Good morning, and thank you for holding. Welcome to Aon plc's second quarter earnings conference call. At this time, all parties will be on 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 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 in the Private Securities Litigation Reform Act of 1995. Such statements are a subject of certain risks and uncertainties that could cause actual results to differ materially from historical results or those anticipated.
Information concerning risk factors that could cause such differences are described in the press release covering our second quarter 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 Chief Executive Officer of Aon.
Good morning, everyone, and welcome to our second quarter 2014 conference call. Joining me here today is our CFO, Christa Davies. Consistent with previous quarters, I'd like to cover three areas before turning the call over to Christa for further financial review and would note that there are slides available on our website for you to follow along with our commentary today. First is our performance against key metrics we communicate to shareholders. Second is overall organic growth performance. Third, continued areas of strategic investment across Aon. On the first topic, our performance versus key metrics. Each quarter, we measure our performance against the four 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 second quarter, organic revenue growth was 2% overall, highlighted by solid growth in our international retail brokerage and HR outsourcing businesses. Operating margin decreased 30 basis points as continued improvement in Risk Solutions was more than offset by unfavorable currency and an anticipated decline in HR Solutions. EPS increased 13% to $1.25, reflecting underlying operational improvement, a lower effective tax rate, and strong share repurchase. Finally, free cash flow increased 5% as solid underlying working capital performance was partially offset by higher cash taxes. Overall, our second quarter results reflect continued underlying progress and effective capital management, marking the fourth consecutive quarter of double-digit earnings growth despite industry and foreign currency headwinds.
We're returning a record amount of capital to shareholders, as highlighted by the return of $1.4 billion of capital through the first six months of 2014, while continuing to make strategic investments that will drive greater long-term growth, strong free cash flow generation, and increased financial flexibility. Turning to slide four, on the second topic of growth. I want to spend the next few minutes discussing the quarter for both of our segments. In Risk Solutions, organic revenue growth was 1%, reflecting solid growth in Retail Brokerage, partially offset by an anticipated decline in reinsurance. As we discussed previously, we're driving a set of initiatives that are strengthening underlying performance and positioning our Risk Solutions segment for long-term growth and improved operating leverage with management of our renewal book portfolio through Client Promise and retention rates of more than 90% on average, highlighting strong client satisfaction in Retail Brokerage.
New business generation of $280 million across our retail business, highlighted by record new business in US Retail and double-digit new business growth in most markets across Asia and Latin America. Investments in innovative technology and service capabilities with the growth of GRIP and Aon Broking delivering increased operational leverage. In our core treaty reinsurance business, net new business trends have now been positive for 13 consecutive quarters, an outstanding performance in today's changing marketplace that reflects Aon Benfield's long-term value proposition for clients, focusing on data, analytics, and the application of excess capital in the industry to previously uninsured risks. Reflecting on the individual businesses within Risk Solutions. In the Americas, organic revenue growth was 2%. Exposures continued to be positive across the region, while the impact from pricing was flat to modestly negative, resulting in continued stable market impact.
We saw growth across all regions, US Retail, Latin America, and Canada, including continued growth across all major businesses, property casualty, health and benefits, and affinity. In US Retail, we saw solid growth driven by record levels of new business generation and strengthening in construction. In international, organic revenue growth was 3%, similar to the prior year quarter. Exposures are stable and the impact from pricing was modestly negative on average, driven by continued softness in many regions across Europe. Results reflect strong growth across Asia and emerging markets, driven by double-digit new business generation in many countries. With solid growth in a number of other markets, namely New Zealand, Italy, and the Netherlands. In Continental Europe, we've continued to deliver solid growth against sustained economic and market headwinds, driven by strong management of our renewal book portfolio.
