Good morning, thank you for holding. Welcome to the Aon plc third quarter 2015 earnings conference call. At this time, all parties are in a listen-only mode until the question and answer portion of today's call. If anyone has an objection, you may disconnect your line at this time. I would also like to remind all parties that this call is being recorded, and that it is important to note that some of the comments in today's call may constitute certain statements that are forward-looking in nature, as defined by Private Securities Litigation Reform Act of 1995. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical results of those anticipated. Information concerning risk factors that could cause such differences are described in press release covering our third quarter 2015 results, as well as having been posted on our website.
Now, it is my pleasure to turn the call over to Greg Case, President and CEO of Aon plc.
Good morning, everyone, and welcome to our third quarter 2015 conference call. Joining me today is our CFO, Christa Davies. I would note that there are slides available on our website for you to follow along with our commentary today. Consistent with previous quarters, I would like to cover two areas before turning the call over to Christa for further financial review. First is our performance against key metrics we communicate to shareholders, and second is overall organic growth performance, including continued areas of strategic investment across Aon. On the first topic, our performance versus key metrics. Each quarter, we measure our performance against the key metrics we focus on achieving over the course of the year: grow organically, expand margins, increase earnings per share, and deliver free cash flow growth. Turning to slide three.
In the third quarter, organic revenue growth was 2% overall, with growth across both segments, highlighted by 5% growth in the HR outsourcing business and 4% growth in the Americas retail brokerage business. Operating margin increased 30 basis points, reflecting solid operating performance in both segments. EPS decreased 4% to $1.24 as unfavorable foreign currency translation and a gain on the sale of a business in the prior year more than offset organic growth, operational improvement, and effective capital management. Finally, free cash flow for the 9 months is up 21% to $850 million, a strong performance driven by operational improvement and working capital management. Turning to slide four, on the second topic of growth and investment. I want to spend the next few minutes discussing the quarter for both of our segments.
In Risk Solutions, organic revenue growth was 1% overall in our seasonally weakest quarter, similar to the prior year, reflecting growth across retail brokerage, partially offset by a decline in reinsurance. For the nine months, organic revenue growth is 2%, in line with our expectation of low- to mid-single digit growth going into our seasonally strongest quarter. As we discussed previously, we're driving a set of initiatives and making strategic investments that are strengthening underlying performance and position our Risk Solutions segment for long-term growth and improved operating leverage. With management of our renewal book through Aon Client Promise and retention rates of more than 90% on average across retail brokerage. New business generation of $240 million across our retail business, with record new business in U.S. retail. 18 consecutive quarters of positive net new business in core treaty reinsurance.
Increased operating leverage from our investments in innovative technology and data analytics, including in the Global Risk Insight Platform, which now captures over 2.9 million trades and $139 billion of bound premium, with more than 40 carriers utilizing the platform today. ReView, our reinsurer dashboard combined with strategic consulting to help reinsurers be more effective markets for ceding company clients. Our Aon Broking initiative to better match client need with insurer appetite for risk and to identify structured portfolio solutions. Finally, we're expanding our content and global footprint through tuck-in acquisitions that increase scale in emerging markets or expand capability. Reflecting on the individual businesses within Risk Solutions. In the Americas, organic revenue growth was 4% compared to 2% in the prior year quarter. Exposures continued to be positive across the region, while the impact from pricing was modestly negative, resulting in continued stable market impact overall.
We saw growth across all regions, U.S. retail, Latin America, and Canada, including growth across all businesses, property casualty, health and benefits, and affinity. In U.S. retail and Canada, growth was driven by strong new business generation, while strong management of the renewable drove growth in Latin America. In international, organic revenue growth was 1%. Exposures continued to be stable and the impact from pricing was modestly negative on average, driven by fragile market conditions in many countries across Europe and continued pressure in the Pacific region. We saw strong growth in New Zealand driven by double-digit new business generation. Results also reflect solid growth across Asia, primarily in emerging markets, China and Thailand, driven by strong management of the renewable portfolio.
In Continental Europe, we continue to see modest growth. With strong leadership across the region, we are well positioned to benefit from potential improvements in the macroeconomic environment. In reinsurance, organic revenue declined 4%, similar to the prior year quarter, and for the nine months was minus 2%, roughly in line with our expectation of a modest decline for the year. Results in the quarter primarily reflect significant unfavorable market globally, a modest decline in facultative placements, and modest unfavorable impact from timing. In our treaty portfolio, we saw a record level of new business generation in the quarter, driven by an increase in ceding demand and growth in new products from areas such as U.S. mortgage and ReView. While excess capital continues to place pressure in the market, the rate of price decline continues to moderate.
Against that price pressure, clients are buying more and capital is being deployed to new markets. New opportunities for growth, combined with industry-leading data and analytics, is positioning the business for a return to growth on a quarterly basis in the next 12 months. Overall, across Risk Solutions, we continue to deliver new business generation and strong retention, driven by a unified approach to serving clients across the portfolio and industry-leading data and analytics. We expect improved performance in the fourth quarter, placing us firmly on track for solid organic revenue growth for the full year 2015, despite continued pricing pressure in reinsurance and fragile economic conditions in continental Europe. Turning to HR Solutions. Organic revenue growth was 5%, with solid growth across both major businesses and in high-demand areas where we have invested in innovative solutions and client-serving capability.
These reflect investments from Aon in client leadership and our in-depth understanding and influence on overall market trends, including as clients manage risk against pension schemes that are frozen, largely underfunded and facing regulatory changes. Solutions to de-risk pension plans and support for delegated investment solutions are a strong area of growth where assets under management have grown from $10 billion to roughly $70 billion in five years. Continued investment to strengthen our industry-leading portfolio of health solutions, covering the full range of benefit strategies, client size, and funding choices. Across Aon's suite of private health exchanges, we expect to enroll roughly 1.4 million lives across 150 clients, compared to roughly 1.2 million lives across 100 clients in the prior year. Broken down into active exchange, with 1 million enrolled lives across 55 clients, and retiree exchange with 400,000 enrolled lives across 75 clients.
