

    1,239     104     186     127     822  

Pensions

    394     55     170     169      

Put options relating to subsidiaries and associates(ii)

    434     316     97         21  
                       

Total contractual obligations

  $ 5,283   $ 1,373   $ 1,140   $ 808   $ 1,962  
                       

(i)
Presented gross.

(ii)
Based on the earliest dates on which options could be exercised.

 

Debt financing

On October 1, 2008, we funded the HRH acquisition with $1 billion from an interim credit facility and $525 million from a $700 million 5-year term loan facility. In addition, we repaid the outstanding balance on our existing revolving credit facility and replaced this with a new $300 million line of credit. In fourth quarter 2008, we repaid $250 million of the interim credit facility and at the same time drew down a further $175 million under the 5-year term loan facility.

In February 2009, the Company entered into an agreement with Goldman Sachs Mezzanine Partners to issue 12.875 percent senior unsecured notes due 2016 in an aggregate principal amount of $500 million. The Company

anticipates that approximately $480 million net proceeds of this issuance will be applied towards the balance of the interim credit facility. Consummation of the issuance, which is subject to customary closing conditions, is expected to take place in March 2009.

Operating leases

We moved from Ten Trinity Square into our new London headquarters in Lime Street in April 2008. In November 2004, we entered into an agreement to lease the Lime Street building and took control of the building in June 2007 under a 25 year operating lease. Annual rentals are $35 million per year and we have subleased approximately 30 percent of the premises under leases up to 15 years long. The outstanding

56


 

contractual obligation for lease rentals at December 31, 2008 was $720 million and the amounts receivable from committed subleases was $106 million.

Pensions

Contractual obligations for our pension plans reflect the contributions we expect to make over the next five years into our US and UK plans. These contributions are based on current funding positions and may increase or decrease dependent on the future performance of the two plans.

In the UK, we are required to agree a funding strategy for our UK defined benefit plan with the plan's trustees. In February 2009, we agreed to make full year contributions to the UK plan of $37 million for 2009 through 2012. However, if certain funding targets are not met at the beginning of 2010 and 2011, full year contributions for these years will increase to $74 million.

For the US plan, expected contributions are the contributions we will be required to make under US pension legislation based on our December 31, 2008 balance sheet position. We currently expect to contribute $18 million in 2009 and between $45 and $50 million per year from 2010 to 2013.

Put options relating to subsidiaries and associates

In connection with many of our investments in less than wholly-owned subsidiaries and associates, we retain rights to increase our ownership percentage over time, typically to a majority or 100 percent ownership position. In addition, in certain instances, the other owners have a right, typically at a price calculated pursuant to a formula based on revenues or earnings, to put some or all of their shares to us.

As part of the 1997 acquisition of our initial 33 percent shareholding of Gras Savoye, we entered into a put arrangement, whereby the other shareholders in Gras Savoye (primarily two families, two insurance companies and Gras Savoye's executive management team) could put their shares to us. Until 2011, we will be obligated to buy the shares of certain

shareholders to the extent those shareholders put their shares, potentially increasing our ownership from the 48 percent holding at December 31, 2008 to 90 percent if all shareholders put their shares, at a price determined by a contractual formula based on earnings and revenue.

Management shareholders of Gras Savoye (representing approximately 10 percent of shares) do not have general put rights before 2011, but have certain put rights on their death, disability or retirement from which payments, at December 31, 2008 based on the formula would not have exceeded $67 million. The shareholders may put their shares individually at any time during the put period.

We believe that, should the aggregate amount of Gras Savoye shares be put to us, sufficient funds would be available to satisfy this obligation. In addition, we have a call option to move to majority ownership under certain circumstances and in any event by December 2009. Upon exercising this call option, the remaining Gras Savoye shareholders have a put option.