While economic conditions still remain relatively fragile across many core markets, we continue to see signs of economic stabilization throughout the region. In reinsurance, as we noted on previous calls, we expect macro factors to be a headwind in 2014. Overall, organic revenue growth was -4% and in line with expectations. Results reflect an anticipated unfavorable market impact in treaty and a decline in facultative placements, which tend to be lumpy quarter to quarter. We saw strong growth in our capital markets transaction and advisory business, and as I mentioned earlier, positive net new business for the 13th consecutive quarter in treaty placements. As we've noted previously, reinsurance capital is at an all-time high and cedents are retaining more risk, driving expected negative market impact, most notably in the U.S., but having impact globally.
Absent of events in the industry, macro factors are expected to continue to be a significant headwind for the balance of 2014, with results lumpy quarter to quarter, given the timing of growth in facultative placements and our capital markets transactions and advisory business. Turning to HR Solutions. Overall organic revenue growth was 2%, similar to the prior year quarter, with growth in both consulting and outsourcing. Underlying performance in the second quarter reflects growth in areas where we're making significant investments in the business, including pension risk and delegated investment solutions. These investments reflect Aon U.S. client leadership, understanding and influence of market trends, and the long-term issues that face our clients. As healthcare reform, healthcare costs, and the associated financial risk continues to rise at a time when overall health and wellness is not improving.
Multinational clients are increasingly looking for global benefit solutions that support their global organizations delivered at the local level. Managing and transferring risk against pension schemes that are increasingly frozen and largely underfunded. Turning to the individual businesses within HR Solutions. In consulting services, organic revenue growth was 1%, a solid performance against a strong comparable of 6% growth in the prior year quarter. Underlying results reflect solid growth in U.S. retirement, primarily for investment consulting and delegated pension management services, as well as growth in talent solutions, which is benefiting from M&A and IPO activity. Results were partially offset by a modest decline in retirement in continental Europe. Similar to Q1, results include an anticipated unfavorable timing of revenue in compensation consulting that will be recognized in the second half of the year. For the full year, we continue to expect low-to mid-single digit organic growth across consulting services.
In outsourcing, organic revenue growth was 3% compared to flat in the prior year quarter. Growth reflects new client wins in Benefits Administration and project related revenue driven by demand for discretionary services. For the full year, we would expect stronger organic growth in outsourcing when taking into consideration the seasonality of revenue recognition and the healthcare exchanges in Q4. Slide five highlights the third topic, areas of investment. Aon has a unique and strong track record of developing innovative solutions to help solve problems and create differentiated value in response to specific client needs. Solid long-term operating performance, combined with expense discipline and strong free cash flow generation, continues to enable substantial investment in colleagues and capabilities around the globe. A few examples include in Risk Solutions, we're investing in client leadership with the international rollout of the Revenue Engine and Client Promise to drive greater productivity and efficiency.
We're investing in innovative technology such as the Global Risk Insight Platform. GRIP is the world's leading global database of risk and insurance placement information, now capturing 2.1 million trades and $108 billion of bound premium. We continue to have a growing list of more than 30 insurance carriers utilizing the platform for its analytics and services capabilities, an increasing number of clients are also adding strategic consulting services. In addition, we're driving our Aon Broking initiatives to better match client needs with insurer appetite for risk. That's highlighted by our ability to package similar risks and place substantial programs and facilities into the market on behalf of clients. We continue to align our global health and benefits platform to better capitalize on our global distribution channel and deep brokerage capabilities. Furthermore, we're developing analytics to create globally consistent actuarial evaluation and benchmarking models for health and other employer-sponsored benefits.
We're also investing in the further development of data and analytics capability at Aon Benfield to strengthen an already industry-leading value proposition and client serving capability. A great example of this is our Impact Forecasting Center, the only catastrophe modeling center integrated into a global reinsurance broker. Another example of this is Freddie Mac, where we're bringing insurance capital to bear against mortgage risk in the U.S. Finally, we're expanding our footprint through over $500 million of tuck-in acquisitions so far in 2014, that either increase scale in emerging markets or expand capability to better serve clients. Year to date, we've completed seven acquisitions in areas including flood, employee benefits, and consultancy, spanning multiple geographies including the U.S., U.K., and the Pacific region. In HR Solutions, we continue to invest in innovative solutions in high growth areas.
