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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-K/A
AMENDMENT NO. 1
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
1934
FOR THE FISCAL YEAR PERIOD ENDED DECEMBER 31, 1994
COMMISSION FILE NUMBER 1-8282
ALEXANDER & ALEXANDER SERVICES INC.
(Exact name of registrant as specified in its charter)
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MARYLAND 52-0969822
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
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1185 AVENUE OF THE AMERICAS
NEW YORK, NEW YORK 10036 (212) 840-8500
(Address and telephone number of principal executive offices)
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TABLE OF CONTENTS
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PAGE
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PART II.
Item 3. Legal Proceedings........................................................... 1
Item 7. Management's Discussion and Analysis........................................ 2
Item 8. Consolidated Financial Statements and Supplementary Data.................... 17
PART IV.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K............. 59
SIGNATURES............................................................................. 60
INDEX TO EXHIBITS...................................................................... 61
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ITEM 3. LEGAL PROCEEDINGS
Information previously submitted under this Item 3 is substituted in its
entirety with the following information:
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.
Reference is made to Note 14 of Notes to Financial Statements and MD&A,
which is incorporated herein by reference, as to information concerning the
Company's contingent liabilities.
In addition to the afore-referenced legal proceedings:
In November 1993, a class action suit was filed against the Company and two
of its 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 said 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. The defendants have filed a motion to dismiss the second amended
complaint. Management of the Company believes there are valid defenses to the
allegations set forth in the complaint and the Company intends to vigorously
dispute this claim. 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.
One of the Company's subsidiaries, Thomas A. Greene & Company Inc., now
operating as Alexander Reinsurance Intermediaries, Inc., is one of 31 defendants
named in a series of antitrust actions which were filed beginning in March 1988
by the attorneys general of 18 states and by 20 private parties. All actions
have been consolidated in the United States District Court for the Northern
District of California (In Re Insurance Antitrust Litigation, C-88-1688-WWS
(N.D. Cal.)). The defendants, which include various insurance and reinsurance
companies, reinsurance brokers and trade associations, are alleged to have
manipulated the market for commercial insurance by, among other things,
conspiring to restrict the terms of, and hence the availability of, general
liability insurance. Plaintiffs seek to enjoin further violations and to order a
restructuring of the insurance industry, in addition to recovering damages for
injuries to both public entities and the private party plaintiffs. During the
fourth quarter of 1994, the plaintiffs and the 31 named defendants entered into
an agreement in principle, subject to certain conditions, to settle all
allegations and potential liabilities relating to this litigation. Of the agreed
to aggregate settlement amount of $36 million, of which the amount of each
defendant's contribution is subject to a confidentiality agreement, the
Company's contribution will be the smallest amount to be paid by any of the
defendants and such amount is fully reserved by the Company.
The Company's contingent liabilities involve significant amounts, and while
it is not possible to predict with certainty the outcome of such contingent
liabilities, the applicability of coverage for such matters under the Company's
professional liability programs, or their financial impact on the Company,
management presently believes that such impact will not be material to the
Company's financial condition. 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.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (MD&A)
Information previously submitted under this Item 7 is submitted in its
entirety with the following information:
OVERVIEW
The year 1994 marked major and significant changes for the Company as a
restructuring process was undertaken by the Company's new senior management and
substantially completed. In addition, the Company reduced its financial
exposures to various longstanding litigation and other contingencies and sold
various non-core businesses. These actions included the following:
NEW MANAGEMENT
. Since mid-June 1994 a new senior management team was appointed and ten new
directors were elected.
DIVIDEND REDUCTION
. In June 1994, the quarterly common stock dividend was reduced by 90
percent resulting in an annualized cash savings of over $39 million.
AIG INVESTMENT
. In July 1994, American International Group, Inc. (AIG) invested $200
million in the Company and received 4 million shares of non-voting 8%
Series B Cumulative Convertible Preferred Stock. The net proceeds of $196
million will be used for general corporate purposes.
EXPENSE REDUCTION AND PROCESS IMPROVEMENT
. In July 1994, the Company began a major internal review of all of its
worldwide operations to identify opportunities to reduce costs and enhance
client service.
. The 1995 savings from these reviews are estimated at approximately $100
million before normal inflationary increases. A portion of the savings
will be reinvested into new technology, product development and other
areas associated with service enhancements as well as revenue generation.
. The Company has also undertaken a long-term reengineering process of its
U.S. risk management and insurance services operations to standardize and
automate work processes and increase productivity.
RESTRUCTURING AND OTHER CHARGES
. In the fourth quarter of 1994, management committed to a formal plan of
restructuring and in February 1995, announced a $69 million fourth quarter
1994 restructuring charge, including $25.2 million to consolidate real
estate space requirements at 48 offices worldwide and $43.8 million for
early retirement programs and worldwide workforce reductions of
approximately 1,100 positions. In addition, a $24.9 million provision was
made to settle certain litigation matters and strengthen reserves related
to the Company's professional indemnity programs.
CREDIT FACILITY
. On March 27, 1995, the Company entered into a new $200 million three-year
credit facility with various banks.
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MD&A (CONTINUED)
CONTINGENCY MATTERS
Shand and Mutual Fire Contingencies
. In January 1995, the Company negotiated the settlement of certain
indemnification obligations relating to the 1987 sale of Shand Morahan &
Company, Inc. (Shand). The settlement resulted in a fourth quarter 1994
pre-tax charge of $32.5 million. Under terms of the settlement, the
Company will pay $14 million in cash, issue a five-year interest bearing
note in the principal amount of $14 million and expects to pay a
contingent obligation of $4.5 million.
. On March 27, 1995, the Company, Shand and the rehabilitator of Mutual
Fire, Marine and Inland Insurance Company (Mutual Fire) entered into a
settlement agreement, which if approved by the courts, would terminate the
rehabilitator's litigation and release the Company and Shand from any
further claims by the rehabilitator. In the fourth quarter of 1994, the
Company increased its previously established reserves of $10 million based
on an estimated settlement amount, and recorded a pre-tax charge of $37.2
million ($24.2 million after-tax or $0.55 per share).
Discontinued Operations
. In July 1994, the Company entered into an insurance-based financing
contract (finite risk contract) with Centre Reinsurance (Bermuda) Limited
(reinsurance company) that affords protection for certain long-tailed
exposures included in the Company's discontinued operations. The contract
provided for a payment of $80 million by the Company ($50 million of which
was subsequently borrowed from the reinsurance company) and for payment by
the Company of the first $73 million of claims. The Company recorded a $6
million charge in 1994 representing the amount of the payment that
exceeded the recoverable portion of existing reserves.
. In December 1994, the Company resolved certain indemnity obligations
related to the 1987 sale of Sphere Drake Insurance Group (Sphere Drake).
The Company provided a $20.9 million loss from discontinued operations in
the third quarter of 1994 related to this agreement.
Other Contingencies
. In February 1995, the Company settled a 1985 lawsuit by the Pine Top
Insurance Company ending litigation seeking compensatory, punitive and
other damages of over $87 million. The amount of the settlement was not
material and was previously reserved by the Company.
SALES OF NON-CORE BUSINESSES
. In November 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 and a pre-tax gain of $20.2 million was reflected
in the fourth quarter of 1994 results.
. 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.
The gain will be reflected in the first quarter of 1995.
. In February 1995, the Company completed the sale of Alexsis, Inc., its
U.S.-based third-party administrator operation, for total cash proceeds of
$47.1 million. The pre-tax gain on this transaction will approximate $30
million and will be reflected in the first quarter of 1995.
These actions were implemented to lay a foundation for improved, sustainable
earnings and to substantially reduce the Company's financial exposure to
litigation and other contingencies.
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MD&A (CONTINUED)
OUTLOOK
The Company's insurance broking revenues are generally affected by premium
rates charged by insurance companies in the property and casualty markets and
the overall available market capacity. Since the mid-to-late 1980s, commission
and fee growth has been constrained due to soft pricing and excess capacity and
the resultant intense competition among insurance carriers and brokers for
market share. Lower interest rates have reduced investment income earned on
fiduciary funds.
The Company's restructuring and related initiatives in part reflect
management's view that insurance premium pricing will not improve significantly
in the foreseeable future. Revenue growth will depend increasingly on the
development of new products and services and new business generation. In
addition, interest rates are expected to increase moderately in the U.S. and
U.K.
During 1995, the Company will also explore geographical market expansion and
further industry specialization as well as consider possible niche and
substantial strategic acquisitions. As part of its evaluation of opportunities,
the Company engages with interested parties in discussions concerning possible
transactions. The Company has evaluated and is evaluating such opportunities and
prospects and will continue to do so throughout 1995. The Company cannot predict
if any transaction will be consummated, nor the terms or form of consideration
required.
Revenue growth from the Company's human resource management consulting
operations was impacted by uncertainty over health care reform in the U.S. Many
clients postponed or reduced planned employee benefit reviews while waiting to
analyze the impact of the potential governmental health care proposals. The
Company anticipates moderate revenue growth in 1995 as corporations recognize
that any such proposals are not likely to affect their efforts to redesign and
streamline employee benefit packages.
Overall comparable operating expenses are expected to decline in 1995
resulting from implementing the plan of restructuring and other expense
initiatives, including employee benefit cost reductions, stringent travel and
entertainment policies, elimination of certain employee perquisites and the
consolidation of vendor and supply management. The Company has estimated that
approximately $100 million of expense savings will be realized from these
efforts; however, approximately one-half of such savings will be offset by
investments in new technology, products and personnel to support revenue growth
as well as normal inflationary increases.
SUMMARY
The Company reported a net loss of $138.7 million, or $3.51 per share for
1994. Included in the results were after-tax charges for restructuring,
contingency settlements and other reserves of $106.6 million, or $2.43 per
share; an after-tax gain of $12.5 million, or $0.28 per share, from the sale of
the Company's U.S.-based personal lines insurance broking business, and
after-tax charges of $28.9 million, or $0.66 per share, relating to certain
indemnity obligations and exposures of the Company's discontinued operations.
In 1993, net income was $26.9 million, or $0.48 per share, including
after-tax gains of $2.3 million, or $0.05 per share, from the sale of three
small operations and a gain relating to a cumulative effect adjustment of $3.3
million, or $0.08 per share, from a change in accounting for income taxes.
In 1992, the Company incurred a net loss of $87.9 million, or $2.03 per
share, including a loss from discontinued operations of $145 million, or $3.35
per share; after-tax gains from the sale of three non-core businesses of $28.5
million, or $0.66 per share, and after-tax special charges of $13.9 million, or
$0.32 per share, relating to the costs of indemnities provided to the purchaser
of a former Company operation.
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MD&A (CONTINUED)
The following discussion and analysis of significant factors affecting the
Company's operating results and liquidity and capital resources should be read
in conjunction with the accompanying financial statements and related notes.
CONSOLIDATED
OPERATING REVENUES
Consolidated operating revenues decreased in 1994 by $17.7 million, or 1.3
percent, compared to a decrease of $27.9 million, or 2 percent, in 1993. Revenue
comparisons were impacted by both foreign currency fluctuations and the effects
of acquisitions and dispositions. After adjusting for the effect of these items,
total revenues decreased $17.4 million in 1994 compared to 1993 levels.
Total 1993 revenues were negatively impacted by $57.7 million due to
appreciation of the U.S. dollar against most of the major currencies of the
Company's international operations and decreased another $8.2 million as a
result of operations sold in 1992. Excluding the effect of these items, total
1993 revenues increased by $38 million over 1992 levels.
Commissions and Fees
Total 1994 commissions and fees decreased from 1993 by $15.4 million, or 1.2
percent, compared to a $9.3 million, or 0.7 percent, decrease in 1993 versus
1992. The sale of non-core operations reduced revenues in the comparable periods
and foreign exchange rates had a negative effect of $54.3 million in 1993. When
adjusted for these items, total commissions and fees decreased by $8 million, or
0.6 percent, in 1994 after increasing $53.2 million, or 4.1 percent, in 1993.
Fiduciary Investment Income
Investment income earned on fiduciary funds decreased by $2.3 million, or
4.3 percent, in 1994 primarily due to lower average investment levels,
particularly in the U.S. In 1993, fiduciary investment income declined by $18.6
million, or 25.7 percent, primarily due to lower average interest rates
worldwide, especially in the U.S. and U.K.
The Company enters into interest rate swaps and forward rate agreements to
limit the earnings volatility associated with changes in short-term interest
rates on its existing and anticipated fiduciary investments with maturities of
three months or less. 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. During 1994, the Company
entered into an increased notional amount of interest rate swaps and forward
rate agreements in order to maintain and extend for a period of time the
increase in interest rates experienced during 1994. These interest rate swap and
forward rate agreements and interest rate options increased the Company's
fiduciary investment income by $0.2 million in 1994, $2.2 million in 1993 and
$3.4 million in 1992. For additional information relating to the Company's
interest rate financial instruments, see Note 12 of Notes to Financial
Statements.
OPERATING EXPENSES
Consolidated operating expenses increased by $117.5 million, or 9.1 percent,
in 1994 compared to a $5.3 million, or 0.4 percent, increase in 1993. Excluding
the restructuring charges described below, total operating expenses increased in
1994 by $48.5 million, or 3.8 percent. Expense comparisons reflect both foreign
currency fluctuations and the effects of acquisitions and dispositions. In 1994,
total operating expenses increased by $44 million after adjusting for these
items.
In 1993 versus 1992, consolidated operating expenses were favorably impacted
by $66.3 million as a result of lower foreign exchange rates and hedging gains.
Operations sold in 1992 also reduced
5
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MD&A (CONTINUED)
operating expenses in 1993 by $1.8 million. Excluding the effect of foreign
exchange variances and sold businesses, total operating expenses increased by
$73.4 million over 1992 levels.
Salaries and Benefits
Consolidated salaries and related benefits increased by $29 million, or 3.7
percent, in 1994 compared to a decrease of $19.2 million, or 2.4 percent, in
1993. The 1994 increase reflects $10.1 million of additional incentive and
benefit expenses in 1994 representing a combination of amendments to existing
incentive plans, payments required to certain employees in the U.K. due to the
modification of employment terms and a special compensation award to a director.
Also contributing to the 1994 change were an additional $9.1 million of
salaries and benefits resulting from the 1993 Mexico acquisition and from the
November 1993 pooling of interests acquisition of Clay & Partners (Clay). Prior
to the acquisition, Clay operated as a partnership and its operations did not
reflect partner draws as salary expense. Excluding the effects of these items
and a decrease due to the effect of operations sold in 1993, salaries and
benefits increased $13.6 million over 1993 levels.
The 1993 decline was primarily attributable to lower foreign exchange rates,
offset by slightly higher staff costs in local currency terms.
Staff costs for the comparable periods also reflect normal salary
progressions and higher benefit costs, partially offset by declines in headcount
of 8.3 percent and 2.7 percent in 1994 and 1993, respectively. Performance-based
incentive costs declined by $4.8 million and $6.7 million in 1994 and 1993,
respectively.