The growth reflects continued progress to achieve scale and drive new revenue, as roughly two-thirds of all clients who have joined the exchange are new to Aon. Our growth reflects both self and fully insured solutions, including the industry's leading large corporate, fully insured multi-carrier model. Our range of solutions provide clients with the unique ability to seamlessly transition between funding choices, depending on their level of risk tolerance. In addition, representation now spans 22 distinct industries. We look forward to providing further details after we complete enrollment in the fourth quarter, with potential further updates on client wins as we are already in very active discussions for 2016 off-cycle and 2017 enrollment.
We would also highlight our investment in Software-as-a-Service model and our HR BPO business, where growth in new clients and conversion of existing clients is driving strong demand, as well as the expansion of our capabilities to include financial implementations. Finally, we're investing in our talent rewards business as we're seeing strong demand for data and analytics to support increasing organizational change. Turning to our individual businesses within HR Solutions. In consulting services, organic revenue growth was 3%. The prior year quarter included a significant favorable benefit from timing due to a change in revenue recognition policy in our compensation consulting business. Results in the quarter reflect continued growth in retirement consulting, primarily driven by demand for delegated investment consulting services.
We also saw continued growth in compensation consulting, driven by demand for survey work as companies require benchmarking and assistance with plan design to address retention and ways to compete for talent more effectively. In outsourcing, organic revenue growth was 5% compared to 3% in the prior year quarter. Results reflect solid growth in benefits administration, driven by an increase in project-related work and growth in our absence management business. We also saw continued growth in HR BPO, driven by new client wins in cloud-based solutions and growth in our healthcare exchange business from off-cycle enrollments on the retiree exchange. Overall, for HR Solutions, we are well-positioned to deliver continued organic revenue growth across both segments for the fourth quarter and full year 2015, driven by high demand areas where we made investments, as well as continued leadership across our core businesses.
In summary, despite short-term headwinds, we continue to drive growth across both segments, improve our operational performance, and deliver significant free cash flow growth. Looking forward, we expect a strong finish to the year and continued long-term growth driven by our industry-leading platform of client-serving capabilities and investments in data and analytics. With that said, I'm now pleased to turn the call over to Christa for further financial review. Christa?
Thank you so much, Greg, and good morning, everyone. As Greg noted, our third quarter is our seasonally weakest quarter, and we continued to face both macroeconomic and specific industry headwinds. However, against these headwinds, the strength of our industry-leading franchise continues to perform. Our results from the quarter reflect organic growth and operating margin improvement across both Risk and HR Solutions, substantial free cash flow growth, and effective capital management, highlighted by the repurchase of $600 million of ordinary shares in the quarter. Now let me turn to the financial results for the quarter on page six of the presentation. Our core EPS performance, excluding certain items, decreased 4% to $1.24 per share for the third quarter compared to $1.29 in the prior year quarter. The prior year quarter included a $25 million pre-tax or $0.07 per share after-tax gain related to the sale of a business.
Certain items that were adjusted for in the core EPS performance and highlighted in the schedules on page 12 of the press release include non-cash intangible asset amortization. Further, included in the results was a $0.09 per share unfavorable impact related to foreign currency translation due to the U.S. dollar strengthening against most major currencies. Excluding the impact of foreign currency translation, our core earnings per share in the third quarter would have been $1.33, up 3% from the prior year quarter. Going forward, while currency movement has been challenging to predict, if currency were to remain stable at today's rates, we would expect a similar impact in Q4 as we incurred in Q3 due to continued U.S. dollar strengthening.
As we look forward to 2016, we would anticipate substantially less of a headwind as year-over-year comparisons become easier, with an unfavorable impact of roughly $0.05-$0.10 per share for the full year 2016, compared to approximately $0.41 of impact for the full year 2015. I would note that this assumes FX rates remain stable at today's rates. Let me talk about each of the segments on the next slide. In our Risk Solutions segment, organic revenue growth was 1%. Operating margin increased 50 basis points to 20.8%, and operating income decreased 6% compared to the prior year quarter. Operating income included a $25 million unfavorable impact from foreign currency translation. Excluding this impact, operating income increased 1% versus the prior year quarter. Operating margin improvement of 50 basis points reflects the 40 basis point favorable impact from foreign currency translation.
Excluding the favorable impact from foreign currency, underlying operating margin improved 10 basis points in the quarter, driven by continued operational improvement in our seasonally weakest quarter. Overall, in Q3, we delivered underlying operational performance in Risk Solutions, despite continued headwinds from an unfavorable market impact in reinsurance, fragile market conditions in Europe, and historically low interest rates. If short-term interest rates were to rise, we believe we have significant leverage from improving interest rate environments, as every 100 basis point rise in global interest rates should result in approximately $45 million of investment income. For the first nine months, excluding the impact of foreign currency translation, operating income increased 4% and operating margin improved 50 basis points.
As we approach our seasonally strongest quarter in Risk Solutions, performance places us firmly on track for further margin expansion in 2015 towards our long-term target of 26%, driven by growth, return on investments, and expense discipline as we optimize our global cost structure in areas such as IT, real estate, and global procurement. Turning to the HR Solutions segment, organic revenue growth was 5%, operating margin increased 90 basis points, and operating income increased 6%. Results reflect solid organic revenue growth, expense discipline, and improved profitability in the areas where we've been investing for long-term growth, including delegated investment consulting, cloud-based solutions in HR BPO, and healthcare exchanges, where we believe we have achieved enough scale to deliver modest profitability in 2015. For the first nine months, excluding the impact of foreign currency translation, operating income increased 6% and operating margin improved 30 basis points.
As we approach our seasonally strongest quarter in HR Solutions, performance places us firmly on track for further margin expansion in 2015 towards our long-term target of 22%, driven by growth, return on investments, and expense discipline. Let me discuss a few of the line items outside of the operating segments on slide nine. Unallocated expenses were $45 million, in line with quarterly guidance. Interest income was $3 million, similar to the prior year quarter. Interest expense increased $7 million to $72 million due to an overlap of expiring debt in the quarter. Other income of $8 million primarily includes net gains from certain long-term investments. The prior year quarter benefited from the sale of certain businesses and net gains from certain long-term investments. Going forward, we expect a run rate of approximately $45 million per quarter of unallocated expense and $2 million per quarter of interest income.
