<PAGE>
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
----------------
DATE OF REPORT (DATE OF EARLIEST EVENT REPORTED): JANUARY 15, 1997
----------------
AON CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 1-7933 36-3051915
(STATE OR OTHER (COMMISSION) (I.R.S. EMPLOYER
JURISDICTION OF FILE NUMBER) IDENTIFICATION NO.)
ORGANIZATION)
123 NORTH WACKER DRIVE 60606
CHICAGO, ILLINOIS (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE
OFFICES)
(312) 701-3000
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE.)
NOT APPLICABLE
(FORMER NAME OR FORMER ADDRESS, IF CHANGED SINCE LAST REPORT.)
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<PAGE>
ITEM 2. ACQUISITION OR DISPOSITION OF ASSETS
On January 15, 1997, Subsidiary Corporation, Inc. ("Purchaser"), a Maryland
corporation and a wholly owned subsidiary of Aon Corporation ("Aon"), a
Delaware corporation, consummated its cash tender offer (the "Offer") for all
the outstanding shares of Common Stock, par value $1.00 per share (the "Common
Stock"), and associated preferred stock purchase rights (collectively, the
"Shares"), of Alexander & Alexander Services Inc. ("A&A"), a Maryland
corporation, at a price of $17.50 net cash per Share. Pursuant to the Offer,
Purchaser acquired approximately 44,293,552 Shares, or 97% of the outstanding
Shares. All Shares validly tendered and not withdrawn before expiration of the
Offer at 12:00 midnight, New York City time, on January 14, 1997, were
accepted for payment, including approximately 1,846,882 Shares tendered
pursuant to guaranteed delivery procedures. The Offer was made pursuant to the
Agreement and Plan of Merger, dated December 11, 1996, as amended (the "Merger
Agreement"), among Aon, Purchaser and A&A. A copy of the press release of Aon
announcing the acquisition of the Shares is filed as Exhibit (c)(4) to this
Form 8-K.
On December 11, 1996, Aon and American International Group, Inc. ("AIG")
entered into the Stock Purchase and Sale Agreement ("Stock Purchase and Sale
Agreement"). Pursuant to the Stock Purchase and Sale Agreement, Aon agreed to
buy and AIG agreed to sell for $317.5 million, plus accrued dividends, all
outstanding shares of 8% Series B Cumulative Convertible Preferred Stock, par
value $1.00 per share (the "Series B Preferred Stock") of the Company. On
January 17, 1997, Aon purchased all 4,846,232 shares of Series B Preferred
Stock. Each share of Series B Preferred Stock is currently convertible into
approximately 2.94 shares of Class D Common Stock of the Company, which Class
D Common Stock is exchangeable for Common Stock on a share-for-share basis.
The Merger Agreement provides for the Offer to be followed by a merger of
Purchaser into A&A, pursuant to which all remaining Shares (other than stock
of A&A owned by A&A, Aon or any of their respective subsidiaries and stock as
to which appraisal rights are available and properly exercised under Maryland
law) will be converted into a right to receive $17.50 cash per share (the
"Merger"). A special meeting of A&A's stockholders will be held on or about
February 18, 1997 to vote upon the Merger. Pursuant to the provisions of A&A's
Charter and applicable Maryland corporation law, the affirmative vote of the
holders of a majority of the voting power of the outstanding shares of Common
Stock, Class A Common Stock, par value $.00001 per share, of the Company (the
"Class A Stock"), Class C Common Stock, par value $1.00 per share (the "Class
C Stock" and, together with the Common Stock and the Class A Stock, the
"Common Capital Stock"), of the Company and the Series B Preferred Stock,
voting together as a single class, is required for approval of the Merger.
Because Aon and Purchaser own all of the Series B Preferred Stock and 97% of
the outstanding shares of Common Capital Stock, Aon and Purchaser have the
ability to approve the Merger without the vote of any other stockholder. The
Merger Agreement obligates Aon to cause all the capital stock of the Company
owned by Aon and its subsidiaries to be voted in favor of the Merger. The
Merger will be effected promptly after stockholder approval of the Merger.
Purchaser's payment of approximately $775 million for the aggregate purchase
price of the Shares purchased by Purchaser in the Offer was funded with
capital contributions to Purchaser by Aon. Aon derived the funds necessary for
such capital contribution and the funds necessary to purchase the Series B
Preferred Stock from cash on hand, the proceeds from the sale of commercial
paper and fixed maturities and the proceeds from a preferred equity financing
completed on January 13, 1997. Pursuant to the preferred equity financing, Aon
received approximately $800 million from the sale by a subsidiary of Aon of
8.205% Capital Securities (the "Capital Securities"), payments which are
guaranteed by Aon.
ITEM 7. FINANCIAL STATEMENTS AND EXHIBITS
(a) FINANCIAL STATEMENTS OF BUSINESS ACQUIRED.
Audited consolidated balance sheets of A&A and subsidiaries as of
December 31, 1995 and 1994, and the related audited consolidated statements
of operations, cash flows and stockholders' equity for each of the three
years in the period ended December 31, 1995 and related report of
independent accountants and
2
<PAGE>
unaudited consolidated balance sheet of A&A as of September 30, 1996, and
unaudited consolidated statements of operations and cash flows for each of
the nine months in the periods ended September 30, 1995 and 1996 and
unaudited consolidated statements of operations for the three months in the
period ended September 30, 1995 and 1996 are included in pages 4 through
57.
(b) PRO FORMA FINANCIAL INFORMATION.
The unaudited pro forma consolidated statement of financial position at
September 30, 1996 of Aon and the unaudited pro forma condensed
consolidated statements of income for the year ended December 31, 1995 and
the nine months ended September 30, 1996 of Aon are included in pages 58
through 65.
(c) EXHIBITS:
<TABLE>
<C> <S>
(1) Agreement and Plan of Merger, dated as of December 11, 1996, among
Aon, Purchaser and A&A. (Incorporated by reference from Exhibit
(c)(1) to Aon's Tender Offer Statement on Schedule 14D-1 filed by
Aon with the Securities and Exchange Commission ("SEC") on December
16, 1996 (the "Schedule 14D-1")).
(2) Stock Purchase and Sale Agreement, dated as of December 11, 1996,
between Aon and AIG. (Incorporated by reference from Exhibit (c)(2)
to the Schedule 14D-1).
(3) First Amendment to Agreement and Plan of Merger, dated as of January
7, 1997, among Aon, Purchaser and A&A. (Incorporated by reference
from Exhibit (c)(3) to Amendment No. 2 to the Schedule 14D-1 filed
by Aon with the SEC on January 9, 1997).
(4) Press release of Aon dated January 15, 1997. (Incorporated by
reference from Exhibit (a)(20) to Amendment No. 3 to the Schedule
14D-1 filed by Aon with the SEC on January 15, 1997.)
(5) Consent of Deloitte & Touche LLP. (To be filed by amendment.)
</TABLE>
3
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Independent Auditors' Report.............................................. 5
FINANCIAL STATEMENTS:
Consolidated Statements of Operations--For the years ended December 31,
1995, 1994 and 1993.................................................... 6
Consolidated Balance Sheets--As of December 31, 1995 and 1994........... 7
Consolidated Statements of Cash Flows--For the years ended December 31,
1995, 1994 and 1993.................................................... 8
Consolidated Statements of Stockholders' Equity--For the years ended De-
cember 31, 1995, 1994 and 1993......................................... 9
Notes to Financial Statements........................................... 10
UNAUDITED FINANCIAL STATEMENTS:
Unaudited Consolidated Statements of Operations--For the three and nine
months ended September 30, 1996 and 1995............................... 43
Condensed Consolidated Balance Sheets--As of September 30, 1996 (Unau-
dited) and December 31, 1995........................................... 44
Unaudited Consolidated Statements of Cash Flows--For the nine months
ended September 30, 1996 and 1995...................................... 45
Unaudited Notes to Financial Statements................................. 46
</TABLE>
4
<PAGE>
INDEPENDENT AUDITORS' REPORT
To The Stockholders of Alexander & Alexander Services Inc.:
We have audited the accompanying consolidated balance sheets of Alexander &
Alexander Services Inc. and Subsidiaries as of December 31, 1995 and 1994, and
the related consolidated statements of operations, cash flows and stockholders'
equity for each of the three years in the period ended December 31, 1995. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on the financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. 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 the companies at December 31, 1995
and 1994, and the results of their operations and their cash flows for each of
the three years in the period ended December 31, 1995 in conformity with
generally accepted accounting principles.
As discussed in Notes 5, 7 and 11 to the consolidated financial statements,
the Company changed its method of accounting for international postretirement
benefits in 1995, certain investments in debt and equity securities and
postemployment benefits in 1994, and income taxes and United States
postretirement benefits in 1993.
/s/ Deloitte & Touche LLP
Deloitte & Touche LLP
Baltimore, Maryland
February 14, 1996
5
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, (IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
1995 1994 1993
-------- -------- --------
<S> <C> <C> <C>
OPERATING REVENUES:
Commissions and fees............................. $1,219.5 $1,272.3 $1,287.7
Fiduciary investment income...................... 62.9 51.6 53.9
-------- -------- --------
Total.......................................... 1,282.4 1,323.9 1,341.6
-------- -------- --------
OPERATING EXPENSES:
Salaries and benefits............................ 735.1 814.3 785.3
Other operating expenses......................... 407.0 523.5 504.0
Restructuring and special charges................ 17.6 69.0 --
-------- -------- --------
Total.......................................... 1,159.7 1,406.8 1,289.3
-------- -------- --------
Operating income (loss).......................... 122.7 (82.9) 52.3
-------- -------- --------
OTHER INCOME (EXPENSES):
Investment income................................ 19.2 10.9 9.6
Interest expense................................. (18.6) (16.0) (14.4)
Other............................................ 32.7 10.9 (15.6)
Special charges.................................. -- (69.7) --
-------- -------- --------
Total.......................................... 33.3 (63.9) (20.4)
-------- -------- --------
Income (loss) before income taxes and minority
interest........................................ 156.0 (146.8) 31.9
Income taxes (benefit)........................... 60.9 (42.6) 6.4
-------- -------- --------
Income (loss) before minority interest........... 95.1 (104.2) 25.5
Minority interest................................ (5.7) (3.0) (1.9)
-------- -------- --------
Income (loss) from continuing operations......... 89.4 (107.2) 23.6
Loss from discontinued operations................ -- (28.9) --
-------- -------- --------
Income (loss) before cumulative effect of change
in accounting................................... 89.4 (136.1) 23.6
Cumulative effect of change in accounting........ -- (2.6) 3.3
-------- -------- --------
Net income (loss).............................. 89.4 (138.7) 26.9
======== ======== ========
Preferred stock dividends........................ (25.4) (15.1) (6.2)
-------- -------- --------
Earnings (loss) attributable to common sharehold-
ers............................................. $ 64.0 $ (153.8) $ 20.7
======== ======== ========
PER SHARE INFORMATION:
Primary earnings per share:
Income (loss) from continuing operations......... $ 1.44 $ (2.79) $ 0.40
Loss from discontinued operations................ -- (0.66) --
Cumulative effect of change in accounting........ -- (0.06) 0.08
-------- -------- --------
Net earnings (loss)............................ $ 1.44 $ (3.51) $ 0.48
======== ======== ========
Average common and common equivalent shares out-
standing........................................ 44.6 43.8 43.4
======== ======== ========
Fully diluted earnings per share:
Income (loss) from continuing operations......... $ 1.42 $ (2.79) $ 0.40
Loss from discontinued operations................ -- (0.66) --
Cumulative effect of change in accounting........ -- (0.06) 0.08
-------- -------- --------
Net earnings (loss)............................ $ 1.42 $ (3.51) $ 0.48
======== ======== ========
Average common and common equivalent shares out-
standing, assuming full dilution................ 57.1 43.8 43.4
======== ======== ========
Cash dividends per common share.................. $ .10 $ .325 $ 1.00
======== ======== ========
</TABLE>
See Notes to Financial Statements.
6
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, (IN MILLIONS)
<TABLE>
<CAPTION>
1995 1994
-------- --------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents:
Operating................................................ $ 241.2 $ 248.7
Fiduciary................................................ 496.4 428.5
Short-term investments:
Operating................................................ 11.3 19.2
Fiduciary................................................ 224.9 292.2
Premiums and fees receivable (less allowance for doubtful
accounts of $20.5 in 1995 and $23.7 in 1994)............. 1,292.8 1,206.1
Deferred income taxes..................................... 20.0 71.5
Other current assets...................................... 85.4 120.7
-------- --------
Total current assets................................... 2,372.0 2,386.9
-------- --------
PROPERTY AND EQUIPMENT:
Land and buildings........................................ 39.2 39.7
Furniture and equipment................................... 274.6 296.5
Leasehold improvements.................................... 83.0 95.1
-------- --------
396.8 431.3
Less accumulated depreciation and amortization............ (270.4) (293.3)
-------- --------
Property and equipment--net............................... 126.4 138.0
-------- --------
OTHER ASSETS:
Intangible assets (net of accumulated amortization of
$124.5 in 1995 and $117.5 in 1994)....................... 210.7 175.1
Deferred income taxes..................................... 102.1 87.1
Long-term operating investments........................... 30.9 64.1
Other..................................................... 100.3 94.5
-------- --------
Total assets........................................... $2,942.4 $2,945.7
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Premiums payable to insurance companies................... $1,810.4 $1,738.3
Short-term debt........................................... 19.1 1.0
Current portion of long-term debt......................... 9.3 17.1
Deferred income taxes..................................... 9.4 8.5
Accrued compensation and related benefits................. 81.8 60.0
Income taxes payable...................................... 24.7 66.3
Other accrued expenses.................................... 165.8 258.1
-------- --------
Total current liabilities.............................. 2,120.5 2,149.3
-------- --------
LONG-TERM LIABILITIES:
Long-term debt............................................ 126.2 132.7
Deferred income taxes..................................... 15.6 13.4
Net liabilities of discontinued operations................ 33.4 56.8
Other..................................................... 234.1 266.0
-------- --------
Total long-term liabilities............................ 409.3 468.9
-------- --------
Commitments and Contingent Liabilities (Notes 5, 6, 13 and
14)
8% Series B cumulative convertible preferred stock contin-
gency (Note 14).......................................... 10.0 10.0
-------- --------
STOCKHOLDERS' EQUITY:
Preferred stock, authorized 15,000,000 shares, $1 par val-
ue:
Series A junior participating preferred stock, issued
and outstanding, none................................... -- --
$3.625 Series A convertible preferred stock, issued and
outstanding, 2,300,000 shares, liquidation preference
of $115 million......................................... 2.3 2.3
8% Series B cumulative convertible preferred stock, is-
sued and outstanding 4,477,170 and 4,136,213 shares,
respectively, liquidation preference of $224 million
and $205 million, respectively.......................... 4.5 4.1
Common stock, authorized 200,000,000 shares, $1 par value;
issued and outstanding 42,259,282 and 41,569,902 shares,
respectively............................................. 42.3 41.5
Class A common stock, authorized 26,000,000 shares,
$.00001 par value; issued and outstanding 1,920,821 and
2,282,088 shares, respectively........................... -- --
Class C common stock, authorized 11,000,000 shares, $1 par
value; issued and outstanding 361,092 and 372,557 shares,
respectively............................................. 0.4 0.4
Class D common stock, authorized 40,000,000 shares, $1 par
value; issued and outstanding, none...................... -- --
Paid-in capital........................................... 638.1 615.0
Accumulated deficit....................................... (227.5) (287.1)
Unrealized investment gains, net of income taxes.......... 5.6 1.5
Accumulated translation adjustments....................... (63.1) (60.2)
-------- --------
Total stockholders' equity............................. 402.6 317.5
-------- --------
Total liabilities and stockholders' equity............. $2,942.4 $2,945.7
======== ========
</TABLE>
See Notes to Financial Statements.
7
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, (IN MILLIONS)
<TABLE>
<CAPTION>
1995 1994 1993
------ ------- ------
<S> <C> <C> <C>
CASH PROVIDED (USED) BY:
OPERATING ACTIVITIES:
Income (loss) from continuing operations............. $ 89.4 $(107.2) $ 23.6
Adjustments to reconcile to net cash provided (used)
by operating activities:
Depreciation and amortization....................... 46.1 51.2 54.5
Deferred income taxes............................... 36.0 (77.5) (27.5)
Gains on disposition of subsidiaries and other as-
sets............................................... (30.4) (20.2) (3.9)
Restructuring and special charges, net of cash pay-
ments.............................................. 17.6 131.8 --
Other............................................... 12.5 14.2 13.4
Changes in assets and liabilities (net of effects
from acquisitions and dispositions):
Net fiduciary cash and cash equivalents and short-
term investments................................... 25.3 105.8 (46.0)
Premiums and fees receivable........................ (58.8) 9.0 (69.3)
Other current assets................................ (13.5) 16.0 (15.8)
Other assets........................................ (13.6) 9.2 (11.9)
Premiums payable to insurance companies............. 16.7 (70.8) 74.6
Other accrued expenses.............................. (90.2) 3.7 8.0
Other long-term liabilities......................... (31.3) (0.6) 12.8
Discontinued operations (net)........................ (16.1) 1.4 (11.9)
Cumulative effect of change in accounting............ -- (2.6) 3.3
------ ------- ------
Net cash provided (used) by operating activities.. (10.3) 63.4 3.9
------ ------- ------
INVESTING ACTIVITIES:
Net purchases of property and equipment.............. (27.7) (21.5) (26.0)
Purchases of businesses.............................. (24.4) (4.7) (21.0)
Proceeds from sales of subsidiaries and other assets. 88.1 4.1 9.6
Purchases of operating investments................... (188.0) (79.2) (61.7)
Sales and maturities of operating investments........ 231.3 9.0 68.3
------ ------- ------
Net cash provided (used) by investing activities.. 79.3 (92.3) (30.8)
------ ------- ------
FINANCING ACTIVITIES:
Cash dividends....................................... (12.7) (22.6) (47.9)
Proceeds from issuance of short-term debt............ 0.2 9.0 18.7
Payments of short-term debt.......................... (0.8) (24.8) (1.5)
Proceeds from issuance of long-term debt............. 62.5 51.8 19.4
Payment for a finite risk contract................... -- (80.0) --
Repayments of long-term debt......................... (126.1) (8.3) (26.0)
Issuance of preferred and common stock............... 1.4 196.1 112.1
Distribution of earnings of pooled entity............ -- -- (5.5)
------ ------- ------
Net cash provided (used) by financing activities..... (75.5) 121.2 69.3
Effect of exchange rate changes on operating cash and
cash equivalents.................................... (1.0) 4.9 (7.9)
Operating cash and cash equivalents at beginning of
year................................................ 248.7 151.5 117.0
------ ------- ------
Operating cash and cash equivalents at end of year... $241.2 $ 248.7 $151.5
====== ======= ======
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid during the year for:
Interest............................................ $ 19.3 $ 14.2 $ 14.6
Income taxes........................................ 72.1 37.0 56.0
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Notes payable issued for contingency settlements..... 45.7 -- --
Series B cumulative convertible preferred stock divi-
dends-in-kind....................................... 17.1 6.8 --
Common stock issued for business acquisitions and em-
ployee benefit and stock plans...................... 5.1 6.8 2.3
Notes received on dispositions of subsidiaries....... -- 29.2 2.0
Notes payable on acquisition of subsidiary........... 18.7 -- --
Sale of direct financing lease and related mortgage
notes............................................... -- 19.0 --
</TABLE>
See Notes to Financial Statements.
8
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, (IN MILLIONS)
<TABLE>
<CAPTION>
1995 1994 1993
------- ------- -------
<S> <C> <C> <C>
$3.625 SERIES A CONVERTIBLE PREFERRED STOCK:
Balance, beginning of year.......................... $ 2.3 $ 2.3 $ --
Shares issued by private placement.................. -- -- 2.3
------- ------- -------
Balance, end of year............................. $ 2.3 $ 2.3 $ 2.3
======= ======= =======
8% SERIES B CUMULATIVE CONVERTIBLE PREFERRED STOCK:
Balance, beginning of year.......................... $ 4.1 $ -- $ --
Shares issued by private placement.................. -- 4.0 --
Dividends-in-kind................................... 0.4 0.1 --
------- ------- -------
Balance, end of year............................. $ 4.5 $ 4.1 $ --
======= ======= =======
COMMON STOCK:
Balance, beginning of year.......................... $ 41.5 $ 40.7 $ 40.1
Conversions of Class A and Class C shares into com-
mon stock, 372,732 shares, 104,125 shares and
502,450 shares, respectively....................... 0.4 0.1 0.5
Other, principally stock compensation transactions.. 0.4 0.7 0.1
------- ------- -------
Balance, end of year............................. $ 42.3 $ 41.5 $ 40.7
======= ======= =======
CLASS A COMMON STOCK:
Balance, beginning of year.......................... $ 0.0 $ 0.0 $ 0.0
Conversions into common stock, 361,267 shares,
87,300 shares and 478,892 shares, respectively..... -- -- --
------- ------- -------
Balance, end of year............................. $ 0.0 $ 0.0 $ 0.0
======= ======= =======
CLASS C COMMON STOCK:
Balance, beginning of year.......................... $ 0.4 $ 0.4 $ 0.4
Conversions into common stock, 11,465 shares, 16,825
shares and 23,558 shares, respectively............. -- -- --
------- ------- -------
Balance, end of year............................. $ 0.4 $ 0.4 $ 0.4
======= ======= =======
PAID-IN CAPITAL:
Balance, beginning of year.......................... $ 615.0 $ 423.4 $ 296.5
Conversions into common stock....................... (0.4) (0.1) (0.4)
Preferred stock issuances........................... 16.7 188.9 108.6
Other, principally stock compensation transactions.. 6.8 2.8 1.1
Tax benefit from acquisitions accounted for as pool-
ing of interests................................... -- -- 17.6
------- ------- -------
Balance, end of year............................. $ 638.1 $ 615.0 $ 423.4
======= ======= =======
ACCUMULATED DEFICIT:
Balance, beginning of year.......................... $(287.1) $(119.0) $ (92.5)
Net income (loss)................................... 89.4 (138.7) 26.9
Dividends:
Common stock....................................... (4.4) (14.3) (41.7)
Preferred stock.................................... (25.4) (15.1) (6.2)
Distribution of earnings of pooled entity........... -- -- (5.5)
------- ------- -------
Balance, end of year............................. $(227.5) $(287.1) $(119.0)
======= ======= =======
UNREALIZED INVESTMENT GAINS, NET OF INCOME TAXES:
Balance, beginning of year.......................... $ 1.5 $ -- $ --
Change in unrealized gains, net of tax.............. 4.1 1.5 --
------- ------- -------
Balance, end of year............................. $ 5.6 $ 1.5 $ --
======= ======= =======
ACCUMULATED TRANSLATION ADJUSTMENTS:
Balance, beginning of year.......................... $ (60.2) $ (71.6) $ (59.0)
Foreign currency translation adjustments............ (2.9) 11.4 (12.6)
------- ------- -------
Balance, end of year............................. $ (63.1) $ (60.2) $ (71.6)
======= ======= =======
</TABLE>
See Notes to Financial Statements.