Other Operating Expenses
Consolidated other operating expenses increased by $19.5 million, or 3.9
percent, in 1994 compared to an increase of $24.5 million, or 5.1 percent in
1993. Excluding the negative impact of changes in foreign exchange rates and
acquisitions and dispositions, other operating expenses increased by $15.8
million in 1994 versus 1993. The 1994 increase includes higher insurance costs
of $17.1 million.
In 1994, the Company provided $29.2 million, including $24.9 million in the
fourth quarter, of additional reserves relating to the settlement of certain
large litigation matters and reserve strengthening. In 1993, a provision of
$15.9 million was made for similar items. In addition, higher system development
costs were reflected in 1994 due to the standardization and automation efforts
underway in the U.S. The 1993 increase reflected higher insurance costs, travel
and entertainment expenses and systems development costs, offset by lower
foreign exchange rates.
Insurance costs reflect higher third-party insurance premiums and
self-insurance reserves for the Company's professional indemnity programs. The
Company believes its insurance-related reserves are sufficient to cover
potential claims and liabilities; however, there is no assurance that escalating
litigation costs and awards, as well as insurance company insolvencies, will not
have an adverse impact on the future overall costs of insurance coverages.
Effective January 1, 1993, the Company adopted SFAS No. 106, "Employers'
Accounting for Postretirement Benefits Other than Pensions" for its U.S. plans.
In 1991, the Company adopted the provisions of SFAS No. 106 relating to deferred
compensation 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
Company has elected to amortize the initial postretirement benefit obligation of
$14 million over a period of twenty years. The Company's
6
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MD&A (CONTINUED)
cash flows were not affected by the implementation of this statement, and the
impact to the results of operations have not been significant.
Restructuring Charges
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 includes
$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 are in the U.S.
The severance portion of the charge amounted to $22.9 million and reflects
the elimination of 898 positions worldwide. The voluntary early retirement
program was accepted by 208 employees prior to December 31, 1994 and amounted to
$20.9 million of the charge. Approximately $5.7 million of these liabilities
were paid in 1994 with a substantial majority of the remainder expected to be
paid in 1995.
The charge associated with real estate activities relates to the closure,
abandonment and downsizing of office space throughout the global operations,
including 34 locations in the U.S. The Company anticipates that these actions
will be essentially completed by the end of 1995. The costs include primarily
remaining lease obligations and write-offs of leasehold improvements and fixed
assets. Approximately $1.2 million of these liabilities were paid in 1994. The
cash portion of the remaining liabilities, excluding the fixed asset and
leasehold improvement write-offs of approximately $5.2 million, will be paid out
over the remaining lease periods, which range from one to ten years.
OTHER INCOME (EXPENSES)
Investment Income
Investment income earned on operating funds increased by $1.3 million, or
13.5 percent, in 1994 compared to a decrease of $2.4 million, or 20 percent, in
1993. The 1994 increase is due primarily from interest income earned on the
proceeds from the July issuance of preferred stock. The 1993 decrease reflected
significantly lower short-term interest rates throughout most of the major world
markets in comparison to 1992.
Interest Expense
Interest expense increased by $1.6 million, or 11.1 percent, in 1994
compared to a decrease of $3.6 million, or 20 percent, in 1993. The 1994
increase is due primarily to a higher debt level associated with the $50 million
borrowing in mid-1994 relating to a contract with a reinsurance company. The
1993 decrease reflected significantly lower worldwide interest rates and a
decrease in average debt compared to 1992 levels.
Other
Other non-operating income (expenses) consists of the following:
FOR THE YEARS ENDED
DECEMBER 31,
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1994 1993 1992
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Gains on sales of businesses....................... $ 20.2 $ 3.9 $43.8
Litigation costs................................... (9.1) (20.2) (5.8)
Other.............................................. (0.2) 0.7 1.9
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$ 10.9 $(15.6) $39.9
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MD&A (CONTINUED)
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 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.
During 1992, the Company sold three non-core businesses, including a
U.K.-based pension fund management operation, a Netherlands-based non-broking
operation and a U.S.-based administrator of workers' compensation funds. Total
proceeds on these sales were $77.4 million with resulting pre-tax gains of $43.8
million ($28.5 million after-tax or $0.66 per share).
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.
Special Charges
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 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, which is subject to court approval, relating to lawsuits
and other disputes brought against the Company and others by the rehabilitator
of Mutual Fire. The resolution of these contingencies reflected management's
view, based upon discussion with the respective counterparties in the latter
part of the fourth quarter of 1994, that negotiated settlements would be more
cost-effective than protracted litigation. For further information relating to
these matters, see Note 14 of Notes to Financial Statements.
In 1992, the Company recorded a $16.5 million pre-tax charge ($13.9 million
after-tax, or $0.32 per share) associated with the sale of Shand. The provision
reflected the estimated cost of indemnities provided to the purchasers of Shand,
including $10 million associated with the Mutual Fire lawsuits and other
disputes.
INCOME TAXES
At December 31, 1994, the Company has a net deferred tax asset balance of
$136.7 million which is comprised of net deferred tax assets in the U.S. of
$152.7 million offset by net deferred tax liabilities of $16 million outside the
U.S. The deferred tax asset is net of a $36.7 million valuation allowance
primarily relating to foreign and U.S. state net operating loss and capital loss
carryforwards. The valuation allowance represents approximately 90 percent of
these carryforwards. At this time the Company believes that it is more likely
than not that this portion of these deferred tax assets will not be realized.
The valuation allowance increased in 1994 by a net amount of $13.6 million,
principally due to increases in U.S. state net operating losses and foreign
capital losses.
A substantial portion of the net deferred tax asset relates to various
financial statement expenses and accruals, primarily in the U.S., that will not
be tax deductible until paid. These costs, which will be paid in future years,
principally include restructuring costs, contingency settlements, deferred
compensation expenses, professional indemnity costs, and pension and other
employee benefit expenses. The net deferred tax asset also includes $26.7
million relating to a $76.2 million U.S. federal net operating loss carryforward
generated in 1994 which will expire in the year 2009, U.S. federal foreign tax
credit carryforwards totaling $8.8 million, portions of which expire in 1998 and
1999, and U.S. federal alternative minimum tax credits of $5.2 million which can
be carried forward indefinitely. The Company expects that sufficient taxable
income will be generated in future years to realize these carryforwards, and
therefore, the Company believes a valuation allowance is not necessary for these
amounts.
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MD&A (CONTINUED)
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 Company will report on its 1995 U.S. federal income tax return
gains totaling an estimated $50 million with respect to the sales of its
personal lines business and its Alexsis subsidiary. Based on 1994 results,
excluding nonrecurring items and sold subsidiaries and businesses, with an
estimated 8.5% reduction in U.S. operating costs as a result of the Company's
restructuring in 1994, the net U.S. deferred tax asset would be realized with
average annual growth in U.S. operating revenues and pre-tax income of less than
two percent.
As discussed in Note 5 of Notes to Financial Statements, the Company is
currently under examination by the IRS for years 1990 and 1991. It is not
expected that the examination will have any effect on realization of the 1994
carryforward.
The Company files a consolidated U.S. federal income tax return which
includes the losses of its U.S. discontinued operations. A reconciliation of the
book to taxable income/(loss carryforward) for the Company's U.S. operations is
as follows:
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FOR THE YEARS ENDED
DECEMBER 31,
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1994 1993 1992
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Income (loss) before taxes........................................ $(200.9) $(74.2) $(39.2)
Amortization of goodwill........................................ 4.2 4.8 4.5
Depreciation.................................................... 6.6 5.4 5.7
Tax leases...................................................... 7.0 7.6 6.8
Dispositions of subsidiaries/businesses......................... (19.2) (8.5) (1.8)
Contingency settlements......................................... 69.7 -- 16.5
Restructuring expenses.......................................... 25.8 (2.9) (29.7)
Repatriation of foreign earnings................................ 9.3 131.0 191.9
Other, including accruals not currently deductible.............. 26.1 39.9 34.7
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Taxable income/(loss carryforward) from continuing operations..... (71.4) 103.1 189.4
Taxable income/(loss) from discontinued operations................ (4.8) 4.6 (1.6)
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U.S. taxable income/(loss carryforward)........................... $ (76.2) $107.7 $187.8
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The Company's effective tax (benefit) rates were (29) percent, 20 percent,
and 42.8 percent in 1994, 1993 and 1992, respectively. These rates compare to
the U.S. statutory rate of 35 percent in 1994 and 1993 and 34 percent in 1992.
The effective tax rates were negatively impacted by certain expenses which were
not deductible in the jurisdictions in which the Company conducts business.
These expenses include amortization of goodwill and entertainment expenses.
Offsetting these factors are state and local tax benefits on losses generated in
the U.S. operations as well as foreign tax rates lower than the U.S. statutory
rate in 1994 and 1993.
The recognition of a $3.5 million tax benefit associated with a prior year
capital loss decreased the Company's 1993 effective tax rate as a result of
capital gains generated in 1993. The effective tax rates in 1993 and 1992 were
also favorably impacted by the results of Clay & Partners, a U.K. based
actuarial consulting operation acquired in 1993 in a pooling of interests
transaction. Prior to the merger, Clay operated as a partnership and
accordingly, its results did not reflect corporate income taxes of approximately
$1.9 million and $2.1 million in 1993 and 1992, respectively.
As discussed in Note 5 of Notes to Financial Statements, the Company was
advised during 1994 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
9
<PAGE>
MD&A (CONTINUED)
the amounts due for years 1980 through 1989 and charged the tax and net interest
totaling $35.6 million against previously established reserves.
In 1994, the Company received a Notice of Proposed Adjustment from the IRS
in connection with the examination of its 1990 and 1991 U.S. federal income tax
returns, proposing an increase in taxable income for the 1991 year which, if
sustained, would result in additional tax liability estimated by the Company at
$50 million. This proposed adjustment relates to intercompany transactions
involving the stock of a U.K. subsidiary.
As discussed in Note 5 of Notes to Financial Statements, the Company
disagrees with the IRS position on this issue. Although the ultimate outcome of
the matter cannot be predicted with certainty, the Company and its independent
tax counsel believe there are meritorious defenses to the proposed adjustment
and substantial arguments to sustain the Company's position and that the Company
should prevail in the event this issue is litigated. A similar set of
transactions occurred in 1993 for which the IRS could propose an increase in
taxable income which would result in an additional tax liability estimated by
the Company at $25 million. 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.
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 plc (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.
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
cleanup (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 data and have used various projection techniques
to estimate the insurance liabilities, consisting principally of incurred but
not reported losses.
On July 1, 1994, the Company entered into a finite risk contract providing
protection primarily for exposures relating to Orion, Syndicate 701 and Swann &
Everett. The contract provided for a payment by the Company of $80 million ($50
million of which was borrowed from the reinsurance company) to the reinsurance
company and for payment by the Company of the first $73 million of paid claims.
The
10
<PAGE>
MD&A (CONTINUED)
contract entitles the Company to recover paid claims in excess of the Company's
$73 million retention. At December 31, 1994, the recoveries were limited to
$108.3 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 recorded a $6 million charge in the second
quarter of 1994 representing the amount of the payment that exceeded the
recoverable portion of existing reserves.
Insurance liabilities in excess of recorded liabilities could develop in the
future. Based on independent actuarial estimates of the amount and timing of
claim payments, it is reasonably possible that such additional liabilities, net
of estimated amounts recoverable for paid losses under the finite risk
contracts, could amount to $74 million. However, management currently believes
that such additional insurance liabilities are not likely to develop.
The Company believes that, based on current estimates, the established total
net liabilities of discontinued operations are sufficient to cover its
exposures. However, there is no assurance that further adverse development may
not occur due to variables inherent in the estimation processes and other
matters described above. The Company currently believes that the effect of such
adverse development, if any, will not be material to the Company's financial
position and results of operations.
In December 1994, the Company entered into an agreement to resolve certain
indemnity obligations to Sphere Drake. 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. The Company recorded a $20.9 million loss from
discontinued operations in the third quarter in connection with this agreement.
CUMULATIVE EFFECT ADJUSTMENTS
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' service 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. The increase to the annual cost of
providing such benefits will not be significant.
Effective January 1, 1993, the Company adopted SFAS No. 109, "Accounting for
Income Taxes." The cumulative effect of adopting this standard increased net
income in the first quarter of 1993 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.
11
<PAGE>
MD&A (CONTINUED)
SEGMENT INFORMATION
INSURANCE SERVICES
Operating results for the Insurance Services segment of the Company's
operations are summarized below:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------
1994 1993 1992
-------- -------- --------
<S> <C> <C> <C>
Operating Revenues:
Risk management and insurance services broking.............. $ 816.4 $ 832.7 $ 827.2
Specialist insurance and reinsurance broking................ 245.4 242.3 229.5
Fiduciary investment income................................. 51.4 53.6 72.3
-------- -------- --------
Total operating revenues................................ 1,113.2 1,128.6 1,129.0
-------- -------- --------
Operating expenses:
Operating expenses.......................................... 1,069.1 1,035.7 1,042.9
Restructuring charges....................................... 56.3 -- --
-------- -------- --------
Total operating expenses................................ 1,125.4 1,035.7 1,042.9
-------- -------- --------
Operating income (loss)....................................... $ (12.2) $ 92.9 $ 86.1
-------- -------- --------
-------- -------- --------
</TABLE>
RISK MANAGEMENT AND INSURANCE SERVICES BROKING REVENUES
Worldwide risk management and insurance services broking commissions and
fees decreased $16.3 million, or 2 percent, in 1994 compared to a $5.5 million,
or 0.7 percent, increase in 1993. Foreign exchange rate variances negatively
impacted such revenues by $1 million and $27.5 million in 1994 and 1993,
respectively.
Broking revenues in the U.S. decreased by $29.7 million in 1994 compared to
1993 reflecting the continued softness in certain insurance markets and lost
business. Partially offsetting the U.S. decline were revenue increases for
certain of the Company's international risk management and insurance services
operations. Particularly, there was an increase of $13.2 million in the Latin
America operations, primarily from the 1993 Mexico acquisition, and also
increases of $5.3 million and $3.7 million occurred in the Europe and Canada
operations, respectively. These increases were due primarily to new business
production. Furthermore, operations sold in 1993, primarily in the U.S., served
to reduce 1994 broking revenues by $7.9 million.
The decrease in 1993 broking revenues compared to 1992 was primarily
attributable to reduced property and casualty premium rates in North America,
coupled with the impact of unfavorable economic conditions which limited revenue
growth. These effects were partially offset by new business production and
moderate firming of premium rates in certain international markets.
SPECIALIST INSURANCE AND REINSURANCE BROKING REVENUES
To achieve operational efficiencies, in late 1994 the specialist insurance
broking and reinsurance broking operations committed to merge their operations
into one business unit, headquartered in London. Prior to the merger, they
operated as independent business units.
Total 1994 broking commissions and fees increased $3.1 million, or 1.3
percent, versus 1993 levels. This compares to an increase of $12.8 million, or
5.6 percent, in 1993. Changes in foreign exchange rates increased 1994 broking
revenues by $0.9 million and decreased 1993 broking revenues by $15.6 million.
Selected premium rate increases and new business in the Company's
international operations, particularly in Canada, France, Asia-Pacific and Latin
America were substantially offset by a decline in the U.S. The increase in 1993
broking revenues over 1992 levels was fueled by strong new business
12
<PAGE>
MD&A (CONTINUED)
production and premium rate increases in most non-U.S. markets, especially in
the U.K. and Asia-Pacific operations.