Interest expense in the fourth quarter is expected to be approximately $68 million as $600 million of overlapping notes were paid in September. Turning to taxes, the adjusted effective tax rate on net income from continued operations, excluding the applicable tax impact associated with expenses related to legacy litigation in Q2, decreased to 16% compared to the prior year quarter at 19.1% due to the favorable impact of certain discrete tax adjustments. Our underlying operating tax rate remains at 19%. Lastly, average shares outstanding decreased to 283.8 million in the third quarter compared to 296.1 million in the prior year quarter. The company repurchased 6.3 million Class A ordinary shares for approximately $600 million in the third quarter. The company has $4.5 billion of remaining authorization under its share repurchase program. Actual shares outstanding on September 30th were 273.9 million, and there are approximately seven million additional dilutive equivalents.
Estimated Q4 2015 beginning dilutive share count is approximately 281 million, subject to share price movement, share issuance, and share repurchase. Now let me turn to the next slide to highlight our solid balance sheet and strong cash flow on slide 10. At September 30th, cash and short-term investments were $783 million. Total debt outstanding increased to approximately $6.1 billion, and total debt to EBITDA on a GAAP basis increased to 2.6 times. Cash flow from operations for the first nine months increased 22% or $192 million to $1.1 billion, driven by working capital improvements, a decline in pension contributions, Restructuring and cash paid for taxes, partially offset by a significant increase in cash paid to settle legacy litigation flowing through net income in the second quarter.
The increase in cash paid of $137 million to settle legacy litigation in the previous quarter will provide a tailwind to free cash flow growth in 2016. Free cash flow as defined by cash flow from operations less CapEx increased 21% or $146 million to $850 million, reflecting strong growth in cash flow from operations, partially offset by a $46 million increase in CapEx. The anticipated increase in CapEx in 2015 is associated with investment in certain real estate projects as we continue to optimize our real estate portfolio globally. Turning to the next slide to discuss our significant financial flexibility and the opportunity to further increase cash flow generation. We value the firm based on free cash flow and allocate capital to maximize free cash flow returns.
There are four primary areas that are expected to contribute to our goal of delivering $2.3 billion or more for the full year 2017. Free cash flow of $2.3 billion is not our end goal, as further long-term sustainable free cash flow will be driven by continued operating income growth and additional working capital initiatives beyond 2017. We continue to believe the plans we've put in place have positioned the firm to benefit from abnormal growth in free cash flow and free cash flow per share in the near term, providing significant opportunity for shareholder value creation. From the graph in the presentation, based on current assumptions, we expect annual free cash flow to increase by approximately $230 million from year-end 2014 to year-end 2017, based only on a reduction in cash used for pensions, restructuring, and CapEx.
Combined with operational improvement in the business, lower cash tax payments, and working capital improvements in areas such as accounts receivable and accounts payable, we have line of sight to delivering on our expectations for substantial free cash flow generation. Regarding our pension plans, we've taken significant steps to reduce volatility and liability as we've closed plans to new entrants and frozen plans from accruing additional benefits and continue to de-risk certain plan assets. We currently expect contributions to decline by roughly $96 million to $220 million in 2015 and continue to decline thereafter. These expectations are based on 12/31/2014 actuarial assumptions. A rise in global long-term interest rates could potentially decrease contributions further. Regarding our restructuring program, cash payments were $82 million in 2014.
As all charges related to the restructuring program have now been incurred, we would expect cash payments to decline by $51 million to approximately $31 million in 2015 and continue to decline significantly each year thereafter. In summary, we delivered organic growth and margin expansion across both segments as we continue to manage expense and create greater operating leverage from our investments in data and analytics. Strong operating performance in the fourth quarter, combined with declining uses of cash and working capital improvements, are expected to deliver double-digit free cash flow growth for 2015, placing us firmly on track towards our goal of generating more than $2.3 billion of free cash flow for the full year 2017. With a strong balance sheet and significant financial flexibility, we've positioned the firm for significant shareholder value creation in 2015 and beyond.
With that, I'd like to turn the call back over to the operator for questions.
Thank you. We will now begin the question-and-answer session. To ask a question, you may press star followed by one. Please unmute your phone and record your name clearly when prompted so I can introduce you for your question. You may also cancel your request by pressing star and then two. One moment please for the first question. Our first question will be coming from David Styblo of Jefferies. Your line is open.
Dave, you might be on mute. Why don't we go to the next one, operator?
David Styblo of Jefferies, your line is open.
Can you guys hear me at this point?
Yeah, we can.
Yes, we can.
Go ahead.
Okay, great. First of all, I was just saying thanks for taking the questions, you missed that part. Wanted to talk a little bit about the Americas business. The retail side there held up well at +4%, and I guess I was surprised it did so well considering it includes Latin America, where you've got economies like Brazil, which are now experiencing a GDP decline. Can you help me understand, is the outperformance or the strong performance there in Latin America continuing, or are we doing just that much better in the other parts of Canada and the U.S. to offset some of the pressure that might be going on in Latin America?
Actually, Dave, we have solid growth across the board. It comes in different categories in different places. If you think about how we think about growth, it's new business, then retention and something we call rollover overall. We've been able to generate substantial new business growth, which is new clients coming into the firm, as well as doing more with existing clients, which is retaining, then rollover, which is actually doing more with them. In businesses like our affinity business, which has been exceptionally strong, we're also seeing substantial growth. We really have on the U.S. side, record new business generation. A lot of the investments we've made over time continue to reap benefits, you're seeing the results. I would emphasize again, though, look at it on an annual basis.
The quarter-to-quarter is always moving around at different places, but it's a very, very positive piece overall.
Okay, that's helpful. Thanks. On HR Solutions, the margins up 90 basis points there year-over-year in light of what I think was I think you guys had a tough comp last year where you had some favorable timing that lifted revenue and margins. Was there any sort of timing in this quarter? Obviously, you guys talked about two of the three factors that did help this quarter. If you could elaborate, to what extent are those sustainable versus project-oriented and maybe one-time in nature?