We recently received a notification from one of the shareholders of Gras Savoye, namely AXA Corporate Solutions, informing us of its intention to put its shares in Gras Savoye to us, subject to the pre-emption provisions set out in bye-laws of Gras Savoye. The shares held by AXA represent approximately 4 percent of the share capital of Gras Savoye. Notwithstanding that we have received this notice from AXA we believe that it is likely that we will not be required to acquire all of the AXA shares in the immediate future or, in some circumstances, at all. We believe that either:-

Gras Savoye itself will buy back all the AXA shares on 23 March 2009 and as a result, we would not acquire any of them; or

AXA will agree to extend the date for payment of the amount due in respect of the AXA shares and that Gras Savoye itself will buy back all the AXA shares on the agreed date for payment. In these circumstances we believe that Gras Savoye will buy back all the AXA shares and would agree to pay the amount due in respect of the shares into an

57


 

    escrow account to be paid to AXA upon completion of the acquisition of the shares. Again, as a result, we would not be required to acquire any of the shares; or

certain of the other shareholders of Gras Savoye will exercise their pre-emption rights to acquire a portion of the AXA shares. In these circumstances we believe that AXA would withdraw its notification in respect of the remaining shares held by it although we believe that it would then exercise its right to put those to us later in 2009.

In the event that none of the above occurred or an alternative arrangement was agreed, we would be required to acquire the AXA shares on 23 March 2009. The amount payable by us for the AXA shares would be approximately $25 million.

Off-balance sheet transactions

Apart from commitments, guarantees and contingencies, as disclosed in Note 17 of the Consolidated Financial Statements, the Company has no off-balance sheet arrangements that have, or are reasonably likely to have, a material effect on the Company's financial condition, results of operations or liquidity.

58


Item 7A—Quantitative and Qualitative Disclosures about Market Risk

Financial Risk Management

We are exposed to market risk from changes in foreign currency exchange rates and interest rates. In order to manage the risk arising from these exposures, we enter into a variety of interest rate and foreign currency derivatives. We do not hold financial or derivative instruments for trading purposes.

A discussion of our accounting policies for financial and derivative instruments is included in Note 2—Basis of Presentation and Significant Accounting Policies of Notes to the Consolidated Financial Statements, and further disclosure is provided in Note 21—Financial Instruments of Notes to the Consolidated Financial Statements.

Foreign exchange risk management

Because of the large number of countries and currencies we operate in, movements in currency exchange rates may affect our results.

We report our operating results and financial condition in US dollars. Our US operations earn revenue and incur expenses primarily in US dollars. Outside the United States, we predominantly generate revenues and expenses in the local currency with the exception of our London market operations which earns revenues in several currencies but incurs expenses predominantly in pounds sterling.

The table below gives an approximate analysis of revenues and expenses by currency in 2008 and includes full year HRH results on a proforma basis.

 
  US Dollars   Pounds
Sterling
  Euros   Other
Currencies
 

Revenues

    60%     11%     14%     15%  

Expenses

    53%     26%     9%     12%  

Our principal exposures to foreign exchange risk arise from:

    our London market operations; and

    translation.

London market operations

In our London market operations, we earn revenue in a number of different currencies, principally US dollars, pounds sterling, euros and Japanese yen, but incur expenses almost entirely in pounds sterling.

We hedge this risk as follows:

    to the extent that forecast pound sterling expenses exceed pound sterling revenues, we limit our exposure to this exchange rate risk by the use of forward contracts matched to specific, clearly identified cash outflows arising in the ordinary course of business; and

    to the extent our London market operations earn significant revenues in euros and Japanese Yen, we limit our exposure to changes in the exchange rate between the US dollar and these currencies by the use of forward contracts matched to a percentage of forecast cash inflows in specific currencies and periods.

Generally, it is our policy to hedge at least 25 percent of the next 12 months' exposure in significant currencies. We do not hedge exposures beyond three years.

In addition, we are also exposed to foreign exchange risk on any net sterling asset or liability position in our London market operations. Where this risk relates to short-term cash flows, we hedge all or part of the risk by forward purchases or sales.