We're expanding solutions to de-risk pension plans and are seeing tremendous growth in our delegated investment solutions, which fulfill our clients' needs for faster execution of their investment strategies. We're also providing a broader set of advisory and advocacy solutions to our clients' employees to enable greater choice and improved decision-making on their retirement options, especially important as regulatory changes around the world require more involvement from individuals. We continue to make significant investments to support future growth and strengthen our industry-leading position in health exchanges for active employees and retirees as part of our comprehensive portfolio of health solutions, covering the full spectrum of benefit strategies. As we progress through the sales cycle, we feel good about the pipeline.
We're focusing on client and employee satisfaction during the upcoming enrollment period. We would anticipate a solid mix of both new and existing clients with a broader range of industries participating. We look forward to updating you on our progress later this year when our primary sales cycle has ended. We also continue to invest in our industry leading Benefits Administration solutions and technology platforms, including strength in our international footprint to support a global workforce with investments in key talent and capabilities across emerging markets. In summary, our second quarter results reflect strong earnings growth of 13%, including growth in each segment, underlying operational improvement, and effective capital management, despite challenges from both foreign currency translation and market impact. We're firmly on track to deliver continued growth across each segment, operational improvement through returns on investments, and significantly increased financial strength in 2014.
With that said, I'm now pleased to turn the call over to Christa for further financial review.
Thank you so much, Greg, and good morning, everyone. As Greg noted, our second quarter results reflect underlying operational improvements, double-digit earnings growth for the fourth consecutive quarter, and effective allocation of capital, highlighted by the repurchase of $650 million of ordinary shares in Q2. I would note this is more share repurchased than we've done in any quarter since 2008, reflecting our long-term belief in the strengthening free cash flow of the firm. Let me turn to the financial results for the quarter on page six of the presentation. Our core EPS performance, excluding non-cash intangible asset amortization, increased 13% to $1.25 per share for the second quarter, compared to $1.11 in the prior year quarter. Results from the quarter reflect underlying operational improvement, a lower effective tax rate, and strong share repurchase.
In addition, foreign currency translation had a $0.03 unfavorable impact on EPS in the quarter, due primarily to a weaker dollar versus the British pound. If currency were to remain stable at today's rates, we would expect a similar unfavorable impact in both Q3 and Q4. 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 20 basis points to 22.7%, and operating income increased 1% versus the prior year quarter. Margin expansion in the quarter was driven by modest organic revenue growth, return on investments, and underlying expense discipline, partially offset by a $15 million, or minus 80 basis point unfavorable impact from foreign currency translation. Excluding foreign currency, adjusted operating income increased 5% and operating margin increased 100 basis points.
Let me spend a moment on the formal restructuring program, key initiatives that have enabled concurrent funding of investments and long-term structural margin expansion. Under the Aon Hewitt program, approximately $99 million of estimated savings will be achieved in Risk Solutions. Approximately $88 million of accumulative savings have been achieved under the program to date, with the remaining $11 million to be achieved by the end of 2014. We have incurred 100% of the charges necessary to deliver the remaining savings. Overall, in the second quarter, we delivered solid underlying operating performance in Risk Solutions despite challenges from foreign currency translation and an unfavorable market impact in reinsurance, demonstrating solid underlying progress as we generate returns on our investments and manage expenses.
For the first six months, Risk Solutions margins are up 70 basis points, including a minus 40 basis point unfavorable impact from current foreign currency, placing us firmly on track for margin improvement for the full year and continued progress towards our long-term target of 26%. Turning to the HR Solutions segment. Organic revenue growth was 2%, operating margin decreased 170 basis points to 13.2%, and operating income decreased 8% versus the prior year quarter. Modest organic revenue growth and restructuring savings in the quarter were more than offset by an anticipated increase in expense to support future growth in our healthcare exchange business. We also had an unfavorable impact from the timing of certain revenue in our consulting business, similar to Q1. Our second quarter results were exactly in line with expectations and management's guidance previously provided to the HR Solutions business.