Yeah, we feel really good about the performance of HR Solutions, not just in Q3, but really in the nine months year-to-date. We've had operating income growth of 6%, excluding FX in the nine months year-to-date, and margin expansion of 30 basis points. We would say they are well on track to solid revenue growth, margin expansion, and operating income growth for the full year. That's really coming from the return on the investments we've made. We're getting continued revenue growth and margin expansion from the significant investments we've made in delegated investment consulting and healthcare exchanges and an HR BPO SaaS.
Okay, great. Then just lastly, on the exchanges, it sounds like the $1.4 million, is that an estimate for January or year-end 2016? I guess that implies something along the lines of 15% or 20% membership growth, which is maybe a little lower than peers. Curious to hear what you're seeing in the market. Is there some clients who maybe have deferred, or what is your thoughts on the adoption and pace of adoption relative to your expectations?
I'd say step back overall. First of all, the number we report, 1.4 million, is enrolled lives. So these are actually folks who are paying us, and money's changing hands for the solutions we provide. There's a lot going on around definitions and how different folks describe the business overall. We are very explicit about how we describe our enrolled lives. I would say, Dave, overall, we agree the adoption across the board, when you think about it, especially at the larger end of the market, has not been as fast as we would have expected. This is especially true given the results we've seen with our existing exchange clients. We have been able to sustainably lower cost, reduce volatility, and very importantly, the employee choice has gone up, and there's very high satisfaction.
Our view is we're very confident that over time, you're going to see the market develop. It's going to accelerate. It's going to be an uneven pace, no doubt. Our pipeline is strong. We're in discussions with a number of very large, innovative companies around solutions and ideas, and we feel very good about the development. I would highlight, we've gone from zero to 1.4 million lives, and Christa described, we're marginally profitable in 2015. We've made progress, and we're seeing continued development on that platform. Last point I'd make on this, it is important to put this in context of our overall health effort. We love the health space. We believe in it. We believe we're going to make a difference globally on behalf of our clients.
From classic health and benefits, global benefits, I just remind you, we place more than 10 million in health benefits in the U.S. alone every year, and exchanges have been very strong, zero to 1.4 million. By the way, as I said in my opening comments, two-thirds of the clients who've come in the exchanges are new to Aon and 150 clients overall. We see this as very positive continued development. Overall, in the context of the health opportunities, we see it as quite strong.
Okay, that's helpful. Just the paying members as of what you'd get in January is what that 1.4 is then, right?
Correct.
Yes.
Okay, thanks.
Lots that's going on mid-cycle, lots that's going on in terms of overall 2017, but that's literally clinically as of today.
Got it. Thanks.
Next, we have Adam Klauber of William Blair. Your line is open.
Thanks. Good morning.
Hi.
Just one follow-up on the active exchange. For those large clients, what are the one or two factors that's holding them back from pulling the trigger right now?
I think, Adam, actually, it's a range of different pieces. They don't look at it as this year or next year. They're really looking at what's in the best interest over time of their employee base and how that's developing. They're also looking at the trend line in the marketplace and what's happening with overall health costs and the level of urgency. For them, it really is a range of different items. We would come back to, for the clients who we brought into this environment, the impact has been substantial and now sustained over a multi-year period. More and more companies are seeing that and actually taking some comfort in some of the sustainability of the overall model. As I said before, the pipeline's strong, and this is going to develop.
If you think back, the lessons around DB to DC and the overall solutions, these things take a period of time. What we keep coming back to is the fundamental value proposition is quite strong and now sustained. We think that's going to carry the day over time. We still keep coming back to, though, it's about an overall health platform and a level of demand across health, which we think is going to continue to go up. The exchanges serve one part of that overall market.
Okay, thanks. On cash flow, the operating cash flow from operations was very strong this quarter. It jumped from $365 million to almost $1.1 billion. I guess two questions. One, was there anything unusual in that? Historically, third quarter is strong, but fourth quarter is stronger from an operating cash flow. Should that continue to hold?
Adam, I think that's a great question. We are exceptionally pleased with the cash flow in the nine months year-to-date. There are no unusual items in there. Yes, Q4 is our seasonally strongest cash flow quarter. We are well on track to deliver double-digit free cash flow growth in 2015. The thing I would note that was unusual in calendar year 2015 was the $137 million impact to cash in Q2 that was an outflow of cash on litigation settlements.
True. Okay. On cash flow, I think you said you expect $230 million annually of free cash flow. Does that exclude or not include just normal improvement from earnings?
Yeah. What I referred to there was from year-end 2014 to year-end 2017, you can see in the slides that we've posted on our website that there is an increase in cash flow of $230 million just from decreased cash spent on pension restructuring and capital expenditure.
Right. Okay.
There are really four big drivers of cash flow to get to our $2.3 billion in cash by 2017. The first is obviously growth in revenue and expansion in margin, which will lead to operating income growth. The second is working capital improvements, and we think they are sustainable for many years to come. The decreased uses of cash I just talked about and the reduction in tax rate leading through to less cash spent on taxes.
Okay, thank you. Finally, from what we hear, the Workday service and implementation business is doing very well. Would you say that's growing much faster than your overall HR consulting business? As you look to 2016, 2017, are you doing more types of products, not just Workday, but adding other software suites to that business?
Yeah. We've obviously invested significantly in this area of the business through the acquisition of OmniPoint and the acquisition of Kloud. We are very pleased with the breadth of solutions we can offer clients in the HR BPO space, and obviously, software as a service offers a much more feature-rich and effective set of services for clients at a much lower cost. It's a very high area of growth for us, and it's continuing to grow double digits. We feel really good about this solution, and being able to continue to grow the solution set for clients.
We put it in context with the other investments we're making in terms of overall size on the investment consulting side, the delegated side, investments on talent, obviously exchanges we've talked about. There's a range of portfolio investments we're making and fully funding, by the way, and sort of as part of the P&L, that we can drive performance and investment future.