However, where the foreign exchange risk relates to any sterling pension assets benefit or liability for pensions benefit, we do not hedge the risk. Consequently, if our London market operations have a significant pension asset or liability, we may be exposed to accounting gains and losses if the US dollar and pounds sterling exchange rate changes. We do, however, hedge the pounds sterling contributions into the pension plan.

Translation risk

Outside our US and London market operations, we predominantly earn revenues and incur expenses in the local currency. When we

59


translate the results and net assets of these operations into US dollars for reporting purposes, movements in exchange rates will affect reported results and net assets. For example, if the US dollar strengthens against the euro, the reported results of our Eurozone operations in US dollar terms will be lower.

We do not hedge translation risk.

The table below provides information about our foreign currency forward exchange contracts, which are sensitive to exchange rate risk. The table summarizes the US dollar equivalent amounts of each currency bought and sold forward and the weighted average contractual exchange rates. All forward exchange contracts mature within three years.

 
  Settlement date before December 31,  
 
  2009   2010   2011  
December 31, 2008
  Contract
amount
  Average
contractual
exchange rate
  Contract
amount
  Average
contractual
exchange rate
  Contract
amount
  Average
contractual
exchange rate
 
 
  (millions)
   
  (millions)
   
  (millions)
   
 

Foreign currency sold

                               

US dollars sold for sterling

  $ 247   $1.85=£1   $ 144   $1.80=£1   $ 32   $1.63=£1  

Euro sold for US Dollars

    83   Euro 1=$1.40     67   Euro 1=$1.43     17   Euro 1=$1.43  

Japanese Yen sold for US Dollars

    18   Yen 106.08=$1     15   Yen 100.20=$1     8   Yen 97.34=$1  
                           

Total

  $ 348       $ 226       $ 57      
                           

Fair Value(1)

  $ (55 )     $ (26 )     $ (4 )    

 

 
  Settlement date before December 31,  
 
  2008   2009   2010  
December 31, 2007
  Contract
amount
  Average
contractual
exchange rate
  Contract
amount
  Average
contractual
exchange rate
  Contract
amount
  Average
contractual
exchange rate
 
 
  (millions)
   
  (millions)
   
  (millions)
   
 

Foreign currency sold

                               

US dollars sold for sterling

  $ 100   $2.00=£1   $ 20   $2.01=£1   $ nil   n/a  

Euro sold for US Dollars

    72   Euro 1=$1.38     73   Euro 1=$1.39     41   Euro 1=$1.41  

Japanese Yen sold for US Dollars

    8   Yen 115.43=$1     5   Yen 111.04=$1     1   Yen 104.98=$1  
                           

Total

  $ 180       $ 98       $ 42      
                           

Fair Value(1)

  $ (5 )     $ (4 )     $ (1 )    

(1)
Represents the difference between the contract amount and the cash flow in US dollars which would have been receivable had the foreign currency forward exchange contracts been entered into on December 31, 2008 or 2007 at the forward exchange rates prevailing at that date.

Income earned within foreign subsidiaries outside of the UK is generally offset by expenses in the same local currency but the Company does have exposure to foreign exchange movements on the net income of these entities. The Company does not hedge net income earned within foreign subsidiaries outside of the UK.

Interest rate risk management

Our operations are financed principally by $1,200 million fixed rate senior notes issued by a subsidiary, which are split between $250 million due 2010, $350 million due 2015 and $600 million due 2017 and by $1,450 million bank facilities which are split between $750 million due 2009 and $700 million which matures in 2013. The 5-year term loan facility

60


amortizes at the rate of $35 million per quarter commencing from December 31, 2009. As of December 31, 2008 we had access to, but had not drawn $300 million under a revolving credit facility that expires in 2013. The interest rate applicable to the bank borrowing is variable according to the period of each individual drawdown.

We are also subject to market risk from exposure to changes in interest rates based on our investing activities where our primary interest rate risk arises from changes in short-term interest rates in both US dollars and pounds sterling.