With respect to the Aon Hewitt restructuring program, approximately $294 million of the $303 million in total cumulative savings have been achieved under the program, with the remaining $9 million to be achieved by the end of 2014. As discussed previously, we provided commentary regarding the outlook for the HR Solutions segment in 2014. That outlook is unchanged. For HR Solutions in 2014, we expect to, Number one, deliver organic growth. Number two, generate greater scale and improve return from investments. Number three, deliver remaining savings related to the restructuring programs. Number four, deliver greater than mid-single digit operating income growth and further margin expansion towards our long-term target of 22%. Overall, we are firmly on track for greater than mid-single digit operating income growth in 2014, with Q1 and Q2 down as expected.
We expect to be up in the second half of the year with the patterning unchanged, relatively flat in Q3, up substantially in Q4, related to strong organic growth driven by healthcare exchanges. Now let me discuss a few of the line items outside of the operating segments on slide nine. Unallocated expenses decreased $3 million to $41 million. Interest income was similar at $2 million. Interest expense increased $17 million due to an increase in total debt outstanding in the second quarter and costs associated with certain derivative hedging programs. Other expenses, $2 million, primarily including $5 million of net losses due to unfavorable impacts of foreign exchange rates on the remeasurement of assets and liabilities in non-functional currencies, partially offset by gains on certain long-term investments.
Going forward, we expect a run rate of approximately $1 million per quarter of interest income, $45 million of unallocated expense, and $66 million of interest expense per quarter. Turning to taxes, the effective tax rate on net income from continuing operations was 17.5% compared to 26.4% in the prior year quarter. The effective tax rate in the second quarter of 2014 was favorably impacted by changes in geographic distribution of income and certain discrete items. As previously noted, potential unfavorable discrete tax adjustments in the second half of 2014 could cause the effective tax rate for the full year 2014 to be higher than the 18.3% effective tax rate reported in the first half of 2014. Lastly, average diluted shares outstanding decreased to 301.6 million in the second quarter compared to 317.1 million in the prior year quarter.
The company repurchased 7.4 million Class A ordinary shares for approximately $650 million in the second quarter. The company has $1.6 billion of remaining authorization under its share repurchase program. Actual shares outstanding on June 30th were 291 million. There are approximately 8 million additional dilutive equivalents. Estimated Q3 2014 beginning dilutive share count is approximately 299 million, subject to share price movement, share issuance and share repurchase. Now let me turn to the next slide to highlight our strong balance sheet and cash flow on page 10. At June 30th, 2014, cash and short-term investments were $726 million. Total debt outstanding was approximately $6 billion. Overall debt to capital increased to 43.6% at June 30th, compared to 37.4% at March 31st, driven by an increase in total debt outstanding at the end of the quarter.
However, I would note that at June 30th, the company held $681 million as a deposit with a trustee, included in other current assets on the balance sheet, which was used subsequent to the close of the quarter to repay $681 million of notes due July 1st. Following this repayment, total debt outstanding was approximately $5.3 billion and overall debt to capital was 40.6%. Cash and short-term investments remain at $726 million. In Q2, cash flow from operations increased 3% to $344 million, driven primarily by solid underlying working capital performance, partially offset by higher cash taxes and organic revenue growth. Free cash flow, as defined by cash flow from operations less CapEx, increased 5% to $284 million in the second quarter, driven by an increase in cash flow from operations and a $2 million decrease in CapEx. Turning to the next slide to discuss our significant financial flexibility.
We value the firm based on free cash flow and allocate capital to maximize free cash flow returns. There are three primary areas that will contribute to our goal of doubling free cash flow to more than $2.3 billion annually within the next three to five years. From the graph in the presentation, based on current assumptions, we expect annual free cash flow to increase by over $600 million over the next five years, based only on a reduction in cash use for pensions and restructuring. Combined with growth in the core business, further margin expansion, and a reduction in the overall effective tax rate, we are well on track to achieve our expectations for substantial cash flow generation.