The Company enters into foreign exchange forward contracts and foreign
exchange option agreements primarily to provide risk management against future
exposures that 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.
Gains and losses on contracts which are designated as hedges of firm
commitments are deferred until the settlement dates. Contracts which are not
designated as hedges 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, 1994 was $2.6 million. For
additional information relating to the Company's foreign exchange financial
instruments, see Note 12 of Notes to Financial Statements.
These foreign exchange contracts are generally purchased from large
international banks and financial institutions with strong credit ratings.
Credit limits are established based upon the credit ratings of such institutions
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 foreign exchange and options
contracts by using probability analysis, external pricing systems and
information from banks and brokers.
FIDUCIARY INVESTMENT INCOME
Investment income earned on fiduciary funds decreased by $2.2 million in
1994 primarily due to lower average investment levels, particularly in the U.S.,
and decreased by $18.7 million in 1993 primarily due to lower worldwide interest
rates, particularly in the U.S. and U.K.
OPERATING EXPENSES
Worldwide risk management and insurance services operating expenses,
excluding $40.2 million of restructuring charges, increased by $18.4 million, or
2.2 percent, in 1994 compared to a decrease of $2.6 million, or 0.3 percent in
1993. Foreign exchange rate changes, including hedging contracts gains and
losses, increased expenses by $7.9 million in 1994 and reduced expenses by $37.8
million in 1993. Contributing to the 1994 increase were higher insurance costs
and increased operating expenses of $13 million in the Latin America operations,
primarily due to the 1993 Mexico acquisition, somewhat offset by a decline in
expenses of $8.9 million for operations sold in 1993. Reductions in 1993
expenses resulting from the favorable effect of foreign exchange rates were
offset by higher insurance costs, travel and entertainment expenses and systems
development costs in comparison to 1992 levels.
Operating expenses, excluding $16.1 million of restructuring charges, for
the specialist insurance and reinsurance broking operations increased by $15
million, or 7.1 percent, in 1994 compared to a decrease of $4.6 million, or 2.1
percent, in 1993. Foreign exchange rate variances, including hedging gains and
losses, favorably impacted expenses by $1.9 million and $19 million in 1994 and
1993, respectively. A significant portion of the 1994 operating expense increase
was due to certain additional incentive and benefit expenses in the U.K.
operations arising from amendments to existing incentive plans and payments
required to its employees as a result of modification of employment terms. The
1993 decrease was primarily the result of the aforementioned favorable effect of
foreign exchange rates partially offset by increased expenses in the U.K.
operations.
13
<PAGE>
MD&A (CONTINUED)
HUMAN RESOURCE MANAGEMENT CONSULTING
Operating results for the Human Resource Management Consulting segment of
the Company's operations are summarized below:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
--------------------------
1994 1993 1992
------ ------ ------
<S> <C> <C> <C>
Operating revenues:
Commissions and fees............................................ $210.5 $212.7 $240.3
Fiduciary investment income..................................... 0.2 0.3 0.2
------ ------ ------
Total operating revenues.................................... 210.7 213.0 240.5
------ ------ ------
Operating expenses:
Operating expenses.............................................. 221.5 220.5 209.7
Restructuring charges........................................... 8.3 -- --
------ ------ ------
Total operating expenses.................................... 229.8 220.5 209.7
------ ------ ------
Operating income (loss)........................................... $(19.1) $ (7.5) $ 30.8
------ ------ ------
------ ------ ------
</TABLE>
Human resource management consulting commissions and fees decreased by $2.2
million, or 1 percent, in 1994 compared to a decrease of $27.6 million, or 11.5
percent in 1993. The impact of changes in foreign exchange rates on such
revenues was an increase of $0.6 million and a decrease of $11.1 million for
1994 and 1993, respectively. Contributing to the 1994 decrease was a shortfall
in the U.K. operations of $5.3 million, primarily due to recent legislation in
the U.K. which requires commission disclosure to clients on financial services
products. In 1993 versus 1992, revenue production was negatively influenced by
the uncertainty surrounding health care reform in the United States and 1993
levels also decreased by $8.2 million as a result of an operation sold in 1992.
Operating expenses, excluding $8.3 million of restructuring charges,
increased by $1 million, or 0.5 percent, in 1994 compared to an increase of
$10.8 million, or 5.2 percent in 1993. The impact of changes in foreign exchange
rates on total operating expenses was an increase of $0.2 million and a decrease
of $9.5 million for 1994 and 1993, respectively. Contributing to the 1994
increase were higher salary costs in the U.K. from the Clay acquisition, which
operated as a partnership in 1993, partially offset by decreases in the total
operating expenses of the U.S. operations due primarily to one-time expenses
reflected in the 1993 results. In comparison to 1992, total operating expenses
in 1993 were also reduced by $1.8 million as a result of an operation sold in
1992.
LIQUIDITY AND CAPITAL RESOURCES
In 1994, the Company changed its presentation of cash flows to distinguish
fiduciary balances from operating balances. The Company believes that this
presentation provides more useful information regarding cash flows that are
available for general corporate purposes.
At December 31, 1994, the Company' operating cash and cash equivalents
totaled $248.7 million, a $97.2 million increase over the 1993 year-end balance.
In addition, the Company had $83.3 million of operating funds invested in short
and long-term investments at December 31, 1994.
Operating Activities
The Company's funds from operating activities consist primarily of net
income adjusted for non-cash items, including depreciation and amortization,
deferred income taxes, gains on sales of business and, in 1994, restructuring
and other special charges as well as changes in working capital balances. In
addition, the net cash flows relating to discontinued operations are included.
In 1994, the Company's operating activities provided $63.4 million of operating
funds.
14
<PAGE>
MD&A (CONTINUED)
The 1994 charges for restructuring required $6.9 million of cash payments
during 1994. The Company anticipates that approximately $35.4 million of the
remaining balance of $62.1 million will be funded in 1995.
The $69.7 million of special charges recorded in 1994 did not require a cash
funding. The terms of the settlement relating to Shand will result in cash
requirements of approximately $14 million in 1995 and a $18.5 million increase
in long-term debt. The Company anticipates that the 1995 net cash requirements
relating to Mutual Fire will approximate $9 million with the remainder
represented by additional long-term debt.
Investing Activities
The Company's net capital expenditures for property and equipment and
acquisitions were $26.2 million and $47 million during 1994 and 1993,
respectively. Capital expenditures for property and equipment remained stable as
the Company continued with its investment in redesigning work processes and
enhancing systems technology. The 1993 expenditures included $16.4 million for
an acquisition in Mexico. As a result of the devaluation of the Mexican peso in
late 1994, the Company's accumulated translation adjustment balance for its
Mexican operation reflected an unrealized loss of $6.2 million at December 31,
1994. 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 permanently impaired.
Of the $30.2 million proceeds from the November 1994 sale of the U.S.-based
personal lines business, $1 million was received in 1994 and the remaining $29.2
million in January 1995. In addition, the Company received $7.2 million in
January 1995 from the sale of its minority interest in a U.K. merchant bank and
$47.1 million from the sale of Alexsis Inc. in February 1995.
Financing Activities
The decline in cash dividend payments reflects the reduction in the
Company's common stock dividend by 90 percent. The estimated annualized savings
from this action is approximately $39 million. In addition, dividends on the
Company's Series B Preferred Shares are payable in kind (additional preferred
shares) until December 15, 1996 and thereafter, at the election by the Board of
Directors, until December 15, 1999.
At December 31, 1994 the Company had a $150 million credit agreement with
various banks which would have expired in July 1995. The Company had full access
to such funds and had no borrowings outstanding at December 31, 1994. At
December 31, 1994, the Company was in technical default on two financial
covenants under this agreement and was granted a waiver with respect to
compliance with such covenants.
Supplementing the credit agreement, the Company has unsecured lines of
credit available for general corporate purposes totaling $97.7 million, of which
$97 million were unused at December 31, 1994. These lines consist of uncommitted
cancellable facilities in the U.S. and other countries. If drawn, the lines bear
interest at market rates and carry annual commitment fees of not greater than
1/2 percent of the line.
On March 27, 1995, the Company's existing credit agreement was cancelled and
replaced by a new $200 million three-year facility with various banks which
expires in March 1998. See Note 8 of Notes to Financial Statements for further
information regarding this credit agreement.
On July 15, 1994, pursuant to the terms of the AIG Agreement, AIG purchased
from the Company 4,000,000 shares of Series B Convertible Preferred Shares at a
purchase price of $50 per share for a total purchase price of $200,000,000. Such
proceeds, net of approximately $3.8 million of related expenses, are available
for general corporate purposes, of which $30 million has been used to
15
<PAGE>
MD&A (CONTINUED)
fund the finite risk contract relating to discontinued operations. For
additional information relating to the AIG Agreement, see Note 10 of Notes to
Financial Statements.
Under the terms of the AIG Agreement, the declaration or payment of
dividends on common stock in excess of prescribed amounts may require the
Company to purchase all or part of the then outstanding Series B Convertible
Preferred Shares. Dividends on the Series B Convertible Preferred Shares will
reduce the amount or earnings otherwise available for common stockholders by
approximately $16 million in the first year after issuance, and by approximately
$23 million in the fifth year after issuance, assuming dividends on the Series B
Convertible Preferred Shares were to be paid in kind throughout the first five
years after issuance.
On July 15, 1994, the purchasers of Shand executed their option to purchase
an office building owned and accounted for by the Company as a direct financing
lease by assuming the non-recourse mortgage notes of $19.5 million. No gain or
loss was recognized on this transaction.
In 1994, the Company made an $80 million payment to a reinsurance company
for the finite risk contract relating to discontinued operations previously
discussed. On July 1, 1994, Alexander & Alexander Services Inc. borrowed $50
million from the reinsurance company that executed the finite risk contract. The
note is payable in five equal annual installments, commencing July 1, 1997 and
bears interest at a rate of 9.45 percent. If Alexander & Alexander Services Inc.
defaults on the borrowing, the reinsurance company may utilize the Alexander &
Alexander Services Inc. note to settle claims under the finite risk contract.
Other
In 1994, the Accumulated Translation Adjustments, which represent the
cumulative effect of translating the Company's international operations to U.S.
dollars, positively impacted total Stockholders' Equity by $11.4 million. The
increase resulted from the weakening of the U.S. dollar against most of the
major currencies of the Company's overseas operations.
At December 31, 1994, the Company has an accumulated deficit of $287.1
million. The Company's current financial position satisfies Maryland law
requirements for the payment of dividends. The Board of Directors will continue
to take into consideration the Company's financial performance and projections,
as well as the provisions of the AIG Agreement pertaining to dividends described
in Note 10 of Notes to Financial Statements, in connection with future decisions
with respect to dividends. In addition, no dividends may be declared or paid on
the Company's Common Stock unless an equivalent amount per share is declared and
paid on the dividend paying shares associated with the Class A and Class C
Common stock.
As described in Notes 3, 6, and 14 of Notes to Financial Statements, the
Company believes its most significant litigation matters and other contingencies
have been settled. In addition, as described in Note 5 of Notes to Financial
Statements, 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 IRS on settlement of tax issues with respect to the 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. In February
1995 the Company paid the amounts due for the years 1980 through 1989 and
charged the net tax and interest totaling $35.6 million against previously
established reserves.
The Company believes that cash flow from operations, along with current cash
balances, supplemented by the proceeds from the Series B Convertible Preferred
Shares and asset sales, will be sufficient to fund working capital as well as
all other obligations on a timely basis. In the event additional funds are
required, the Company believes it will have sufficient resources, including
borrowing capacity, to meet such requirements.
16
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Information previously submitted under this Item 8 is substituted in its
entirety with the following information.
ALEXANDER & ALEXANDER SERVICES INC. AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENTS AND RELATED INFORMATION
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Management.................................................................. 18
Independent Auditors' Report.......................................................... 19
Consolidated Statements of Operations for each of the three years in the period ended
December 31, 1994..................................................................... 20
Consolidated Balance Sheets, December 31, 1994 and 1993............................... 21
Consolidated Statements of Cash Flows for each of the three years in the period ended
December 31, 1994..................................................................... 23
Consolidated Statements of Stockholders' Equity for each of the three years in the
period ended December 31, 1994...................................................... 25
Notes to Financial Statements, including unaudited quarterly financial data........... 27
Schedule II--Valuation and Qualifying Accounts........................................ 58
</TABLE>
17
<PAGE>
REPORT OF MANAGEMENT
The Company's management is responsible for the preparation and contents of
the information and representations contained in the consolidated financial
statements and other sections of this Annual Report on Form 10-K. Management
believes that the consolidated financial statements and related information have
been prepared in accordance with generally accepted accounting principles
appropriate in the circumstances, including amounts that are based on
management's judgment and best estimates.
The Company maintains a system of internal accounting controls to provide
reasonable assurance that assets are safeguarded against loss from unauthorized
use or disposition and that accounting records provide a reliable basis for the
preparation of financial statements. The internal accounting control system is
augmented by an internal auditing program, written policies and guidelines and
the careful selection and training of qualified personnel.
Deloitte & Touche LLP has been engaged, with the approval of the Company's
stockholders, as the independent auditors to audit the financial statements of
the Company and to express an opinion thereon. Their opinion is based on
procedures believed by them to be sufficient to provide reasonable assurance
that the financial statements present fairly, in all material respects, the
Company's financial position, cash flows and results of operations. Their report
is set forth on Page 19. The Audit Committee of the board of directors is
composed of four directors, none of whom is an employee of the Company. It
assists the board in exercising its fiduciary responsibilities for oversight of
audit and related matters, including corporate accounting, reporting and control
practices. It is responsible for recommending to the board of directors the
independent auditors to be employed for the coming year. The Audit Committee
meets periodically with management, internal auditors and the independent
auditors to review internal accounting controls, auditing and financial
reporting matters. The independent auditors and the internal auditors have
unrestricted access to the Audit Committee.
Frank G. Zarb
Chairman of the Board,
Chief Executive Officer & President
Edward F. Kosnik
Executive Vice President &
Chief Financial Officer
18
<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, 1994 and 1993, and
the related consolidated statements of operations, cash flows and stockholders'
equity for each of the three years in the period ended December 31, 1994. Our
audits also included the financial statement schedule listed in the Index at
Item 8. These financial statements and financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on the financial statements and financial statement schedule based on
our audits.
We conducted our audits in accordance with 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,
1994 and 1993, and the results of their operations and their cash flows for each
of the three years in the period ended December 31, 1994 in conformity with
generally accepted accounting principles. Also, in our opinion, such financial
statement schedule, when considered in relation to the basic consolidated
financial statements taken as a whole, presents fairly in all material respects
the information set forth therein.
As discussed in Notes 5, 7 and 11 to the consolidated financial statements,
in 1994 the Company changed its method of accounting for certain investments in
debt and equity securities and postemployment benefits, and, in 1993, income
taxes and postretirement benefits.