As a consequence of our insurance and reinsurance broking activities, there is a delay between the time we receive cash for premiums and claims and the time the cash needs to be paid. We earn interest on this float, which is included in our consolidated financial statements as investment income.

This float is regulated in terms of access and the instruments in which it may be invested, most of

which are short-term in maturity. We manage the interest rate risk arising from this exposure primarily through the use of interest rate swaps. It is our policy that, for currencies with significant balances, a minimum of 25 percent of forecast income arising is hedged for each of the next three years.

The table below provides information about our derivative instruments and other financial instruments that are sensitive to changes in interest. For interest rate swaps, the table presents notional principal amounts and average interest rates analyzed by expected maturity dates. Notional principal amounts are used to calculate the contractual payments to be exchanged under the contracts. The duration of interest rate swaps varies between one and four years, with re-fixing periods of three months. Average fixed and variable rates are, respectively, the weighted-average actual and market rates for the interest hedges in place. Market rates are the rates prevailing at December 31, 2008 or 2007, as appropriate.

 
  Expected to mature before December 31,    
   
   
 
 
   
   
  Fair
Value(1)
 
December 31, 2008
  2009   2010   2011   2012   2013   Thereafter   Total  
 
  ($ millions, except percentages)
 

Short-term investments

                                                 

Principal ($)

    7     5                             12     12  

Fixed rate receivable

    4.82 %   3.75 %                           4.41 %      

Principal (£)

    7     1                             8     8  

Fixed rate receivable

    5.50 %   4.75 %                           5.42 %      

Fixed rate debt

                                                 

Principal ($)

          250                       950     1,200     881  

Fixed rate payable

          5.13 %                     6.02 %   5.97 %      

Floating rate debt

                                                 

Principal ($)

    785     140     140     140     245           1,450     1,450  

Variable rate payable

    3.21 %   3.94 %   4.53 %   4.85 %   5.15 %         4.51 %      

Interest rate swaps

                                                 

Principal ($)

    350     235     240                       825     29  

Fixed rate receivable

    4.69 %   5.14 %   4.45 %                     4.72 %      

Variable rate payable

    2.36 %   2.03 %   1.61 %                     1.85 %      

Principal (£)

    71     70     52     44                 237     8  

Fixed rate receivable

    4.83 %   5.11 %   5.69 %   5.07 %               5.25 %      

Variable rate payable

    3.78 %   3.03 %   2.68 %   2.92 %               2.98 %      

Principal (€)

    72     15     56                       143     2  

Fixed rate receivable

    3.97 %   4.14 %   4.04 %                     4.04 %      

Variable rate payable

    3.51 %   2.86 %   2.75 %                     2.88 %      

(1)
Represents the net present value of the expected cash flows discounted at current market rates of interest as appropriate.

61


 
  Expected to mature before December 31,    
   
   
 
 
   
   
  Fair
Value(1)
 
December 31, 2007
  2008   2009   2010   2011   2012   Thereafter   Total  
 
  ($ millions, except percentages)
 

Short-term investments

                                               

Principal ($)

    9     7     5                     21     21  

Fixed rate receivable

    4.91 %   4.83 %   3.75 %                   4.63 %      

Principal (£)

    5     13     1                     19     19  

Fixed rate receivable

    6.25 %   5.50 %   4.75 %                   5.64 %      

Fixed rate debt

                                               

Principal ($)

                250               950     1,200     1,197  

Fixed rate payable

                5.13 %             6.01 %   5.95 %      

Floating rate debt

                                               

Principal ($)

                50                     50     50  

Variable rate payable

                5.31 %                   5.31 %      

Interest rate swaps

                                               

Principal ($)

    230     350     235     190               1,005     12  

Fixed rate receivable

    4.21 %   4.65 %   5.12 %   4.81 %             4.85 %      

Variable rate payable

    4.70 %   4.07 %   3.79 %   3.98 %             3.96 %      

Principal (£)