Regarding our underfunded pension plans, we've taken significant steps to reduce volatility and liability as we've closed plans to new entrants, frozen plans from accruing additional benefits, and continued to de-risk certain plan assets. We currently expect contributions to decline by roughly $138 million-$385 million in 2014, and continue to decline thereafter. Regarding our restructuring plans, cash payments were $152 million in 2013. As all charges related to the restructuring programs have now been incurred, we would expect cash payments to decline by $54 million to approximately $98 million in 2014, and continue to decline significantly each year thereafter. In summary, we delivered strong earnings growth and underlying operational improvement in the second quarter. We are firmly on track to generate more than $2.3 billion of annual free cash flow over the next three to five years.
Combined with a strong balance sheet and significant financial flexibility, we continue to strengthen the firm for significant shareholder value creation in 2014 and beyond. With that, I'd like to turn the call back over to the operator for questions.
Thank you. At this time, if you do have a question or comment, please press star followed by one on your touch tone phone. Again, that is star followed by one on your touch tone phone for any questions or comments. Thank you. Our first question comes from Elyse Greenspan from Wells Fargo. Your line is open.
Hi, good morning. I was first hoping to start off just in terms of more commentary in terms of the reinsurance market. It just seems like a sharp shift to go from the 3% growth you saw last quarter to the 4% decline this quarter, and I know the competitive dynamics have seemed to have intensified a bit. If you can just talk about what specifically changed in the second quarter a little bit more, and then also in terms of an outlook for the balance of the year, would you look for a similar decline in about that 4% range? I know you mentioned some one-time items that did serve to negatively impact that number in the quarter.
Yeah, Elyse, a couple of thoughts on this. First, I just think about the evolution on the reinsurance side. It has been about what we talked about, we've really been talking about this for the last couple of years as we talked about first, more capital in the industry. We're at an all-time high, a little over $550 billion now at the end of Q1 2014. Against that, we knew that there would be pressure and movement on price, there certainly has been, again, largely as expected. A little maybe more in this quarter. As we said before, there was a little bit of lumpiness with the fac business. We expect to be offset through the balance of the year. Generally, as we said before, overall pressure on the overall market.
What we'd also highlight, though, as we've been talking about, look, at the end of the day, this is really about helping match capital with client need. While this brings about some challenges, it also brings about lots of different opportunities. As you think about the opportunity in the insurance-linked security world and the cat bond world, really bringing capital in to do things it hasn't done before, as we've done with Freddie Mac, the example I gave in my commentary. We would say, on balance, there's pressure, no doubt. There'll continue to be pressure in the second half of the year, but it also marks with an opportunity. For the first time ever, we're starting to see the retentions which were going up, start to actually stabilize as clients see more opportunity than they've seen before to actually utilize reinsurance capital. We see the market pressure.
I would continue to put it in context, though. We look at our overall Risk Solutions business, and in the context of our Risk Solutions business, we finished the first half of the year with the market pressure, with the FX pressure, having grown the business, increased margin, and we fully expect that to continue. We believe with as much conviction now as we had at the beginning of the year that our team will finish the year with organic growth and Risk Solutions and with margin expansion and Risk Solutions, irrespective of the other pieces. That's roughly where we are.
Okay. Thank you. In terms of the share repurchase, we saw the level remain kind of elevated from where you had trended last year in the first two quarters of this year. In the second quarter, I know you guys did issue some incremental debt. I was wondering how that played into your decision surrounding share repurchases and where you would kind of look for that number on a quarterly basis from here.
As always, Elyse, we evaluate all forms of capital usage based on return on capital. Share repurchase was higher in the first half than it will be in the second half due to incremental leverage in Q2, as you said, we did raise debt quite substantially. We also utilized cash from the balance sheet at year-end 2013. Those two things really meant that our share repurchase in the first half will be much higher than in the second half. We are leveraging the opportunity as we grow free cash flow to continue to deploy capital in the highest return opportunities for shareholders, and share repurchase remains the highest ROIC usage. As cash flow continues to grow, you'll expect us to redeploy capital on a return on capital basis.