Would you say, is the margin on that business equal or greater to your average HR consulting margins?
What we've said historically, as we think about our margin growth from where we are in HR Solutions, let's call it 17% today, to our 22% long-term target, that there are really three big drivers of margin expansion. The first is the return on the investments that we've made. We've invested a lot in delegated and exchanges, et cetera. The second is the growth in margins in our HR BPO business. We've talked historically about our HR BPO business being about a $500 million business that had very low single-digit margins. Really one of the things that is driving the expansion in margin is our investments in BPO SaaS and these innovative solutions for clients. The third driver of margin expansion in HR Solutions is our expense discipline, and continuing to manage expenses very carefully around IT real estate and procurement.
Great. Thank you very much.
Sure.
Next, we have Sarah DeWitt of JPMorgan. Your line is open.
Hi, good morning.
Hi, Sarah.
In insurance brokerage, the organic growth in the quarter of 1% was at the lower end of your target of low to mid single digits organic growth. Is there anything unusual that suppressed that, and should we expect to see a rebound in the fourth quarter in 2016?
Yeah, Sarah, I would characterize really. Chris has started on this path. If you really look at for the first nine months of the year, first nine months of the year is as strong or stronger now than it was against 2014. The short answer is no. In fact, look at it over the course of the year, nothing has changed. We would characterize the quarter as a quarter of continued progress against the long-term objectives. Look at Risk Solutions, organic revenue for the nine months was 2%. Operating income increased 4%, margin up 50 basis points. That's roughly where it was last year. We're now going into our strongest quarter. We believe the reinsurance business is improving. Continental Europe looks a bit more positive or at least stable. A lot of the investments we've made are very, very good.
From our standpoint, we feel like this quarter in Risk Solutions, and by the way, in HR Solutions as well, is just another quarter of continued progress.
Okay, great. Thanks. In HR Solutions, last year you did high single-digit adjusted operating income growth. Given that the private exchange enrollment for 2016 sounds maybe a little bit lighter than we would have expected, can you still achieve that level of growth for the full year?
Sarah, we are exactly on track with the goals we outlined for HR Solutions for the full year. We're going to grow organically, we're going to expand margins, and we're going to grow operating income in 2015.
Okay, but no clarity on to what extent you can grow operating income because it tends to be pretty lumpy, right, quarter to quarter?
Yeah, we have said, Sarah, that we are going to be modestly profitable in healthcare exchanges for the full year 2015.
Okay, great. Thanks for the answers.
Next, we have Paul Newsome of Sandler O'Neill. Your line is open.
Good morning, and thanks for the call. I wanted to ask a little bit about the M&A outlook in general, and perhaps a little bit in specific, and it looks like you're actually divesting a little bit more than you're acquiring. Is that a.
Typical of the trend, you're obviously doing a lot of activity in the area. Could you just give us some general sense about what you think the direction of M&A is going for Aon, what the outlook in general is for the sector?
Yeah. We would, Paul, not observe that trend. In fact, if you think back and just reflect on Aon over the last 10 years, we've done roughly $8 billion in acquisitions over that period of time. We said before, we're probably on track for $200 million-$500 million a year, really adding content capability that we can expand across our portfolio, and we're looking to do that all the time. To the extent we divest, it really is around the discipline, around return on invested capital. We're deploying capital around the world, whether it's acquisitions or buyback or whatever, organic investment, around the discipline that Christa has set up, really gauging each investment around improving return on invested capital.
To the extent we end up divesting something, it's because we've made a determination that it's better off in somebody else's hands on behalf of our clients, and we'll do that from time to time. If you just think about just even in 2014, we did $500 million in acquisitions, and in a flood business, which we really love across the U.S., and in a benefits business in the U.K. We are excited about adding capability when it makes sense to add capability.
We should assume that it's a positive number in terms of the revenue impact perspective from acquisitions.
I would say generally, if you look over the last 10 years, absolutely, it will be a positive number. Again, it'll be lumpy depending on sort of what happens from quarter to quarter, but overall, absolutely positive.
I apologize, one more exchange question. A lot of your peers have talked about a move towards more middle market and exchange. Some of them even talked about doing deals to move them in that direction. What's your thoughts on that, and is Aon also doing a similar thing?
We would start, Paul, with, we love the health business. We love the opportunity to serve clients who face increasing pressures that are very real for them. Now, promises they've made to employees about trying to help them serve their family's health needs and the increasing cost of that. Against that backdrop, we provide an absolute large range of solutions. Remember, we actually do health benefits greater than $10 million in the U.S. alone. We actually do more of this than anybody else and love that set of solutions. Exchanges end up being a set of solutions for a subset of that group, like that as well. We've got exchanges, large, medium, small. We've got exchanges that are fully insured and self-insured. We actually go through a range of different options depending on the client situation.
In the end, we're addressing the health needs of clients, which we believe are going to continue to increase over time. Again, I just love the platform and have been very successful in growing pieces called the exchanges, but also in developing other areas as well.
Great. Thank you very much.
Next we have Brian Meredith of UBS. Your line is open.
Yes, thanks. A couple questions here. Greg, back on the healthcare solutions. Has the discussion about the potential repeal of the Cadillac tax had any impact on just the large corporate markets, and companies thinking about changing not only to exchanges, but other types of plans?
Not really, Brian. I think in the end, it's a great question. Our clients are really looking at the pressure around cost overall. That could be an accelerant, frankly, they're feeling the pinch anyway. They're also feeling the pinch around volatility. It really is how do you help your employees meet their demands, what they need for their family, and do it in a way that's reasonably cost-effective, more pressure there, and do it in a way that it's not super volatile quarter to quarter for the company. It's very, very difficult. Wow, if we'd actually lower the cost curve over time, which we've been able to do in the exchange examples, 150, 200 basis points a year, that's hugely positive. It really is, that's the dialogue. The Cadillac tax ends up being out there, but it really hasn't been a driver.
Did you think it'd be a catalyst, though, in the next, call it next year or the year after, as clients potentially face this Cadillac tax if this stays in place?