    93     96     95     71               355      

Fixed rate receivable

    5.00 %   4.79 %   5.09 %   5.69 %             5.17 %      

Variable rate payable

    6.06 %   5.43 %   5.08 %   4.82 %             5.14 %      

Principal (€)

    41     74     16     29               160     (2 )

Fixed rate receivable

    3.28 %   3.54 %   4.04 %   4.21 %             3.81 %      

Variable rate payable

    4.69 %   4.54 %   4.49 %   4.50 %             4.53 %      

Forward rate agreements

                                               

Principal ($)

    20                                 20      

Fixed rate receivable

    6.19 %                               6.19 %      

Variable rate payable

    6.50 %                               6.50 %      

(1)
Represents the net present value of the expected cash flows discounted at current market rates of interest as appropriate.

62



WILLIS GROUP HOLDINGS LIMITED

Item 8—Financial Statements and Supplementary Data


Index to Consolidated Financial Statements and Supplementary Data

 
  Page

Report of Independent Registered Public Accounting Firm

  64

Consolidated Statements of Operations for each of the three years in the period ended December 31, 2008

  65

Consolidated Balance Sheets as of December 31, 2008 and 2007

  66

Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 2008

  67

Consolidated Statements of Stockholders' Equity and Comprehensive Income for each of the three years in the period ended December 31, 2008

  68

Notes to the Consolidated Financial Statements

  69

63



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of Willis Group Holdings Limited
Hamilton, Bermuda

We have audited the accompanying consolidated balance sheets of Willis Group Holdings Limited and subsidiaries (the "Company") as of December 31, 2008 and 2007, and the related consolidated statements of operations, stockholders' equity and comprehensive income, and cash flows for each of the three years in the period ended December 31, 2008. Our audits also included the consolidated financial statement schedule listed in the Index at Item 15. These financial statements and financial statement schedule are the responsibility of Willis Group Holdings Limited management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Willis Group Holdings Limited and subsidiaries as of December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2008, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of December 31, 2008, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 27, 2009 expressed an unqualified opinion on the Company's internal control over financial reporting.

Deloitte LLP
London, United Kingdom
February 27, 2009

64



WILLIS GROUP HOLDINGS LIMITED

CONSOLIDATED STATEMENTS OF OPERATIONS

 
  Years ended December 31,  
 
  2008   2007   2006  
 
  (millions, except per share data)
 

REVENUES

                   
 

Commissions and fees

  $ 2,751   $ 2,463   $ 2,328  
 

Investment income

    81     96     87  
 

Other income (Note 2)

    2     19     13  
               
   

Total revenues

    2,834     2,578     2,428  
               

EXPENSES

                   
 

Salaries and benefits (including share-based compensation of $40 million, $33 million and $18 million (Note 4))

    (1,642 )   (1,448 )   (1,457 )
 

Other operating expenses

    (605 )   (460 )   (454 )
 

Depreciation expense

    (54 )   (52 )   (49 )
 

Amortization of intangible assets

    (36 )   (14 )   (14 )
 

Gain on disposal of London headquarters (Note 5)

    7     14     102  
 

Net gain (loss) on disposal of operations (Note 6)

        2     (4 )
               
   

Total expenses

    (2,330 )   (1,958 )   (1,876 )
               

OPERATING INCOME

    504     620     552  
 

Interest expense

    (105 )   (66 )   (38 )
               

INCOME BEFORE INCOME TAXES, INTEREST IN EARNINGS OF ASSOCIATES AND MINORITY INTEREST

    399     554     514  
 

Income taxes (Note 7)

    (97 )   (144 )   (63 )
               

INCOME BEFORE INTEREST IN EARNINGS OF ASSOCIATES AND MINORITY INTEREST

    302     410     451  
 

Interest in earnings of associates, net of tax (Note 14)

    22     16     16  
 

Minority interest, net of tax

    (21 )   (17 )   (18 )
               

NET INCOME

  $ 303   $ 409   $ 449  
               

EARNINGS PER SHARE (Note 8)

                   
 

—Basic

  $ 2.05   $ 2.82   $ 2.86  
 

—Diluted

  $ 2.05   $ 2.78   $ 2.84  

AVERAGE NUMBER OF SHARES OUTSTANDING (Note 8)

                   
 

—Basic

    148     145     157  
 

—Diluted

    148     147     158  
               

CASH DIVIDENDS DECLARED PER COMMON SHARE

  $ 1.04   $ 1.00   $ 0.94  
               

The accompanying notes are an integral part of these consolidated financial statements.