Okay, thank you. One last question. In terms of the tax rate, I know you guys mentioned last quarter about 200 to 300 basis points of benefit from discrete adjustments. Was the level the same this quarter? Also, if we're looking on a quarterly basis, are there any quarters that would tend to potentially have a higher tax rate just due to the revenue? For instance, when the healthcare exchange business comes on in the fourth quarter, will we potentially see the tax rate just from that business coming on kind of tick up in the fourth quarter?
As we think about the tax rate, Elyse, for the full year 2014, what I would say is our first half 2014 tax rate was 18.3%. As we discussed in Q1, we do expect potential unfavorable discrete tax adjustments in the second half of 2014 could cause the rate to be higher for the full year 2014. We're not giving specific guidance for full year 2014, but what we can say is full year 2013 rate had two to 300 basis points of unfavorable impact from discrete items.
Okay, thank you very much.
Thank you. Our next question comes from Jay Cohen from Bank of America. Your line is open.
Yes, thank you. You had talked about some timing issues in the HR Solutions business, which hurt the revenue comparison should help in the second half. Can you quantify that?
Inside, Jay, it was in our compensation consulting business, it really decreased organic revenue growth in both Q1 and Q2. If you normalize for that consulting organic revenue growth, it'd be somewhere around 3%-4% in both Q1 and Q2. What you'll see, Jay, is that will show up in the second half of the year. As we think about our consulting organic revenue growth for the full year, it's really in the low to mid-single digit organic revenue growth, so it's exactly where we think it should be. It's really just a patterning issue between Q1 and Q2 and the second half of the year.
That's helpful. Secondly, you guys have done a good job of de-risking the pension obligations, we have had a drop in interest rates. Have you done enough work so that drop in interest rates this year shouldn't have a big impact on your pension expense going forward?
As we think about pension expense, Jay, we definitely think that pension expense for 2014 is immaterial, and we expect that to continue. In terms of the work we've done on our pension plans, they certainly are closed, they're frozen, and they're de-risked. As you know, we measure our pension liabilities at year-end, so 12/31/2014. At that point, we'll look at asset returns, discount rates, and mortality as the three biggest drivers. Pension expense for us is a lot less volatile as a result of the closed and frozen and all the work we've done on our pension plans.
Great. Thanks, Christa.
Thank you. Our next question comes from Vinay Misquith from Evercore. Your line is open.
Hi, good morning.
Vinay?
First is, could you give us some color on the slowdown in the organic revenue growth in the critical insurance segment in the Americas?
Well, Vinay, to sort of back up is we think of sort of overall, instead of the overall commentary, solid organic growth in the Americas on the retail side, we actually had 2% and very strong new business generation in the U.S. retail, for example, we had record levels of new business generation. Really overall across property casualty, health and benefits and affinity, we saw growth, U.S. retail, Latin America and Canada. From our standpoint, we had a very strong prior year comp. Our view is the year's progressing very fine from a retail risk standpoint, and we expect the year to finish well also. Again, if you step back, you look at this at overall Risk Solutions, our risk business more than offset some of the challenges on the reinsurance side we talked about. For us, it just reflects what Aon's all about.
We're an incredibly diverse business, geographically, product, client segment, et cetera, and that showed up in the first half of the year on the Risk Solutions side overall, and showed up in the Americas, too.
Now, what do you think should be the normalized organic growth in the Americas?
Yeah, we've essentially talked about low to mid-single digits overall. That's roughly how we see things will play out.
Sure. Was last year's second half very strong, should we see a slight slowdown versus last year's second half?
Yeah, I would, again, it would be plus or minus. We look at this over the course of a year. From us, again, I would say, for the year, low to mid-single digits, and that's roughly what we've been able to achieve. I would also say, as we've invested in the business, we're able to actually improve margin at lower levels of growth. We've got more leverage, operating leverage in the business. That's why we're comfortable as we look at Risk Solutions overall to say we're going to grow organically, and we're going to improve margins in the face of the headwinds we talked about before. It's an evolving business and, in our belief, a stronger business than it was a year ago and a year before that.