DELOITTE & TOUCHE LLP
Baltimore, Maryland
February 15, 1995 (February
28, March 16 and 27, 1995
with respect to certain
information in Notes 2, 5, 8
and 14)
19
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31,
(IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
1994 1993 1992
-------- -------- --------
<S> <C> <C> <C>
OPERATING REVENUES:
Commissions and fees........................................ $1,272.3 $1,287.7 $1,297.0
Fiduciary investment income................................. 51.6 53.9 72.5
-------- -------- --------
1,323.9 1,341.6 1,369.5
-------- -------- --------
OPERATING EXPENSES:
Salaries and benefits....................................... 814.3 785.3 804.5
Other....................................................... 523.5 504.0 479.5
Restructuring charges....................................... 69.0 -- --
-------- -------- --------
1,406.8 1,289.3 1,284.0
-------- -------- --------
OPERATING INCOME (LOSS)....................................... (82.9) 52.3 85.5
-------- -------- --------
OTHER INCOME (EXPENSES):
Investment income........................................... 10.9 9.6 12.0
Interest expense............................................ (16.0) (14.4) (18.0)
Other....................................................... 10.9 (15.6) 39.9
Special charges............................................. (69.7) -- (16.5)
-------- -------- --------
(63.9) (20.4) 17.4
-------- -------- --------
Income (loss) before income taxes and minority interest....... (146.8) 31.9 102.9
Income taxes (benefit)........................................ (42.6) 6.4 44.0
-------- -------- --------
Income (loss) before minority interest........................ (104.2) 25.5 58.9
Minority interest............................................. (3.0) (1.9) (1.8)
-------- -------- --------
Income (loss) from continuing operations...................... (107.2) 23.6 57.1
Loss from discontinued operations............................. (28.9) -- (145.0)
-------- -------- --------
Income (loss) before cumulative effect of accounting change... (136.1) 23.6 (87.9)
Cumulative effect of change in accounting..................... (2.6) 3.3 --
-------- -------- --------
Net income (loss)............................................. (138.7) 26.9 (87.9)
-------- -------- --------
Preferred stock dividends................................... (15.1) (6.2) --
-------- -------- --------
Earnings (loss) attributable to common shareholders........... $ (153.8) $ 20.7 $ (87.9)
-------- -------- --------
-------- -------- --------
Per share of common stock:
Income (loss) from continuing operations.................... $ (2.79) $ .40 $ 1.32
Loss from discontinued operations........................... (.66) -- (3.35)
-------- -------- --------
Income (loss) before cumulative effect of accounting
change........................................................ (3.45) .40 (2.03)
Cumulative effect of change in accounting................... (.06) .08 --
-------- -------- --------
Net income (loss)........................................... $ (3.51) $ .48 $ (2.03)
-------- -------- --------
-------- -------- --------
Cash dividends.............................................. $ .325 $ 1.00 $ 1.00
-------- -------- --------
-------- -------- --------
Weighted average number of shares............................. 43.8 43.4 43.2
-------- -------- --------
-------- -------- --------
</TABLE>
See Notes to Financial Statements.
20
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31,
(IN MILLIONS)
<TABLE>
<CAPTION>
1994 1993
-------- --------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents:
Operating........................................................... $ 248.7 $ 151.5
Fiduciary........................................................... 428.5 490.7
Short-term investments:
Operating........................................................... 19.2 3.2
Fiduciary........................................................... 292.2 313.4
Premiums and fees receivable (less allowance for doubtful accounts of
$23.7 in 1994 and $20.3 in 1993)........................................ 1,206.1 1,172.3
Deferred income taxes................................................. 71.5 35.4
Other current assets.................................................. 120.7 105.2
-------- --------
Total current assets.............................................. 2,386.9 2,271.7
-------- --------
PROPERTY AND EQUIPMENT:
Land and buildings.................................................... 39.7 38.2
Furniture and equipment............................................... 296.5 305.4
Leasehold improvements................................................ 95.1 101.1
-------- --------
431.3 444.7
Less accumulated depreciation and amortization........................ (293.3) (292.3)
-------- --------
Property and equipment--net....................................... 138.0 152.4
-------- --------
OTHER ASSETS:
Intangible assets (net of accumulated amortization of $117.5 in 1994
and $112.1 in 1993)................................................. 175.1 188.8
Deferred income taxes................................................. 87.1 53.3
Long-term operating investments....................................... 64.1 4.7
Other................................................................. 94.5 122.9
-------- --------
$2,945.7 $2,793.8
-------- --------
-------- --------
</TABLE>
--continued--
21
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS--(CONTINUED)
AS OF DECEMBER 31,
(IN MILLIONS)
<TABLE>
<CAPTION>
1994 1993
-------- --------
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Premiums payable to insurance companies............................... $1,738.3 $1,744.0
Short-term debt....................................................... 1.0 17.5
Current portion of long-term debt..................................... 17.1 11.7
Deferred income taxes................................................. 8.5 13.2
Accrued compensation and related benefits............................. 60.0 68.1
Income taxes payable.................................................. 66.3 82.4
Other accrued expenses................................................ 258.1 148.6
-------- --------
Total current liabilities......................................... 2,149.3 2,085.5
-------- --------
LONG-TERM LIABILITIES:
Long-term debt........................................................ 132.7 111.8
Deferred income taxes................................................. 13.4 17.9
Net liabilities of discontinued operations............................ 56.8 106.5
Other................................................................. 266.0 195.9
-------- --------
Total long-term liabilities....................................... 468.9 432.1
-------- --------
COMMITMENTS AND CONTINGENT LIABILITIES (NOTES 5, 6, 13 AND 14)
8% SERIES B CUMULATIVE CONVERTIBLE PREFERRED STOCK CONTINGENCY.......... 10.0 --
-------- --------
STOCKHOLDERS' EQUITY:
Preferred stock, authorized 15 shares, $1 par value:
Series A junior participating preferred stock, issued and
outstanding, none................................................. -- --
$3.625 Series A convertible preferred stock, issued and outstanding,
2.3 and 2.3 shares, respectively, liquidation preference of $115
million................................................................. 2.3 2.3
8% Series B cumulative convertible preferred stock, issued and
outstanding, 4.1 shares and none, respectively, liquidation
preference of $205 million........................................ 4.1 --
Common stock, authorized 200 shares, $1 par value; issued and
outstanding 41.5 and 40.7 shares, respectively.......................... 41.5 40.7
Class A common stock, authorized 26 shares, $.00001 par value; issued
and outstanding 2.3 and 2.4 shares, respectively........................ -- --
Class C common stock, authorized 11 shares, $1 par value; issued and
outstanding 0.4 and 0.4 shares, respectively............................ 0.4 0.4
Class D common stock, authorized 40 shares, $1 par value; issued and
outstanding, none....................................................... -- --
Paid-in capital....................................................... 615.0 423.4
Accumulated deficit................................................... (287.1) (119.0)
Net unrealized investment gains--net of deferred income taxes......... 1.5 --
Accumulated translation adjustments................................... (60.2) (71.6)
-------- --------
Total stockholders' equity........................................ 317.5 276.2
-------- --------
$2,945.7 $2,793.8
-------- --------
-------- --------
</TABLE>
See Notes to Financial Statements.
22
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
(IN MILLIONS)
<TABLE>
<CAPTION>
1994 1993 1992
------- ------- -------
<S> <C> <C> <C>
CASH PROVIDED (USED) BY:
OPERATING ACTIVITIES:
Income (loss) from continuing operations........................ $(107.2) $ 23.6 $ 57.1
Adjustments to reconcile to net cash provided (used) by
operating activities:
Depreciation and amortization................................. 51.2 54.5 60.5
Deferred income taxes......................................... (75.5) (27.5) (2.9)
Gains on disposition of subsidiaries and other assets......... (20.2) (3.9) (43.8)
Restructuring charges, net of cash payments................... 62.1 -- 13.9
Special charges............................................... 69.7 -- 16.5
Other......................................................... 14.2 13.4 10.1
Changes in assets and liabilities (net of effects from
acquisitions and dispositions):
Net fiduciary cash and cash equivalents and short-term
investments..................................................... 105.8 (46.0) (101.5)
Premiums and fees receivable.................................. 9.0 (69.3) (160.0)
Other current assets.......................................... 16.0 (15.8) 22.2
Other assets.................................................. 9.2 (11.9) 26.4
Premiums payable to insurance companies....................... (70.8) 74.6 247.9
Other accrued expenses........................................ 3.7 8.0 (58.3)
Other long-term liabilities................................... (2.6) 12.8 (6.3)
Discontinued operations (net)................................... 1.4 (11.9) (13.1)
Cumulative effect of change in accounting....................... (2.6) 3.3 --
------- ------- -------
Net cash provided by operating activities................. 63.4 3.9 68.7
------- ------- -------
INVESTING ACTIVITIES:
Net purchases of property and equipment....................... (21.5) (26.0) (16.7)
Purchases of businesses....................................... (4.7) (21.0) (5.7)
Proceeds from sales of subsidiaries and other assets.......... 4.1 9.6 61.1
Purchases of operating investments............................ (79.2) (61.7) (28.0)
Sales/maturities of operating investments..................... 9.0 68.3 38.2
------- ------- -------
Net cash provided (used) by investing activities.......... (92.3) (30.8) 48.9
------- ------- -------
</TABLE>
--continued--
23
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS--(CONTINUED)
FOR THE YEARS ENDED DECEMBER 31,
(IN MILLIONS)
<TABLE>
<CAPTION>
1994 1993 1992
------- ------- -------
<S> <C> <C> <C>
FINANCING ACTIVITIES:
Cash dividends................................................ $ (22.6) $ (47.9) $ (40.9)
Proceeds from issuance of short-term debt..................... 9.0 18.7 81.2
Payments of short-term debt................................... (24.8) (1.5) (122.7)
Proceeds from issuance of long-term debt...................... 51.8 19.4 29.6
Payment for a finite risk contract............................ (80.0) -- --
Repayments of long-term debt.................................. (8.3) (26.0) (31.4)
Issuance of preferred and common stock........................ 196.1 112.1 2.0
Distribution of earnings of pooled entity..................... -- (5.5) (5.2)
------- ------- -------
Net cash provided (used) by financing activities.......... 121.2 69.3 (87.4)
------- ------- -------
Effect of exchange rate changes on operating cash and cash
equivalents..................................................... 4.9 (7.9) (10.4)
Operating cash and cash equivalents at beginning of year........ 151.5 117.0 97.2
------- ------- -------
Operating cash and cash equivalents at end of year.............. $ 248.7 $ 151.5 $ 117.0
------- ------- -------
------- ------- -------
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid during the year for:
Interest.................................................... $ 14.2 $ 14.6 $ 15.9
Income taxes................................................ 37.0 56.0 47.6
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Sale of direct financing lease and related mortgage notes..... 19.0 -- --
Common stock issued for business acquisitions and employee
benefit and stock plans......................................... 6.8 2.3 1.4
Series B cumulative convertible preferred stock
dividends-in-kind............................................... 6.8 -- --
Notes received on dispositions of subsidiaries................ 29.2 2.0 --
</TABLE>
See Notes to Financial Statements.
24
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31,
(IN MILLIONS)
<TABLE>
<CAPTION>
1994 1993 1992
------- ------- ------
<S> <C> <C> <C>
$3.625 SERIES A CONVERTIBLE PREFERRED STOCK:
Balance, beginning of year..................................... $ 2.3 $ -- $ --
Shares issued by private placement............................. -- 2.3 --
------- ------- ------
Balance, end of year........................................... $ 2.3 $ 2.3 $ --
------- ------- ------
------- ------- ------
8% SERIES B CUMULATIVE CONVERTIBLE PREFERRED STOCK:
Balance, beginning of year..................................... $ -- $ -- $ --
Shares issued by private placement............................. 4.0 -- --
Dividends-in-kind.............................................. 0.1 -- --
------- ------- ------
Balance, end of year........................................... $ 4.1 $ -- $ --
------- ------- ------
------- ------- ------
COMMON STOCK:
Balance, beginning of year..................................... $ 40.7 $ 40.1 $ 39.7
Issued for acquisitions, none, none and 0.1 shares,
respectively..................................................... -- -- 0.1
Conversions of Class A and Class C shares into common stock,
0.1, 0.4 and 0.2 shares, respectively........................ 0.1 0.4 0.2
Other, principally stock option transactions................... 0.7 0.2 0.1
------- ------- ------
Balance, end of year........................................... $ 41.5 $ 40.7 $ 40.1
------- ------- ------
------- ------- ------
CLASS A COMMON STOCK:
Balance, beginning of year..................................... $ 0.0 $ 0.0 $ 0.0
Conversions into common stock, 0.1, 0.4 and 0.1 shares,
respectively..................................................... -- -- --
------- ------- ------
Balance, end of year........................................... $ 0.0 $ 0.0 $ 0.0
------- ------- ------
------- ------- ------
CLASS C COMMON STOCK:
Balance, beginning of year..................................... $ 0.4 $ 0.4 $ 0.5
Conversions into common stock, none, none and 0.1 shares,
respectively..................................................... -- -- (0.1)
------- ------- ------
Balance, end of year........................................... $ 0.4 $ 0.4 $ 0.4
------- ------- ------
------- ------- ------
PAID-IN CAPITAL:
Balance, beginning of year..................................... $ 423.4 $ 296.5 $291.4
Issued for acquisitions........................................ -- -- 1.3
Conversions into common stock.................................. (0.1) (0.4) (0.1)
Preferred stock issuance....................................... 188.9 108.6 --
Other, principally stock option transactions................... 2.8 3.1 2.9
Transactions of pooled entity prior to acquisition............. -- (2.0) 1.0
Tax benefit from acquisitions accounted for as pooling of
interests........................................................ -- 17.6 --
------- ------- ------
Balance, end of year........................................... $ 615.0 $ 423.4 $296.5
------- ------- ------
------- ------- ------
</TABLE>
--continued--
25
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY--(CONTINUED)
FOR THE YEARS ENDED DECEMBER 31,
(IN MILLIONS)
<TABLE>
<CAPTION>
1994 1993 1992
------- ------- ------
<S> <C> <C> <C>
RETAINED EARNINGS (ACCUMULATED DEFICIT):
Balance, beginning of year..................................... $(119.0) $ (92.5) $ 42.5
Net income (loss).............................................. (138.7) 26.9 (87.9)
Dividends:
Common stock................................................. (14.3) (41.7) (40.9)
Preferred stock.............................................. (15.1) (6.2) --
Distribution of earnings of pooled entity...................... -- (5.5) (6.2)
------- ------- ------
Balance, end of year........................................... $(287.1) $(119.0) $(92.5)
------- ------- ------
------- ------- ------
NET UNREALIZED INVESTMENT GAINS--NET OF DEFERRED INCOME TAXES:
Balance, beginning of year..................................... $ -- $ -- $ --
Change in unrealized gains, net of tax......................... 1.5 -- --
------- ------- ------
Balance, end of year........................................... $ 1.5 $ -- $ --
------- ------- ------
------- ------- ------
ACCUMULATED TRANSLATION ADJUSTMENTS:
Balance, beginning of year..................................... $ (71.6) $ (59.0) $ (4.0)
Foreign currency translation adjustments....................... 11.4 (12.6) (55.0)
------- ------- ------
Balance, end of year........................................... $ (60.2) $ (71.6) $(59.0)
------- ------- ------
------- ------- ------
</TABLE>
See Notes to Financial Statements.