65



WILLIS GROUP HOLDINGS LIMITED

CONSOLIDATED BALANCE SHEETS

 
  December 31,  
 
  2008   2007  
 
  (millions, except
share data)

 

ASSETS

             
 

Cash and cash equivalents

  $ 176   $ 200  
 

Fiduciary funds—restricted (Note 10)

    1,854     1,520  
 

Short-term investments (Note 10)

    20     40  
 

Accounts receivable, net of allowance for doubtful accounts of $24 million in 2008 and $32 million in 2007

    9,131     8,241  
 

Fixed assets, net of accumulated depreciation of $236 million in 2008 and $211 million in 2007 (Note 11)

    312     315  
 

Goodwill (Note 12)

    3,275     1,648  
 

Other intangible assets, net of accumulated amortization of $79 million in 2008 and $46 million in 2007 (Note 13)

    682     78  
 

Investments in associates (Note 14)

    273     193  
 

Deferred tax assets (Note 7)

    76     21  
 

Pension benefits asset (Note 15)

    111     404  
 

Other assets

    492     309  
           

TOTAL ASSETS

  $ 16,402   $ 12,969  
           

LIABILITIES AND STOCKHOLDERS' EQUITY

             
 

Accounts payable

  $ 10,314   $ 9,265  
 

Deferred revenue and accrued expenses

    471     388  
 

Deferred tax liabilities (Note 7)

    21     26  
 

Income taxes payable

    18     43  
 

Short-term debt (Note 16)

    785      
 

Long-term debt (Note 16)

    1,865     1,250  
 

Liability for pension benefits (Note 15)

    237     43  
 

Other liabilities

    796     559  
           
   

Total liabilities

    14,507     11,574  
           

COMMITMENTS AND CONTINGENCIES (Note 17)

             

MINORITY INTEREST

    50     48  

STOCKHOLDERS' EQUITY

             
 

Common shares, $0.000115 par value; Authorized: 4,000,000,000; Issued and outstanding, 166,757,654 shares in 2008 and 143,093,509 shares in 2007

         
 

Additional paid-in capital

    886     41  
 

Retained earnings

    1,593     1,463  
 

Accumulated other comprehensive loss, net of tax (Note 18)

    (630 )   (153 )
 

Treasury stock, at cost, 83,580 shares in 2008 and 71,858 shares in 2007

    (4 )   (4 )
           
   

Total stockholders' equity

    1,845     1,347  
           

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY

  $ 16,402   $ 12,969  
           

The accompanying notes are an integral part of these consolidated financial statements.

66



WILLIS GROUP HOLDINGS LIMITED

CONSOLIDATED STATEMENTS OF CASH FLOWS

 
  Years ended December 31,  
 
  2008   2007   2006  
 
  (millions)
 

CASH FLOWS FROM OPERATING ACTIVITIES

                   

Net income

  $ 303   $ 409   $ 449  
 

Adjustments to reconcile net income to net cash provided by operating activities:

                   
 

Net (gain) loss on disposal of operations, fixed and intangible assets and short-term investments

    (2 )   (20 )   1  
 

Gain on disposal of London headquarters (Note 5)

    (7 )   (14 )   (102 )
 

Depreciation expense

    54     52     49  
 

Amortization of intangible assets

    36     14     14  
 

Provision for doubtful accounts

    (8 )   2     2  
 

Minority interest

    8     10     10  
 

Provision for deferred income taxes

    46     66     82  
 

Excess tax benefits from share-based payment arrangements

    (6 )   (9 )   (11 )
 