I would say either way, it's going to evolve because the answer is a good one, and it adds value, and our clients see that. Anything, by the way, that increases cost, the Cadillac tax or anything else, actually is a catalyst for change. To the extent that's out there and it happens, it's a catalyst for change. To the extent it doesn't, I wouldn't overplay it either. As clients see opportunities to reduce costs, flatten the curve, and reduce volatility, they're going to embrace it. I would say clients that really innovate on the health side drive it. I'm going to just give you an example. We are working with a very well-known new car company, who's as excited about innovation and health for their employees as they are about, frankly, changing the way the world buys cars.
Against that, we've helped them create a solution that provides transparency, choice, accountability, a whole series of things for their employees. For them, it's as much about innovation and the idea of better health and better wellness as it is about cost. Oh, yeah, by the way, you can save and reduce volatility. That's really the dynamic that's going on.
Great. Thanks. A quick question on the BPO business. I know margins are pretty low there as you're kind of investing that business. What do the margins look like right now? What is the kind of outlook for those margins to kind of improve here? How much of an impact could that have on the HR Solutions margins overall?
Yeah. Margins are improving, Brian, what I would say is we're still at low single-digit margins. As you know, historically, several years ago, the margins were negative. They have improved, we do believe that we'll move from low single-digit margins to sort of mid-teens margins over time.
How quickly can that happen? Is it simply just getting rid of some of these investments? For a long, long time, they have been low.
Yeah. We're continuing to improve margins every year, Brian. Clients today are on an average of three to seven-year contracts. As clients increasingly choose software as a service options, our margins improve.
Got you. I just thought we might be getting closer to the end of that three to seven years since when you bought Hewitt.
Yeah. It's progressing every year, Brian.
Okay, thanks.
Next, we have Meyer Shields of KBW. Your line is open.
Thanks. Good morning. Two quick questions if I can. One, it looks like the average number of employees on the active exchange per company went down significantly. Is that because you're adding smaller companies, or did any companies from last year not renew?
No, really, this is, again, remember, we have been privileged. We've actually brought on board on the exchange front the largest ever on the exchange. Almost by definition, as we continue to add clients, the average is going to go down. By the way, the same is true on the retiree exchange, where we've added what was the largest client in history on the retiree exchange. I wouldn't read too much into that. As we add clients, that average is invariably going to come down. We're not too worried about that.
Okay.
We're still though, in terms of the category, serving this category, we think in a very unique way with a very unique set of options.
Okay. No, that's helpful. Are there any margin implications of adding smaller clients besides the underlying trajectory of improvement?
No. For us, in the end, we've seen overall positive trajectory, as Christa has described before, again, as I said, fundamentally, this is a solution which has actually proven to be quite effective for the category of clients, large and medium and small, in fact. We're excited about adding clients as it makes sense for them, and as they elect to come on board.
The other thing I would add is, because we've created a platform, we're now adding more and more products to be able to offer to employees. We've now got over 11 different products, not just medical. It's medical, dental, vision, short-term disability, long-term disability, health, pet insurance, and others. So it becomes a platform for employees to really have choice as to how they want to invest their dollars.
This is consistent on the exchange, as Christa is describing, Meyer, with the idea of a platform to serve, similar to what we do across the overall health segment, which is really how do we actually serve clients in an effective way across a range of needs beyond a single product, this just happens to be a platform to do that.
Okay. That's very helpful. I appreciate the detail. On a year-to-date basis, I guess organic revenue growth in the brokerage, how does that compare to overall global premium growth?
Overall, if you look at year to date at give or take 2% overall, that's probably roughly in line. We would say with overall premium growth globally, what you're getting to, Meyer, is a great outcome that this really isn't about price. It's really about underlying demand. Our view is underlying demand in the risk world has continued to grow. That's going to be reflected in premiums, which tend to increase year to year. We're roughly in line with that. We're also doing things to bring new categories into play. The work we've done, for example, in the reinsurance world, bringing reinsurance capital into the mortgage world actually creates net new markets for what we do overall. That's true in cyber. That's true in terrorism as well. For us, we think this is a demand opportunity, irrespective of what's happening in the micro price environment.
We're seeing it play out over time, and we're benefiting from that.
Okay. That is what I was getting at. Thanks so much.
Next, we have Kai Pan of Morgan Stanley. Your line is open.
Thank you, and good morning.
Morning.
First, I have two questions. First question on the margin. It's pretty good that you can maintain and improve your margin on the recent solution given the 1% organic growth. I just wonder what are the drivers behind being able to better manage expense. Looking longer term, if you look at Risk Solutions, the margin has been stable for about 5 years, and the HR has been stable 4 years. There's still pretty significant upside to your long-term aspiration goal. Just wonder if the macro environment remains the same, what are the key drivers within your control that we can see meaningful margin expansion in both segments?
I think it's a great question, Kai, because one of the things we have been investing in are investments in data analytics, particularly on the risk side. They are enabling us to drive margin expansion at lower rates of growth. What you're seeing is we absolutely invested disproportionately in our data analytics business, particularly up until 2012. What you're seeing in 2013, 2014, and 2015 are the return on those investments. As we think about our margin growth from 22.7%, which is where we finished at year-end calendar 2000, or 22.9%, sorry, year-end 2014 to 26%, there are three big drivers of that margin expansion. First is the return on the investments we've made in data analytics, which are substantial, and you're seeing that drive the majority of our margin expansion in 2013, 2014, and again this calendar year.
Second is the revenue engine, which is allowing us to get record levels of retention of existing clients and record levels of new business wins. You've seen that in our business in calendar year 2015. Third is the continued expense discipline across our Risk Solutions business. We are on track for record margins in both segments in 2015.
That would be, Kai, at the end of the day, we want to be really clear. Chris has described the track for us to improve margins irrespective of the external environment. We didn't talk about pricing, we didn't talk about inflation, we didn't talk about interest rates. We anticipate and expect none of those. If any of those happen, those are substantial accelerants of our margin expansion. We've been able to expand margin without any of that help, with increased operating leverage in the business. That's why we are comfortable, and this quarter's done nothing except reinforce that comfort that we're going to improve margin in 2015, 2016, 2017, irrespective of the external environment.