26
<PAGE>
NOTES TO FINANCIAL STATEMENTS
(DOLLARS 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.
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 all its debt and equity securities as available for sale, which 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, which approximated
market value at December 31, 1993. The cost of securities sold is determined by
the specific identification method.
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 $4.8 million, $9 million and $5.6 million for the years ended
December 31, 1994, 1993 and 1992, respectively.
PROPERTY AND DEPRECIATION The cost of property and equipment is depreciated
generally using the straight-line method over the estimated useful lives of the
related assets which range from 3 to 40 years for buildings and 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 $11.9 million, $13 million and $14 million for the years ended
December 31, 1994, 1993 and 1992, respectively.
The Company periodically evaluates the carrying value of its intangible
assets, principally goodwill, 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 Statement of
Financial Accounting Standards No. 109 (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.
27
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
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.
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 and upon conversion of the convertible subordinate
debentures. The $3.625 Series A Convertible Preferred Stock and the 8% Series B
Convertible Preferred Stock are not common stock equivalents. Fully diluted
earnings per share for the periods presented was antidilutive; 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.
During 1994, the Company changed its presentation of cash flows to
distinguish fiduciary cash and cash equivalents and fiduciary investments from
operating cash and cash equivalents and operating investments. The Company
believes that this presentation of cash flows provides more useful information
regarding the cash flows that are available for general corporate purposes.
2. ACQUISITIONS AND DISPOSITIONS
ACQUISITIONS
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 has been accounted
for as a pooling of interests and, accordingly, the consolidated financial
statements have been restated for all periods prior to the acquisition. 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 and 1992 do not include approximately $2.2 million
and $3.2 million, respectively, for partners' salaries or $0.7 million and $1
million, respectively, for corporate income taxes. Pro-forma net income (loss)
for the Company, assuming partner salaries and corporate income taxes were
charged to operations, would be $28.5 million, or $0.51 per share, in 1993 and
$(85.9) million, or $(1.99) per share, in 1992.
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 1995. The
excess of the purchase price over the fair value of net tangible assets acquired
was
28
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
approximately $16 million. As a result of the devaluation of the Mexican peso in
late 1994, the Company's accumulated translation adjustment balance for its
Mexican operation reflected an unrealized loss of $6.2 million at December 31,
1994. 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 permanently impaired.
DISPOSITIONS
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.
During 1992, the Company sold three non-core businesses, including a
U.K.-based pension fund management operation, a Netherlands-based non-broking
operation and a U.S.-based administrator of workers' compensation funds. Total
proceeds on these sales were $77.4 million with resulting pre-tax gains of $43.8
million ($28.5 million after-tax or $0.66 per share).
These gains are included in Other Income (Expenses) in the Consolidated
Statements of Operations.
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. The pre-tax gain on this transaction will approximate $30 million and
will be reflected in the first quarter of 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. The
gain will be reflected in the first quarter of 1995.
Total revenues and operating income (loss) from all of these operations were
$120.9 million, $128.3 million and $127.1 million and $10.4 million, $2.5
million and $(1.5) million, respectively, for the years ended December 31, 1994,
1993 and 1992.
3. RESTRUCTURING AND SPECIAL CHARGES
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 are in the U.S.
The involuntary severance portion of the charge amounted to $22.9 million
and reflects the elimination of 898 positions worldwide. The voluntary early
retirement program was accepted by 208 employees prior to December 31, 1994 and
amounted to $20.9 million of the charge. Approximately $5.7 million of these
liabilities were paid in 1994 with a substantial majority of the remainder
expected to be paid in 1995.
The charge associated with real estate activities relates to the closure,
abandonment and downsizing of office space globally, including 34 locations in
the U.S. The Company anticipates that these
29
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
actions will be completed by the end of 1995. The costs include primarily
remaining lease obligations and write-offs of leasehold improvements and fixed
assets. Approximately $1.2 million of these liabilities were paid in 1994. The
cash portion of the remaining liabilities, excluding the fixed asset and
leasehold improvement write-offs of approximately $5.2 million, will be paid out
over the remaining lease periods, which range from one to ten years.
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, which is subject to court approval,
relating to lawsuits and other disputes brought against the Company and others
by the rehabilitator of Mutual Fire, Marine & Inland Insurance Company (Mutual
Fire) (See Note 14 of Notes to Financial Statements).
In 1992, the Company recorded a $16.5 million pre-tax charge ($13.9 million
after-tax, or $0.32 per share) associated with the sale of Shand. The provision
reflected the estimated cost of indemnities provided to the purchasers of Shand,
including $10 million associated with the Mutual Fire lawsuits and other
disputes.
4. OTHER NON-OPERATING INCOME (EXPENSES)
Other non-operating income (expenses) consists of the following:
FOR THE YEARS ENDED
DECEMBER 31,
------------------------
1994 1993 1992
----- ------ -----
Gains on sales of businesses (See Note 2)........... $20.2 $ 3.9 $43.8
Litigation costs.................................... (9.1) (20.2) (5.8)
Other............................................... (0.2) 0.7 1.9
----- ------ -----
$10.9 $(15.6) $39.9
----- ------ -----
----- ------ -----
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.
30
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
The components of income (loss) from continuing operations before income
taxes are as follows:
FOR THE YEARS ENDED
DECEMBER 31,
---------------------------
1994 1993 1992
------- ------ ------
United States.................................... $(200.9) $(74.2) $(39.2)
International.................................... 54.1 106.1 142.1
------- ------ ------
$(146.8) $ 31.9 $102.9
------- ------ ------
------- ------ ------
The components of the provision (benefit) for income taxes on continuing
operations are as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
-------------------------
<S> <C> <C> <C>
1994 1993 1992
------ ------ -----
Current:
Federal........................................... $ 1.7 $ (0.2) $(4.1)
State and local................................... (0.7) (0.8) (1.0)
International..................................... 33.9 34.9 54.6
------ ------ -----
34.9 33.9 49.5
------ ------ -----
Deferred:
Federal........................................... (67.3) (28.7) (3.5)
State and local................................... (3.6) (2.0) 1.2
International..................................... (6.6) 3.2 (3.2)
------ ------ -----
(77.5) (27.5) (5.5)
------ ------ -----
$(42.6) $ 6.4 $44.0
------ ------ -----
------ ------ -----
</TABLE>
Federal income taxes have not been provided on undistributed earnings of
foreign subsidiaries which aggregated approximately $309.8 million at December
31, 1994, 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.
31
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
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,
----------------
1994 1993
------ ------
<S> <C> <C>
Deferred tax assets:
Deferred compensation.................................................... $ 10.2 $ 13.3
Restructuring charges.................................................... 19.6 3.6
Shand/Mutual Fire reserves............................................... 30.9 6.3
Capital loss carryforwards............................................... 16.7 9.1
Net operating loss and tax credit carryforwards.......................... 63.6 21.1
Business combinations.................................................... 17.1 17.1
Other accruals not currently deductible.................................. 81.5 80.9
------ ------
239.6 151.4
Less: Valuation allowance................................................ (36.7) (23.1)
------ ------
Total deferred tax assets............................................ 202.9 128.3
------ ------
Deferred tax liabilities:
Deferred commissions..................................................... 9.6 11.4
Depreciation............................................................. 3.0 8.0
Gains on settlement of pension liabilities, net of accruals.............. 19.7 18.3
Gain on sale of personal lines business.................................. 11.3 --
Tax leases............................................................... 13.9 17.6
Other accruals........................................................... 8.7 15.4
------ ------
Total deferred tax liabilities....................................... 66.2 70.7
------ ------
Net deferred tax asset..................................................... $136.7 $ 57.6
------ ------
------ ------
</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, 1994, the Company has a U.S. federal net operating loss
carryforward of $76.2 million which expires in the year 2009 and U.S. state net
operating loss carryforwards totaling $165.2 million which expire in various
years through 2009. The Company also has U.S. federal foreign tax credit
carryforwards of $8.8 million, $3.2 million of which expires in 1998 and $5.6
million which expires in 1999, and U.S. federal alternative minimum tax credits
of $5.2 million which can be carried forward indefinitely. In addition, the
Company has foreign net operating loss and capital loss carryforwards for tax
purposes of $10.5 million and $42.1 million, respectively, which can be carried
forward indefinitely and approximately $7.1 million of foreign net operating
losses which expire in various years through 2002.
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. 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 Company will report on its 1995
U.S. federal income tax return gains totaling an estimated $50 million with
respect to the sales of its personal lines business and its Alexsis subsidiary.
Based on 1994 results, excluding nonrecurring items and sold subsidiaries and
businesses, with an estimated 8.5% reduction in U.S. operating costs as a result
of the Company's restructuring in 1994, the
32
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
net U.S. deferred tax asset would be realized with average annual growth in U.S.
operating revenues and pre-tax income of less than two percent.
The $36.7 million valuation allowance at December 31, 1994 relates primarily
to foreign and U.S. state net operating loss and capital loss carryforwards. The
valuation allowance increased by a net amount of $13.6 million in 1994, of which
$7.6 million relates to increases in foreign capital loss carryforwards and $6
million to increases in U.S. state and foreign net operating losses.
Prior to the change in accounting for income taxes, the components of the
provision for deferred income taxes for the year ended December 31, 1992 were as
follows:
Depreciation....................................................... $ (2.5)
Tax leases......................................................... (3.2)
Financial accounting accruals, net................................. (17.5)
Net deferred losses on subsidiary dispositions..................... 3.6
Special charges.................................................... 14.3
Other.............................................................. (0.2)
------
$ (5.5)
------
------
A reconciliation of the tax provision and the amount computed by applying
the U.S. federal income tax rate of 35% in 1994 and 1993 and 34% in 1992 to
income (loss) from continuing operations before income taxes is as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
------------------------
1994 1993 1992
------ ----- -----
<S> <C> <C> <C>
Computed "expected" tax expense (benefit)............................ $(51.4) $11.2 $35.0
State and local income taxes-net of federal income tax............. (1.6) (1.9) (0.4)
Foreign statutory rates over (under) U.S. federal statutory rate... (2.8) (2.9) 1.7
Foreign partnership income not taxed............................... -- (1.9) (2.1)
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 2.5 2.6
Repatriation of foreign earnings, net of tax credits............... 0.5 3.3 0.5
Other non-deductible expenses...................................... 7.5 4.1 3.9
Other, net......................................................... 2.6 (0.4) 2.8
------ ----- -----
Actual tax expense (benefit)......................................... $(42.6) $ 6.4 $44.0
------ ----- -----
------ ----- -----
</TABLE>
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 years 1980 through 1989
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
33
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
Company at $50 million. This proposed adjustment relates to intercompany
transactions involving the stock of a U.K. subsidiary.
The Company disagrees with the IRS position on this issue. Although the
ultimate outcome of the matter cannot be predicted with certainty, the Company
and its independent tax counsel believe there are meritorious defenses to the
proposed adjustment and substantial arguments to sustain the Company's position
and that the Company should prevail in the event this issue is litigated. A
similar set of transactions occurred in 1993 for which the IRS could propose an
increase in taxable income which would result in an additional tax liability
estimated by the Company at $25 million. 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 plc (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.
A summary of the net liabilities of discontinued operations is as follows:
<TABLE>
<CAPTION>
AS OF DECEMBER
31,
----------------
1994 1993
------ ------
<S> <C> <C>
Liabilities:
Insurance liabilities.................................................... $277.6 $252.4
Other.................................................................... 31.4 38.4
------ ------
Total liabilities.................................................... 309.0 290.8
------ ------
Assets:
Recoverable under finite risk contracts:
Insurance liabilities.................................................. 135.7 36.7
Premium adjustment..................................................... 10.8 10.4
Reinsurance recoverables................................................. 64.2 60.7
Zero coupon notes........................................................ -- 28.5
Cash and investments..................................................... 23.6 18.8
Other.................................................................... 10.9 22.2
------ ------
Total assets......................................................... 245.2 177.3
------ ------
Total net liabilities of discontinued operations........................... 63.8 113.5
Less current portion classified as other accrued expenses................ 7.0 7.0
------ ------
Remainder classified as net liabilities of discontinued operations......... $ 56.8 $106.5
------ ------
------ ------
</TABLE>
34
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
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
cleanup (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 data and have used various projection techniques
to estimate the insurance liabilities, consisting principally of incurred but
not reported losses.
In 1994, Orion who has financial responsibility for sharing certain of the
indemnity 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, 1994, based on an
estimate by an independent actuarial firm, the Company had recorded $6.6 million
of the deductible.
On July 1, 1994, the Company entered into an insurance-based financing
contract (finite risk contract) providing protection primarily for exposures
relating to Orion, Syndicate 701 and Swann & Everett. The contract provided for
a payment by the Company of $80 million ($50 million of which was borrowed from
the reinsurance company) to 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, 1994, recoveries were limited to $108.3 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, presently
considered to be remote by the Company, 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.
35
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
Insurance liabilities in excess of recorded liabilities could develop in the
future. Based on independent actuarial estimates of the amount and timing of
claim payments, it is reasonably possible that such additional liabilities, net
of estimated amounts recoverable for paid losses under the finite risk
contracts, could amount to $74 million. However, management currently believes
that such additional insurance liabilities are not likely to develop.
Changes in the total net liabilities of discontinued operations are as
follows:
FOR THE YEARS ENDED
DECEMBER 31,
--------------------------
1994 1993 1992
------ ------ ------
Beginning balance................................. $113.5 $102.4 $(36.4)
Provisions for loss............................. 28.9 -- 145.0
Litigation settlement........................... -- 22.3 --
Net cash proceeds on the zero coupon notes...... 5.0 -- --
Claims and expense payments..................... (7.0) (11.9) (13.1)
Payment for a finite risk contract.............. (80.0) -- --
Other........................................... 3.4 -- --
Translation adjustment.......................... -- 0.7 6.9
------ ------ ------
Ending balance.................................... $ 63.8 $113.5 $102.4
------ ------ ------
------ ------ ------
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. The provision for
loss in 1992 relates principally to increases in estimated liabilities
associated with the indemnities provided to the purchaser of Sphere Drake
resulting from more complete information becoming available in the fourth
quarter of 1992.
The Company believes that, based on current estimates, the established total
net liabilities of discontinued operations are sufficient to cover its
exposures. However, there is no assurance that further adverse development may
not occur due to variables inherent in the estimation processes and other
matters described above. The Company currently believes that the effect of such
adverse development, if any, will not be material to the Company's financial
position and results of operations.