Share-based compensation (Note 4)

    40     33     18  
 

Undistributed earnings of associates

    (13 )   (10 )   (11 )
 

Other

    (12 )   (9 )   (9 )
 

Changes in operating assets and liabilities, net of effects from purchase of subsidiaries:

                   
 

Fiduciary funds—restricted

    (212 )   285     (131 )
 

Accounts receivable

    (590 )   628     (287 )
 

Accounts payable

    785     (953 )   430  
 

Additional funding of UK and US pension plans

    (107 )   (153 )   (211 )
 

Other assets

    394     (78 )   34  
 

Other liabilities

    (196 )   11     (219 )
 

Effect of exchange rate changes

    (302 )   4     39  
               
   

Net cash provided by operating activities

    211     268     147  
               

CASH FLOWS FROM INVESTING ACTIVITIES

                   
 

Proceeds on disposal of fixed and intangible assets

    6     27     205  
 

Additions to fixed assets

    (94 )   (185 )   (55 )
 

Net cash proceeds from disposal of operations, net of cash disposed

    11         5  
 

Acquisitions of subsidiaries, net of cash acquired

    (947 )   (81 )   (73 )
 

Investments in associates

    (31 )   (1 )   (25 )
 

Proceeds on sale of short-term investments

    15     19     10  
               
   

Net cash (used in) provided by investing activities

    (1,040 )   (221 )   67  
               

CASH FLOWS FROM FINANCING ACTIVITIES

                   
 

Proceeds from draw down of revolving credit facility

        50     200  
 

Proceeds from short-term debt, net of debt issuance costs

    1,026          
 

Proceeds from long-term debt, net of debt issuance costs

    643          
 

Repayments of debt

    (641 )   (200 )    
 

Senior notes issued, net of debt issuance costs

        593      
 

Repurchase of shares (Note 20)

    (75 )   (480 )   (211 )
 

Proceeds from issue of shares

    15     25     16  
 

Excess tax benefits from share-based payment arrangements

    6     9     11  
 

Dividends paid

    (146 )   (143 )   (145 )
               
   

Net cash provided by (used in) financing activities

    828     (146 )   (129 )
               

(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS

    (1 )   (99 )   85  

Effect of exchange rate changes on cash and cash equivalents

    (23 )   11     10  

CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR

    200     288     193  
               

CASH AND CASH EQUIVALENTS, END OF YEAR

  $ 176   $ 200   $ 288  
               

The accompanying notes are an integral part of these consolidated financial statements.

67



WILLIS GROUP HOLDINGS LIMITED

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

AND COMPREHENSIVE INCOME

 
  December 31,  
 
  2008   2007   2006  
 
  (millions, except share data)
 

COMMON SHARES OUTSTANDING (thousands)

                   

Balance, beginning of year

    143,094     153,003     156,958  
 

Common shares issued

    24,720     406     78  
 

Repurchase of shares (Note 20)

    (2,270 )   (11,515 )   (5,397 )
 

Exercise of stock options

    1,214     1,200     1,364  
               

Balance, end of year

    166,758     143,094     153,003  
               

ADDITIONAL PAID-IN CAPITAL

                   

Balance, beginning of year

  $ 41   $ 388   $ 557  
 

Issue of common shares under employee stock compensation plans and related tax benefits

    20     35     19  
 

Repurchase of shares (Note 20)

    (55 )   (432 )   (211 )
 

Issue of common shares for acquisitions

    840     16     3  
 

Share-based compensation

    40     33     18  
 

Gains on sale of treasury stock

        1     2  
               

Balance, end of year

    886     41     388  
               

RETAINED EARNINGS

                   

Balance, beginning of year

    1,463     1,250     948  
 

Adjustment on adoption of FIN 48

        (4 )    
               

    1,463     1,246