To be clear, the pace of the improvements, would that be similar to what we have seen in the last few years if the environment keeps the same?
We're going to continue to make progress in margin every year.
Okay, that's great. My second question is on your capacity for buybacks. The buyback number is significant this quarter again. If you're looking forward, if you achieve your $2.3 billion of free cash flow for 2017, which implies about $300 million a year increasing in free cash flow through 2017 from 2014. The two variables then to drive your increased buybacks would be the emerging acquisitions as well as the debt. You spoke about the acquisition side, but on the debt side, are there increasing capacity for you to issue in debt? For example, if your EBITDA grow about $100 million a year, would you be able to increase your debt by $260 million a year to maintain the 2.6 times leverage ratio, or you want to sort of keep the debt, lower the leverage ratio going forward?
Kai, it's a great question, I think it gets to the heart of free cash flow growth for Aon and how we allocate capital. We expect double-digit free cash flow growth for the full year 2015. We've obviously demonstrated 21% growth in free cash flow in the nine months year to date, and we're heading into our seasonally strongest cash flow growth quarter. We feel really good about being able to grow free cash flow double digits this calendar year. As we think about the capacity for buyback, you're absolutely right. It's the growth in free cash flow, it's the leverage. As we think about leverage, we are absolutely committed to our current investment-grade ratings. Therefore, as we grow EBITDA and as our pension unfunded liability comes down, we absolutely have the ability to increase leverage.
That's the way we think about it. You could say, are we allocating this capital towards buyback, or are we allocating it towards M&A? It's really about how we think about return on capital, which is on a cash-on-cash return. Our highest return on capital use of cash today is buyback, because we do believe we're substantially undervalued. Because many people still look at sort of earnings growth. For us, there's a very big disconnect between earnings growth and free cash flow growth. You do have double-digit free cash flow growth to deliver $2.3 billion in 2017.
You're comfortable with the 2.6 leverage ratio at these levels?
Yes, we are.
Okay. Thank you very much.
Next, we have Elyse Greenspan of Wells Fargo. Your line is open.
Hi. Good morning. Few questions. First, on the tax rate, the legacy litigation had a benefit this quarter from the second quarter legacy litigation. Should we expect any kind of benefit on the tax rate in the fourth quarter, or should we revert back to around that 19% level?
Yeah. The way that works is that legacy litigation that occurred in Q2 that had a positive benefit on the tax rate will impact the full-year tax rate for 2015. Yes, it will show up again in Q4, Elyse. It will not repeat in 2016. As I've said, the underlying operating rate is 19%, and that's the right rate to use for 2016.
Okay. Shifting on to the private healthcare exchanges, the enrollment figures that you gave for 2016, I just want to make sure, are those just on the fully-insured exchange? The 55 accounts on the Active Exchange, does that compare to the 30 that you had on last year?
Yeah, this is overall sort of what we put on the exchange, Elyse, it's $1.4 million for 2015 into 2016, just as you described.
Okay. Are you breaking out the self-insured versus the fully-insured component?
Look at that as an overall. We haven't broken those out explicitly. Basically, we increased the number of clients from 30 to 55 on the Active Exchange. The majority are fully-insured, but we also have a number on the self-insured side as well.
Okay. And then in terms of thinking about the economics, Chris, I know you mentioned that you'll see modest positive earnings this year. When we think through that, is that more of a function of the investments and the expenses on the exchanges going down as it gains greater scale or growth in revenue? Which of either revenue or expenses is contributing to you guys kind of hitting the inflection point this year and seeing positive earnings?
Elyse, the way to think about it is the investments we've made are really operating expenses. They're going to show up every year. Then as we get incremental participants enrolled, then our revenue increases, which is how we get the scale to be modestly profitable this year and continued improvements in profitability in each year thereafter. It's the revenue growth, Elyse.
Okay. Then lastly, on the share repurchases, we saw that pick up this quarter from where you guys have been trending year to date. Did you move up any kind of share repurchases that you had geared for the fourth quarter? Anything more on just the pick up in the level in the third quarter and expectations for fourth quarter, that you have?
Yeah. Elyse, what we said coming into the second half of the year was that share repurchases would be stronger in the second half of the year than the first half of the year, because the second half of the year is our seasonally strongest cash flow half, and that's exactly what you've seen. We would expect Q4 as our strongest cash flow quarter. As you think about share repurchases going forward, we would expect to continue to allocate capital based on the highest return on capital. Then I would say, as you think about sort of hitting the $2.3 billion in free cash flow in 2017, you should assume that the share count is going to continue to trend down over that time period.
If you think about the $2.3 billion of cash divided by a share count, it is the highest return on capital opportunity we have.
Okay. Thank you very much.
Thank you. The next question is from Michael Nannizzi of Goldman Sachs. Your line is open.
Thanks so much. Just to go back to the cash question, again, here. We go back to 2012, when we sort of laid out the double cash by 2017. Since that point, we've had sort of very clear tangible drivers of cash generation, the restructuring program, the reduction in pension contributions from freezing the pension plan, and then the reduction in tax payments from the lower tax rate. That gets us maybe, depending on what happens this year in the fourth quarter, maybe that gets us halfway there. I guess I'm just trying to understand, looking from here, do we have line of sight into a chart similar like we have on page 11 in the presentation? What gets us the rest of the 50% of the way to that $2.3 billion?
It's just hard to understand what that is, if it isn't going to be reaching those margin targets that you guys have laid out specifically by 2017. Thanks.
Look, it's a great question, Michael, if you look at the pension restructuring and CapEx, it's $230 million. You add reduction in cash taxes of about $100 million or about $330 million. You've got a gap. The gap has really come from operating income growth in revenue, and margin expansion. That'll be absolutely a big driver of the free cash flow growth. The second is working capital improvements. Michael, if you look at 2011, our accounts receivable divide by revenue, you get days sales outstanding. It was about 103 days sales outstanding in 2011. In 2014, that reduced to 85 days. You've basically got an improvement of 18 days in days sales outstanding over that four-year period, which on 2014 revenue is the equivalent of $575 million in cash from working capital.