9
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
(IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
1. SIGNIFICANT ACCOUNTING POLICIES
Consolidation
The accompanying consolidated financial statements of Alexander & Alexander
Services Inc. (the Company) include the accounts of all majority-owned
subsidiaries. All significant intercompany transactions and balances have been
eliminated.
Nature of Operations
The Company is a holding company which, through its subsidiaries, provides
risk management, insurance brokerage and human resource management consulting
services on a global basis. The principal industry segment is insurance
services. This segment accounted for approximately 84 percent of the Company's
total revenues in 1995 which are derived primarily from risk management and
insurance services, specialist and reinsurance broking operations. Human
resource management consulting operations, which represent approximately 16
percent of total revenues in 1995, provide integrated advisory and support
services in human resource management, including retirement planning, health
care management, organizational effectiveness, compensation, human resource-
related communications, information technologies and also offers brokerage
services for group health and welfare coverages.
The Company operates from offices located in more than 80 countries and
territories through wholly-owned subsidiaries, affiliates and other servicing
capabilities. The Company's extensive international operations represented 53
percent of consolidated operating revenues in 1995, primarily in the United
Kingdom and Canada.
The Company's clients are primarily commercial enterprises, including a broad
range of industrial, transportation, service, financial and other businesses.
Clients also include government and governmental agencies, not-for-profit
organizations and individuals.
Use of estimates in the preparation of financial statements
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Cash Equivalents and Investments
Cash equivalents are highly liquid investments, including certificates of
deposit, government securities and time deposits, with maturities of three
months or less at the time of purchase and are stated at estimated fair value
or cost. Short-term investments are similar investments with maturities of more
than three months but less than one year from the date of purchase. Long-term
investments consists of debt securities with maturities greater than one year
and equity securities.
Effective January 1, 1994, the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in
Debt and Equity Securities." In accordance with the statement, the Company has
classified as available for sale, all of its debt and equity securities. These
securities are carried at fair value with unrealized gains and losses reported
as a separate component of Stockholders' Equity. Prior to the adoption of this
statement, cash equivalents and short-term investments were stated at cost. The
cost of securities sold is determined by the specific identification method.
10
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Foreign Currency Translation
The financial statements of the Company's foreign operations, where the
local currency is the functional currency, are translated into U.S. dollars at
the exchange rates in effect at each year end for assets and liabilities and
average exchange rates during the year for the results of operations. The
related unrealized gains or losses resulting from translation are reported as
a separate component of Stockholders' Equity.
Net foreign currency transaction gains, included in operating income,
amounted to $5.7 million, $4.8 million and $9 million for the years ended
December 31, 1995, 1994 and 1993, respectively.
Property and Depreciation
The cost of property and equipment is generally depreciated using the
straight-line method over the estimated useful lives of the related assets
which range from 3 to 40 years for buildings and 3 to 10 years for equipment.
Leasehold improvements are capitalized and amortized over the shorter of the
life of the asset or the lease term.
Intangible Assets
Intangible assets resulting from acquisitions, principally expiration lists
and goodwill, are amortized using the straight-line method over periods not
exceeding 17 and 40 years, respectively. The costs of non-compete agreements
are amortized using the straight-line method over the terms of the agreements.
Amortization of intangible assets included in operating expenses amounted to
$12.3 million, $11.9 million and $13 million for the years ended December 31,
1995, 1994 and 1993, respectively.
The Company periodically evaluates the carrying value of its intangible
assets by projecting operating results over the remaining lives of such assets
on an undiscounted basis. Such projections take into account past financial
performance as well as management's estimate of future operating results.
Income Taxes
Effective January 1, 1993, the Company adopted SFAS No. 109, "Accounting for
Income Taxes." The adoption of SFAS No. 109 changes the Company's method of
accounting for income taxes from the deferred method to an asset and liability
method whereby deferred income taxes reflect the net tax effects of temporary
differences between the tax bases and financial reporting bases of assets and
liabilities.
Income taxes are generally not provided on undistributed earnings of foreign
subsidiaries because they are considered to be permanently invested or will
not be repatriated unless any additional federal income taxes would be
substantially offset by foreign tax credits.
Fiduciary Funds
Premiums which are due from insureds are reported as assets of the Company
and as corresponding liabilities, net of commissions, to the insurance
carriers. Premiums received from insureds but not yet remitted to the carriers
are held as cash or investments in a fiduciary capacity.
Revenue Recognition
Commissions and fees for insurance services are generally recognized on the
effective date of the policies or the billing date, whichever is later. Any
subsequent commission adjustments, including policy cancellations, are
generally recognized upon notification from the insurance carriers. Contingent
commissions and commissions on policies billed and collected directly by
insurance carriers are recognized when received.
11
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Fees and commissions for human resource management consulting services are
generally recognized when the services are provided.
Per Share Data
Primary earnings per share are computed by dividing earnings (loss)
attributable to common stockholders by the weighted average number of shares of
Common Stock and their equivalents (Class A and Class C Common Stock)
outstanding during the period and, if dilutive, shares issuable upon the
exercise of stock options. The $3.625 Series A Convertible Preferred Stock and
the 8% Series B Cumulative Convertible Preferred Stock are not common stock
equivalents for primary share computations.
Fully diluted earnings per share in the first and second quarters and for the
full year of 1995 assumes the conversion of the 8% Series B Cumulative
Convertible Preferred Stock. In 1995, the $3.625 Series A Convertible Preferred
Stock and the 11% Convertible Subordinated Debentures were anti-dilutive for
fully diluted earnings per share calculations.
Fully diluted earnings per share for the 1994 and 1993 periods were anti-
dilutive; therefore, the amounts for primary and fully diluted earnings are the
same.
Presentation
Unless otherwise indicated, all amounts are stated in millions of U.S.
dollars. Certain prior period amounts have been reclassified to conform with
the current year presentation.
2. ACQUISITIONS AND DISPOSITIONS
Acquisitions
On October 12, 1995, the Company acquired most of the U.S. retail insurance
broking and consulting business of Jardine Insurance Brokers, Inc. (the JIB
acquisition) for a purchase price not to exceed $48.3 million. The Company paid
$21.1 million at closing and issued two 6.375% promissory notes totaling $21.2
million with payments of $10.6 million due on April 9 and October 12, 1996,
respectively. During the fourth quarter of 1995, the October promissory note
was revalued to $8.1 million as a result of certain revenue retention criteria
with respect to former JIB offices. The remaining purchase price of
approximately $6 million is contingent on the retention of specific accounts
over a four-year period ending October 12, 1999. The acquired offices generated
revenues of approximately $53 million in 1994.
The acquisition was accounted for as a purchase. Of the purchase price, $44.3
million has been allocated to identifiable intangible assets (expiration lists)
and goodwill. The expiration lists will be amortized over an average of nine
years and goodwill will be amortized over twenty years.
On November 30, 1993, the Company issued 2.3 million shares of its Common
Stock for all of the partnership interests of Clay & Partners (Clay), a U.K.-
based actuarial consulting operation. This acquisition was accounted for as a
pooling of interests. In connection with the merger, the Company recorded $14.4
million as additional paid-in capital representing deferred tax benefits
associated with the taxable business combination of Clay.
Prior to the merger, Clay operated as a partnership. Accordingly, the
Company's results for 1993 do not include approximately $2.2 million for
partners' salaries or $0.7 million for corporate income taxes. Pro-forma net
income (loss) for the Company, assuming partner salaries and corporate income
taxes were charged to operations, would have been $28.5 million, or $0.51 per
share, in 1993.
12
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Effective July 1, 1993, the Company acquired an 80 percent interest in a
Mexican insurance brokerage company which was accounted for as a purchase. The
purchase price was $16.9 million, including a $7.4 million cash payment and
notes payable of $9.5 million due in three installments from 1994 to 1996. The
excess of the purchase price over the fair value of net tangible assets
acquired was approximately $16 million.
As a result of the devaluation of the Mexican peso, the Company's accumulated
translation adjustment balance for its Mexican operations reflected an
unrealized loss of $9.5 million and $6.2 million at December 31, 1995 and
December 31, 1994, respectively. However, the Company expects to maintain its
strategic investment in Mexico for the long-term and further anticipates that
its Mexican operation will remain profitable. Accordingly, the Company does not
currently consider its investment in Mexico to be impaired.
Dispositions
On February 28, 1995, the Company completed the sale of Alexsis Inc., its
U.S.-based third party claims administrator for total cash proceeds of $47.1
million resulting in a pre-tax gain of $28.7 million ($18.7 million after-tax
or $0.42 per share).
During 1995, the Company sold three small operations for gross proceeds of
$9.1 million resulting in pre-tax gains totaling $1.7 million ($1.1 after-tax
or $0.02 per share).
On November 10, 1994, the Company completed the sale of its U.S.-based
personal lines insurance broking business. The total proceeds from the sale
were $30.2 million, including $1 million in cash and a note receivable of $29.2
million due in January 1995, with a resulting pre-tax gain of $20.2 million
($12.5 million after-tax or $0.28 per share).
During 1993, the Company sold three small operations for gross proceeds of
$9.6 million. Pre-tax gains of $3.9 million have been recognized on the sales
with resulting after-tax gains totaling $2.3 million or $0.05 per share.
These gains are included in Other Income (Expenses) in the Consolidated
Statements of Operations.
Total revenues and operating income from all of these operations were $12
million, $120.9 million and $128.3 million; and $4.1 million, $10.4 million and
$2.5 million, respectively, for the years ended December 31, 1995, 1994 and
1993.
3. RESTRUCTURING AND SPECIAL CHARGES
In the fourth quarter of 1995, the Company recorded a $17.6 million pre-tax
charge ($11.2 million after-tax or $0.25 per share) related primarily to the
JIB acquisition. The JIB portion of this charge amounted to $13 million, of
which $12.5 million reflects the anticipated costs associated with the
abandonment of certain of the Company's office space and the remaining balance
reflects the anticipated costs associated with involuntary workforce
reductions. The lease liability will be paid through the year 2007. The
remaining $4.6 million of the charge primarily represents costs associated with
other involuntary workforce reductions in the U.S.
In the fourth quarter of 1994, management committed to a formal plan of
restructuring the Company's operations and recorded a $69 million pre-tax
charge ($45.1 million after-tax or $1.03 per share). The restructuring charge
included $25.2 million to consolidate real estate space requirements at 48
offices worldwide, and $43.8 million for voluntary early retirement programs
and involuntary workforce reductions involving approximately 1,100 positions,
of which 650 were in the U.S.
13
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
The involuntary severance portion and voluntary early retirement program
amounted to $22.9 million and $20.9 million, respectively. Of these amounts,
$8.8 million will be paid from various pension plans of the Company. The
Company paid $17.1 million and $5.7 million of the liabilities in 1995 and
1994, respectively, and expects to pay $5.2 million of the liabilities in 1996.
The remainder of the liabilities will generally be paid in the form of
annuities through the year 2020.
The charge associated with real estate activities relates to the closure,
abandonment and downsizing of office space globally. The costs primarily
include remaining lease obligations and write-offs of leasehold improvements
and fixed assets. The Company paid $9.3 million and $1.2 million of these
liabilities during the years 1995 and 1994, respectively, and has written off
assets of $2.7 million during 1995.
The Company expects to pay $3.8 million of the liability in 1996. The
remainder of the liability will be paid out over the remaining lease periods,
which extend through the year 2009.
In the fourth quarter of 1994, the Company recorded pre-tax special charges
of $69.7 million ($45.3 million after-tax or $1.03 per share). These charges,
which are reflected in non-operating results, include a $32.5 million
settlement in January 1995 which resolved certain indemnification obligations
relating to the 1987 sale of Shand Morahan & Company (Shand) and a $37.2
million increase to the Company's pre-existing reserves, based on settlement
discussions which led to a March 1995 settlement agreement with the
rehabilitator of Mutual Fire, Marine & Inland Insurance Company, (Mutual Fire).
See Note 14 of Notes to Financial Statements.
4. OTHER INCOME (EXPENSES)
Other income (expenses) consists of the following:
<TABLE>
<CAPTION>
FOR THE YEARS
ENDED DECEMBER 31,
--------------------
1995 1994 1993
----- ----- ------
<S> <C> <C> <C>
Gains on sales of businesses (See Note 2).......... $30.4 $20.2 $ 3.9
Litigation costs................................... (0.1) (9.1) (20.2)
Other.............................................. 2.4 (0.2) 0.7
----- ----- ------
$32.7 $10.9 $(15.6)
===== ===== ======
</TABLE>
Litigation costs are associated primarily with the Mutual Fire lawsuit
described in Note 14 of Notes to Financial Statements as well as a 1993
settlement of certain other litigation matters.
5. INCOME TAXES
Effective January 1, 1993, the Company adopted SFAS No. 109, "Accounting for
Income Taxes." The cumulative effect of adopting this standard increased 1993
net income by $3.3 million or $0.08 per share. Tax benefits of $3.2 million
were also allocated to paid-in capital representing the difference in the tax
bases over the book bases of the net assets of taxable business combinations
accounted for as pooling of interests. These benefits would have been
recognized at the respective dates of combination if SFAS No. 109 had been
applied at that time.
The components of income (loss) from continuing operations before income
taxes are as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
----------------------
1995 1994 1993
------ ------- ------
<S> <C> <C> <C>
United States..................................... $ 37.4 $(200.9) $(74.2)
International..................................... 118.6 54.1 106.1
------ ------- ------
$156.0 $(146.8) $ 31.9
====== ======= ======
</TABLE>
14
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
The components of the provision (benefit) for income taxes on continuing
operations are as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
---------------------
1995 1994 1993
------ ------ -----
<S> <C> <C> <C>
Current:
Federal.......................................... $(17.7) $ 1.7 $(0.2)
State and local.................................. 1.9 (0.7) (0.8)
International.................................... 40.7 33.9 34.9
------ ------ -----
24.9 34.9 33.9
------ ------ -----
Deferred:
Federal.......................................... 28.7 (67.3) (28.7)
State and local.................................. -- (3.6) (2.0)
International.................................... 7.3 (6.6) 3.2
------ ------ -----
36.0 (77.5) (27.5)
------ ------ -----
$ 60.9 $(42.6) $ 6.4
====== ====== =====
</TABLE>
A reconciliation of the tax provision and the amount computed by applying the
U.S. federal income tax rate of 35% to income (loss) from continuing operations
before income taxes is as follows:
<TABLE>
<CAPTION>
FOR THE YEARS
ENDED DECEMBER 31,
--------------------
1995 1994 1993
----- ------ -----
<S> <C> <C> <C>
Computed "expected" tax expense (benefit).......... $54.6 $(51.4) $11.2
State and local income taxes--net of federal income
tax............................................... 1.2 (1.6) (1.9)
Foreign statutory rates under U.S. federal statu-
tory rate......................................... (0.4) (2.8) (2.9)
Foreign partnership income not taxed............... -- -- (1.9)
Tax benefit of capital losses...................... -- -- (3.5)
Tax rate changes................................... -- -- (1.2)
Adjustment to prior year tax provisions............ -- -- (2.9)
Amortization of intangible assets.................. 2.6 2.6 2.5
U.S. federal income tax on foreign earnings, net of
credits........................................... 0.9 0.5 3.3
Other non-deductible expenses...................... 4.2 7.5 4.1
Other, net......................................... (2.2) 2.6 (0.4)
----- ------ -----
Actual tax expense (benefit)..................... $60.9 $(42.6) $ 6.4
===== ====== =====
</TABLE>
Federal income taxes have not been provided on undistributed earnings of
foreign subsidiaries which aggregated approximately $364.6 million at December
31, 1995, because such earnings are permanently invested or will not be
repatriated unless any additional income taxes would be substantially offset by
foreign tax credits. It is not practicable to determine the amount of
unrecognized deferred income tax liabilities on these undistributed earnings.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying value of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes as well as loss and tax
credit carryforwards.
15
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
The following is a summary of the significant components of the Company's
gross deferred tax assets and liabilities:
<TABLE>
<CAPTION>
AS OF
DECEMBER 31,
-------------
1995 1994
----- ------
<S> <C> <C>
Deferred tax assets:
Deferred compensation................................... $ 9.2 $ 10.2
Restructuring charges................................... 11.0 19.6
Shand/Mutual Fire reserves.............................. -- 30.9
Capital loss carryforwards.............................. 13.2 16.7
Net operating loss and tax credit carryforwards......... 63.1 63.6
Business combinations................................... 16.5 17.1
Other accruals not currently deductible................. 78.6 81.5
----- ------
191.6 239.6
Less: Valuation allowance............................... (35.2) (36.7)
----- ------
Total deferred tax assets............................. 156.4 202.9
----- ------
Deferred tax liabilities:
Deferred commissions.................................... 8.6 9.6
Depreciation............................................ 2.2 3.0
Gains on settlement of pension liabilities, net of
accruals............................................... 22.7 19.7
Gain on sale of personal lines business................. -- 11.3
Tax leases.............................................. 10.5 13.9
Other accruals.......................................... 15.3 8.7
----- ------
Total deferred tax liabilities........................ 59.3 66.2
----- ------
Net deferred tax asset................................ $97.1 $136.7
===== ======
</TABLE>
The deferred tax balances shown in the Consolidated Balance Sheets are after
reclassification of the above amounts within the various jurisdictions in which
the Company operates.
As of December 31, 1995, the Company has a U.S. federal net operating loss
carryforward of $45 million which expires in the year 2009 and U.S. state net
operating loss carryforwards totaling $224.9 million which expire in various
years through 2010. The Company also has U.S. federal foreign tax credit
carryforwards of $11.8 million which expire in years 1998 through 2000, and
U.S. federal alternative minimum tax credits of $7.5 million which can be
carried forward indefinitely. In addition, the Company has foreign net
operating loss and capital loss carryforwards for tax purposes of $12.2 million
and $31.3 million, respectively, which can be carried forward indefinitely and
approximately $7 million of foreign net operating losses which expire in
various years through 2009.
The Company expects that sufficient taxable income will be generated in
future years to realize the U.S. federal net operating loss and tax credit
carryforwards and, therefore, the Company believes that a valuation allowance
is not necessary for these amounts. The $35.2 million valuation allowance at
December 31, 1995 relates primarily to foreign and U.S. state net operating
loss and capital loss carryforwards. The valuation allowance decreased by a net
amount of $1.5 million in 1995, of which $3.5 million relates to a decrease in
foreign capital loss carryforwards and $2 million to increases in foreign and
U.S. state net operating losses.
Although future earnings cannot be predicted with certainty, management
currently believes that realization of the net deferred tax asset is more
likely than not. The net U.S. deferred tax asset would be realized with average
future annual earnings equivalent to 1995 results, excluding nonrecurring items
and sold subsidiaries and businesses.
16
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
During 1994, the Company was advised that the Joint Committee on Taxation had
approved the agreement reached in 1993 by the Company and the Appeals Office of
the Internal Revenue Service (IRS) on settlement of tax issues with respect to
years 1980 through 1986. Also during 1994, the Company reached an agreement
with the IRS on settlement of the examination of years 1987 through 1989. On
February 28, 1995, the Company paid the amounts due for such years and charged
the tax and net interest totaling $35.6 million against previously established
reserves.
The Company is currently under examination by the IRS for years 1990 and
1991. In 1994, the Company received a Notice of Proposed Adjustment from the
IRS proposing an increase in taxable income for the 1991 year which, if
sustained, would result in an additional tax liability estimated by the Company
at $50 million, excluding interest and penalties. This proposed adjustment
relates to intercompany transactions involving the stock of a U.K. subsidiary.
The Company disagrees with the proposed adjustment and has requested advice
from the IRS National Office on this issue. The Company currently believes that
the National Office review should be completed in the first half of 1996.
Although the ultimate outcome of the matter cannot be predicted with certainty,
the Company and its independent tax counsel believe there are substantial
arguments in support of the Company's position and that the Company should
prevail in the event that the issue were to be litigated.
A similar set of transactions occurred in 1993. Depending on the outcome of
the IRS National Office review of the 1991 issue, the IRS could propose an
increase in 1993 taxable income which would result in an additional tax
liability estimated by the Company at $25 million, excluding interest and
penalties. The Company's 1993 tax return is not currently under examination.
The Company believes it should prevail in the event this similar issue is
raised by the IRS. Accordingly, no provision for any liability with respect to
the 1991 and 1993 transactions has been made in the consolidated financial
statements.
The Company believes that its current tax reserves are adequate to cover all
of its tax liabilities.