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 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,
--------------------------
<S> <C> <C> <C>
1994 1993 1992
------ ------ ------
Service cost....................................... $ 38.8 $ 29.5 $ 29.4
Interest cost...................................... 43.4 38.4 36.9
Actual return on plan assets....................... 22.7 (73.4) (68.9)
Net amortization and deferral...................... (99.7) 7.4 3.7
------ ------ ------
Net pension costs............................ $ 5.2 $ 1.9 $ 1.1
------ ------ ------
------ ------ ------
</TABLE>
36
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
The following table sets forth the funded status and amounts recognized in
the Company's Consolidated Balance Sheets:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
----------------------------------------------------
1994 1993
------------------------ ------------------------
U.S. INTERNATIONAL U.S. INTERNATIONAL
------- ------------- ------- -------------
<S> <C> <C> <C> <C>
Vested benefit obligation.................. $ 199.1 $ 247.1 $ 221.5 $ 246.4
------- ------------- ------- -------------
------- ------------- ------- -------------
Accumulated benefit obligation............. $ 223.3 $ 248.7 $ 235.3 $ 252.4
------- ------------- ------- -------------
------- ------------- ------- -------------
Projected benefit obligation............... $(271.6) $(270.3) $(308.1) $(284.7)
Plan assets at fair market value........... 289.3 383.7 298.5 387.2
------- ------------- ------- -------------
Excess (shortfall) of plan assets over
projected benefit obligation............. 17.7 113.4 (9.6) 102.5
Unrecognized net (loss) gain............... (5.5) (26.8) 33.4 (39.0)
Unrecognized prior service cost............ (1.3) (6.6) (1.4) 13.4
Unrecognized net assets being amortized
over the plans' average remaining service
lives...................................... (14.0) (29.4) (16.3) (30.8)
------- ------------- ------- -------------
Prepaid (accrued) pension cost............. $ (3.1) $ 50.6 $ 6.1 $ 46.1
------- ------------- ------- -------------
------- ------------- ------- -------------
</TABLE>
<TABLE>
<S> <C> <C> <C> <C>
Assumptions used were as follows:
Assumed discount rate...................... 8.5% 6.5-9.5% 7.0% 5.0-8.25%
Assumed rate of compensation increase...... 5.0% 3.5-5.0% 5.0% 4.0-6.5%
Expected rate of return on plan assets..... 9.75% 7.0-10.25% 9.75% 7.0-11.0%
------- ------------- ------- -------------
</TABLE>
At December 31, 1994 and 1993, approximately 84 percent and 85 percent,
respectively, of all plan assets are invested in equity securities and 16
percent and 15 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 $11.9 million in 1994, $11.3 million in 1993 and $10.8 million in 1992.
POSTRETIREMENT BENEFITS Effective January 1, 1993, the Company adopted SFAS
No. 106 "Employers' Accounting for Postretirement Benefits Other Than Pensions"
for its U.S. 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 over a period of twenty years. The Company's
cash flows are not affected by implementation of this statement and the impact
to the results of operations for 1993 was not significant.
37
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
Total postretirement benefit costs are summarized as follows:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED FOR THE YEAR ENDED
DECEMBER 31, 1994 DECEMBER 31, 1993
-------------------------- --------------------------
HEALTH LIFE HEALTH LIFE
CARE INSURANCE TOTAL CARE INSURANCE TOTAL
------ --------- ----- ------ --------- -----
<S> <C> <C> <C> <C> <C> <C>
Service Cost......................................... $0.8 $-- $0.8 $0.8 $-- $ 0.8
Interest Cost........................................ 1.3 0.2 1.5 1.2 0.2 1.4
Actual return on plan assets......................... -- 0.2 0.2 -- (0.2) (0.2)
Net amortization and deferral........................ 1.2 (0.6) 0.6 0.8 (0.2) 0.6
------ --------- ----- ------ --------- -----
Net postretirement costs (credits)............. $3.3 $(0.2) $3.1 $2.8 $(0.2) $ 2.6
------ --------- ----- ------ --------- -----
------ --------- ----- ------ --------- -----
</TABLE>
The following table sets forth the funded status and amounts recognized in
the Company's consolidated financial statements:
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1994 AS OF DECEMBER 31, 1993
--------------------------- ---------------------------
HEALTH LIFE HEALTH LIFE
CARE INSURANCE TOTAL CARE INSURANCE TOTAL
------ --------- ------ ------ --------- ------
<S> <C> <C> <C> <C> <C> <C>
Accumulated postretirement benefit obligation:
Retirees....................................... $ (8.0) $(3.0) $(11.0) $ (7.0) $(3.2) $(10.2)
Fully eligible active participants............. (3.1) -- (3.1) (1.7) (0.3) (2.0)
Other active participants...................... (5.4) -- (5.4) (10.4) -- (10.4)
------ --------- ------ ------ --------- ------
(16.5) (3.0) (19.5) (19.1) (3.5) (22.6)
Plan assets at fair market value............... -- 5.4 5.4 -- 5.7 5.7
------ --------- ------ ------ --------- ------
Accumulated benefit obligation in excess
(shortfall) of plan assets................... (16.5) 2.4 (14.1) (19.1) 2.2 (16.9)
Unrecognized net obligation (asset)............ 13.9 (2.2) 11.7 15.5 (2.3) 13.2
Unrecognized net loss.......................... 1.8 0.1 1.9 3.0 0.3 3.3
------ --------- ------ ------ --------- ------
(Accrued) prepaid post-retirement benefit
liability........................................ $ (0.8) $ 0.3 $ (0.5) $ (0.6) $ 0.2 $ (0.4)
------ --------- ------ ------ --------- ------
------ --------- ------ ------ --------- ------
</TABLE>
The discount rate used in determining the accumulated postretirement benefit
obligation was 8.5 percent and the compensation rate increase was 4.5 percent.
The expected rate of return on plan assets was 5.75 percent. The assumed medical
trend rate is 10 percent in 1995 and gradually declines to 5.5 percent in 2000
and thereafter. Increasing the trend rate by 1 percent and holding all other
assumptions constant, the impact on the cost component and the accumulated
benefit obligation is an increase of $0.2 million and $1.2 million,
respectively.
Certain of the Company's international subsidiaries have similar plans for
their employees; however, most retirees are covered primarily by government
sponsored programs. As a result, the cost to the Company for retired employees
is not significant for these programs.
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. The increase to the annual cost of providing such benefits will not be
significant.
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, 1994, the cash
surrender value of
38
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
these policies was $0.6 million, which is net of $38.7 million of policy loans.
The Company's obligation under the plan, including accumulated interest, was
$16.2 million and $15.6 million at December 31, 1994 and 1993, respectively, and
is included in Other Long-Term Liabilities in the Consolidated Balance Sheets.
8. DEBT
Consolidated short-term debt outstanding is as follows:
DECEMBER 31,
--------------
1994 1993
----- -----
Lines of credit............................................... $ 0.7 $ 5.3
Notes payable to financial institutions....................... 0.3 12.2
----- -----
$ 1.0 $17.5
----- -----
----- -----
The weighted average interest rate on short-term borrowings was 7.0 percent
and 5.2 percent at December 31, 1994 and 1993, respectively.
Consolidated long-term debt outstanding is as follows:
<TABLE>
<CAPTION>
AS OF DECEMBER
31,
----------------
1994 1993
------ ------
<S> <C> <C>
11% Convertible subordinated debentures (A)................................ $ 60.2 $ 60.2
Note payable (B)........................................................... 50.0 --
Obligation under capital lease (C)......................................... 22.1 20.8
Non-recourse mortgage notes (D)............................................ -- 19.6
Term loans (E)............................................................. 10.0 10.0
Credit agreement (F)....................................................... -- --
Other, primarily for acquisitions.......................................... 7.5 12.9
------ ------
149.8 123.5
Less current portion....................................................... 17.1 11.7
------ ------
$132.7 $111.8
------ ------
------ ------
</TABLE>
The principal payments required during the next five years are $17.1 million
in 1995, $5.6 million in 1996, $14.5 million in 1997, $14.5 million in 1998, and
$14.5 million in 1999.
A. 11% CONVERTIBLE SUBORDINATED DEBENTURES The debentures are unsecured
subordinated obligations maturing April 15, 2007. The debentures were issued in
connection with the acquisition of Alexander Howden under an Indenture agreement
dated February 1, 1982, and are convertible into common stock at $39 per share,
subject to adjustment under certain conditions and to prior redemption. The
remaining debentures are redeemable any time, at 102.2 percent of par value
prior to April 15, 1995, and at declining prices thereafter until April 15, 1997
and at par thereafter. Commencing April 15, 1992, and annually thereafter, 5
percent of the aggregate principal amount outstanding as of October 15, 1991,
must be redeemed at par value through the operation of a mandatory sinking fund.
The Company may make an optional sinking fund payment in each year not exceeding
the amount of the mandatory sinking fund payment. In 1994 and 1993, the Company
satisfied the mandatory sinking fund payment through the use of previously
repurchased debentures.
B. NOTE PAYABLE In July 1994, Alexander & Alexander Services Inc. 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
39
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
interest at a rate of 9.45 percent. If Alexander & Alexander Services Inc.
defaults on the borrowing, the reinsurance company may utilize the Alexander &
Alexander Services Inc. note to settle reinsurance claims under the finite risk
contract.
C. OBLIGATION UNDER CAPITAL LEASE A French subsidiary has a lease agreement
for office facilities which is classified as a capital lease. Future minimum
lease payment obligations are approximately $2.5 million for each of the next
five years and an aggregate of $24.7 million thereafter.
D. NON-RECOURSE MORTGAGE NOTES Two subsidiaries of the Company had an
investment in a direct financing lease of an office building and related
non-recourse mortgage notes. In July 1994, a contractual option to purchase the
office building was exercised by the lessee by assuming the non-recourse
mortgage notes. No gain or loss was recognized on this transaction.
E. TERM LOANS In August 1992, a U.S. subsidiary entered into an unsecured
$10 million three-year term loan agreement with a bank. The interest rate
(6.8125 percent at December 31, 1994) floats with the LIBOR rate. The agreement,
guaranteed by the Company, contains financial covenants on minimum consolidated
net worth and maximum consolidated indebtedness.
F. CREDIT AGREEMENT At December 31, 1994 the Company had a $150 million
credit agreement with various banks which would have expired in July 1995. The
agreement provided for unsecured borrowings and contained various financial
covenants, including limits on minimum net worth, maximum consolidated debt,
minimum interest coverage and minimum consolidated cash flow from operations.
The Company had full and immediate access to the $150 million credit line and
had no borrowings outstanding under this agreement at December 31, 1994. At
December 31, 1994, the Company was in technical default on two financial
covenants under this agreement and was granted a waiver with respect to
compliance with such covenants.
Supplementing the credit agreement, the Company has unsecured lines of
credit available for general corporate purposes totaling $97.7 million of which
$97 million were unused as of December 31, 1994. These lines consist of both
committed and uncommitted facilities in the U.S. and certain other countries. If
drawn, the lines bear interest at market rates and carry annual commitment fees
of not greater than 1/2 percent of the line.
On March 27, 1995, the Company's existing credit agreement was cancelled and
replaced by a new $200 million three-year facility with various banks which
expires in March 1998. The new agreement provides for unsecured borrowings and
contains various covenants, including minimum consolidated tangible capital
funds, minimum consolidated tangible net worth, maximum leverage and minimum
cash flow coverage requirements. The Company currently believes that the
covenant regarding minimum cash flow coverage is the most restrictive. This
covenant requires that the ratio of earnings before interest, taxes,
depreciation and amortization to interest expense and cash dividends exceed 4.25
to 1. In addition, the occurrence of a "Special Event" under the AIG Agreement
which is not waived would constitute an event of default under the new
agreement. (See Note 10 to Notes to Financial Statements)
9. STOCK OPTION AND INCENTIVE PLANS
Under the 1988 Long-Term Incentive Compensation Plan (1988 Plan), as amended
by action of the Board of Directors in September 1994, up to 5,499,000 shares of
the Company's Common Stock may be awarded to officers and key employees. The
1988 Plan includes grants in the form of incentive stock options and
non-qualified options, stock appreciation rights, restricted stock awards,
performance share/unit awards and other stock based awards.
40
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
Stock options may be granted under the 1988 Plan 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.
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. Such awards are
subject to forfeiture if the participant does not remain in the employ of the
Company throughout the restricted time period. A maximum of 1,250,000 shares may
be issued under the 1988 Plan. There were 308,500, 60,000 and 92,810 shares
issued in 1994, 1993 and 1992, respectively. Also 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. In addition, 140,000
shares of Common Stock were delivered to a Company trust to fund a special
compensation award to a non-executive director.
Performance share/unit awards may be granted based upon certain performance
criteria as determined by the Company and Benefits Committee of the Board of
Directors. 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 23,000 performance share/unit awards made in 1994. No
performance share/unit awards were made in 1993 and 1992.
Stock option transactions were as follows:
<TABLE>
<CAPTION>
NUMBER OPTION PRICE
OF PER SHARE
SHARES RANGE
--------- -------------
<S> <C> <C>
Outstanding, January 1, 1992..................................... 2,757,084 $17.75-$38.63
Granted........................................................ 485,000 21.63- 23.69
Exercised...................................................... (106,439) 21.56- 27.38
Canceled....................................................... (210,590)
--------- -------------
Outstanding, December 31, 1992................................... 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 $17.75-$38.63
--------- -------------
--------- -------------
</TABLE>
The number of options exercisable at December 31 were as follows:
1994 2,197,405
1993 2,231,301
1992 1,976,017
At the 1995 Annual Meeting of Stockholders, the Company intends to submit
for stockholder approval four new compensation plans. The plans to be submitted
for stockholder approval are: (1) the 1995 Long-Term Incentive Plan (1995 Plan)
to provide for compensation of executive officers and other
41
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
key employees of the Company and its subsidiaries through stock options,
restricted stock, performance units and other equity-based incentives; (2) the
Employee Discount Stock Purchase Plan (Purchase Plan) to provide for the
purchase by employees, through salary deferrals, of the Company's Common Stock
at a discount from fair market value; (3) the Performance Bonus Plan for
Executive Officers, to provide for the compensation of executive officers by
means of awards (including equity-based awards) for achievement by the Company
of certain performance goals; and (4) the Non-Employee Director Deferred Stock
Ownership Plan, to provide an equity based non-employee director deferred
compensation plan. If approved by stockholders at the annual meeting, 4,700,000
shares of Common Stock will be reserved for issuance under the 1995 Plan and
750,000 shares of Common Stock will be reserved for issuance under the Purchase
Plan.
10. COMMON AND PREFERRED STOCK
At a special meeting of the Company's stockholders held on July 15, 1994
(Special Meeting) an amendment to the Company's Charter (Charter Amendment) was
approved. The Charter Amendment authorized (i) an increase in the number of
authorized shares of stock of the Company (ii) the terms of a new class of
common stock, Class D Common Stock, par value $1.00 (Class D Stock) and (iii)
other minor amendments. At the special meeting, stockholders also approved the
transactions contemplated by the Stock Purchase and Sale Agreement entered into
by the Company and AIG on June 7, 1994, as it may be amended from time to time
(AIG Agreement), which included approval of the issuance and sale of 4,000,000
shares of the Company's 8% Series B Cumulative Convertible Preferred Stock, par
value $1.00 (Series B Convertible Preferred Shares) to three wholly owned
subsidiaries of AIG at a purchase price of $50 per share for a total purchase
price of $200 million (AIG Investment).