What I would say is we've got substantial improvements in working capital to come over the next five plus years as we continue to improve the processes around Aon, improve our operating model, and improve the collection of cash from customers and the payments to suppliers.
From this point, it's going to be less about earnings and margins and more about sort of balance sheet optimization, in order to kind of extract that additional $500 million-$600 million of annual cash flow. Is that fair?
No, actually. It's really about revenue growth and margin expansion. It's absolutely about operating income growth. I did start there. I would say there are two big drivers of cash flow growth. There are really four big drivers of cash flow growth. One is revenue and margin expansion, driving operating income growth. Two is working capital improvements, which we believe are sustainable over multiple years. Three is the reduction in uses of capital on pension restructuring and CapEx. Four is reduced cash taxes. They're the four big drivers, and all four of them will contribute.
Okay. Just so I could on healthcare exchanges. It sounds like you're getting closer to scale there. Do you have visibility, or can you give some insight into what the modeled margins are on exchanges as you think about that relative to your benefits business? Obviously, you've got still some investments in there, and you're probably not fully at scale, but how should we think about the trade-off between your sort of legacy benefits business and this new sort of platform as you start to scale that up?
As we said before, listen, as we bring this sort of up online, it is going to be higher accretive to our margin currently and certainly helps us and gets us on track and accretive to our 22% target. We're investing on behalf of clients. We're absorbing it in the P&L. We're still able to improve margins. As we bring this on board and we continue to see adoption, it's going to reinforce our overall margin progress and margin improvements.
Okay. Last one on exchanges. I guess ADP is a large payroll company that has talked about building an exchange platform. What is the risk, if there is one? Are those potential partners? Are those potential competitors? It's still somewhat unclear about how they're bringing people to the table and partners to the table and potentially competing in the space. How do you think about the potential encroachment, either from new competitors or opportunity to partner with new partners like them? Thanks.
We'd step back and say, listen, we're actually operating in the health space, which is why we love this space so much. This is massive, and we would say largely broken. This is one of the most important, biggest sectors of the global economy, certainly in the U.S. economy. Our clients are begging for an option or a set of options that can flatten the cost curve a bit, reduce volatility, and most important, give employees better choice and better transparency and hopefully a bit of accountability, maybe even change their behavior, improve health overall. Against that backdrop, we've brought a range of solutions. It is a massive, vast ocean with lots of opportunities there. The thing we love is, we start with the fact that we actually already do this for 22 million Americans across the overall benefits spectrum, 10 in health alone.
We've got very tremendous access to the companies to have a great set of discussions. We would observe, by the way, when we first started talking about exchanges, most of the world said that, no, they don't like them, we should never have them. Eventually everybody showed up with exchanges, we talked about the idea of actually maybe even putting the risk on an insurance balance sheet. Let's call it fully insured. Everyone said, "No, no, those are terrible, too." Eventually everybody's got one of those as well. Our view is there's going to be lots of folks coming to the fore here to try to serve this market. It's an important market, and at the end of the day, we love our position.
We feel very privileged to be where we are, but we also are very clear we need to keep innovating. We need to keep improving. We need to keep investing behind and on behalf of our clients, because none of us have gotten our clients to a place where they really need to be going forward, and that really is the aspiration.
Great. Thank you so much.
Our last question is from Vinay Misquith of Sterne Agee CRT. Your line is open.
Hi, good morning. Most of my questions have been answered. Just one clarification on the working capital. Christa, if you could help me understand how that works. I believe you're asking clients to pay up slightly earlier, curious about what impact it's having on client relationships, also, how much more of this working capital benefits can you squeeze out over the next couple of years?
Yeah. Really, Vinay, the way this works is it's collecting the cash that customers owe us. I think historically, we've had a focus on revenue growth and then on margin expansion, and then really sort of in the last four or five years, cash flow. I think we haven't had the discipline around the processes and the collections that we're now putting in place. I think it's allowing us to translate a dollar of revenue into free cash flow much more efficiently. I'd say it's both on that side, and then as we aggregate together our supplier spending, we're able to get better terms in terms of how we pay suppliers. Both of those contribute to working capital.
I would say as we continue to bring together global Aon, and improve our overall efficiency, we see substantial improvements in working capital over the next five years.
In many respects, Vinay, philosophically to the cash piece, it's worth spending a minute on this. Listen, we have brought what we believe is, it's not rocket science, but in the world of brokerage, it's an innovation. No one has actually ever looked at the idea of how you translate operating income into cash. It turns out, we're not actually squeezing. We're actually just being slightly disciplined. Slight discipline means we've got a better engine to translate operating income into cash. It turns out it's massive.
That's why we've actually got a set of structural changes between now and 2013, structural in pension, structural in restructuring, structural in tax, and structural in working capital that, again, aren't rocket science if you're outside the brokerage world, but in our world require a lot of energy, a lot to change, but when you do, creates a tremendous benefit. For every $1 of operating profit we're generating, our translation into free cash flow is stronger and getting stronger, and that gets us to the $2.3 billion. I would highlight, as Christa described before, we do not need to get to a 26% margin and a 22% margin, our targets, to make $2.3 billion. In fact, if we achieve those margins, we'd be well above $2.3 billion. From our standpoint, we're focused on cash because it's important to our investors and important to us.
It's an important bellwether on how much we can invest back into the business, we're taking steps to improve that profile. The 21% in the first nine months just says, hey, we're on track, we're going to continue to do that. I think importantly, as Christa described, we're going to be able to sustain that past 2017 and the $2.3 billion.
Okay, let's have just one numbers question on the tax rate. Christa, the fourth quarter, should we expect a 16% tax rate once again?
The underlying rate's really going to be 19.
Then I think it depends on discrete items. That's what you saw this quarter, which made it lower.
Okay. Thank you.
Thank you. I would like to turn the call back to Greg Case for closing remarks.
Just appreciate everybody joining the call and look forward to our discussion next quarter. Thanks very much.
That concludes today's conference. Thank you all for joining. You may all disconnect.