6. DISCONTINUED OPERATIONS
In 1985, the Company discontinued its insurance underwriting operations. In
1987, the Company sold Sphere Drake Insurance Group (Sphere Drake). The Sphere
Drake sales agreement provides indemnities by the Company to the purchaser for
various potential liabilities including provisions covering future losses on
certain insurance pooling arrangements from 1953 to 1967 between Sphere Drake
and Orion Insurance Company (Orion), a U.K.-based insurance company, and future
losses pursuant to a stop-loss reinsurance contract between Sphere Drake and
Lloyd's Syndicate 701 (Syndicate 701). In addition, the sales agreement
requires the Company to assume any losses in respect of actions or omissions by
Swann & Everett Underwriting Agency (Swann & Everett), an underwriting
management company previously managed by Alexander Howden Group Limited
(Alexander Howden).
The net liabilities of discontinued operations shown in the accompanying
Consolidated Balance Sheets include insurance liabilities associated with the
above indemnities, liabilities of insurance underwriting subsidiaries currently
in run-off and other related liabilities.
17
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
A summary of the net liabilities of discontinued operations is as follows:
<TABLE>
<CAPTION>
AS OF
DECEMBER 31,
-------------
1995 1994
------ ------
<S> <C> <C>
Liabilities:
Insurance liabilities.................................... $257.1 $277.6
Other.................................................... 14.9 31.4
------ ------
Total liabilities.................................... 272.0 309.0
------ ------
Assets:
Recoverable under finite risk contracts:
Insurance liabilities.................................. 126.4 135.7
Premium adjustment..................................... 9.8 10.8
Reinsurance recoverables................................. 51.6 64.2
Cash and investments..................................... 27.2 23.6
Other.................................................... 9.3 10.9
------ ------
Total assets......................................... 224.3 245.2
------ ------
Total net liabilities of discontinued operations........... 47.7 63.8
Less current portion classified as other accrued expenses.. 14.3 7.0
------ ------
Remainder classified as net liabilities of discontinued op-
erations.................................................. $ 33.4 $ 56.8
====== ======
</TABLE>
The insurance liabilities represent estimates of future claims expected to be
made under occurrence-based insurance policies and reinsurance business written
through Lloyd's and the London market covering primarily asbestosis,
environmental pollution, and latent disease risks in the United States which
are coupled with substantial litigation expenses. These claims are expected to
develop and be settled over the next twenty to thirty years.
Liabilities stemming from these claims cannot be estimated using conventional
actuarial reserving techniques because the available historical experience is
not adequate to support the use of such techniques and because case law, as
well as scientific standards for measuring the adequacy of site clean-up (both
of which have had, and will continue to have, a significant bearing on the
ultimate extent of the liabilities) is still evolving. Accordingly, the
Company's independent actuaries have combined available exposure information
with other relevant industry data and have used various projection techniques
to estimate the insurance liabilities, consisting principally of incurred but
not reported losses.
In 1994, Orion which has financial responsibility for sharing certain of the
insurance pool liabilities, was placed in provisional liquidation by order of
the English Courts. Based on current facts and circumstances, the Company
believes that the provisional liquidation will not have a material adverse
effect on the net liabilities of discontinued operations.
The Company has certain protection against adverse developments of the
insurance liabilities through two finite risk contracts issued by Centre
Reinsurance (Bermuda) Limited (reinsurance company). A contract entered into in
1989 provides the insurance underwriting subsidiaries currently in run-off with
recoveries of recorded liabilities of $76 million, and for up to $50 million of
additional recoveries in excess of those liabilities subject to a deductible
for one of the run-off companies of $15 million. At December 31, 1995, based on
an estimate by an independent actuarial firm, the Company had recorded $13.5
million of the deductible.
On July 1, 1994, the Company entered into an insurance-based financing
contract (finite risk contract) with the reinsurance company providing
protection primarily for exposures relating to Orion, Syndicate 701 and Swann &
Everett. The contract provided for the payment by the Company of $80 million,
$50 million of which
18
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
was borrowed from the reinsurance company, and for payment by the Company of
the first $73 million of paid claims. The contract entitles the Company to
recover paid claims in excess of the Company's $73 million retention. At
December 31, 1995, recoveries were limited to $115.2 million, which includes
the Company's payment of $80 million. In addition, commencing December 31,
1996, depending on the timing and amount of paid loss recoveries under the
contract, the Company may be entitled to receive a payment from the reinsurance
company in excess of the amounts recovered for paid losses if the contract is
terminated. The contract is accounted for under the deposit method of
accounting and the accounting requirements for discontinued operations.
The Company's right to terminate the contract entered into in 1994 is subject
to the consent of American International Group, Inc. (AIG) as long as AIG is
the holder of certain shares of the Company's stock. In addition, the
reinsurance company also has the right, under certain circumstances, all of
which are under the Company's control, to terminate that contract.
The insurance liabilities set forth above represent the Company's best
estimates of the probable liabilities based on independent actuarial estimates.
The recoverable amounts under the finite risk contracts, which are considered
probable of realization based on independent actuarial estimates of losses and
pay-out patterns, represent the excess of such liabilities over the Company's
retention levels. The premium adjustment represents the recoverable amount
considered probable of realization at the earliest date the Company can
exercise its right to terminate the finite risk contract covering the insurance
underwriting subsidiaries currently in run-off.
Changes in the total net liabilities of discontinued operations are as
follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
---------------------
1995 1994 1993
----- ------ ------
<S> <C> <C> <C>
Beginning balance.................................. $63.8 $113.5 $102.4
Provisions for loss................................ -- 28.9 --
Litigation settlement.............................. -- -- 22.3
Net cash proceeds on the zero coupon notes......... -- 5.0 --
Claims and expense payments........................ (7.3) (7.0) (11.9)
Payment for a finite risk contract................. -- (80.0) --
Net capital infusion............................... (3.0) -- --
Tax settlement..................................... (5.8) -- --
Other.............................................. -- 3.4 --
Translation adjustment............................. -- -- 0.7
----- ------ ------
Ending balance................................... $47.7 $ 63.8 $113.5
===== ====== ======
</TABLE>
The 1994 provision for loss of $28.9 million includes a $6 million charge
associated with the 1994 finite risk contract, a $20.9 million charge relating
to an agreement that resolved certain indemnity obligations to Sphere Drake and
a $2 million charge recorded in the fourth quarter of 1994 related to other
liabilities. Under terms of the Sphere Drake agreement, the Company received a
cash payment of $5 million in settlement of the zero coupon notes receivable
and related indemnities as well as certain income tax liabilities.
While the insurance liabilities set forth above represent the Company's best
estimate of the probable liabilities within a range of independent actuarial
estimates of reasonably probable loss amounts, there is no assurance that
further adverse development may not occur due to variables inherent in the
estimation processes and other matters described above. Based on independent
actuarial estimates of a range of reasonably possible
19
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
loss amounts, liabilities could exceed recorded amounts by approximately $170
million. However, in the event of such adverse development, based on
independent actuarial estimates of pay-out patterns, up to approximately $130
million of this excess would be recoverable under the finite risk contracts.
The Company believes that, based on current estimates, the established total
net liabilities of discontinued operations are sufficient to cover its
exposures.
7. EMPLOYEES' RETIREMENT PLANS AND BENEFITS
Pension Plans
The Company has contributory and non-contributory defined benefit pension
plans covering substantially all employees. The plans generally provide pension
benefits that are based on the employee's years of service and compensation
prior to retirement. In general, it is the Company's policy to fund these plans
consistent with the laws and regulations of the respective jurisdictions in
which the Company operates.
Total pension costs are summarized as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
-----------------------
1995 1994 1993
------- ------ ------
<S> <C> <C> <C>
Service cost..................................... $ 23.8 $ 38.8 $ 29.5
Interest cost.................................... 46.2 43.4 38.4
Actual return on plan assets..................... (127.9) 22.7 (73.4)
Net amortization and deferral.................... 55.8 (99.7) 7.4
------- ------ ------
Net pension costs (credit)..................... $ (2.1) $ 5.2 $ 1.9
======= ====== ======
</TABLE>
During the first quarter of 1995, the Company realized a pension curtailment
gain of $4.4 million due to the sale of Alexsis Inc. (see Note 2 of Notes to
Financial Statements).
The following table sets forth the funded status and amounts recognized in
the Company's Consolidated Balance Sheets:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------------------------
1995 1994
------------------ ------------------
U.S. INT'L U.S. INT'L
------- --------- ------- ---------
<S> <C> <C> <C> <C>
Vested benefit obligation........ $ 289.5 $ 277.1 $ 199.1 $ 247.1
======= ========= ======= =========
Accumulated benefit obligation... $ 299.6 $ 278.5 $ 223.3 $ 248.7
======= ========= ======= =========
Projected benefit obligation..... $(351.8) $ (298.9) $(271.6) $ (270.3)
Plan assets at fair market value. 344.5 427.1 289.3 383.7
------- --------- ------- ---------
Excess (shortfall) of plan assets
over projected benefit obliga-
tion............................ (7.3) 128.2 17.7 113.4
Unrecognized net loss (gain)..... 18.2 (33.5) (5.5) (26.8)
Unrecognized prior service cost.. 0.1 (6.2) (1.3) (6.6)
Unrecognized net assets being am-
ortized over the plans' average
remaining service lives......... (11.6) (26.9) (14.0) (29.4)
------- --------- ------- ---------
Prepaid (accrued) pension cost... $ (0.6) $ 61.6 $ (3.1) $ 50.6
======= ========= ======= =========
Assumptions used were as follows:
Assumed discount rate............ 7.0% 6.0-9.0% 8.5% 6.5-9.5%
Assumed rate of compensation in-
crease.......................... 4.5% 3.5-5.0% 5.0% 3.5-5.0%
Expected rate of return on plan
assets.......................... 9.75% 7.0-10.75% 9.75% 7.0-10.25%
</TABLE>
20
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
At December 31, 1995 and 1994, approximately 75 percent and 76 percent,
respectively, of all plan assets are invested in equity securities and 25
percent and 24 percent, respectively, in cash equivalents and/or fixed-income
securities.
Thrift Plans
The Company maintains thrift plans for most U.S. and Canadian employees.
Under the thrift plans, eligible employees may contribute amounts through
payroll deduction, supplemented by Company contributions, for investments in
various funds established by the plans. The cost of these plans was $9.1
million in 1995, $11.9 million in 1994 and $11.3 million in 1993.
Postretirement Benefits
The Company adopted SFAS No. 106, "Employers' Accounting for Postretirement
Benefits Other Than Pensions," effective January 1, 1993 for its U.S. plans
and effective January 1, 1995 for its international plans. This statement
requires the Company to accrue the estimated cost of future retiree benefit
payments during the years the employee provides services. The Company
previously expensed the cost of these benefits, which are principally health
care and life insurance, as premiums or claims were paid. The statement
allowed recognition of the cumulative effect of the liability in the year of
the adoption or the amortization of the obligation over a period of up to
twenty years. The Company elected to recognize the initial postretirement
benefit obligation of $14 million and $5.9 million for its U.S. plans and
international plans, respectively, over a period of twenty years.
Total postretirement benefit costs are summarized as follows:
<TABLE>
<CAPTION>
FOR THE YEARS
ENDED DECEMBER
31,
-----------------
1995 1994
------------ ----
U.S. INT'L U.S.
----- ----- ----
<S> <C> <C> <C>
Service cost........................................... $ 0.5 $0.3 $0.8
Interest cost.......................................... 1.5 0.6 1.5
Actual return on plan assets........................... (0.6) -- 0.2
Net amortization and deferral.......................... 1.0 0.3 0.6
----- ---- ----
Net postretirement costs............................. $ 2.4 $1.2 $3.1
===== ==== ====
</TABLE>
21
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
The following table sets forth the funded status and amounts recognized in
the Company's consolidated financial statements:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
--------------------------------
1995 1994
--------------------- ---------
U.S. INT'L U.S.
-------- ----------- ---------
<S> <C> <C> <C>
Accumulated postretirement benefit ob-
ligation:
Retirees............................. $ (14.0) $ (2.9) $ (11.0)
Fully eligible active participants... (1.9) (1.0) (3.1)
Other active participants............ (5.3) (2.8) (5.4)
-------- ----------- ---------
(21.2) (6.7) (19.5)
Plan assets at fair market value....... 5.8 -- 5.4
-------- ----------- ---------
Accumulated benefit obligation in
excess of plan assets................. (15.4) (6.7) (14.1)
Unrecognized net obligation............ 8.7 5.7 11.7
Unrecognized net loss.................. 2.8 0.2 1.9
-------- ----------- ---------
Accrued postretirement benefit liabili-
ty.................................... $ (3.9) $ (0.8) $ (0.5)
======== =========== =========
Assumptions used were as follows:
Assumed discount rate.................. 7.0% 8.5-9.0% 8.5%
Assumed rate of compensation increase.. 4.5% 4.0-5.0% 4.5%
Expected rate of return on plan assets. 5.75% -- 5.75%
Assumed medical trend rate-1996 and af-
ter................................... 9 to 5.5% 11.5 to 7.5% 10 to 5.5%
The amount of a 1% increase in assumed
trend rate on:
Aggregate of service and interest
cost............................... $ 0.2 $ 0.2 $ 0.2
Accumulated postretirement benefit
obligation......................... 1.2 0.9 1.2
======== =========== =========
</TABLE>
During the first quarter of 1995, the Company incurred a postretirement
curtailment loss of $2.8 million due to the sale of Alexsis Inc.
Postemployment Benefits
Effective January 1, 1994, the Company adopted SFAS No. 112, "Employers
Accounting for Postemployment Benefits." This statement requires that certain
benefits provided to former or inactive employees after employment but prior
to retirement, including disability benefits and health care continuation
coverage, be accrued based upon the employees' services already rendered. The
cumulative effect of this accounting change was an after-tax charge of $2.6
million or $0.06 per share in the first quarter of 1994.
Deferred Compensation Plan
The Company has a deferred compensation plan which permitted certain of its
key officers and employees to defer a portion of their incentive compensation
during 1986 to 1989. The Company has purchased whole life insurance policies
on each participant's life to assist in the funding of the deferred
compensation liability. At December 31, 1995, the cash surrender value of
these policies was $0.6 million, which is net of $44.9 million of policy
loans. The Company's obligation under the plan, including accumulated
interest, was $16 million and $16.2 million at December 31, 1995 and 1994,
respectively, and is included in Other Long-Term Liabilities in the
Consolidated Balance Sheets.
22
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
8. DEBT
Consolidated short-term debt outstanding is as follows:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
-------------------
1995 1994
--------- ---------
<S> <C> <C>
Lines of credit........................................ $ 0.1 $0.7
Notes payable (A)...................................... 19.0 0.3
--------- --------
$19.1 $1.0
========= ========
</TABLE>
The weighted average interest rate on short-term borrowings was 6.5 percent
and 7.0 percent at December 31, 1995 and 1994, respectively.
Consolidated long-term debt outstanding is as follows:
<TABLE>
<CAPTION>
AS
OF DECEMBER 31,
-----------------
1995 1994
-------- -------
<S> <C> <C>
11% Convertible subordinated debentures (B)............ $ -- $ 60.2
Notes payable (C)...................................... 77.5 50.0
Obligations under capital leases (D)................... 24.2 22.1
Term loans (E)......................................... -- 10.0
Credit agreement (F)................................... 30.0 --
Other.................................................. 3.8 7.5
-------- -------
135.5 149.8
Less current portion................................... (9.3) (17.1)
-------- -------
$ 126.2 $ 132.7
======== =======
</TABLE>
The principal payments required during the next five years are $9.3 million
in 1996, $18 million in 1997, $47.8 million in 1998, $17.4 million in 1999, and
$15.9 million in 2000.
A. Current Notes Payable
In connection with the JIB acquisition on October 12, 1995, the Company
issued two 6.375% promissory notes totaling $21.2 million with payments of
$10.6 million due on April 9 and October 12, 1996, respectively. During the
fourth quarter of 1995, the October promissory note was revalued to $8.1
million in accordance with the revenue retention criteria for the former JIB
offices stipulated in the purchase agreement. (See Note 2 of Notes to Financial
Statements.)
B. 11% Convertible Subordinated Debentures
On October 13, 1995, the Company redeemed all $60.2 million of its
outstanding 11% Convertible Subordinated Debentures due 2007 together with
accrued interest and a $0.9 million redemption premium. This redemption was
primarily funded by the Company through the borrowing of $60 million under its
revolving long-term credit facility. (See Item F.)
C. Notes Payable
As a result of the Mutual Fire settlement as described in Note 14 of Notes to
Financial Statements, the Company issued a $35 million zero coupon note in
March 1995. Using a discount rate of 9.3%, the present value of the note was
recorded as a $25.9 million long-term debt obligation. The note is payable in
six annual installments, commencing April 1, 1996. The carrying value of the
outstanding principal balance, including imputed interest, of the note payable
at December 31, 1995 was $27.5 million.
23
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
In January 1995, the Company negotiated the settlement of certain obligations
relating to the 1987 sale of Shand. Under the terms of the settlement, the
Company paid $14 million in cash, issued a five year interest bearing note in
the principal amount of $14 million, which was pre-paid in June 1995, and paid
a net contingent obligation of $4.5 million.
In July 1994, the Company borrowed $50 million from the reinsurance company
that executed a finite risk contract relating to the Company's discontinued
operations. The note is payable in five equal annual installments, commencing
July 1, 1997, and bears interest at a rate of 9.45 percent. If the Company
defaults on the borrowing, the reinsurance company may utilize the note to
settle reinsurance claims under the finite risk contract.
D. Obligations Under Capital Leases
The Company's obligations under capital leases consists primarily of lease
agreements for office facilities. Future minimum lease payment obligations are
approximately $2.7 million for each of the next five years and an aggregate of
$24.2 million thereafter.
E. Term Loans
In March 1995, a U.S. subsidiary prepaid an unsecured $10 million term loan
with a bank which was due August 1995.
F. Credit Agreement
On March 27, 1995, the Company's then existing credit agreement was replaced
by a new $200 million three-year facility with various banks which expires in
March 1998. The agreement provides for unsecured borrowings and for the
issuance of up to $100 million of letters of credit, and contains various
covenants, including minimum consolidated tangible net worth, maximum leverage
and minimum cash flow requirements. The Company currently believes that the
covenant regarding minimum cash flow coverage is the most restrictive. The
covenant requires that the Company's ratio of profits before taxes, interest
expense and depreciation and amortization to interest expense and cash
dividends exceed 4.25 at all times. The Company's ratio was 6.85 at December
31, 1995. In addition, the occurrence of a "Special Event" under the terms of
the Series B convertible preferred stock purchase agreement, which, if not
waived, would constitute an event of default under the new agreement. (See Note
10 of Notes to Financial Statements.) Interest rates charged on amounts drawn
on this credit agreement are dependent upon the Company's credit ratings, the
duration of the borrowings and the Company's choice of one of a number of
published rates, including the prime lending rate, certificate of deposit
rates, the federal funds rate and LIBOR.
During the second quarter of 1995, the Company arranged a $10 million letter
of credit under the agreement. On October 13, 1995, the Company borrowed $60
million under the agreement to fund the redemption of its outstanding 11%
Convertible Subordinated Debentures due 2007. In December 1995, the Company
repaid $30 million of its long-term revolving credit agreement borrowings. The
interest rate on the remaining $30 million is 6.3125 percent as of December 31,
1995. The Company borrowed $10 million under this agreement in January 1996 and
an additional $20 million in February 1996.
Supplementing the credit agreement, the Company has unsecured lines of credit
available for general corporate purposes totaling $87.9 million of which $87.8
million were unused as of December 31, 1995. These lines consist of uncommitted
facilities principally in the U.K. and Canada. If drawn, the lines bear
interest at market rates and carry annual fees of not greater than 1/2 percent
of the line.
24
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
9. STOCK OPTION AND INCENTIVE PLANS
Long-Term Incentive Awards
The Company's 1995 Long-Term Incentive Plan (1995 LTIP) was approved by
stockholders at the 1995 annual meeting of stockholders and became effective on
May 18, 1995. The 1995 LTIP includes grants in the form of non-qualified stock
options and incentive stock options, stock appreciation rights, restricted
stock awards, bonus equity awards, performance share/unit awards and other
stock based awards.
As of the effective date of the 1995 LTIP, the Company had awards outstanding
under the 1988 Long-Term Incentive Compensation Plan (1988 Plan) and under the
1982 Employee Stock Option Plan (1982 Plan). Awards outstanding under the 1988
Plan include stock options, stock appreciation rights and restricted stock.
Only stock option awards are outstanding under the 1982 Plan. At December 31,
1995, 4,226,067 shares of common stock were available for issuance. This amount
includes 538,761 shares available under the 1988 Plan.
Stock options may be granted at a price not less than the fair market value
of the Common Stock on the date the option is granted and, with respect to
incentive stock options, must be exercised not later than 10 years from date of
grant and, with respect to non-qualified options, must be exercised not later
than 10 years and one day from date of grant. The 1995 LTIP also provides for
replacement options for a limited number of key executives. In December 1995,
the Company exchanged 1,358,300 stock options ranging in a per-share exercise
price of $24.50 to $23.13 for stock options having an exercise price of $19.63.
The Company will adopt SFAS No. 123, "Accounting for Stock Based
Compensation," in December 1996. The Company has elected to continue to measure
compensation costs using APB Opinion No. 25 and accordingly will provide the
disclosures required by SFAS No 123.