The Charter Amendment, which became effective on July 15, 1994, increased
the total authorized capital stock of the Company to 292,000,000 shares of five
classes consisting of 200,000,000 shares of Common Stock, par value $1.00
(Common Stock); 26,000,000 shares of Class A Common Stock, par value $.00001
(Class A Common Stock) 11,000,000 shares of Class C Common Stock, par value
$1.00 (Class C Common Stock); 40,000,000 Class D Stock; and 15,000,000 shares of
Preferred Stock, par value $1.00 (Preferred Shares). The aggregate par value of
all shares of all classes of stock which the Company will, pursuant to the
Charter Amendment, have authority to issue is $266,000,260. Prior to the
effective date of the Charter Amendment, the Company had total authorized
capital stock equal to 88,500,000 shares of four classes consisting of
60,000,000 shares of Common Stock; 13,000,000 Class A Common Stock, 5,500,000
Class C Common Stock, and 10,000,000 Preferred Shares.
In related matters, on July 15, 1994, the Board of Directors authorized an
increase in the number of authorized shares of the Series A Junior Participating
Preferred Stock, par value $1.00 (Participating Preferred Shares), from 600,000
shares to 1,000,000 shares and certain amendments were made to the Company's
Rights Agreement associated with the Participating Preferred Shares.
COMMON STOCK AND EQUIVALENTS In addition to its Common Stock, the Company
has issued two classes of voting equity securities, Class A and Class C Common
Stock, with voting rights equal to the Company's Common Stock. Associated with
each such share is a dividend paying share issued by a Canadian (RSC Class 1
share) or a United Kingdom (AASUK Dividend share) subsidiary which pays
dividends in Canadian dollars and pounds sterling respectively, equivalent to
the dividends paid on shares of Common Stock. Holders of these securities,
therefore, hold the economic equivalent of shares of Common Stock. Each Class A
share (together with an RSC Class 1 share) and Class C share (together with an
AASUK Dividend share) may be exchanged at any time for a share of Common Stock.
No dividends may be declared or paid on the Company's Common Stock unless an
equivalent amount per share is declared and paid on the RSC Class 1 and AASUK
Dividend shares. Accordingly,
42
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
the Company's ability to pay dividends is limited by the amounts available to
the Canadian and U.K. subsidiaries for such purposes. These amounts approximate
Canadian $82 million or $58.2 million, assuming certain solvency tests are met
under Canadian law, and 104.4 million pounds sterling or $162.8 million,
respectively, at December 31, 1994. In the event sufficient earnings are not
available in the Canadian or the U.K. subsidiary to declare dividends, the
Company's legal structure allows it to make earnings or capital available in
those subsidiaries to pay dividends. In addition, the Series A Convertible
Preferred Stock and the Series B Convertible Preferred Stock described below
have priority as to dividends over the Common Stock.
At December 31, 1994, the Company had 5.5 million shares of Common Stock
reserved for issuance under employee stock option plans, 1.5 million shares
reserved for issuance in the event of conversion of the 11 percent convertible
subordinated debentures and 2.7 million shares reserved for issuance upon
redemption or conversion of the Class A and Class C shares.
The Board of Directors has authorized, subject to certain business and
market conditions, the purchase of up to 5 million shares of the Company's
Common Stock. As of December 31, 1994, the total number of shares purchased was
3.7 million at an average price of $21.77 per share. No shares were repurchased
in 1994 or 1993. Shares of its own stock acquired by the Company constitute
authorized but unissued shares.
CLASS D STOCK Shares of the Company's Series B Convertible Preferred Shares
are convertible into Class D Stock, at a conversion price of $17 per share,
subject to adjustment. No shares of Class D Stock are currently outstanding.
Holders of the Class D Stock have the same rights to receive dividends and
distributions as the holders of the Common Stock. In the event of the voluntary
or involuntary liquidation, dissolution or winding up of the Company, the
holders of Class D Stock and Common Stock participate ratably in proportion to
the number of shares held by each such holder in any distribution of assets of
the Company to such stockholders. In addition, in the event the Company effects
a subdivision or combination or consolidation of the outstanding shares of Class
D Stock into a greater or lesser number of shares of Class D Stock, then in each
such case the Company will effect an equivalent subdivision or combination or
consolidation of the outstanding shares of Common Stock into a greater or lesser
number of shares of Common Stock. The Class D Stock are non-voting, except as
provided by law, in the event of a proposed amendment to the Company's Charter
that would adversely affect holders of shares of Class D Stock and following the
occurrence of a Specified Corporate Event. The holders of the Class D Stock have
the right to exchange Class D Stock for Common Stock, at any time or from time
to time, 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, or will have the then contractual right to acquire
through conversion, exercise of warrants or otherwise, more than 9.9 percent of
the combined voting power of the Company's voting shares then outstanding,
absent certain events.
PREFERRED STOCK AND RELATED RIGHTS The Company's Preferred Stock, $1.00 par
value (Preferred Stock), 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 SHARES In March 1993, the Company completed a
private placement of 2.3 million shares of $3.625 Series A Convertible Preferred
Shares (Series A Convertible Preferred Shares). Gross proceeds of the offering
were $115 million with net proceeds to the Company of $110.9 million. Holders of
the Series A Convertible Preferred Shares are entitled to receive cumulative
cash dividends at an annual rate of $3.625 per share, payable quarterly in
arrears. The Series A Convertible Preferred Shares have priority as to dividends
over the Common Stock. The shares are convertible into Common Stock at a
conversion price of $31.875 per share of Common Stock, subject to adjustments.
Common Stock issued upon conversion will include Rights, as described below,
43
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
provided the conversion occurs prior to the distribution, redemption or
expiration of such Rights. The Series A Convertible Preferred Shares may be
redeemed by the Company on and after March 22, 1997, in whole or in part, 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 Shares are non-voting, except as provided by law and
except that, among other things, holders will be entitled to vote as a separate
class with any other series of outstanding Preferred Stock to elect a maximum of
two directors if the equivalent of six or more quarterly dividends on the Series
A Convertible Preferred Shares are in arrears. The Series A Convertible
Preferred Shares have a liquidation preference of $50 per share.
SERIES B CONVERTIBLE PREFERRED SHARES The Series B Convertible Preferred
Shares were issued on July 15, 1994. After giving effect to estimated
transaction expenses, a $10 million indemnification provision and the cost of an
option for an insurance-based financing arrangement, the sale of the Series B
Convertible Preferred Shares increased the Company's capital by approximately
$186 million. The shares are convertible into Class D Stock at a conversion
price of $17 per share of Class D Stock, subject to adjustment. The holders of
the Class D Stock have the right to exchange Class D Stock for Common Stock, at
any time or from time to time, on a share-for-share basis, subject to certain
limitations discussed below as to the amount of shares which may be converted.
Dividends on the Series B Convertible Preferred Shares will reduce the amount of
earnings otherwise available for common stockholders by approximately $16
million in the first year after issuance, and by approximately $23 million by
the fifth year after issuance, assuming dividends on the Series B Convertible
Preferred Shares were to be paid in kind throughout the first five years after
issuance.
Holders of Series B Convertible Preferred Shares are entitled to receive
cumulative dividends at a rate of 8 percent per annum payable quarterly in
arrears. Until December 15, 1996, dividends on the Series B Convertible
Preferred Shares are payable in kind and thereafter, at the election of the
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. With respect to
dividend rights and rights of liquidation, dissolution and winding up, Series B
Convertible Preferred Shares rank senior to Common Stock, Class A Common Stock,
Class C Common Stock, Class D Stock and Participating Preferred Shares (when and
if issued) and pari passu with the Series A Convertible Preferred Shares.
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.
Series B Convertible Preferred Shares are non-voting, except as provided by
law and except that, among other things, holders will be entitled to vote as a
separate class with any other series of outstanding Preferred Stock to elect a
maximum of two directors if the equivalent of six or more quarterly dividends on
the Series B Convertible Preferred Shares are in arrears. Following the
occurrence of a Specified Corporate Action (as defined in the Company's Charter)
holders shall 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 Shares will be deemed holders of that number of shares
of Class D Stock into which such shares would then be convertible.
44
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
The Series B Convertible Preferred Shares 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 will be $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.
Holders of Series B Convertible Preferred Shares have the right to require
the Company to purchase all or any part of the Series B Convertible Preferred
Shares 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 payment of dividends aggregating in excess of $0.075
per share of Common Stock during the last seven months of 1994, cumulatively 25
percent of earnings in 1995 and 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 stock after June 1994 (other than the Company's Series B Convertible
Preferred Shares) in excess of net proceeds to the Company from the sale of
stock after June 1994 (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 at a specified premium, ranging from $66.18 per share, if the Special Event
occurs within six and twelve months after the original issue date, to $72.06 per
share, if the Special Event occurs more than twelve months after the original
issue date, plus in each case accrued and unpaid dividends. The approximately
11,765,000 shares of Common Stock issuable upon the ultimate conversion of the
Series B Convertible Preferred Shares represent approximately 21 percent of the
aggregate number of voting shares outstanding after giving effect to such
issuance. If dividends on the Series B Convertible Preferred Shares are paid in
kind for the full five year period permitted, approximately 18,069,000 shares of
Common Stock will be issuable upon such exchange, representing approximately 29
percent of the total number of voting shares outstanding after giving effect to
such issuance.
SERIES A JUNIOR PARTICIPATING PREFERRED SHARES In 1987, Participating
Preferred Shares were authorized and a dividend of one preferred share purchase
right (a Right) for each outstanding share of Common Stock, each share of Class
A and Class C Common Stock and each subsequently issued share was declared. With
respect to the Rights, the Class D Stock will be treated as if such shares are
Class C Common Stock. Each Right, as amended, entitles the holder thereof to buy
one one-hundredth of a Participating Preferred Share at a price of $85 (subject
to adjustment). The Rights become exercisable only following the announcement by
the Company that a person or a group has acquired beneficial ownership of 15
percent or more of the Company's voting shares or has commenced a tender or
exchange offer that if consummated would result in the ownership of 15 percent
or more of such voting shares. If the Rights become exercisable, each holder
will be entitled to purchase at the then-current exercise price that number of
Participating Preferred Shares having a value equal to twice the then-current
exercise price.
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 each Right. In addition, if
a person or group acquires more than 15 percent, but less than 50 percent, of
the Company's voting shares, the Board of Directors may exchange each Right for
one one-hundredth of a Participating Preferred Share. The Rights are redeemable
by the Board until the time of
45
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
announcement that any person or group has beneficially acquired 15 percent or
more of the Company's voting shares. All rights beneficially owned by a holder
of 15 percent or more of the voting shares become void once such holder passes
the 15 percent threshold. The Rights are redeemable by action of the Board of
Directors prior to becoming exercisable at a redemption price of $.01 per Right.
The Rights will expire on July 6, 1997.
On April 21, 1992, the Board of Directors of the Company approved an
Amendment to the Rights Agreement (the Rights Agreement), dated as of June 11,
1987, between the Company and First Chicago Trust Company of New York, as
amended and restated as of March 22, 1990. The Amendment provides for certain
technical revisions in the Rights Agreement including definition of Shares
Acquisition Date to mean the first date of public announcement by the Company
that an Acquiring Person has become such. The Amendment also provides that if
the Rights become exercisable, the Company, acting by resolution of the Board of
Directors, may (and if a sufficient number of Participating Preferred Shares is
not available for issuance upon exercise of the Right, shall), issue equity
securities, debt securities, cash and/or other property in lieu of Participating
Preferred Shares.
In connection with the AIG Investment, the Board of Directors amended the
Rights Agreement. Pursuant to Amendment No. 2 to the Rights Agreement, effective
as of June 6, 1994, the acquisition of Series B Convertible Preferred Shares
upon closing of the AIG Agreement, the acquisition of Class D Stock upon
conversion of Series B Convertible Preferred Shares, the acquisition of Common
Stock upon exchange for Class D Stock or the acquisition by AIG or its
affiliates or any transferee thereof of any securities of the Company (if such
acquisition is permitted by the Purchase Agreement) will not (i) cause any
person to become an Acquiring Person, (ii) cause the Distribution Date or the
Shares Acquisition Date to occur, or (iii) give rise to a Section 11(a)(ii)
Event (as such capitalized terms are defined in the Rights Agreement).
In addition, on July 15, 1994, the Board of Directors approved Amendment No.
3 to the Rights Agreement, which provides for, among other things, modifications
of the definitions of Acquiring Person and Distribution Date to raise from 10
percent to 15 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).
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. At December 31, 1994, net unrealized holding gains totaled
$1.5 million, net of deferred income taxes of $0.2 million, and are reported as
a separate component of Stockholders' Equity. During 1994, the net unrealized
holding gains decreased by approximately $2 million and proceeds from sales of
securities totaled $157.4 million with gross realized gains totaling $0.5
million.
46
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
The amortized cost and estimated fair value of the Company's debt and equity
securities and financial instruments used to hedge the existing and anticipated
fiduciary portion of such investments as of December 31, 1994 are summarized
below:
<TABLE>
<CAPTION>
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 securities................... 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, 1994 as
follows:
Cash and cash equivalents:
Operating....................................................... $ 63.9
Fiduciary....................................................... 51.8
Short-term investments:
Operating....................................................... 1.8
Fiduciary....................................................... 117.9
Long-term operating investments................................... 62.2
------
Total....................................................... $297.6
------
------
The amortized cost and estimated fair value of debt securities at December
31, 1994 by contractual maturity are summarized below:
<TABLE>
<CAPTION>
ESTIMATED
AMORTIZED FAIR
COST VALUE
--------- ---------
<S> <C> <C>
Due in one year or less................................................. $ 152.7 $ 152.6
Due after one year through five years................................... 46.7 46.7
Due after five years through ten years.................................. 0.7 0.7
Due after ten years..................................................... 10.1 10.1
--------- ---------
210.2 210.1
Mortgage-backed securities.............................................. 83.8 83.8
--------- ---------
Total debt securities............................................. $ 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
47
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
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 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 contracts which are designated as hedges of firm
commitments are deferred until the settlement dates. Contracts which are not
designated as hedges 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, 1994 was $2.6 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. Based on foreign exchange rates at December 31, 1994,
these options could be exercised at a nominal cost to the Company.
At December 31, 1994, the Company had approximately $108.5 million notional
principal of forward exchange contracts outstanding, primarily to exchange U.S.
dollars into U.K. pounds sterling, and approximately $47.7 million notional
principal outstanding, primarily to exchange U.K. pounds sterling into U.S.
dollars. In addition, at December 31, 1994, the Company has approximately $4.6
million notional principal of foreign exchange contracts outstanding related to
intercompany loans.
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 with maturities of three months or less.
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,
1994, an unrealized loss of $2.8 million on interest rate swaps and forward rate
agreements which hedge existing and anticipated fiduciary investments with
maturities of three months or less was reflected in fiduciary cash and
equivalents in the Consolidated Balance Sheet.