Stock option transactions were as follows:
<TABLE>
<CAPTION>
NUMBER OPTION PRICE
OF PER SHARE
SHARES RANGE
---------- -------------
<S> <C> <C>
Outstanding,
January 1, 1993................................ 2,925,055 $17.75-$38.63
Granted....................................... 488,500 26.00- 27.63
Exercised..................................... (93,948) 17.75- 25.38
Canceled...................................... (188,307)
---------- -------------
Outstanding,
December 31, 1993.............................. 3,131,300 $17.75-$38.63
Granted....................................... 2,361,500 14.19- 20.63
Exercised..................................... (5,375) 17.75
Canceled...................................... (503,320)
---------- -------------
Outstanding,
December 31, 1994.............................. 4,984,105 $14.19-$38.63
Granted....................................... 3,006,100 19.63- 25.63
Exercised..................................... (7,685) 17.75- 23.13
Canceled...................................... (1,841,136)
---------- -------------
Outstanding,
December 31, 1995.............................. 6,141,384 $14.19-$38.63
========== =============
</TABLE>
25
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
The number of options exercisable at December 31 were as follows:
<TABLE>
<S> <C>
1995........................... 2,592,525
1994........................... 2,197,405
1993........................... 2,231,301
</TABLE>
Stock appreciation rights may be granted alone or in conjunction with a stock
option at a price not less than the fair market value of the Common Stock at
date of grant. Upon exercise of a stock appreciation right, the participant
will receive cash, Common Stock or a combination thereof equal to the excess of
the market value over the exercise price of the stock appreciation right.
Exercise of either the right or the stock option will result in the surrender
of the other.
Restricted stock awards may be granted which limit the sale or transfer of
the shares until the expiration of a specified time period. With certain
specified exceptions, such awards are subject to forfeiture if the participant
does not remain in the employ of the Company until the end of the restricted
time period. A maximum of 940,000 shares may be issued under the 1995 LTIP.
There were 202,798 shares, 308,500 shares, and 60,000 shares of restricted
stock, excluding BEP Awards (described below), issued in 1995, 1994 and 1993,
respectively. In addition to awards made under the 1988 Plan in 1994, 271,307
shares of restricted stock were awarded to an executive officer to offset the
loss of certain benefits from the executive's prior employer when the executive
joined the Company.
Bonus equity program awards (BEP Awards) may be granted based on a percentage
of the cash incentive compensation otherwise payable to a participant under any
compensation program of the Company. The size of the BEP Award is determined by
formula. The number of shares of Common Stock is determined by dividing the
dollar amount designated for the award by the fair market value (based on a
five-day average of the Common Stock closing price) discounted by up to 25
percent. Shares subject to the BEP Award are restricted as to transfer
(generally for a period of up to three years) and are subject to forfeiture
should the participant terminate employment for reasons other than death,
disability or retirement during the restricted period. No BEP Awards were
granted in 1995, 1994 and 1993.
Performance share/unit awards may be granted based upon specified performance
criteria. Upon achievement of the performance share/unit criteria, the
participant will receive cash, Common Stock or a combination thereof equal to
the award. There were no performance share/unit awards made in 1995 or 1993 and
23,000 awards were made in 1994.
Performance Bonus Plan for Executive Officers.
The Company's Performance Bonus Plan for Executive Officers (Performance
Bonus Plan) was approved by stockholders at the 1995 annual meeting of
stockholders and became effective as of January 1, 1995.
The Performance Bonus Plan establishes certain performance criteria for
determining the maximum amount of bonus compensation, including BEP Awards, for
those executive officers who, on the last day of the Company's taxable year,
consist of the chief executive officer and the four most highly compensated
executive officers and whose compensation is deductible in the U.S. (Covered
Employees). The Performance Bonus Plan is designed to comply with Section
162(m) of the Internal Revenue Code of 1986, which is effective for the tax
year commencing 1995, and which limits the tax deductibility by the Company of
annual compensation paid to Covered Employees in excess of $1 million, except
to the extent such compensation is paid pursuant to the performance criteria
established by the Performance Bonus Plan. For 1995, the compensation paid to
the one Covered Employee eligible under the Performance Bonus Plan, should be
fully deductible to the Company.
26
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Employee Discount Stock Purchase Plan
The Company's 1995 Employee Discount Stock Purchase Plan (Employee Purchase
Plan) was approved by stockholders at the 1995 annual meeting of stockholders
and became effective as of July 1, 1995. Eligible U.S. employees may purchase
up to an aggregate of 750,000 shares of the Company's Common Stock, at a price
equal to the lower of the closing price of the Common Stock reported on the New
York Stock Exchange at the beginning or end of the offering period, discounted
by up to 15 percent.
Shares purchased are limited to the number of shares that can be purchased by
the aggregate amount deducted from the participant's salary during a 6-month
purchase period. Shares of Common Stock purchased under the Employee Purchase
Plan must remain in an employee's account for one year after the purchase date.
As of December 31, 1995, 81,994 shares of Common Stock were issued under the
1995 Employee Purchase Plan, at a weighted average price of $16.15 per share.
At December 31, 1995, there were 668,006 shares available for issuance under
the Employee Purchase Plan.
In January 1996, the Company commenced offering to eligible employees outside
the U.S., the opportunity to participate in an international employee discount
stock purchase plan (Plan). At the end of the 5-year offering period,
participants can elect to purchase from the contributions saved, shares of the
Company's Common Stock at a 15 percent discount of the closing price of the
Common Stock reported on the New York Stock Exchange on the first date of the
5-year offering period. Non-U.S. employees who are "executive officers" of the
Company, as that term is defined pursuant to Section 16 of the Securities
Exchange Act of 1934, participate in a subplan of the Employee Purchase Plan on
terms similar to the Plan.
Non-Employee Director Deferred Stock Ownership Plan
The Company's Non-Employee Director Deferred Stock Ownership Plan ("NEDD
Plan") was approved by stockholders at the 1995 annual meeting of stockholders
and became effective as of January 1, 1995.
Under the NEDD Plan each non-employee director of the Company is entitled to
a single annual fee or retainer (Annual Fee) for all services as a director
during the period from one annual meeting of stockholders to the next. The
Annual Fee is currently set at $40,000 per year. Under the NEDD Plan, in lieu
of payment of the Annual Fee, the Company will generally contribute shares of
Common Stock to a grantor trust established by the Company (Company Trust)
equal to that portion of the Annual Fee then payable. Under the NEDD Plan,
shares of Common Stock delivered to the grantor trust may not be sold for a
period of one year from the date of grant or earlier in the event of a change
of control.
Approximately 160,000 shares of Common Stock are authorized for issuance
under the NEDD Plan which will expire on December 31, 2005. As of December 31,
1995, 50,103 shares were delivered to the Company's trust under the NEDD Plan.
Of that number 24,285 shares were delivered in connection with the termination
of the Non-Employee Director Retirement Plan. During 1994, 140,000 shares of
Common Stock were also delivered to the Company Trust to fund a special
compensation award to a non-employee director.
10. COMMON AND PREFERRED STOCK
Authorized Capital Stock
The Company has authorized capital stock of 292 million shares of five
classes of stock consisting of 200 million shares of Common Stock, par value
$1.00 (Common Stock); 26 million shares of Class A Common Stock, par value
$.00001 (Class A Stock); 11 million shares of Class C Common Stock, $1.00 par
value (Class C Stock); 40 million shares of Class D Common Stock, $1.00 par
value (Class D Stock) and 15 million shares of Preferred Stock, $1.00 par value
(Preferred Stock).
27
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Of the 15 million shares of Preferred Stock authorized, the Board of
Directors in March 1993 designated 2.3 million shares as $3.625 Series A
Convertible Preferred Stock, $1.00 par value (Series A Convertible Preferred
Stock), and in July 1994 designated (i) 6.2 million shares as 8% Series B
Cumulative Convertible Preferred Stock, $1.00 par value (Series B Convertible
Preferred Stock) and (ii) 1 million shares as Series A Junior Participating
Preferred Stock, $1.00 par value (Junior Participating Preferred Stock).
At December 31, 1995, the Company had 10.4 million shares of Common Stock
reserved for issuance under its employee stock incentive plans; 2.3 million
shares reserved for issuance upon the conversion or redemption of Class A
Stock, the Class C Stock, the Class D Stock and the Series A Convertible
Preferred Stock; and 13.2 million shares of Class D Stock reserved for issuance
in connection with the conversion of the Series B Convertible Preferred Stock.
Common Stock Classes
Each holder of the Common Stock, Class A Stock and Class C Stock is entitled
to one vote for each share held on all matters voted upon by the stockholders
of the Company, including the election of directors. In certain instances,
however, holders of the Class A and Class C Stock vote as a group. Holders of
the Class D Stock are not entitled to vote, except that the Company's Charter
cannot be amended so as to adversely affect the holders of the Class D Stock
without the approval of the holders of two-thirds of such shares then
outstanding. The Common Stock, Class A Stock, Class C Stock and Class D Stock
do not have pre-emptive or conversion rights or cumulative voting rights for
the election of directors and there are no redemption or sinking fund
provisions applicable thereto.
Subject to the provisions of Maryland law, dividends on the Common Stock and
the Class D Stock (when and if issued) may be declared and paid by the Board of
Directors. Neither the Class A Stock nor the Class C Stock have dividend
rights; however, associated with each share of Class A Stock is a dividend
paying share (RSC Class 1 Share) issued by Reed Stenhouse Companies Limited, a
Canadian subsidiary of the Company, and associated with each share of Class C
Stock is a dividend paying share (UK Dividend Share) issued by Alexander &
Alexander Services UK plc, a U.K. subsidiary of the Company. No dividends may
be declared or paid on the Common Stock, unless an equivalent amount per share
is declared and paid on the RSC Class 1 Shares and the UK Dividend Shares.
Accordingly, the Company's ability to pay dividends is limited by the amounts
available to the Canadian and U.K. subsidiaries for such purposes. At December
31, 1995, these amounts approximate Canadian $96.5 million or $70.9 million,
assuming certain solvency tests are met under Canadian law, and 127 million
U.K. pounds sterling or $196.6 million. In the event sufficient earnings are
not available in the Canadian or U.K. subsidiary to pay dividends the Company's
legal structure allows it to make earnings or capital available in those
subsidiaries to pay dividends.
Holders of the Common Stock, Class C Stock and Class D Stock are entitled to
receive, upon liquidation of the Company, all remaining assets available for
distribution to stockholders after satisfaction of the Company's liabilities
and the preferential rights of any Preferred Stock which may then be
outstanding. Holders of the Class A Stock are not entitled to receive any
dividends or liquidating or other distributions with respect to such shares
from the Company, but are entitled to receive in respect of their associated
RSC Class 1 Shares an amount in Canadian dollars equivalent to the U.S. dollar
amount to be paid on the Common Stock.
The Class C Stock shares are convertible at any time into, and shares of RSC
Class 1 Shares are exchangeable at any time (and the Class A Stock is
concurrently redeemable), for fully paid, non-assessable shares of Common Stock
on the basis of one share of Common Stock for each share of Class C Stock or
RSC Class 1 Share (subject to adjustment). In addition, upon the happening of
certain events, the Company can require such conversion. Shares of the Series B
Convertible Preferred Stock are convertible into Class D Stock, at a
28
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
conversion price of $17 per share (subject to adjustment). The Class D Stock
may be exchanged for Common Stock at anytime on a share-for-share basis,
provided, however, that no person is entitled to acquire Common Stock upon
such exchange if after giving effect thereto such person has more than 9.9
percent of the combined voting power of the common stock voting shares then
outstanding, absent certain events. The Common Stock, Class A Stock, Class C
Stock and Class D Stock have customary anti-dilution provisions.
Preferred Stock Series and Related Rights
The Company has one class of Preferred Stock which can be issued in one or
more series with full or limited voting rights, with the rights of each series
to be determined by the Board of Directors before each issuance.
Series A Convertible Preferred Stock
Holders of the Series A Convertible Preferred Stock are entitled to receive
cumulative cash dividends at an annual rate of $3.625 per share, payable
quarterly in arrears. The shares are convertible into Common Stock at a
conversion price of $31.875 per share (subject to adjustments). The Series A
Convertible Preferred Stock may be redeemed by the Company on or after March
22, 1997, at $52.18 per share until March 14, 1998, and declining ratably
annually to $50 per share on or after March 15, 2003, plus accrued and unpaid
dividends. The Series A Convertible Preferred Stock is non-voting, except as
provided by law, and except that, among other things, holders will be entitled
to vote as a separate class with other series of outstanding Preferred Stock
to elect a maximum of two directors if the equivalent of six or more quarterly
dividends of the Series A Convertible Stock is in arrears. With respect to
dividend rights and rights of liquidation, dissolution and winding up, the
Series A Convertible Preferred Stock ranks senior to all classes of common
capital stock and to the Junior Participating Preferred Stock (when and if
issued) and pari passu to the Series B Convertible Preferred Stock. The
liquidation preference for the Series A Convertible Preferred Stock is $50 per
share.
Series B Convertible Preferred Stock
Holders of the Series B Convertible Preferred Stock are entitled to receive
dividends at a rate of 8% per annum payable quarterly in arrears. Until
December 15, 1996, dividends on the Series B Convertible Preferred Stock are
payable in kind and thereafter, at the discretion of the Company's Board of
Directors, in cash or in kind until December 15, 1999, provided that if the
Company at any time pays dividends in cash on or after December 15, 1996, the
Company may not thereafter declare or pay dividends in kind. The Series B
Convertible Preferred Stock has the same dividend rights, voting rights and
rights of liquidation, dissolution and winding up as the Series A Convertible
Preferred Stock. In addition, however, following the occurrence of a Specified
Corporate Action (as defined in the Company's Charter) holders of the Series B
Convertible Preferred Stock also have the right to vote as a class with the
holders of the Common Stock and the Class D Stock on all matters as to which
the holders of Common Stock are entitled to vote. A Specified Corporate Action
is defined generally as an action by the Company that would permit a change in
control and certain related events. For the purposes of such vote, the holders
of the Series B Convertible Preferred Stock will be deemed holders of that
number of shares of Class D Stock into which such shares would then be
convertible.
The Series B Convertible Preferred Stock may be redeemed in whole or in part
by the Company after December 15, 1999, so long as after that date the Common
Stock has traded 30 consecutive trading days on the New York Stock Exchange at
a price in excess of 150 percent of the then effective conversion price. The
redemption price is $54 per share until December 14, 2000, declining ratably
annually to $50 per share on or after December 14, 2006, plus accrued and
unpaid dividends. All redemptions are to be made pro-rata.
29
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Holders of Series B Convertible Preferred Stock have the right to require the
Company to purchase all or any part of the Series B Convertible Preferred Stock
then held by such holders upon the occurrence of a Special Event. A Special
Event consists of actions solely within the control of the Company and includes
the declaration or payments of dividends aggregating in excess of cumulatively
25 percent of earnings in 1996, and cumulatively 50 percent of earnings
thereafter; the disposition by the Company of assets representing 35 percent or
more of the Company's book value or gross revenues; certain mergers or
consolidations of the Company or any of its principal subsidiaries with or into
any other firm or entity involving 20 percent or more of the total market value
of the Company's equity securities; and repurchases and redemptions of the
Company's securities (other than the Company's Series B Convertible Preferred
Stock) in excess of net proceeds to the Company from the sale of stock (less
amounts expended for repurchases and redemptions of the Company's preferred
shares). Other Special Events include the acquisition by a third party, with
the consent or approval of the Company, of beneficial ownership of securities
representing 35 percent or more of the Company's total outstanding voting
power. The repurchase price in the event of a Special Event is $72.06 per
share, plus in each case accrued and unpaid dividends.
Junior Participating Preferred Stock and Related Rights.
The Company has a Shareholder Rights Plan (the "Rights Plan") designed to
deter coercive takeover tactics and to prevent an acquirer from gaining control
of the Company without offering a fair price to all stockholders.
Under the terms of the Rights Plan, adopted in July 1987 and as amended, one
preferred share purchase right (a "Right") accompanies each share of
outstanding Common Stock, Class A Stock, Class C Stock and Class D Stock. Each
Right entitles the holder thereof to purchase one one-hundredth of a share of
Junior Participating Preferred Stock.
The Rights become exercisable only following the public announcement by the
Company that a person or group (i) has acquired beneficial ownership of 20
percent or more of the Company's voting shares or (ii) has commenced a tender
or exchange offer that if consummated would result in the ownership of 20
percent or more of such voting shares. Under such circumstances, if the Rights
become exercisable, each holder will be entitled to purchase at the then-
current exercise price, that number of Junior Participating Preferred Stock
equal to twice the exercise price of the Right. If the Company is subsequently
acquired, each right will entitle the holder to purchase at the then-current
exercise price, stock of the surviving company having a market value of twice
the exercise price of one Right. In addition, if a person or group acquires
more than 20 percent, but less than 50 percent, of the Company's common voting
shares, the Board of Directors may exchange each Right for one one-hundredth of
a share of Junior Participating Preferred Stock. Rights beneficially owned by a
holder of 20 percent or more of the voting shares become void once such holder
passes the 20 percent threshold. The Rights, which expire on July 6, 1997, are
redeemable by the Board of Directors prior to becoming exercisable at a
redemption price of $.01 per Right.
In June 1994, the Board of Directors amended the Rights Plan so that the
initial acquisition of the Series B Convertible Preferred Shares, the
acquisition of the Class D Stock upon conversion of the Series B Convertible
Preferred Stock, the acquisition of Common Stock upon exchange of the Class D
Stock, or permitted acquisitions by the purchaser, its affiliates or any
transferee thereof of the Company's securities will not cause the Rights to
become exercisable. In addition, on November 16, 1995, the Rights Plan was
amended to provide for modifications of the definitions of Acquiring Person and
Distribution Date to raise from 15 percent to 20 percent the percentage of
stock ownership needed to cause a person to become an Acquiring Person or to
cause a Distribution Date to occur (as such capitalized terms are defined in
the Rights Agreement).
Each share of Junior Participating Preferred Stock will be entitled to a
minimum preferential quarterly dividend payment of $10 per share but will be
entitled to an aggregate dividend of 100 times the dividend declared per share
of Common Stock. In the event of liquidation, the holders of the Junior
Participating Preferred
30
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Stock will be entitled to a minimum preferential liquidation payment of $100
per share but will be entitled to an aggregate payment of 100 times the payment
made per share of Common Stock. Each share of Junior Participating Preferred
Stock will have 100 votes, voting together with the Company's common voting
shares. In the event of any merger, consolidation or other transaction in which
voting shares are exchanged, each share of Junior Participating Preferred Stock
will be entitled to receive 100 times the amount received per share of Common
Stock. The Junior Participating Preferred Stock shares have customary anti-
dilution provisions. Because of the nature of the dividend, liquidation and
voting rights of the Junior Participating Preferred Stock, the value of the one
one-hundredth interest in a share of Junior Participating Preferred Stock
purchasable upon exercise of each Right should approximate the value of one
share of Common Stock. Shares of Junior Participating Preferred Stock
purchasable upon exercise of the Rights will not be redeemable.
Dividends and Distributions
Under Maryland General Corporation Law, the Board of Directors of the Company
may not declare or pay dividends to holders of any class of the Company's
capital stock if, after giving effect to such distribution, (1) the Company
would be unable to pay its debts as they become due in the usual course; or (2)
the Company's total assets would be less than the sum of its liabilities plus
the dissolution preference of the holders of any class or series of preferred
stock issued and outstanding. In determining whether a distribution by the
Company (other than upon voluntary or involuntary liquidation), by dividend,
redemption or other acquisition of shares or otherwise, is permitted pursuant
to the balance sheet solvency test under the Maryland General Corporation Law,
the aggregate liquidation preference of the Series B Convertible Preferred
Shares will not be counted as a liability. The Series B Convertible Preferred
Shares have a liquidation preference of $50 per share.
11. INVESTMENTS
Effective January 1, 1994, the Company adopted SFAS No. 115, "Accounting for
Certain Investments in Debt and Equity Securities." In accordance with the
Statement, the Company has classified all debt and equity securities as
available for sale. The net unrealized holding gains totaled $5.6 million and
$1.5 million, net of deferred income taxes of $2 million and $0.2 million, and
are reported as a separate component of Stockholders' Equity for December 31,
1995 and 1994, respectively. Net unrealized holding gains increased $4.1
million and decreased $2 million during 1995 and 1994, respectively.
At December 31, 1995 and 1994, the amortized cost and estimated fair value of
the Company's debt and equity securities and related financial instruments used
to hedge such investments are summarized below:
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1995
-----------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
U.S. Government agencies/state
issuances..................... $ 2.7 $-- $ -- $ 2.7
Other interest-bearing securi-
ties.......................... 138.1 -- -- 138.1
Mortgage-backed securities..... -- -- -- --
Equity securities.............. 3.1 6.5 -- 9.6
Financial instruments used as
hedges........................ -- 1.3 (0.2) 1.1
------ ---- ----- ------
Total........................ $143.9 $7.8 $(0.2) $151.5
====== ==== ===== ======
</TABLE>
31
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1994
-----------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
U.S. Government agencies/state
issuances..................... $ 63.5 $-- $(0.1) $ 63.4
Other interest-bearing securi-
ties.......................... 146.7 -- -- 146.7
Mortgage-backed securities..... 83.8 -- -- 83.8
Equity securities.............. 1.9 4.6 -- 6.5
Financial instruments used as
hedges........................ -- 0.3 (3.1) (2.8)
------ ---- ----- ------
Total........................ $295.9 $4.9 $(3.2) $297.6
====== ==== ===== ======
</TABLE>
The above debt and equity securities and financial instruments used as hedges
are classified in the Consolidated Balance Sheet at December 31, as follows:
<TABLE>
<CAPTION>
AS OF
DECEMBER 31,
-------------
1995 1994
------ ------
<S> <C> <C>
Cash and cash equivalents:
Operating................................................ $ 34.1 $ 63.9
Fiduciary................................................ 73.1 51.8
Short-term investments:
Operating................................................ 0.3 1.8
Fiduciary................................................ 18.8 117.9
Long-term operating investments............................ 25.2 62.2
------ ------
Total.................................................. $151.5 $297.6
====== ======
</TABLE>
At December 31, 1995 and 1994, the amortized cost and estimated fair value of
debt securities by contractual maturity are summarized below:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
---------------------------------------
1995 1994
------------------- -------------------
ESTIMATED ESTIMATED
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Due in one year or less.......... $120.8 $120.8 $152.7 $152.6
Due after one year through five
years........................... 4.8 4.8 46.7 46.7
Due after five years through ten
years........................... 10.2 10.2 0.7 0.7
Due after ten years.............. 5.0 5.0 10.1 10.1
------ ------ ------ ------
140.8 140.8 210.2 210.1
Mortgage-backed securities....... 0.0 0.0 83.8 83.8
------ ------ ------ ------
Total debt securities.......... $140.8 $140.8 $294.0 $293.9
====== ====== ====== ======
</TABLE>
Certain of the above investments with maturities greater than one year are
classified as short-term and included in current assets as they represent
fiduciary investments that will be utilized during the normal operating cycle
of the business to pay premiums payable to insurance companies that are
included in current liabilities.
12. FINANCIAL INSTRUMENTS
The Company enters into foreign exchange forward contracts and foreign
exchange option agreements primarily to provide risk management against
existing firm commitments as well as anticipated future exposures that will
arise at its London-based specialist insurance and reinsurance broking
operations. The exposures arise
32
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
because a significant portion of the revenues of these operations are
denominated in U.S. dollars, while their expenses are primarily denominated in
U.K. pounds sterling.
The Company generally sells forward U.S. dollars and purchases U.K. pounds
sterling for periods of up to two years in the future. Such contracts provide
risk management against future anticipated transactions which are not firm
commitments. In addition, the Company enters into foreign exchange contracts to
manage market risk associated with foreign exchange volatility on intercompany
loans and expected intercompany dividends. Finally, the Company enters into
foreign exchange contracts to effectively offset existing contracts when
anticipated exchange rate movements would benefit the Company.
Gains and losses on foreign exchange contracts are marked to market at each
balance sheet date and are included in other current assets or liabilities,
with the resulting gain or loss recorded as a component of other operating
expenses. The fair market value of all foreign exchange contracts at December
31, 1995, was a liability of $0.7 million.
Foreign exchange options written by the Company are marked to market at each
balance sheet date and the resulting gain or loss is recorded as a component of
other operating expenses. Future cash requirements may exist if the option is
exercised by the holder. At December 31, 1995, the Company had $20 million
notional principal of written foreign exchange options outstanding. Based on
foreign exchange rates at December 31, 1995, the Company recognized a current
liability of $0.6 million, consisting of unamortized premiums, representing the
estimated cost to settle these options at that date. At December 31, 1994, the
Company's foreign exchange options could have been exercised at a nominal cost
to the Company.
At December 31, 1995, the Company had $69.9 million notional principal of
forward exchange contracts outstanding, primarily to exchange U.S. dollars into
U.K. pounds sterling, and $16.3 million notional principal outstanding,
primarily to exchange U.K. pounds sterling into U.S. dollars.
The Company has entered into interest rate swaps and forward rate agreements,
which are accounted for as hedges, as a means to limit the earnings volatility
associated with changes in short-term interest rates on its existing and
anticipated fiduciary investments. These instruments are contractual agreements
between the Company and financial institutions which exchange fixed and
floating interest rate payments periodically over the life of the agreements
without exchanges of the underlying principal amounts. The notional principal
amounts of such agreements are used to measure the interest to be paid or
received and do not represent the amount of exposure to credit loss. The
Company records the difference between the fixed and floating rates of such
agreements as a component of its fiduciary investment income. Interest rate
swaps and forward rate agreements which relate to debt securities are marked to
market in accordance with SFAS No. 115. At December 31, 1995, an unrealized
gain of $1.1 million on interest rate swaps and forward rate agreements which
hedge existing fiduciary investments was reflected in fiduciary cash and
equivalents in the Consolidated Balance Sheet.
33
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
At December 31, 1995 and 1994, the Company has the following interest rate
swaps and forward rate agreements in effect, by year of final maturity:
AS OF DECEMBER 31, 1995
<TABLE>
<CAPTION>
NET WEIGHTED NET WEIGHTED
GROSS AVERAGE GROSS AVERAGE
RECEIVING INTEREST PAYING INTEREST
YEAR FIXED RATE FIXED RATE
---- --------- ------------ ------ ------------
<S> <C> <C> <C> <C>
1996........................... $390.3 7.38% $471.7 6.27%
1997........................... 203.2 6.68 40.0 5.90
1998........................... 182.9 7.08 -- --
------ ------
Total........................ $776.4 7.13% $511.7 6.24%
====== ==== ====== ====
AS OF DECEMBER 31, 1994
<CAPTION>
NET WEIGHTED NET WEIGHTED
GROSS AVERAGE GROSS AVERAGE
RECEIVING INTEREST PAYING INTEREST
YEAR FIXED RATE FIXED RATE
---- --------- ------------ ------ ------------
<S> <C> <C> <C> <C>
1995........................... $457.0 6.84% $257.0 6.83%
1996........................... 291.9 7.30 31.2 8.85
1997........................... 97.8 6.65 -- --
------ ------
Total........................ $846.7 6.98% $288.2 7.05%
====== ==== ====== ====
</TABLE>
The Company generally enters into interest rate swap agreements with a final
maturity of three years or less. The floating rate on these agreements is
generally based upon the six-month LIBOR rate on the relevant reset dates.
Forward rate agreements generally have a final maturity date that is less than
two years, and use six-month LIBOR as the floating rate index.
In addition, as part of its interest rate management program, the Company
utilizes various types of interest rate options, including caps, collars,
floors and interest rate guarantees. The Company generally writes covered
interest rate options under which the Company receives a fixed interest rate.
The options are marked to market at each balance sheet date, based on the
Company's estimated cost to settle the options. The estimated cost to settle
the options, less any premium deferred by the Company, is recognized as a
reduction to fiduciary investment income in the period when such changes in
market value occur. The Company recognized a current liability of $0.3 million
and $1.3 million, representing the estimated cost to settle these options at
December 31, 1995 and 1994, respectively. The estimated cost to settle these
agreements was determined by obtaining quotes from banks and other financial
institutions which make a market in these instruments.
34
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
At December 31, 1995 and 1994, the Company had the following written
interest rate option agreements outstanding, by year of final maturity:
AS OF DECEMBER 31, 1995
<TABLE>
<CAPTION>
NET WEIGHTED NET WEIGHTED
GROSS AVERAGE GROSS AVERAGE
RECEIVING INTEREST PAYING INTEREST
YEAR FIXED RATE FIXED RATE
---- --------- ------------ ------ ------------
<S> <C> <C> <C> <C>
1996........................... $43.2 5.41% $10.0 4.60%
1997........................... 15.5 8.50 -- --
1998........................... 10.0 8.50 -- --
----- -----
Total........................ $68.7 6.54% $10.0 4.60%
===== ==== ===== ====
AS OF DECEMBER 31, 1994
<CAPTION>
NET WEIGHTED NET WEIGHTED
GROSS AVERAGE GROSS AVERAGE
RECEIVING INTEREST PAYING INTEREST
YEAR FIXED RATE FIXED RATE
---- --------- ------------ ------ ------------
<S> <C> <C> <C> <C>
1995........................... $15.6 5.27% $ -- --
1996........................... 43.4 5.42 10.0 4.60%
----- -----
Total........................ $59.0 5.38% $10.0 4.60%
===== ==== ===== ====
</TABLE>
The above financial instruments are purchased from large international banks
and financial institutions with strong credit ratings. Credit limits are
established based on such credit ratings and are monitored on a regular basis.
Management does not anticipate incurring any losses due to non-performance by
these institutions. In addition, the Company monitors the market risk
associated with these agreements by using probability analyses, external
pricing systems and information from banks and brokers.
The following methods and assumptions were used in estimating the fair value
of each class of financial instrument. The fair values of short-term and long-
term investments were estimated based upon quoted market prices for the same
or similar instruments. The fair value of long-term debt, including the
current portion, was estimated on the basis of market prices for similar
issues at current interest rates for the applicable period. The fair value of
interest rate swaps and forward rate agreements was estimated by discounting
the future cash flows using rates currently available for agreements of
similar terms and maturities. The fair value of foreign exchange forward
contracts and foreign exchange option agreements was estimated based upon
year-end exchange rates. The fair value of interest rate options was estimated
based upon market quotes of the cost to settle these agreements. The carrying
amounts of the Company's other financial instruments approximate fair value
due to their short-term maturities.
The following table presents the carrying amounts and the estimated fair
value of the Company's financial instruments that are not marked to market.
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
---------------------------------------
1995 1994
------------------- -------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
-------- ---------- -------- ----------
<S> <C> <C> <C> <C>
Long-term debt, including current
portion......................... $135.6 $135.8 $149.8 $146.4
Interest rate swaps and forward
rate agreements................. -- 5.1 -- (5.4)
</TABLE>
35
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
13. COMMITMENTS
Lease Commitments
The Company leases property and equipment under noncancelable operating
lease agreements which expire at various dates.
Future minimum annual rentals under noncancelable operating leases,
excluding $18.6 million of future sublease rental income, which have been
translated at December 31, 1995 closing foreign exchange rates, are as
follows:
<TABLE>
<CAPTION>
OPERATING
LEASES
---------
<S> <C>
1996............................................................ $ 83.3
1997............................................................ 67.7
1998............................................................ 55.3
1999............................................................ 46.3
2000............................................................ 41.4
Thereafter...................................................... 192.2
------
Total minimum lease payments.................................. $486.2
======
</TABLE>
Rent expense for office space, which includes property taxes and certain
other costs, amounted to $83.9 million, $93.6 million and $92 million for the
years ended December 31, 1995, 1994, and 1993, respectively.
Other Commitments
At December 31, 1995, the Company had $76.4 million of letters of credit
outstanding which are required under certain agreements in the ordinary course
of business.
14. CONTINGENCIES
The Company and its subsidiaries are subject to various claims and lawsuits
from both private and governmental parties, which include claims and lawsuits
in the ordinary course of business, consisting principally of alleged errors
and omissions in connection with the placement of insurance and in rendering
consulting services. In some of these cases, the remedies that may be sought
or damages claimed are substantial. Additionally, the Company and its
subsidiaries are subject to the risk of losses resulting from the potential
uncollectibility of insurance and reinsurance balances and claims advances
made on behalf of clients and indemnifications connected with the sales of
certain businesses.
Certain claims asserted against the Company and certain of its subsidiaries
alleging, among other things, that certain Alexander Howden subsidiaries
accepted, on behalf of certain insurance companies, insurance or reinsurance
at premium levels not commensurate with the level of underwriting risks
assumed and retroceded or reinsured those risks with financially unsound
reinsurance companies.
A claim asserting these allegations is pending in a suit filed in New York.
In an action brought in 1988 against the Company and certain subsidiaries
(Certain Underwriters at Lloyd's of London Subscribing to Insurance Agreements
ML8055801, et al. v. Alexander & Alexander Services Inc., et al., formerly
captioned Dennis Edward Jennings v. Alexander & Alexander Europe plc, et al.,
88 Civ. 7060 (RO) (S.D.N.Y.)), plaintiffs seek compensatory and punitive
damages, as well as treble damages under RICO totaling $36 million. The
defendants have counterclaimed against certain of the plaintiffs for
contribution. Discovery in this case remains to be concluded and no trial date
has been set. Management of the Company believes there are valid defenses to
all the claims that have been made with respect to these activities and the
Company is vigorously defending the pending action.
36
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Certain other claims were resolved during 1995: (1) In a New York action
brought in 1985, claims were asserted against the Company and certain
subsidiaries (Pine Top Insurance Company, Ltd. v. Alexander & Alexander
Services Inc., et al., 85 Civ. 9860 (RPP) (S.D.N.Y.)). The plaintiff sought
compensatory and punitive, as well as treble damages under RICO totaling
approximately $87 million, arising from alleged RICO violations, common law
fraud, breach of contract and negligence. Two subsidiaries counterclaimed for
breach of certain reinsurance contracts with the plaintiff. This action was
settled as of January 12, 1995 and the action was voluntarily dismissed in
February 1995. The settlement amount was $4.5 million. The Company's portion
was $2.1 million which was previously reserved under its professional
indemnity program; and (2) In an Ohio action brought in 1985 (The Highway
Equipment Company, et al. v. Alexander Howden Limited, et al. (Case No. 1-
8501667, U.S. Bankruptcy Court, So. Dist. Ohio, Western Div.)), plaintiffs
sought compensatory and punitive damages, as well as treble damages under RICO
totaling $24 million. A directed verdict in the Company's favor was reaffirmed
on August 15, 1995 by the U.S. Court of Appeals for the Sixth Circuit.
These above actions are covered under the Company's professional indemnity
program, except for possible damages under RICO. The Company currently
believes the reasonably possible loss that might result from these actions, if
any, would not be material to the Company's financial position or results of
operations.
In 1987, the Company sold Shand, its domestic underwriting management
subsidiary. Prior to the sale, Shand and its subsidiaries had provided
underwriting management services for and placed insurance and reinsurance with
and on behalf of Mutual Fire. Mutual Fire was placed in rehabilitation by the
Courts of the Commonwealth of Pennsylvania in December 1986. In February 1991,
the rehabilitator commenced an action captioned Foster v. Alexander &
Alexander Services Inc., 91 Civ. 1179 (E.D.Pa.). The complaint, which sought
compensatory and punitive damages, alleged that Shand and, in certain
respects, the Company breached duties to and agreements with Mutual Fire. The
rehabilitator sought damages estimated at approximately $234 million.
On March 27, 1995, the Company, Shand and the rehabilitator entered into a
settlement agreement which was subsequently approved by the Courts and which
terminated the rehabilitator's litigation and released the Company and Shand
from any further claims by the rehabilitator. Under the terms of the
settlement, the Company paid $12 million in cash and issued a $35 million six-
year zero coupon note. In addition, in 1995 Shand returned $4.6 million of
trusteed assets to the rehabilitator and the rehabilitator has eliminated any
right of set-offs previously estimated to be $4.7 million. The Mutual Fire
settlement agreement includes certain features protecting the Company from
potential exposure to claims for contribution brought by third parties and
expenses arising out of such claims.
Although the Company's professional liability underwriters have denied
coverage for the Mutual Fire lawsuit, the Company has instituted a declaratory
judgment action attempting to validate coverage (Alexander & Alexander
Services Inc. and Alexander & Alexander Inc. v. Those Certain Underwriters at
Lloyd's of London, subscribing to insurance evidenced by policy numbers 879/P.
31356 and 879/P. 35349 and Assicurazioni Generali, S.P.A., No. 92 Civ. 6319
(F.D.N.Y.). All required documents in this case have been submitted to the
Court, and the Company is awaiting a decision on the matter.
Under the 1987 agreement with the purchaser of Shand, the Company agreed to
indemnify the purchaser against certain contingencies, including, among
others, (i) losses arising out of pre-sale transactions between Shand or
Shand's subsidiaries, on the one hand, and Mutual Fire, on the other, and (ii)
losses arising out of pre-sale errors or omissions by Shand or Shand's
subsidiaries. The Company's obligations under the indemnification provisions
in the 1987 sales agreement were not limited as to amount or duration.
Starting in late 1992, the purchaser of Shand had asserted a number of
claims under both the Mutual Fire indemnification provision and the errors and
omissions indemnification provision of the sales agreement. During 1995 most
of those claims have been resolved by a series of settlement agreements,
involving the settlement or
37
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
release of (a) claims relating to reinsurance recoverables due to Shand's
subsidiaries from Mutual Fire, (b) claims relating to deterioration of
reserves for business written by Mutual Fire and ceded to Shand's
subsidiaries, and (c) a number of potential errors and omissions claims by
third-party reinsurers against Shand. Under the settlement agreement entered
into in January 1995, covering the errors and omissions claims by third-party
reinsurers, the Company obtained from the purchasers of Shand a release and
limitation of indemnification obligations relating to certain third-party
errors and omissions claims, and restructured the contractual relationship
with the purchaser so that the parties' future interests as to third-party
claims are more closely aligned. The Company paid $14 million in cash, issued
a five-year interest bearing note in the principal amount of $14 million and
expected to pay a contingent obligation of $4.5 million. In June 1995, the $14
million note payable was prepaid in whole. The remaining contingent note
payable of $4.5 million was paid in full in September 1995.
Notwithstanding these settlements, the limitation of certain contract
obligations and the restructuring of the parties' relationship, some of the
Company's indemnification provisions under the 1987 agreement are still in
effect. As a result, there remains the possibility of substantial exposure
under the indemnification provisions of the 1987 agreement, although the
Company, based on current facts and circumstances, believes the possibility of
a material loss resulting from these exposures is remote.
In November 1993, a class action suit was filed against the Company and two
of its then directors and officers, Tinsley H. Irvin and Michael K. White, in
the United States District Court for the Southern District of New York under
the caption Harry Glickman v. Alexander & Alexander Services Inc., et al.
(Civil Action No. 93 Civ. 7594). On January 6, 1995, the plaintiff filed a
second amended complaint which, among other things, dropped Mr. White as a
defendant. The second amended complaint purports to assert claims on behalf of
a class of persons who purchased the Company's Common Stock during the period
May 1, 1991 to November 4, 1993, alleging that during this period the
Company's financial statements contained material misrepresentations as a
result of inadequate reserves established by the Company's subsidiary,
Alexander Consulting Group Inc., for unbillable work-in-progress. The second
amended complaint seeks damages in an unspecified amount, as well as
attorneys' fees and other costs, for alleged violations of Sections 10(b) and
20(a) of the Securities Exchange Act of 1934. In response to the second
amended complaint, the Company filed a motion to dismiss. A hearing on the
Company's motion to dismiss was held on January 26, 1996. On February 27, 1996
the Company's motion to dismiss was granted and plaintiff was denied leave to
replead. Plaintiff has until April 1, 1996 to appeal the verdict. Should
plaintiff appeal, management will vigorously defend the matter as management
believes there are valid defenses to the allegations set forth in the amended
complaint. The Company currently believes that this action is covered by the
Company's insurance program and that the reasonably possible loss that might
result, if any, would not be material to the Company's financial position or
results of operations.
These contingent liabilities involve significant amounts. While it is not
possible to predict with certainty the outcome of such contingent liabilities,
the applicability or availability of coverage for such matters under the
Company's professional indemnity insurance program, or their financial impact
on the Company, management currently believes that such impact will not be
material to the Company's financial position. However, it is possible that
future developments with respect to these matters could have a material effect
on future interim or annual results of operations.
Under the Series B Convertible Preferred Stock Purchase Agreement, as
amended, the Company has agreed to make certain payments to the purchaser
pursuant to indemnifications given with respect to tax payments and reserves
in excess of recorded tax reserves as of March 31, 1994. The Company's
potential exposures under the indemnification, individually or in the
aggregate, are limited to $10 million. As a result of this indemnification,
the Company has classified $10 million of the proceeds from the issuance of
the Series B Convertible Preferred Shares outside stockholders' equity until
such time as the indemnification, if any, is satisfied or terminated.
38
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
15. BUSINESS SEGMENTS
Segment information is provided for the Company's two reportable industry
segments, Insurance Services and Human Resource Management Consulting.
Insurance Services operations include risk management and insurance
services, specialist insurance and reinsurance broking.
Human Resource Management Consulting includes a variety of human resource
management consulting services, including actuarial and benefit plan
consulting services, flexible compensation consulting, communications and
management consulting services, executive planning services and human resource
organizational analysis, as well as brokerage services for group health and
welfare coverages.
The following tables present information about the Company's operations by
business segment and geographical areas for each of the three years in the
period ended December 31, 1995:
BUSINESS SEGMENTS
<TABLE>
<CAPTION>
OPERATING OPERATING IDENTIFIABLE DEPRECIATION & CAPITAL
REVENUES INCOME(A) ASSETS AMORTIZATION EXPENDITURES
--------- --------- ------------ -------------- ------------
<S> <C> <C> <C> <C> <C>
1995
Insurance services...... $1,071.8 $143.4 $2,667.6 $39.4 $25.2
Human resource manage-
ment consulting........ 210.6 10.0 125.5 6.1 3.0
General corporate....... -- (30.7) 149.3 0.6 (0.5)
-------- ------ -------- ----- -----
$1,282.4 $122.7 $2,942.4 $46.1 $27.7
======== ====== ======== ===== =====
1994
Insurance services...... $1,113.2 $(12.2) $2,525.4 $44.7 $19.0
Human resource manage-
ment consulting........ 210.7 (19.1) 130.3 6.0 2.9
General corporate....... -- (51.6) 290.0 0.5 (0.4)
-------- ------ -------- ----- -----
$1,323.9 $(82.9) $2,945.7 $51.2 $21.5
======== ====== ======== ===== =====
1993
Insurance services...... $1,128.6 $ 92.9 $2,544.1 $48.3 $21.0
Human resource manage-
ment consulting........ 213.0 (7.5) 121.4 5.6 4.0
General corporate....... -- (33.1) 128.3 0.6 1.0
-------- ------ -------- ----- -----
$1,341.6 $ 52.3 $2,793.8 $54.5 $26.0
======== ====== ======== ===== =====
</TABLE>
- --------
(a) Includes restructuring/special charges of $15.7 million and $56.3 million
for 1995 and 1994, respectively, in insurance services, $1.4 million and
$8.3 million for 1995 and 1994, respectively, in human resource management
consulting and $0.5 million and $4.4 million for 1995 and 1994,
respectively, in general corporate as described in Note 3 of Notes to
Financial Statements.
39
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
GEOGRAPHICAL AREAS
<TABLE>
<CAPTION>
OPERATING OPERATING IDENTIFIABLE
REVENUES INCOME(A)(B) ASSETS
--------- ------------ ------------
<S> <C> <C> <C>
1995
United States.............................. $ 608.2 $ 36.1 $ 895.5
United Kingdom............................. 317.5 55.1 1,092.3
Canada, principally Reed Stenhouse Cos.