48
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
At December 31, 1994 and 1993 the Company has the following interest rate
swaps and forward rate agreements in effect, by year of final maturity:
<TABLE>
<CAPTION>
DECEMBER 31, 1994
-----------------------------------------------------
GROSS NET WEIGHTED GROSS NET WEIGHTED
RECEIVING AVERAGE PAYING AVERAGE
YEAR FIXED INTEREST RATE FIXED INTEREST 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>
<TABLE>
<CAPTION>
DECEMBER 31, 1993
-----------------------------------------------------
GROSS NET WEIGHTED GROSS NET WEIGHTED
RECEIVING AVERAGE PAYING AVERAGE
YEAR FIXED INTEREST RATE FIXED INTEREST RATE
- -------------------------------------------------- --------- ------------- ------ -------------
<S> <C> <C> <C> <C>
1994.............................................. $ 208.0 5.81% $358.0 5.63%
1995.............................................. 129.0 6.57 -- --
1996.............................................. 105.0 5.44 -- --
--------- --- ------ ---
Total....................................... $ 442.0 5.94% $358.0 5.63%
--------- --- ------ ---
--------- --- ------ ---
</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 six-month reset
dates. The Company also generally uses six-month LIBOR as the floating rate
index for its forward rate agreements. Forward rate agreements generally have a
final maturity date that is less than two years.
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. At December 31, 1994, the Company recognized a current liability of $1.3
million, representing the estimated cost to settle these options at that date.
The estimated cost to settle these options was nominal at December 31, 1993. 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.
49
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
At December 31, 1994 and 1993, the Company had the following written
interest rate option agreements outstanding, by year of final maturity:
<TABLE>
<CAPTION>
DECEMBER 31, 1994
-----------------------------------------------------
GROSS NET WEIGHTED GROSS NET WEIGHTED
RECEIVING AVERAGE PAYING AVERAGE
YEAR FIXED INTEREST RATE FIXED INTEREST RATE
- --------------------------------------------------- --------- ------------- ------ -------------
<S> <C> <C> <C> <C>
1995............................................... $15.6 5.27% $-- -- %
1996............................................... 43.4 5.42 10.0 4.6
--
--------- --- ------
Total........................................ $59.0 5.38% $10.0 4.6%
--
--
--------- --- ------
--------- --- ------
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1993
-----------------------------------------------------
GROSS NET WEIGHTED GROSS NET WEIGHTED
RECEIVING AVERAGE PAYING AVERAGE
YEAR FIXED INTEREST RATE FIXED INTEREST RATE
- --------------------------------------------------- --------- ------------- ------ -------------
<S> <C> <C> <C> <C>
1994............................................... $20.0 4.59% $15.0 4.87%
1995............................................... 22.0 5.75 -- --
1996............................................... 42.0 5.40 7.0 5.00
--------- --- ------ ---
Total........................................ $84.0 5.30% $22.0 4.91%
--------- --- ------ ---
--------- --- ------ ---
</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.
50
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
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 DECEMBER 31, 1994 AS OF DECEMBER 31, 1993
------------------------- -------------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
-------- ---------- -------- ----------
<S> <C> <C> <C> <C>
Long-term debt, including current portion.... $149.8 $146.4 $123.5 $125.3
Foreign exchange forward contracts........... 1.6 2.6 0.5 0.5
Interest rate swaps and forward rate
agreements................................. (2.8) (8.2) -- 2.7
</TABLE>
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 $11.3 million of future sublease rental income, which have been
translated at December 31, 1994 closing foreign exchange rates, are as follows:
OPERATING
LEASES
---------
1995............................................................. $ 84.4
1996............................................................. 71.7
1997............................................................. 52.8
1998............................................................. 41.6
1999............................................................. 37.5
Thereafter....................................................... 206.9
---------
Total minimum lease payments............................... $ 494.9
---------
---------
Rent expense for office space, which includes property taxes and certain
other costs, amounted to $93.6 million, $92 million and $99.3 million for the
years ended December 31, 1994, 1993, and 1992, respectively.
OTHER COMMITMENTS At December 31, 1994, the Company had $32.7 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.
51
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
Claims asserting these allegations are pending in suits filed in New York and
Ohio. 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 totalling
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. In a similar New York 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 some of the plaintiffs for
contribution. Discovery in this case remains to be concluded and no trial date
has been set. In the Ohio action brought in 1985 (The Highway Equipment Company,
et al. v. Alexander Howden Limited, et al. (Case No. 1-85-01667, U.S. Bankruptcy
Court, So. Dist. Ohio, Western Div.)), plaintiffs seek compensatory and punitive
damages, as well as treble damages under RICO totaling $24 million. A directed
verdict in the Company's favor was affirmed on March 14, 1994 in a decision by
the U.S. District Court for the Southern District of Ohio. The plaintiffs have
appealed this decision to the U.S. Court of Appeals for the Sixth Circuit.
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 actions. These 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 filed a complaint in the Commonwealth court against Shand and
the Company. The case was subsequently removed to the U.S. District Court for
the Eastern District of Pennsylvania and is captioned Foster v. Alexander &
Alexander Services Inc., 91 Civ. 1179. The complaint, which seeks compensatory
and punitive damages, alleges that Shand and, in certain respects, the Company
breached duties to and agreements with, Mutual Fire. The rehabilitator, through
an expert's report, indicated that the alleged damages are approximately $234
million, a conclusion with which the Company, based on substantial arguments,
strongly disagreed.
On March 27, 1995, the Company, Shand and the rehabilitator entered into a
settlement agreement which, if approved by the courts, would terminate the
rehabilitator's litigation and release the Company and Shand from any further
claims by the rehabilitator. Under the terms of the settlement, the Company
would pay $12 million in cash and an additional $35 million in the form of a
six-year zero-coupon note with a discounted value of $25.9 million. In addition,
Shand is required to return $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 possible third-party claims 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
52
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
coverage (Alexander & Alexander Services Inc. and Alexander & Alexander Inc.
plaintiffs against those certain underwriters at Lloyd's, London, England
subscribing to insurance evidence by policy numbers 879/P. 31356 and 879/P.
35349 and Assicurazioni Generali, S.P.A., defendants No. 92 Civ. 6319
(F.D.N.Y.)). In the fourth quarter of 1994, the Company increased its previously
established reserves of $10 million based on an estimated settlement amount, and
recorded a pre-tax charge of $37.2 million ($24.2 million after-tax or $0.55 per
share).
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. 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 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 will
pay $14 million in cash, issue a five-year interest bearing note in the
principal amount of $14 million and expects to pay a contingent obligation of
$4.5 million. In the fourth quarter of 1994, the Company recorded a pre-tax
charge of $32.5 million ($21.1 million after-tax, or $0.48 per share) associated
with this settlement. 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 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 said 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. The defendants have filed a motion to dismiss the second amended
complaint. Management of the Company believes there are valid defenses to the
allegations set forth in the complaint and the Company intends to vigorously
dispute this claim. The Company currently believes that this action is covered
by
53
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
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 AIG Agreement, the Company has agreed to make certain payments to
AIG pursuant to indemnifications given with respect to the Company's balance
sheet as of March 31, 1994. Pursuant to an amendment to the AIG Agreement, dated
November 10, 1994, the Company's potential exposures under the indemnification,
individually or in the aggregate, was limited to $10 million. Pursuant to a
second amendment, dated March 16, 1995, the indemnification was further limited
to cover only tax payments and reserves in excess of recorded tax reserves as of
March 31, 1994. 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.
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 and executive planning services, as well as human resource
organizational analysis and planning.
54
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
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, 1994:
<TABLE>
<CAPTION>
OPERATING
OPERATING INCOME IDENTIFIABLE DEPRECIATION CAPITAL
REVENUES (LOSS)(A) ASSETS & AMORTIZATION EXPENDITURES
--------- -------------- ------------ -------------- ------------
<S> <C> <C> <C> <C> <C>
BUSINESS SEGMENTS:
1994
Insurance services.............. $ 1,113.2 $(12.2) $2,525.4 $ 44.7 $ 19.0
Human resource management
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 management
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
--------- ------ ------------ ----- -----
--------- ------ ------------ ----- -----
1992
Insurance services.............. $ 1,129.0 $ 86.1 $2,422.5 $ 52.9 $ 16.2
Human resource management
consulting...................... 240.5 30.8 130.2 7.0 0.5
General corporate............... -- (31.4) 56.9 0.6 --
--------- ------ ------------ ----- -----
$ 1,369.5 $ 85.5 $2,609.6 $ 60.5 $ 16.7
--------- ------ ------------ ----- -----
--------- ------ ------------ ----- -----
</TABLE>
- ------------
(a) The restructuring charge referred to in Note 3 of Notes to Financial
Statement includes $56.3 million for insurance services, $8.3 million for
human resource management consulting and $4.4 million for general corporate.
55
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
OPERATING OPERATING IDENTIFIABLE
REVENUE INCOME (LOSS)(A) ASSETS
--------- ----------------- ------------
<S> <C> <C> <C>
GEOGRAPHICAL AREAS:
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
--------- ------ ------------
--------- ------ ------------
1992
United States........................................... $ 731.1 $ 17.4 $ 960.8
United Kingdom.......................................... 338.4 63.9 980.8
Canada, principally Reed Stenhouse Cos. Ltd............. 130.0 16.1 213.6
Other countries......................................... 170.0 19.5 397.5
General corporate....................................... -- (31.4) 56.9
--------- ------ ------------
$ 1,369.5 $ 85.5 $2,609.6
--------- ------ ------------
--------- ------ ------------
</TABLE>
- ------------
(a) The 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.
56
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
16. QUARTERLY FINANCIAL DATA (UNAUDITED)
Quarterly operating results for 1994 and 1993 are summarized below (in
millions, except per share data).
<TABLE>
<CAPTION>
INCOME
(LOSS) FROM NET
OPERATING OPERATING CONTINUING INCOME
REVENUE INCOME (LOSS) OPERATIONS (LOSS)
--------- ------------- ----------- -------
<S> <C> <C> <C> <C>
1994
1st............................................ $ 323.0 $ 5.2 $ (1.8) $ (4.4)
2nd............................................ 335.1 14.6 3.8 (2.2)(a)
3rd............................................ 332.6 4.2 0.1 (20.8)(b)
4th............................................ 333.2 (106.9) (109.3) (111.3)(c)
--------- ------------- ----------- -------
Year..................................... $ 1,323.9 $ (82.9) $(107.2) $(138.7)
--------- ------------- ----------- -------
--------- ------------- ----------- -------
1993
1st............................................ $ 324.8 $ 18.9 $ 9.9 $ 13.2
2nd............................................ 341.9 25.6 13.1 13.1
3rd............................................ 327.1 0.2 (2.6) (2.6)
4th............................................ 347.8 7.6 3.2 3.2
--------- ------------- ----------- -------
Year..................................... $ 1,341.6 $ 52.3 $ 23.6 $ 26.9
--------- ------------- ----------- -------
--------- ------------- ----------- -------
</TABLE>
<TABLE>
<CAPTION>
PER SHARE OF COMMON STOCK:
------------------------------------------------------------
INCOME
(LOSS) FROM NET
CONTINUING INCOME
OPERATIONS (LOSS) DIVIDENDS HIGH LOW
----------- ------ --------- ------ ------
<S> <C> <C> <C> <C> <C> <C> <C>
1994
1st.................................... $ (.09) $ (.15) $ .25 $22 3/4 $17 1/4
2nd.................................... .04 (.10)(a) .025 18 1/8 14
3rd.................................... (.11) (.58)(b) .025 20 7/8 16
4th.................................... (2.61) (2.66)(c) .025 21 1/2 18 1/2
----------- ------ ---------
Year............................. $ (2.79)(d) $(3.51)(d) $.325
----------- ------ ---------
----------- ------ ---------
1993
1st.................................... $ .22 $ .30 $ .25 $28 7/8 $24
2nd.................................... .26 .26 .25 28 24 3/8
3rd.................................... (.11) (.11) .25 27 3/4 21 3/8
4th.................................... .03 .03 .25 21 3/4 17 5/8
----------- ------ ---------
Year............................. $ .40 $ .48 $1.00
----------- ------ ---------
----------- ------ ---------
</TABLE>
- ------------
(a) 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).
(b) 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).
(c) Includes charges of $163.6 million ($106.6 million after-tax or $2.43 per
share) for restructuring, contingency settlements and other reserves.
(d) 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.
57
<PAGE>
SCHEDULE II
ALEXANDER & ALEXANDER SERVICES INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
FOR THE THREE YEARS ENDED DECEMBER 31, 1994
(THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
- ------------------------------------- ---------- -------------------------- -------------- --------
ADDITIONS
--------------------------
BALANCE AT CHARGED TO CHARGED TO BALANCE
BEGINNING COSTS AND OTHER AT END
DESCRIPTION OF YEAR EXPENSES ACCOUNTS (1) DEDUCTIONS (2) OF YEAR
- ------------------------------------- ---------- ---------- ------------ -------------- --------
<S> <C> <C> <C> <C> <C>
Allowance for doubtful accounts
receivable:
Year Ended December 31, 1992 (3)... $ 24,408 $5,424 $ (5,081) $2,632 $22,119
---------- ---------- ------------ ------- --------
---------- ---------- ------------ ------- --------
Year Ended December 31, 1993....... $ 22,119 $3,793 $ (2,019) $3,566 $20,327
---------- ---------- ------------ ------- --------
---------- ---------- ------------ ------- --------
Year Ended December 31, 1994....... $ 20,327 $7,880 $ (1,279) $3,203 $23,725
---------- ---------- ------------ ------- --------
---------- ---------- ------------ ------- --------
</TABLE>
- ------------
NOTES:
(1) Recoveries and adjustments for foreign currency translation.
(2) Writeoffs of receivables which are not recoverable.
(3) Restated to reflect acquisition of Clay & Partners.
58
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) and (2) The financial statements, supplemental schedules and related
information are listed in the accompanying table of contents on page 17 of this
report.
(a)(3)--Exhibits: All exhibits, except for Exhibit 23.0 are
incorporated by reference from the Company's Form 10-K for the year ended
December 31, 1994 and are supplemented by the following exhibit.
23.0--Independent Auditors' Consent.
59
<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, thereunto duly authorized, on the 5th day of April 1995.
ALEXANDER & ALEXANDER SERVICES INC.
By /s/ Edward F. Kosnik
...................................
Edward F. Kosnik
Director, Executive Vice President
and Chief Financial Officer
Dated April 5, 1995
60
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC.
ANNUAL REPORT ON FORM 10-K/A, AMENDMENT NO. 1
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1994
INDEX TO EXHIBITS
The following exhibits are being filed herewith:
<TABLE>
<CAPTION>
EXHIBIT PAGE NO.
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<S> <C>
23.0 --Independent Auditors' Consent. 62
</TABLE>
61
EXHIBIT 23.0
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Alexander & Alexander
Services Inc. Registration Statement Nos. 2-98915 and 33-10440 on Form S-4;
Registration Statement Nos. 33-5316 and 33-55081 on Form S-3; Registration
Statement Nos. 2-68206, 2-94427, 33-16608, 2-86820, 33-16609, 33-8152, 33-25580
and 33-60054 on Form S-8; and Registration Statement Nos. 2-97056, 2-97057 and
2-97734 on Form S-14 of our report dated February 15, 1995 (February 28, March
16 and 27, 1995 with respect to certain information in Notes 2, 5, 8 and 14)
appearing in the Form 10-K/A of Alexander & Alexander Services Inc. for the year
ended December 31, 1994.
DELOITTE & TOUCHE LLP
Baltimore, Maryland
April 5, 1995
62