Ltd....................................... 121.2 21.7 201.2
Other countries............................ 235.5 40.5 604.1
General corporate.......................... -- (30.7) 149.3
-------- ------ --------
$1,282.4 $122.7 $2,942.4
======== ====== ========
1994
United States.............................. $ 685.4 $(78.8) $ 904.2
United Kingdom............................. 312.5 19.4 1,065.8
Canada, principally Reed Stenhouse Cos.
Ltd....................................... 118.9 10.0 191.0
Other countries............................ 207.1 18.1 494.7
General corporate.......................... -- (51.6) 290.0
-------- ------ --------
$1,323.9 $(82.9) $2,945.7
======== ====== ========
1993
United States.............................. $ 727.1 $(11.8) $1,029.2
United Kingdom............................. 315.5 64.1 987.8
Canada, principally Reed Stenhouse Cos.
Ltd....................................... 120.9 13.0 208.1
Other countries............................ 178.1 20.1 440.4
General corporate.......................... -- (33.1) 128.3
-------- ------ --------
$1,341.6 $ 52.3 $2,793.8
======== ====== ========
</TABLE>
- --------
(a) The 1995 special charges referred to in Note 3 of Notes to Financial
Statements have been allocated to their respective geographical areas in
1995, including $16 million in the U.S., $1 million in the U.K., $0.1
million in other countries and $0.5 million in general corporate.
(b) The 1994 restructuring charges referred to in Note 3 of Notes to Financial
Statements have been allocated to their respective geographical areas in
1994, including $31.8 million in the U.S., $21.9 million in the U.K., $4
million in Canada, $6.9 million in Other Countries and $4.4 million in
general corporate.
40
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
16. QUARTERLY FINANCIAL DATA (UNAUDITED)
Quarterly operating results for 1995 and 1994 are summarized below (in
millions, except per share data).
<TABLE>
<CAPTION>
INCOME (LOSS)
FROM
OPERATING OPERATING CONTINUING NET
REVENUES INCOME (LOSS) OPERATIONS INCOME (LOSS)
--------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
1995
1st........................ $ 324.2 $ 41.7 $ 41.7 $ 41.7
2nd........................ 328.1 39.2 22.7 22.7
3rd........................ 299.7 27.6 17.5 17.5
4th........................ 330.4 14.2 7.5 7.5 (a)
-------- ------ ------- -------
Year....................... $1,282.4 $122.7 $ 89.4 $ 89.4
-------- ------ ------- -------
1994
1st........................ $ 323.0 $ 5.2 $ (1.8) $ (4.4)
2nd........................ 335.1 14.6 3.8 (2.2)(b)
3rd........................ 332.6 4.2 0.1 (20.8)(c)
4th........................ 333.2 (106.9) (109.3) (111.3)(d)
-------- ------ ------- -------
Year....................... $1,323.9 $(82.9) $(107.2) $(138.7)
======== ====== ======= =======
</TABLE>
<TABLE>
<CAPTION>
INCOME (LOSS)
FROM FULLY DILUTED
PER SHARE OF CONTINUING PRIMARY NET NET
COMMON STOCK OPERATIONS EARNINGS (LOSS) EARNINGS (LOSS) DIVIDENDS HIGH LOW
- ------------ ------------- --------------- --------------- --------- -------- -------
<S> <C> <C> <C> <C> <C> <C>
1995
1st..................... $ .80 $ .80 $ .69 $.025 $23 3/4 $18 1/2
2nd..................... .37 .37 .36 .025 26 7/16 22 1/8
3rd..................... .25 .25 .25 .025 25 1/2 22 3/8
4th..................... .02 .02 (a) .02 .025 24 3/8 18 5/8
------ ------ ------ -----
Year $ 1.44 $ 1.44 $ 1.42 (e) $.100
------ ------ ------ -----
1994
1st..................... $ (.09) $ (.15) $ (.15) $.250 $22 3/4 $17 1/4
2nd..................... .04 (.10)(b) (.10) .025 18 1/8 14
3rd..................... (.11) (.58)(c) (.58) .025 20 7/8 16
4th..................... (2.61) (2.66)(d) (2.66) .025 21 1/2 18 1/2
------ ------ ------ -----
Year.................... $(2.79)(e) $(3.51)(e) $(3.51)(e) $.325
====== ====== ====== =====
</TABLE>
- --------
(a) Includes a charge of $17.6 million ($11.2 million after-tax or $0.25 per
share) for restructuring and other special charges related primarily to
the acquisition of certain U.S. operations from Jardine Insurance Brokers,
Inc. (see Note 3 of Notes to Financial Statements).
(b) Includes a charge of $6 million, or $.14 per share, relating to the
Company's discontinued operations (see Note 6 of Notes to Financial
Statements).
(c) Includes a loss from discontinued operations of $20.9 million, or $.47 per
share, relating to an agreement in principle to resolve certain indemnity
obligations to Sphere Drake (see Note 6 of Notes to Financial Statements).
(d) Includes charges of $163.6 million ($106.6 million after-tax or $2.43 per
share) for restructuring, contingency settlements and other reserves.
(e) Full year earnings per share amounts do not equal the sum of the quarterly
amounts due to changes in weighted average shares during the periods.
41
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS--(CONCLUDED)
17. SUBSEQUENT EVENTS (UNAUDITED)
On December 11, 1996, the Company entered into an Agreement and Plan of
Merger (the "Merger Agreement") with Aon Corporation ("Aon"). The Merger
Agreement provides for the acquisition, subject to the terms and conditions
thereof, of the Company by Aon. As contemplated by the Merger Agreement, on
December 16, 1996, Aon launched a cash tender offer for all of the Company's
common stock and the associated preferred stock purchase rights of the
Company. In addition, Aon has entered into a stock purchase agreement with
American International Group, Inc. ("AIG"), pursuant to which Aon has agreed
to purchase the Company's 8% Series B Cumulative Convertible Preferred Stock
owned by AIG or its subsidiaries.
Pursuant to the terms of the Merger Agreement, on December 16, 1996, Aon
commenced its tender offer to purchase all the outstanding shares of Company
stock at $17.50 per share. The tender offer expired on January 14, 1997, at
which time 44,293,552 shares, or approximately 97%, of the Common Stock had
been validly tendered and accepted for payment.
In connection with the acquisition of the Company by Aon, the Company will
incur in 1996 significant expenses relating to the change of control,
primarily due to the accelerated vesting of certain employee stock-based
compensation and option plans, as well as the transaction costs.
In addition, in 1997, the Company and/or its successors is expected to incur
significant severance and other related costs associated with the transaction.
42
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1995
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------- --------------
1996 1995 1996 1995
------ ------ ------ ------
(IN MILLIONS, EXCEPT PER
SHARE AMOUNTS)
<S> <C> <C> <C> <C>
OPERATING REVENUES:
Commissions and fees........................... $301.6 $283.7 $920.6 $903.4
Fiduciary investment income.................... 16.3 16.0 46.8 48.6
------ ------ ------ ------
Total........................................ 317.9 299.7 967.4 952.0
------ ------ ------ ------
OPERATING EXPENSES:
Salaries and benefits.......................... 191.6 175.4 566.6 543.9
Other.......................................... 104.6 96.7 312.5 299.6
------ ------ ------ ------
Total........................................ 296.2 272.1 879.1 843.5
------ ------ ------ ------
Operating income............................... 21.7 27.6 88.3 108.5
------ ------ ------ ------
OTHER INCOME (EXPENSES):
Investment income.............................. 3.5 4.6 10.6 13.9
Interest expense............................... (3.9) (4.6) (11.8) (14.1)
Other.......................................... 1.1 1.2 0.6 34.0
------ ------ ------ ------
Total........................................ 0.7 1.2 (0.6) 33.8
------ ------ ------ ------
Income before income taxes and minority inter-
est........................................... 22.4 28.8 87.7 142.3
Income taxes................................... (9.0) (11.0) (35.0) (54.7)
------ ------ ------ ------
Income before minority interest................ 13.4 17.8 52.7 87.6
Minority interest.............................. (0.3) (0.3) (5.0) (5.7)
------ ------ ------ ------
Net income..................................... 13.1 17.5 47.7 81.9
Preferred stock dividends...................... (6.7) (6.4) (19.9) (18.9)
------ ------ ------ ------
Earnings attributable to common shareholders... $ 6.4 $ 11.1 $ 27.8 $ 63.0
====== ====== ====== ======
PER SHARE INFORMATION:
Primary earnings per share..................... $ 0.14 $ 0.25 $ 0.62 $ 1.42
====== ====== ====== ======
Average common and common equivalent shares
outstanding................................... 45.3 44.6 45.1 44.5
====== ====== ====== ======
Fully diluted earnings per share............... $ 0.14 $ 0.25 $ 0.62 $ 1.33
====== ====== ====== ======
Average common shares outstanding, assuming
full dilution................................. 45.3 44.6 45.1 57.1
====== ====== ====== ======
Cash dividends per common share................ $0.025 $0.025 $0.075 $0.075
====== ====== ====== ======
</TABLE>
See accompanying notes to financial statements.
43
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 1996 (UNAUDITED) AND DECEMBER 31, 1995
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1996 1995
------------- ------------
(IN MILLIONS)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents:
Operating.......................................... $ 232.0 $ 241.2
Fiduciary.......................................... 526.2 496.4
Short-term investments:
Operating.......................................... 21.1 11.3
Fiduciary.......................................... 265.0 224.9
Premiums and fees receivable (less allowance for
doubtful accounts of $20.6 in 1996 and $20.5 in
1995).............................................. 1,200.7 1,292.8
Deferred income taxes............................... 16.8 20.0
Other current assets................................ 74.1 85.4
-------- --------
Total current assets............................. 2,335.9 2,372.0
Property and equipment--net......................... 120.4 126.4
Intangible assets--net.............................. 221.2 210.7
Deferred income taxes............................... 103.6 102.1
Long-term operating investments..................... 21.4 30.9
Other............................................... 119.5 100.3
-------- --------
$2,922.0 $2,942.4
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Premiums payable to insurance companies............. $1,775.9 $1,810.4
Short-term debt..................................... 13.8 19.1
Current portion of long-term debt................... 7.7 9.3
Deferred income taxes............................... 8.8 9.4
Accrued compensation and related benefits........... 56.1 81.8
Income taxes payable................................ 34.6 24.7
Other accrued expenses.............................. 130.6 165.8
-------- --------
Total current liabilities........................ 2,027.5 2,120.5
-------- --------
LONG-TERM LIABILITIES:
Long-term debt...................................... 142.4 126.2
Deferred income taxes............................... 18.9 15.6
Net liabilities of discontinued operations.......... 27.0 33.4
Other............................................... 243.7 234.1
-------- --------
Total long-term liabilities...................... 432.0 409.3
-------- --------
Commitments and contingent liabilities (Notes 3, 6
and 9)
8% Series B cumulative convertible preferred stock
contingency (Note 9)............................... 0.0 10.0
STOCKHOLDERS' EQUITY:
Preferred stock, authorized 15,000,000 shares, $1
par value:
Series A junior participating preferred stock, is-
sued and outstanding, none........................ -- --
$3.625 Series A convertible preferred stock, is-
sued and outstanding, 2,300,000 shares, liquida-
tion preference of $115 million................... 2.3 2.3
8% Series B cumulative convertible preferred
stock, issued and outstanding, 4,751,208 and
4,477,170 shares, respectively, liquidation
preference of $238 million and $224 million,
respectively...................................... 4.8 4.5
Common stock, authorized 200,000,000 shares, $1 par
value; issued and outstanding 43,005,799 and
42,259,282 shares, respectively.................... 43.0 42.3
Class A common stock, authorized 26,000,000 shares,
$.00001 par value; issued and outstanding 1,811,121
and 1,920,821 shares, respectively................. -- --
Class C common stock, authorized 11,000,000 shares,
$1 par value; issued and outstanding 350,003 and
361,092 shares, respectively....................... 0.4 0.4
Class D common stock, authorized 40,000,000 shares,
$1 par value; issued and outstanding, none......... -- --
Paid-in capital..................................... 666.7 638.1
Accumulated deficit................................. (203.1) (227.5)
Net unrealized investment gains--net of income tax-
es................................................. 6.7 5.6
Accumulated translation adjustments................. (58.3) (63.1)
-------- --------
Total stockholders' equity....................... 462.5 402.6
-------- --------
$2,922.0 $2,942.4
======== ========
</TABLE>
See accompanying notes to financial statements.
44
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1995
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
SEPTEMBER 30,
--------------
1996 1995
------ ------
(IN MILLIONS)
<S> <C> <C>
CASH PROVIDED (USED) BY:
OPERATING ACTIVITIES:
Income from continuing operations............................. $ 47.7 $ 81.9
Adjustments to reconcile to net cash provided by operating ac-
tivities:
Depreciation and amortization................................ 36.9 33.3
Deferred income taxes........................................ 5.7 28.9
Gains on dispositions of subsidiaries and other assets....... -- (30.4)
Other........................................................ 10.3 7.8
Changes in assets and liabilities (net of effects from acqui-
sitions and dispositions):
Net fiduciary cash and cash equivalents and short-term in-
vestments................................................... (65.4) (44.7)
Premiums and fees receivable................................. 106.5 38.2
Prepaid expenses and other current assets.................... 17.3 (8.4)
Other non-current assets..................................... (15.2) (13.2)
Premiums payable to insurance companies...................... (53.1) (10.1)
Other accrued expenses....................................... (67.5) (104.2)
Other long-term liabilities.................................. 15.7 (8.5)
Discontinued operations (net)................................. (10.4) (12.8)
------ ------
Net cash provided (used) by operating activities........... 28.5 (42.2)
------ ------
INVESTING ACTIVITIES:
Net purchases of property and equipment....................... (18.6) (15.1)
Purchases of businesses....................................... (22.8) (2.8)
Proceeds from sales of subsidiaries and other assets.......... 0.7 88.1
Purchases of operating investments............................ (26.0) (180.2)
Sales and maturities of operating investments................. 27.8 196.1
------ ------
Net cash provided (used) by investing activities........... (38.9) 86.1
------ ------
FINANCING ACTIVITIES:
Cash dividends................................................ (9.6) (9.6)
Proceeds from issuance of short-term debt..................... 12.0 0.2
Repayments of short-term debt................................. (15.2) (0.4)
Proceeds from issuance of long-term debt...................... 30.1 4.6
Repayments of long-term debt.................................. (18.9) (35.1)
Issuance of common stock...................................... 1.2 0.1
------ ------
Net cash used by financing activities...................... (0.4) (40.2)
------ ------
Effect of exchange rate changes on operating cash and cash
equivalents.................................................. 1.6 2.4
Operating cash and cash equivalents at beginning of year...... 241.2 248.7
------ ------
Operating cash and cash equivalents at end of period.......... $232.0 $254.8
====== ======
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid during the period for:
Interest..................................................... $ 14.7 $ 13.9
Income taxes................................................. 14.0 67.5
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Notes payable issued for contingency settlements.............. $ -- $ 45.7
Series B cumulative convertible preferred stock dividends-in-
kind......................................................... 13.7 12.6
Common stock issued for employee benefit and stock plans...... 4.5 3.6
Common stock issued for non-employee stock plans.............. 0.2 0.4
</TABLE>
See accompanying notes to financial statements.
45
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
UNAUDITED NOTES TO FINANCIAL STATEMENTS
(IN MILLIONS, EXCEPT PER SHARE INFORMATION)
1. INTERIM FINANCIAL PRESENTATION
Unless otherwise indicated, all amounts are stated in millions of U.S.
dollars. In the opinion of the management of the Company, all adjustments,
consisting only of normal recurring accruals, necessary for a fair presentation
have been included in the consolidated financial statements. The results of
operations for the first nine months of the year are not necessarily indicative
of results for the year.
These unaudited consolidated financial statements should be read in
conjunction with the audited consolidated financial statements and the notes
thereto included in the Company's 1995 Annual Report to Shareholders.
2. ACQUISITIONS AND DISPOSITIONS
Acquisitions
In the first nine months of 1996, the Company acquired in transactions
accounted for as purchases, or invested in ten brokerage and consulting
operations, primarily in the Asia/Pacific region, for combined purchase prices
approximating $27.5 million. The Company paid a total of $21.9 million at
closing for these acquisitions. These acquisitions produced approximately $30
million in annualized revenues.
In October 1996, the Company acquired a European retail broking operation for
a purchase price not to exceed $5.3 million of which $3.3 million was paid at
closing.
Dispositions
On February 28, 1995, the Company completed the sale of Alexsis Inc., its
U.S.-based third party claims administrator for total cash proceeds of $47.1
million resulting in a pre-tax gain of $30.3 million, ($20.8 million after-tax
or $0.47 per share). Adjustments, including post closing adjustments pursuant
to the agreement, resulted in a final reported pre-tax gain of $28.7 million,
($18.7 million after-tax or $0.42 per share) for the year ended December 31,
1995.
In January 1995, the Company sold its minority interest in a U.K. merchant
bank for cash proceeds of $7.2 million and a pre-tax gain of $0.3 million.
These gains are included in Other Income (Expenses) in the Consolidated
Statements of Operations.
3. INCOME TAXES
On August 6, 1996, the Company received a technical advice memorandum
("TAM"), issued by the IRS National Office, favorable to the Company with
respect to the federal income tax consequences of certain 1991 intercompany
transactions involving the stock of a U.K. subsidiary. The IRS District
Director's Office subsequently adopted the TAM and withdrew its proposal to
increase taxable income for the year 1991 with respect to this issue. The
examination of the 1990 and 1991 federal income tax returns will come to a
conclusion with the disposition of this issue.
Based upon the favorable TAM relating to the 1991 transactions, the Company
does not expect IRS examiners to take issue with the Company's reporting of a
similar series of transactions that occurred in 1993. The IRS commenced its
examination of the tax years 1992 through 1994 in July 1996. The potential tax
liability, excluding interest and penalties, associated with the 1993
transactions had been estimated by the Company at $25 million.
46
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
UNAUDITED NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
No provision for any potential liability with respect to the 1991 and 1993
transactions had been made in the consolidated financial statements.
The Company believes that its current tax reserves are adequate to cover its
tax liabilities.
4. EMPLOYEES' RETIREMENT PLANS AND BENEFITS
Effective January 1, 1996, the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 123, "Accounting for Stock Based Compensation".
The Company has elected to continue to measure compensation costs using APB
Opinion No. 25 and accordingly will provide the pro-forma disclosures required
by SFAS No. 123 in its Annual Report on Form 10-K for the year ended December
31, 1996.
5. STOCK OPTION AND INCENTIVE PLANS
Worldwide Employee Savings-Related Stock Purchase Plan
The Company's Worldwide Employee Savings-Related Stock Purchase Plan
(Worldwide Employee Purchase Plan) was approved by the Board of Directors and
became effective as of May 16, 1996. Under the Worldwide Employee Purchase Plan
eligible employees outside the U.S. may purchase up to an aggregate 750,000
shares of the Company's Common Stock. At the end of the 5-year offering period,
participants can elect to purchase from the contributions saved, shares of the
Company's Common Stock at a 15 percent discount of the closing price of the
Common Stock reported on the New York Stock Exchange on the first date of the
5-year offering period. 471,000 shares have been subscribed to as of September
30, 1996. Non-U.S. employees who are "executive officers" of the Company, as
that term is defined pursuant to Section 16 of the Securities Exchange Act of
1934, participate in a subplan of the Employee Discount Stock Purchase Plan
with similar terms.
1995 Long-Term Incentive Plan Amendment
On May 16, 1996 an amendment to the 1995 Long-Term Incentive Plan (1995 LTIP)
was approved by stockholders. The 1995 LTIP provided that no more than 940,000
restricted shares may be used for Restricted Stock Awards and Bonus Equity Plan
Awards (BEP). The amendment excludes BEP Awards from the 940,000 restricted
share limitation, but does not increase the number of shares authorized under
the 1995 LTIP.
6. DISCONTINUED OPERATIONS
In 1985, the Company discontinued its insurance underwriting operations. In
1987, the Company sold Sphere Drake Insurance Group (Sphere Drake). The Sphere
Drake sales agreement provides indemnities by the Company to the purchaser for
various potential liabilities including provisions covering future losses on
certain insurance pooling arrangements from 1953 to 1967 between Sphere Drake
and Orion Insurance Company (Orion), a U.K.-based insurance company, and future
losses pursuant to a stop loss reinsurance contract between Sphere Drake and
Lloyd's Syndicate 701 (Syndicate 701). In addition, the sales agreement
requires the Company to assume any losses in respect of actions or omissions by
Swann & Everett Underwriting Agency (Swann & Everett), an underwriting
management company previously managed by Alexander Howden Group Limited
(Alexander Howden).
The net liabilities of discontinued operations shown in the accompanying
Consolidated Balance Sheets include insurance liabilities associated with the
above indemnities, liabilities of insurance underwriting subsidiaries currently
in run-off and other related liabilities.
47
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
UNAUDITED NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
A summary of the net liabilities of discontinued operations is as follows:
<TABLE>
<CAPTION>
AS OF AS OF
SEPTEMBER 30, DECEMBER 31,
1996 1995
------------- ------------
<S> <C> <C>
Liabilities:
Insurance liabilities....................... $252.4 $257.1
Other....................................... 15.1 14.9
------ ------
Total liabilities....................... 267.5 272.0
------ ------
Assets:
Recoverable under finite risk contracts:
Insurance liabilities..................... 129.4 126.4
Premium adjustment........................ 9.7 9.8
Reinsurance recoverables.................... 52.6 51.6
Cash and investments........................ 29.7 27.2
Other....................................... 8.8 9.3
------ ------
Total assets............................ 230.2 224.3
------ ------
Total net liabilities of discontinued opera-
tions........................................ 37.3 47.7
Less current portion classified as other ac-
crued expenses............................... 10.3 14.3
------ ------
Remainder classified as net liabilities of
discontinued operations...................... $ 27.0 $ 33.4
====== ======
</TABLE>
The insurance liabilities represent estimates of future claims expected to be
made under occurrence-based insurance policies and reinsurance business written
through Lloyd's and the London Market covering primarily asbestosis,
environmental pollution, and latent disease risks in the United States which
are coupled with substantial litigation expenses. These claims are expected to
develop and be settled over the next twenty to thirty years.
Liabilities stemming from these claims cannot be estimated using conventional
actuarial reserving techniques because the available historical experience is
not adequate to support the use of such techniques and because case law, as
well as scientific standards for measuring the adequacy of site clean-up (both
of which have had, and will continue to have, a significant bearing on the
ultimate extent of the liabilities) is still evolving. Accordingly, the
Company's independent actuaries have combined available exposure information
with other relevant industry data and have used various projection techniques
to estimate the insurance liabilities, consisting principally of incurred but
not reported losses.
In 1994, Orion, which has financial responsibility for sharing certain of the
insurance pool liabilities, was placed in provisional liquidation by order of
the English Courts. Based on current facts and circumstances, the Company
believes that the provisional liquidation will not have a material adverse
effect on the net liabilities of discontinued operations.
The Company has certain protection against adverse developments of the
insurance liabilities through two finite risk contracts issued by Centre
Reinsurance (Bermuda) Limited (reinsurance company). A contract entered into in
1989 provides the insurance underwriting subsidiaries currently in run-off with
recoveries of recorded liabilities of $76 million, and for up to $50 million of
additional recoveries in excess of those liabilities subject to a deductible
for one of the run-off companies of $15 million. At September 30, 1996, based
on an estimate by an independent actuarial firm, the Company had accrued $12.9
million of the deductible.
48
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
UNAUDITED NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
On July 1, 1994, the Company entered into an insurance-based financing
contract (finite risk contract) with the reinsurance company providing
protection primarily for exposures relating to Orion, Syndicate 701 and Swann &
Everett. The contract provided for the payment by the Company of $80 million,
$50 million of which was borrowed from the reinsurance company, and for payment
by the Company of the first $73 million of paid claims. The contract entitles
the Company to recover paid claims in excess of the Company's $73 million
retention. At September 30, 1996, recoveries were limited to $120.8 million,
which includes the Company's payment of $80 million. In addition, commencing
December 31, 1996, depending on the timing and amount of paid loss recoveries
under the contract, the Company may be entitled to receive a payment from the
reinsurance company in excess of the amounts recovered for paid losses if the
contract is terminated. The contract is accounted for under the deposit method
of accounting and the accounting requirements for discontinued operations.
The Company's right to terminate the contract entered into in 1994 is subject
to the consent of American International Group, Inc. (AIG) as long as AIG is
the holder of certain shares of the Company's stock. In addition, the
reinsurance company also has the right, under certain circumstances, all of
which are under the Company's control, to terminate that contract.
The insurance liabilities set forth above represent the Company's best
estimates of the probable liabilities based on independent actuarial estimates.
The recoverable amounts under the finite risk contracts, which are considered
probable of realization based on independent actuarial estimates of losses and
pay-out patterns, represent the excess of such liabilities over the Company's
retention levels. The premium adjustment represents the recoverable amount
considered probable of realization at the earliest date the Company can
exercise its right to terminate the finite risk contract covering the insurance
underwriting subsidiaries currently in run-off.
Changes in the total net liabilities of discontinued operations for the nine
months ended September 30, 1996 are as follows:
<TABLE>
<S> <C>
Beginning balance.................................................. $47.7
Claims and expense payments...................................... (10.4)
-----
Ending Balance..................................................... $37.3
=====
</TABLE>
While the insurance liabilities set forth above represent the Company's best
estimate of the probable liabilities within a range of independent actuarial
estimates of reasonably probable loss amounts, there is no assurance that
further adverse developments may not occur due to variables inherent in the
estimation processes and other matters described above. Based on independent
actuarial estimates of a range of reasonably possible loss amounts, liabilities
could exceed recorded amounts by approximately $165 million. However, in the
event of such adverse developments, based on independent actuarial estimates of
pay-out patterns, up to approximately $125 million of this excess would be
recoverable under the finite risk contracts.
The Company believes that, based on current estimates, the established total
net liabilities of discontinued operations are sufficient to cover its
exposures.
7. INVESTMENTS
At September 30, 1996, net unrealized holding gains totaled $6.7 million, net
of deferred income taxes of $2.4 million, and are reported as a separate
component of Stockholders' Equity.
49
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
UNAUDITED NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
At September 30, 1996 and December 31, 1995, the amortized cost and estimated
fair value of the Company's debt and equity securities and related financial
instruments used to hedge such investments are summarized below:
<TABLE>
<CAPTION>
SEPTEMBER 30, 1996
-----------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
U.S. Government agencies/state
issuances.................... $ -- $-- $ -- $ --
Other interest-bearing securi-
ties......................... 138.1 -- -- 138.1
Mortgage-backed securities.... 5.7 -- -- 5.7
Equity securities............. 4.7 8.7 -- 13.4
Financial instruments--used as
hedges....................... -- 0.9 (0.5) 0.4
------ ---- ----- ------
Total..................... $148.5 $9.6 $(0.5) $157.6
====== ==== ===== ======
<CAPTION>
DECEMBER 31, 1995
-----------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
U.S. Government agencies/state
issuances.................... $ 2.7 $-- $ -- $ 2.7
Other interest-bearing
securities................... 138.1 -- -- 138.1
Equity securities............. 3.1 6.5 -- 9.6
Financial instruments--used as
hedges....................... -- 1.3 (0.2) 1.1
------ ---- ----- ------
Total..................... $143.9 $7.8 $(0.2) $151.5
====== ==== ===== ======
</TABLE>
The above debt and equity securities and financial instruments used as hedges
are classified in the Consolidated Balance Sheets as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1996 1995
------------- ------------
<S> <C> <C>
Cash and cash equivalents:
Operating.................................... $ 41.7 $ 34.1
Fiduciary.................................... 93.2 73.1
Short-term investments:
Operating.................................... 0.7 0.3
Fiduciary.................................... 2.3 18.8
Long-term operating investments................ 19.7 25.2
------ ------
Total...................................... $157.6 $151.5
====== ======
</TABLE>
50
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
UNAUDITED NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
At September 30, 1996 and December 31, 1995, the amortized cost and estimated
fair value of debt securities by contractual maturity are summarized below:
<TABLE>
<CAPTION>
SEPTEMBER 30, 1996
-------------------
ESTIMATED
AMORTIZED FAIR
COST VALUE
--------- ---------
<S> <C> <C>
Due in one year or less............................... $137.8 $137.8
Due after one year through five years................. 0.2 0.2
Due after five years through ten years................ 0.1 0.1
Due after ten years................................... -- --
------ ------
138.1 138.1
Mortgage-backed securities............................ 5.7 5.7
------ ------
Total debt securities............................. $143.8 $143.8
====== ======
<CAPTION>
DECEMBER 31, 1995
-------------------
ESTIMATED
AMORTIZED FAIR
COST VALUE
--------- ---------
<S> <C> <C>
Due in one year or less............................... $120.8 $120.8
Due after one year through five years................. 4.8 4.8
Due after five years through ten years................ 10.2 10.2
Due after ten years................................... 5.0 5.0
------ ------
140.8 140.8
Mortgage-backed securities............................ -- --
------ ------
Total debt securities............................. $140.8 $140.8
====== ======
</TABLE>
Certain of the above investments with maturities greater than one year are
classified as short-term and included in current assets as they represent
fiduciary investments that will be utilized during the normal operating cycle
of the business to pay premiums payable to insurance companies that are
included in current liabilities.
8. DEBT
The Company has a $200 million three year credit facility with various banks,
which expires in March 1998. The agreement provides for unsecured borrowings
and for the issuance of up to $100 million of letters of credit, and contains
various covenants, including minimum consolidated net worth, maximum leverage
and minimum cash flow requirements. Interest rates charged on amounts drawn on
this credit agreement are dependent upon the Company's credit ratings, the
duration of the borrowings and the Company's choice of one of a number of
indices, including the prime lending rate, certificate of deposit rates, the
federal funds rate and LIBOR.
In August 1996, the Company obtained two short-term bank loans totaling $7
million. The proceeds from these loans were used to reduce the amount
outstanding under the agreement. As of September 30, 1996, $50 million of
unsecured borrowings were outstanding. During the first quarter of 1996, a $10
million letter of credit was issued, and, in July 1996, the $10 million letter
of credit was cancelled.
In March 1996, the Company obtained a $10 million, short term bank loan which
was subsequently repaid in April 1996.
51
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
UNAUDITED NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
As part of the October 1995 agreement for the purchase of JIB, the Company
paid a promissory note totaling $10.6 million in April, 1996. During the second
quarter of 1996, the October 1996 promissory note was revalued to $6 million in
accordance with the revenue retention criteria for the former JIB offices
stipulated in the purchase agreement.
In April 1996, the Company paid the first installment of $5.8 million on the
Mutual Fire zero-coupon note. (See Note 9 of the Unaudited Notes to Financial
Statements).
In May 1996, the Company issued a $2.7 million, 9 percent two year note,
relating to an acquisition in the Asia-Pacific region. This note is contingent
upon future results of the acquired business. (See Note 2 of the Unaudited
Notes to Financial Statements.)
9. CONTINGENCIES
The Company and its subsidiaries are subject to various claims and lawsuits
from both private and governmental parties, which include claims and lawsuits
in the ordinary course of business, consisting principally of alleged errors
and omissions in connection with the placement of insurance and in rendering
consulting services. In some of these cases, the remedies that may be sought or
damages claimed are substantial. Additionally, the Company and its subsidiaries
are subject to the risk of losses resulting from the potential uncollectibility
of insurance and reinsurance balances and claims advances made on behalf of
clients and indemnifications connected with the sales of certain businesses.
Certain claims were asserted against the Company and certain of its
subsidiaries alleging, among other things, that certain Alexander Howden
subsidiaries accepted, on behalf of certain insurance companies, insurance or
reinsurance at premium levels not commensurate with the level of underwriting
risks assumed and retroceded or reinsured those risks with financially unsound
reinsurance companies. The remaining claim asserting these allegations is
pending in a suit filed in New York. In an action brought in 1988 against the
Company and certain subsidiaries (Certain Underwriters at Lloyd's of London
Subscribing to Insurance Agreements ML8055801, et al. v. Alexander & Alexander
Services Inc., et al., formerly captioned Dennis Edward Jennings v. Alexander &
Alexander Europe plc, et al., 88 Civ. 7060 (RO) (S.D.N.Y.)), plaintiffs seek
compensatory and punitive damages, as well as treble damages under RICO
totaling $36 million. The defendants have counterclaimed against certain of the
plaintiffs for contribution. Discovery in this case remains to be concluded and
no trial date has been set. Management of the Company believes there are valid
defenses to all the claims that have been made with respect to these activities
and the Company is vigorously defending the pending action. This action is
covered under the Company's professional indemnity program, except for possible
damages under RICO. The Company currently believes the reasonably possible loss
that might result from this action, if any, would not be material to the
Company's financial position or results of operations.
In 1987, the Company sold Shand Morahan & Company (Shand), its domestic
underwriting management subsidiary. Prior to the sale, Shand and its
subsidiaries had provided underwriting management services for and placed
insurance and reinsurance with and on behalf of Mutual Fire Marine & Inland
Insurance Company (Mutual Fire). Mutual Fire was placed in rehabilitation by
the Courts of the Commonwealth of Pennsylvania in December 1986. In February
1991, the rehabilitator commenced an action captioned Foster v. Alexander &
Alexander Services Inc., 91 Civ. 1179 (E.D.Pa.). The complaint, which sought
compensatory and punitive damages, alleged that Shand, and in certain respects,
the Company breached duties to and agreements with, Mutual Fire. The
rehabilitator sought damages estimated at approximately $234 million.
On March 27, 1995, the Company, Shand and the rehabilitator entered into a
settlement agreement which was approved by the courts and which terminated the
rehabilitator's litigation and released the Company and Shand from any further
claims by the rehabilitator. Under the terms of the settlement, the Company
paid $12 million in cash and issued a $35 million six-year zero-coupon note. In
addition, in 1995 Shand returned $4.6 million of trusteed assets to the
rehabilitator and the rehabilitator has eliminated any right of set-offs
previously
52
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
UNAUDITED NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
estimated to be $4.7 million. The Mutual Fire settlement agreement includes
certain features protecting the Company from potential exposure to claims for
contribution brought by third-parties and expenses arising out of such claims.
In April 1996 the Company paid the first installment on the zero-coupon note in
the amount of $5.8 million.
Although the Company's professional liability underwriters have denied
coverage for the Mutual Fire lawsuit, the Company has instituted a declaratory
judgment action attempting to validate coverage (Alexander & Alexander Services
Inc. and Alexander & Alexander Inc. v. Those Certain Underwriters at Lloyd's of
London, subscribing to insurance evidence by policy numbers 879/P. 31356 and
879/P. 35349 and Assicurazioni Generali, S.P.A., No. 92 Civ. 6319 (F.D.N.Y.)).
On October 16, 1996, the Court issued a decision holding that the Company is
not entitled to coverage for the rehabilitator's claims. The Company plans to
appeal the ruling.
Under the 1987 agreement with the purchaser of Shand, the Company agreed to
indemnify the purchaser against certain contingencies, including, among others,
(i) losses arising out of pre-sale transactions between Shand or Shand's
subsidiaries, on the one hand, and Mutual Fire, on the other, and (ii) losses
arising out of pre-sale errors or omissions by Shand or Shand's subsidiaries.
The Company's obligations under the indemnification provisions in the 1987
sales agreement were not limited as to amount or duration.
Starting in late 1992, the purchaser of Shand has asserted a number of claims
under both the Mutual Fire indemnification provision and the errors and
omissions indemnification provision of the sales agreement. During 1995, most
of those claims have been resolved by a series of settlement agreements,
involving the settlement or release of (a) claims relating to reinsurance
recoverables due to Shand's subsidiaries from Mutual Fire, (b) claims relating
to deterioration of reserves for business written by Mutual Fire and ceded to
Shand's subsidiaries, and (c) a number of potential errors and omissions claims
by third-party reinsurers against Shand. Under the settlement agreement entered
into in January 1995, covering the errors and omissions claims by third-party
reinsurers, the Company obtained a release and limitation of indemnification
obligations relating to certain third-party errors and omissions claims, and
restructured the contractual relationship with the purchaser so that the
parties' future interests as to third-party claims are more closely aligned.
The Company paid $14 million in cash, issued a five-year interest bearing note
in the principal amount of $14 million and expected to pay a contingent
obligation of $4.5 million. In June 1995, the $14 million note payable was
prepaid in whole. The remaining contingent note payable of $4.5 million was
paid in full in September 1995.
Notwithstanding these settlements, the limitation of certain contract
obligations and the restructuring of the parties' relationship, some of the
Company's indemnification provisions under the 1987 agreement are still in
effect. As a result there remains the possibility of substantial exposure under
the indemnification provisions of the 1987 agreement, although the Company,
based on current facts and circumstances, believes the possibility of a
material loss resulting from these exposures is remote.
In November 1993, a class action suit was filed against the Company and two
of its then directors and officers, Tinsley H. Irvin and Michael K. White, in
the United States District Court for the Southern District of New York under
the caption Harry Glickman v. Alexander & Alexander Services Inc., et al.
(Civil Action No. 93 Civ. 7594). On January 6, 1995, the plaintiff filed a
second amended complaint which, among other things, dropped Mr. White as a
defendant. The second amended complaint purported to assert claims on behalf of
a class of persons who purchased the Company's Common Stock during the period
May 1, 1991 to November 4, 1993, alleging that during this period the Company's
financial statements contained material misrepresentations as a result of
inadequate reserves established by the Company's subsidiary, Alexander
Consulting Group Inc., for unbillable work-in-progress. The second amended
complaint sought damages in an unspecified amount, as well as attorneys' fees
and other costs, for alleged violations of Sections 10(b) and 20(a) of the
Securities Exchange Act of 1934.
53
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
UNAUDITED NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
In response to the second amended complaint, the Company filed a motion to
dismiss. On March 4, 1996, the Court entered an order granting the Company's
motion to dismiss the action and plaintiff was denied leave to replead.
Following plaintiff's filing a notice of appeal, the parties entered into a
stipulation withdrawing the appeal, which was entered by the court on June 17,
1996, thereby terminating the litigation.
These contingent liabilities involve significant amounts. While it is not
possible to predict with certainty the outcome of such contingent liabilities,
the applicability or availability of coverage for such matters under the
Company's professional indemnity insurance program, or their financial impact
on the Company, management currently believes that such impact will not be
material to the Company's financial position. However, it is possible that
future developments with respect to these matters could have a material effect
on future interim or annual results of operations.
Under the Series B Convertible Preferred Stock Purchase Agreement, as
amended, the Company had agreed to make certain payments to the purchaser
pursuant to indemnifications given with respect to tax payments and reserves in
excess of recorded tax reserves as of March 31, 1994. The Company's potential
exposures under the indemnification, individually or in the aggregate, were
limited to $10 million. As a result of the IRS decision discussed in Note 3,
the Company's Series B Convertible Preferred Stock purchase agreement has been
amended to terminate contingent payment obligations for all remaining
indemnifications given by the Company with respect to tax payments and reserves
for contingent liabilities. Accordingly, the Company increased shareholder
equity by $10 million by reclassifying proceeds from the issuance of the Series
B stock.
10. FINANCIAL INSTRUMENTS
The Company enters into foreign exchange forward contracts and foreign
exchange option agreements primarily to provide risk management against
existing firm commitments as well as anticipated future exposures that will
arise at its London-based specialist insurance and reinsurance broking
operations. The exposures arise because a significant portion of the revenues
of these operations are denominated in U.S. dollars, while their expenses are
primarily denominated in U.K. pounds sterling.
The Company generally sells forward U.S. dollars and purchases U.K. pounds
sterling with settlements of up to two years in the future. Such contracts
provide risk management against future anticipated transactions which are not
firm commitments. In addition, the Company enters into foreign exchange
contracts to manage market risk associated with foreign exchange volatility on
intercompany loans and expected intercompany dividends. Finally, the Company
enters into foreign exchange contracts to effectively offset existing contracts
when anticipated exchange rate movements would benefit the Company.
Gains and losses on foreign exchange forward contracts are marked to market
at each balance sheet date and are included in other current assets or
liabilities, with the resulting gain or loss recorded as a component of other
operating expenses. The fair market value of all foreign exchange forward
contracts at September 30, 1996 was an asset of $1.4 million and a liability of
$0.1 million as of December 31, 1995.
At September 30, 1996 and December 31, 1995, the Company had $87.1 million
and $69.9 million, respectively, notional principal of forward exchange
contracts outstanding, primarily to exchange U.S. dollars into U.K. pounds
sterling, and $34.5 million and $16.3 million, respectively, notional principal
outstanding, primarily to exchange U.K. pounds sterling into U.S. dollars.
Foreign exchange options written by the Company are marked to market at each
balance sheet date and the resulting gain or loss is recorded as a component of
other operating expenses. Future cash requirements may exist if the option is
exercised by the holder. At September 30, 1996, the Company had $20 million
notional
54
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
UNAUDITED NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
principal of written foreign exchange options outstanding. Based on foreign
exchange rates at September 30, 1996 and December 31, 1995, the Company
recognized a current liability of $0.5 million and $0.6 million, respectively,
consisting of unamortized premiums and the estimated cost to settle these
options on those dates.
The Company has entered into interest rate swaps and forward rate agreements,
which are accounted for as hedges, as a means to limit the earnings volatility
associated with changes in short-term interest rates on its existing and
anticipated fiduciary investments. These instruments are contractual agreements
between the Company and financial institutions which exchange fixed and
floating interest rate payments periodically over the life of the agreements
without exchanges of the underlying principal amounts. The notional principal
amounts of such agreements are used to measure the interest to be paid or
received and do not represent the amount of exposure to credit loss. The
Company records the difference between the fixed and floating rates of such
agreements as a component of its fiduciary investment income. Interest rate
swaps and forward rate agreements which relate to debt securities held as
investments by the Company are marked to market in accordance with SFAS No. 115
and are recorded as a separate component of stockholders' equity, net of taxes.
At September 30, 1996, an unrealized gain of $0.3 million on interest rate
swaps and forward rate agreements which hedge existing fiduciary investments
was reflected in fiduciary cash and equivalents in the Consolidated Balance
Sheet.
At September 30, 1996 and December 31, 1995 the Company had the following
interest rate swaps and forward rate agreements in effect, by year of final
maturity:
<TABLE>
<CAPTION>
SEPTEMBER 30, 1996
------------------------------------------
NET WEIGHTED NET WEIGHTED
GROSS AVERAGE GROSS AVERAGE
RECEIVING INTEREST PAYING INTEREST
YEAR FIXED RATE FIXED RATE
---- --------- ------------ ------ ------------
<S> <C> <C> <C> <C>
1996........................... $ 112.8 6.05% $100.6 5.71%
1997........................... 612.0 6.57 156.3 6.12
1998........................... 249.4 6.97 10.0 6.80
1999........................... 101.3 6.73 -- --
-------- ---- ------ ----
Total........................ $1,075.5 6.63% $266.9 5.99%
======== ==== ====== ====
<CAPTION>
DECEMBER 31, 1995
------------------------------------------
NET WEIGHTED NET WEIGHTED
GROSS AVERAGE GROSS AVERAGE
RECEIVING INTEREST PAYING INTEREST
YEAR FIXED RATE FIXED RATE
---- --------- ------------ ------ ------------
<S> <C> <C> <C> <C>
1996........................... $ 390.3 7.38% $471.7 6.27%
1997........................... 203.2 6.68 40.0 5.90
1998........................... 182.9 7.08 -- --
-------- ---- ------ ----
Total........................ $ 776.4 7.13% $511.7 6.24%
======== ==== ====== ====
</TABLE>
The Company generally enters into interest rate swap agreements with a final
maturity of three years or less. The floating rate on these agreements is
generally based upon the six-month LIBOR rate on the relevant reset dates.
Forward rate agreements generally have a final maturity date that is less than
two years, and use six-month LIBOR as the floating rate index.
In addition, as part of its interest rate management program, the Company
utilizes various types of interest rate options, including caps, collars,
floors and interest rate guarantees. The Company generally writes covered
interest rate options under which the Company receives a fixed interest rate.
The options are marked to market at each balance sheet date, based on the
Company's estimated cost to settle the options. The estimated cost to settle
the options, less any premium deferred by the Company, is
55
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
UNAUDITED NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
recognized as a reduction to fiduciary investment income in the period when
such changes in market value occur. The Company recognized a current liability
of $0.5 million and $0.3 million, representing the estimated cost to settle
these options at September 30, 1996 and December 31, 1995, respectively. The
estimated cost to settle these agreements was determined by obtaining quotes
from banks and other financial institutions which make a market in these
instruments.
At September 30, 1996 and December 31, 1995, the Company had the following
written interest rate option agreements outstanding, by year of final maturity:
<TABLE>
<CAPTION>
SEPTEMBER 30, 1996
------------------------------------------
NET WEIGHTED NET WEIGHTED
GROSS AVERAGE GROSS AVERAGE
RECEIVING INTEREST PAYING INTEREST
YEAR FIXED RATE FIXED RATE
---- --------- ------------ ------ ------------
<S> <C> <C> <C> <C>
1996........................... $ 7.8 6.00% $ -- -- %
1997........................... 55.6 6.17 -- --
1998........................... 61.3 7.05 -- --
------ ---- ----- ----
Total........................ $124.7 6.59% $ -- -- %
====== ==== ===== ====
<CAPTION>
DECEMBER 31, 1995
------------------------------------------
NET WEIGHTED NET WEIGHTED
GROSS AVERAGE GROSS AVERAGE
RECEIVING INTEREST PAYING INTEREST
YEAR FIXED RATE FIXED RATE
---- --------- ------------ ------ ------------
<S> <C> <C> <C> <C>
1996........................... $ 43.2 5.41% $10.0 4.60%
1997........................... 15.5 8.50 -- --
1998........................... 10.0 8.50 -- --
------ ---- ----- ----
Total........................ $ 68.7 6.54% $10.0 4.60%
====== ==== ===== ====
</TABLE>
The above financial instruments are purchased from large international banks
and financial institutions with strong credit ratings. Credit limits are
established based on such credit ratings and are monitored on a regular basis.
Management does not anticipate incurring any losses due to non-performance by
these institutions. In addition, the Company monitors the market risk
associated with these agreements by using probability analyses, external
pricing systems and information from banks and brokers.
The following methods and assumptions were used in estimating the fair value
of each class of financial instrument. The fair values of short-term and long-
term investments were estimated based upon quoted market prices for the same or
similar instruments. The fair value of long-term debt, including the current
portion, was estimated on the basis of market prices for similar issues at
current interest rates for the applicable period. The fair value of interest
rate swaps and forward rate agreements was estimated by discounting the future
cash flows using rates currently available for agreements of similar terms and
maturities. The fair value of foreign exchange forward contracts and foreign
exchange option agreements was estimated based upon period-end exchange rates.
The fair value of interest rate options was estimated based upon market quotes
of the cost to settle these agreements. The carrying amounts of the Company's
other financial instruments approximate fair value due to their short-term
maturities.
56
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
UNAUDITED NOTES TO FINANCIAL STATEMENTS--(CONCLUDED)
The following table presents the carrying amounts and the estimated fair
value of the Company's financial instruments that are not carried at fair
value.
<TABLE>
<CAPTION>
AS OF AS OF
SEPTEMBER 30, 1996 DECEMBER 31, 1995
------------------- -------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
-------- ---------- -------- ----------
<S> <C> <C> <C> <C>
Long-term debt, including current
portion......................... $150.1 $148.1 $135.6 $135.8
Interest rate swaps and forward
rate agreements................. -- 2.2 -- 5.1
</TABLE>
57
<PAGE>
PRO FORMA CONSOLIDATED FINANCIAL INFORMATION
The following unaudited pro forma consolidated financial information for Aon
is based on historical financial statements of Aon and of A&A which are
incorporated by reference into this Form 8-K. The unaudited pro forma
condensed consolidated statement of financial position at September 30, 1996
has been prepared as if the acquisition of A&A and the issuance of the Capital
Securities and other financing had been consummated on September 30, 1996, and
the unaudited pro forma condensed consolidated statements of income for the
nine months ended September 30, 1996 and the year ended December 31, 1995 have
been prepared as if the acquisition of A&A and the issuance of the Capital
Securities and other financing had been consummated on January 1, 1995.
Unaudited pro forma financial data do not purport to be indicative of either
the future results of operations or the results of operations that would have
occurred if these transactions had been consummated on the indicated dates.
The pro forma adjustments are based upon available information and certain
assumptions that Aon believes to be reasonable.
58
<PAGE>
AON CORPORATION
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF FINANCIAL POSITION
AS OF SEPTEMBER 30, 1996
(IN MILLIONS)
<TABLE>
<CAPTION>
HISTORICAL
---------------------
ALEXANDER
AON & PRO FORMA PRO FORMA
CORPORATION ALEXANDER ADJUSTMENTS CONSOLIDATED(1)
----------- --------- ----------- ---------------
<S> <C> <C> <C> <C>
ASSETS
Fixed maturities avail-
able for sale........... $ 2,707.4 $ -- $(200.0)(1) $ 2,507.4
Equity securities........ 821.3 -- -- 821.3
Short-term investments... 1,174.2 286.1 -- 1,460.3
Other investments........ 219.6 21.4 -- 241.0
Cash..................... 226.4 758.2 (100.0)(1) 884.6
Brokerage and other re-
ceivables............... 3,920.2 1,200.7 -- 5,120.9
Intangible assets includ-
ing goodwill............ 1,393.4 221.2 850.5 (2) 2,465.1
Assets held under special
contracts............... 305.9 -- -- 305.9
Other assets............. 1,458.6 434.4 -- 1,893.0
--------- -------- ------- ---------
Total Assets......... $12,227.0 $2,922.0 $ 550.5 $15,699.5
========= ======== ======= =========
LIABILITIES AND STOCKHOLD-
ERS' EQUITY
Total policy liabilities. $ 3,795.2 $ -- $ -- $ 3,795.2
Insurance premiums pay-
able.................... 3,394.1 1,775.9 -- 5,170.0
Short term borrowings.... 59.6 21.5 153.0 (1) 234.1
Notes payable and debt
guarantee of employee
stock ownership plan.... 522.9 142.4 -- 665.3
Liabilities held under
special contracts....... 305.9 -- -- 305.9
Other liabilities........ 1,381.2 519.7 60.0 (2) 1,960.9
--------- -------- ------- ---------
Total Liabilities.... 9,458.9 2,459.5 213.0 12,131.4
--------- -------- ------- ---------
Redeemable Preferred Stock. 50.0 -- -- 50.0
Company-obligated
Mandatorily Redeemable
Preferred Capital Securi-
ties of Subsidiary........ -- -- 800.0 (1) 800.0
STOCKHOLDERS' EQUITY
Preferred stock
8% cumulative perpetual
preferred stock....... 5.5 -- -- 5.5
6.25% cumulative
convertible
exchangeable preferred
stock................. 2.1 -- -- 2.1
Series A Preferred
Stock................. -- 2.3 (2.3)(3) --
Series B Preferred
Stock................. -- 4.8 (4.8)(4) --
Common stock............. 111.5 43.4 (43.4) 111.5
Paid-in additional capi-
tal..................... 454.1 666.7 (666.7) 454.1
Retained earnings and
other less treasury
stock................... 2,144.9 (254.7) 254.7 2,144.9
--------- -------- ------- ---------
Total Stockholders'
Equity.............. 2,718.1 462.5 (462.5)(2) 2,718.1
--------- -------- ------- ---------
Total Liabilities and
Stockholders' Equi-
ty.................. $12,227.0 $2,922.0 $ 550.5 $15,699.5
========= ======== ======= =========
</TABLE>
See accompanying notes.
59
<PAGE>
AON CORPORATION
NOTES TO THE PRO FORMA CONDENSED CONSOLIDATED
STATEMENT OF FINANCIAL POSITION
AS OF SEPTEMBER 30, 1996
1. Reflects the acquisition of A&A at a price of $1,253 million and funding
sources for the acquisition as follows (in millions):
<TABLE>
<S> <C>
Sale of fixed maturities........................................ $ 200.0
Issuance of commercial paper.................................... 153.0
Issuance of Capital Securities.................................. 800.0
A&A cash used to finance transaction............................ 100.0
--------
Purchase Price................................................ $1,253.0
========
</TABLE>
The effect of Aon's acquisition of the Bain Hogg Group plc ("Bain Hogg") on
October 18, 1996 is not included. The purchase price was $260 million. Bain
Hogg's total assets as of September 30, 1996 were approximately $1.0 billion.
2. Assumes that Aon's purchase price allocation resulted in additional
goodwill of $850.5 million which was calculated as follows (in millions):
<TABLE>
<S> <C>
Purchase price.................................................. $1,253.0
A&A stockholders' equity........................................ (462.5)
Purchase related liabilities net of tax......................... 60.0
--------
Goodwill........................................................ $ 850.5
========
</TABLE>
3. Assumes that all of the Series A Preferred Stock was converted to cash at
a cost of $121 million to Aon.
4. Reflects the purchase by Aon of all of the Series B Preferred Stock for
$318 million.
60
<PAGE>
AON CORPORATION
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF INCOME
YEAR ENDED DECEMBER 31, 1995
(MILLIONS EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
HISTORICAL
-----------------------
ALEXANDER
AON & PRO FORMA PRO FORMA
CORPORATION ALEXANDER ADJUSTMENTS CONSOLIDATED(1)
----------- --------- ----------- ---------------
<S> <C> <C> <C> <C>
REVENUE
Brokerage commissions
and fees.............. $1,651.3(2) $1,219.5 $ -- $2,870.8
Premiums earned........ 1,426.5 -- -- 1,426.5
Net investment income.. 329.4 82.1 (20.3)(3) 391.2
Realized investment
gains................. 13.1 -- -- 13.1
Other income........... 45.4(2) 32.7 -- 78.1
-------- -------- ------ --------
Total Revenue........ 3,465.7 1,334.3 (20.3) 4,779.7
-------- -------- ------ --------
BENEFITS AND EXPENSES
Commissions and general
expenses.............. 1,982.3 1,147.4 -- 3,129.7
Benefits to policyhold-
ers................... 698.5 -- -- 698.5
Interest expense....... 37.3 18.6 8.2 (4) 64.1
Amortization of de-
ferred policy acquisi-
tion costs............ 207.5 -- -- 207.5
Amortization of intan-
gible assets.......... 82.1 12.3 34.1 (5) 128.5
-------- -------- ------ --------
Total Benefits and
Expenses............ 3,007.7 1,178.3 42.3 4,228.3
-------- -------- ------ --------
INCOME FROM CONTINUING
OPERATIONS BEFORE INCOME
TAX AND MINORITY INTER-
EST..................... 458.0 156.0 (62.6) 551.4
Provision for income
tax (benefit)......... 154.3 60.9 (10.6)(6) 204.6
-------- -------- ------ --------
INCOME FROM CONTINUING
OPERATIONS BEFORE MINOR-
ITY INTEREST............ 303.7 95.1 (52.0) 346.8
Minority interest, in-
cluding subsidiary dis-
tributions.............. -- (5.7) (41.3)(7) (47.0)
-------- -------- ------ --------
INCOME FROM CONTINUING
OPERATIONS............... 303.7 89.4(8) (93.3) 299.8
Preferred stock divi-
dends................... (24.7) (25.4) 25.4 (9) (24.7)
-------- -------- ------ --------
INCOME FROM CONTINUING
OPERATIONS ATTRIBUTABLE
TO COMMON STOCKHOLDERS.. $ 279.0 $ 64.0 $(67.9) $ 275.1
======== ======== ====== ========
Income from continuing
operations per share
attributable to common
stockholders............ $ 2.57 $ 2.53
Average common and common
equivalent shares
outstanding............. 108.7 108.7
</TABLE>
See accompanying notes.
61
<PAGE>
AON CORPORATION
NOTES TO THE PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF INCOME
YEAR ENDED DECEMBER 31, 1995
1. Reflects the acquisition of A&A at a price of $1,253 million and funding
sources for the acquisition as follows (in millions):
<TABLE>
<S> <C>
Sale of fixed maturities........................................ $ 200.0
Issuance of commercial paper.................................... 153.0
Issuance of Capital Securities.................................. 800.0
A&A cash used to finance transaction............................ 100.0
--------
Purchase Price.................................................. $1,253.0
========
</TABLE>
The effect of Aon's acquisition of Bain Hogg on October 18, 1996 is not
included. The purchase price was $260 million. Bain Hogg's revenue and pretax
income for the year ended December 31, 1995 were $333 million and $33 million,
respectively.
The unaudited pro forma condensed consolidated statement of income does not
include the potential effect of one-time restructuring charges which
management of Aon expects to be incurred in the next twelve months in the
range of $100 to $150 million related to the A&A and Bain Hogg acquisitions.
This statement also does not include any anticipated cost savings that may be
realized as a result of the restructuring. Management of Aon estimates cost
savings related to the A&A and Bain Hogg acquisitions should be in excess of
$100 million annually.
2. Certain historical amounts have been reclassified to conform to the
presentation for the nine months ended September 30, 1996.
3. Reflects foregone investment income on cash of $100 million at an assumed
rate of 5.35% held by A&A and on fixed maturities of $200 million at an
assumed rate of 7.5% held by Aon.
4. Reflects interest expense on $153 million of commercial paper at an
assumed rate of 5.35%.
5. Assumes Aon amortizes intangible assets over a 25 year period.
6. Assumes an effective tax rate of 37% on the pro forma adjustments
excluding amortization of intangible assets.
7. Reflects Distributions on the Capital Securities of $65.6 million net of
a tax benefit of $24.3 million.
8. Includes non-recurring revenues of $30.4 million ($20.1 million after
tax) related to A&A's sale of certain operations and non-recurring
restructuring and special charges of $17.6 million.
9. Reflects elimination of the dividends on the Series A Preferred Stock and
the Series B Preferred Stock.
62
<PAGE>
AON CORPORATION
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF INCOME
NINE MONTHS ENDED SEPTEMBER 30, 1996
(MILLIONS EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
HISTORICAL
---------------------
ALEXANDER
AON & PRO FORMA PRO FORMA
CORPORATION ALEXANDER ADJUSTMENTS CONSOLIDATED(1)
----------- --------- ----------- ---------------
<S> <C> <C> <C> <C>
REVENUE
Brokerage commissions
and fees............... $1,368.0 $920.6 $ -- $2,288.6
Premiums earned......... 1,141.4 -- -- 1,141.4
Net investment income... 269.7 57.4 (15.2)(2) 311.9
Realized investment in-
come................... 3.1 -- -- 3.1
Other income............ 36.6 0.6 -- 37.2
-------- ------ ------ --------
Total Revenue......... 2,818.8 978.6 (15.2) 3,782.2
-------- ------ ------ --------
BENEFITS AND EXPENSES
Commissions and general
expenses............... 1,621.4 867.4 -- 2,488.8
Benefits to policyhold-
ers.................... 582.1 -- -- 582.1
Interest expense........ 28.4 11.8 6.1 (3) 46.3
Amortization of deferred
policy acquisition
costs.................. 156.4 -- -- 156.4
Amortization of intangi-
ble assets............. 55.6 11.7 25.5 (4) 92.8
-------- ------ ------ --------
Total Benefits and Ex-
penses............... 2,443.9 890.9 31.6 3,366.4
-------- ------ ------ --------
INCOME FROM CONTINUING
OPERATIONS BEFORE INCOME
TAX AND MINORITY
INTEREST................. 374.9 87.7 (46.8) 415.8
Provision for income tax
(benefit).............. 129.3 35.0 (7.9)(5) 156.4
-------- ------ ------ --------
INCOME FROM CONTINUING OP-
ERATIONS BEFORE MINORITY
INTEREST................. 245.6 52.7 (38.9) 259.4
Minority interest, includ-
ing subsidiary distribu-
tions.................... -- (5.0) (31.0)(6) (36.0)
-------- ------ ------ --------
INCOME FROM CONTINUING OP-
ERATIONS................. 245.6 47.7 (69.9) 223.4
Preferred stock dividends. (15.2) (19.9) 19.9 (7) (15.2)
-------- ------ ------ --------
INCOME FROM CONTINUING OP-
ERATIONS ATTRIBUTABLE TO
COMMON STOCKHOLDERS...... $ 230.4 $ 27.8 $(50.0) $ 208.2
======== ====== ====== ========
Income from continuing op-
erations per share at-
tributable to common
stockholders............. $ 2.11 $ 1.90
Average common and common
equivalent shares
outstanding.............. 109.7 109.7
</TABLE>
See accompanying notes.
63
<PAGE>
AON CORPORATION
NOTES TO THE PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF INCOME
NINE MONTHS ENDED SEPTEMBER 30, 1996
1. Assumes the acquisition of A&A at a price of $1,253 million and funding
sources for the acquisition as follows (in millions):
<TABLE>
<S> <C>
Sale of fixed maturities........................................ $ 200.0
Issuance of commercial paper.................................... 153.0
Issuance of Capital Securities.................................. 800.0
A&A cash used to finance transaction............................ 100.0
--------
Purchase Price................................................ $1,253.0
========
</TABLE>
The effect of Aon's acquisition of Bain Hogg on October 18, 1996 is not
included. The purchase price was $260 million. Bain Hogg's revenue and pretax
income for the nine months ended September 30, 1996 were $245 million and $16
million, respectively.
The unaudited pro forma condensed consolidated statement of income does not
include the potential effect of one-time restructuring charges which
management of Aon expects to be incurred in the next twelve months in the
range of $100 to $150 million related to the A&A and Bain Hogg acquisitions.
This statement also does not include any anticipated cost savings that may be
realized as a result of restructuring. Management of Aon estimates cost
savings related to the A&A and Bain Hogg acquisitions should be in excess of
$100 million annually.
2. Reflects foregone investment income on cash of $100 million held by A&A
at an assumed rate of 5.35% and on fixed maturities of $200 million held by
Aon at an assumed rate of 7.5%.
3. Reflects interest expense on $153 million of commercial paper at an
assumed rate of 5.35%.
4. Assumes that Aon amortizes intangible assets over a 25 year period.
5. Assumes an effective tax rate of 37% on the pro forma adjustments
excluding amortization of intangible assets.
6. Reflects Distributions on the Capital Securities of $49.2 million net of
a tax benefit of $18.2 million.
7. Reflects elimination of the dividends on the Series A Preferred Stock and
the Series B Preferred Stock.
64
<PAGE>
PRO FORMA RATIOS OF EARNINGS TO FIXED CHARGES
The following table sets forth Aon's pro forma ratio of earnings to fixed
charges for the periods indicated.
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
1995 1996
------------ -------------
<S> <C> <C>
Historical ratio of earnings to fixed charges. 6.6 7.6
Pro forma ratio of earnings to fixed charges
(1).......................................... 3.7 4.1
Supplemental pro forma ratio of earnings to
fixed charges (2)............................ 3.4 3.5
</TABLE>
- --------
(1) Gives effect to the increase in fixed charges as a result of the issuance
of the Capital Securities.
(2) Gives effect to the increase in fixed charges as a result of the issuance
of the Capital Securities and the acquisition of A&A as reflected in the
pro forma condensed consolidated statements of income. The supplemental
pro forma ratios exclude any restructuring charges that may be incurred
and any cost savings Aon may realize. See "Pro Forma Consolidated
Financial Information."
65
<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THE
REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE
UNDERSIGNED HEREUNTO DULY AUTHORIZED.
Aon Corporation
/s/ Raymond I. Skilling
By: _________________________________
Name: Raymond I. Skilling
Title: Executive Vice President
and Chief Counsel
DATE: January 29, 1997
66
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NO. PAGE
------- ----
<C> <S> <C>
(c)(1) Agreement and Plan of Merger, dated as of December 11, 1996, *
among Aon, Purchaser and A&A. (Incorporated by reference from
Exhibit (c)(1) to Aon's Tender Offer Statement on Schedule
14D-1 filed by Aon with the Securities and Exchange
Commission ("SEC") on December 16, 1996 (the "Schedule 14D-
1")).
(c)(2) Stock Purchase and Sale Agreement, dated as of December 11, *
1996, between Aon and AIG. (Incorporated by reference from
Exhibit (c)(1) to the Schedule 14D-1).
(c)(3) First Amendment to Agreement and Plan of Merger, dated as of *
January 7, 1997, among Aon, Purchaser and A&A. (Incorporated
by reference from Exhibit (c)(3) to Amendment No. 2 to the
Schedule 14D-1 filed by Aon with the SEC on January 9, 1997).
(c)(4) Press release of Aon dated January 15, 1997. (Incorporated by *
reference from Exhibit (a)(20) to Amendment No. 3 to the
Schedule 14D-1 filed by Aon with the SEC on January 15,
1997).
(c)(5) Consent of Deloitte & Touche LLP. **
</TABLE>
- --------
*Incorporated by reference.
**To be filed by amendment.
67