Okay, great. The follow-up is on margins in that segment. Those improved, I believe, 60 basis points for the first six months if you exclude the restructuring savings and if you exclude the FX headwinds. Do you think that pace of margin expansion can increase over time if your organic growth picks up a little bit?
Here's what I would say. We think about our Risk Solutions margin for the first half of the year as 70 basis points because we certainly include the restructuring savings because we've worked very hard to achieve those. Included in the 70 basis points was negative 40 basis points of FX impact for the first half of the year. Underlying operational margin expansion of 110 basis points for the first half of the year. As we look at the second half of the year, we see that the FX impact on Risk Solutions margin will remain similar at minus 40 basis points. We do believe that we'll drive Risk Solutions margin expansion for the full year, driven by the investments we've made in GRIP and the return we're getting, Aon Broking, and continued expense discipline.
We do believe we'll drive Risk Solutions margin expansion for full year 2014 and on track for our 26% long-term Risk Solutions targets.
Okay, thank you.
Thank you. Our next question comes from Brian Meredith from UBS. Your line is open.
Hi. A couple questions. First, Greg, I was hoping you could expand a little bit about what's going on with the corporate healthcare exchanges and just kind of what the pipeline's looking like. I know you kind of gave a couple comments. Then specifically, how it's going on with the corporate with respect to the Medicare and how that's going as well.
We'd say, Brian, overall, we feel very good about the pipeline. Again, as I emphasized before, for us, it's very much about focusing on client employee satisfaction as we go into Q4 enrollment. That's been an absolute focus of our team. We're very excited about some of the progress there. That'll be our priority. Against that backdrop, pipeline's been exceptional. Very solid mix of new and existing clients. We're very pleased with the industry breadth. It's a much broader mix and continues to broaden. We're also pleased with the fact that over half the clients we're seeing are new across the process. For us, feel really good about the pipeline. As I said before, we're looking forward to updating you all later in the year once we kind of complete the enrollment, the sales cycle, I should say.
Net-net, feel very good about the overall progress. On the retiree side, also equally positive. We've got a value proposition that is literally really focused on the retiree and exactly what their experience is like. We've invested heavily to sort of make that happen. As a result of that value proposition, we've been very privileged to be able to serve some of the largest, including the largest client in the space. For us, that value proposition around truly focusing on the retiree experience has proved out very well. We would say another quarter of continued progress on the exchange front. Recognizing, by the way, as we said before, Brian, the exchange world fits into a much broader world of Aon Hewitt.
When you think about what we do on the benefits side, 7.5 million active employees in our Benefits Administration business and another 2 million retirees sort of in the Benefits Administration business. It's a business we know well now augmented and reinforced by what we're doing on the exchange front. That's the background.
On that topic, are you still seeing pricing pressure in the Benefits Administration business?
We are, Brian, it's very much what we expected. It's slightly less than what we experienced last year, it's mitigated slightly, but we expect that trend to continue.
Great. Last question, Greg. I'm just curious, on the reinsurance business, as there's more and more of the capital markets activity that kind of picks up here, is that going to have a long-term depressing effect on your margins in that business?
Yeah. As we step back, as I said before, Brian, at the end of the day, for us, it really is about bringing capital to bear on client need. As we said before, we don't think about this on a product-by-product basis, which is why in the end, we've invested behind this business and are very strong believers in the opportunity for our clients in this business. It's why we're number one in treaty, number one in facultative, number one in the cat bond, insurance-linked security world. We think the whole complement, as you bring it to bear on behalf of clients, creates potential for great client value. Our view is we create client value, our compensation will take care of itself over time.
Even though you've got sort of individual moves on specific product areas up and down, some recurring, some not recurring, all the pieces that go into that, our view is the opportunity here is substantial. Equally exciting is the fact that we see opportunities to really move beyond just the core demand. The things we're doing, bringing capital to bear in areas, as I described before in the mortgage arena in the U.S., we're really excited about, and we're excited for our clients. For us, we are very optimistic about the business long term. We feel like the opportunity to serve clients and create value for them is quite high. Our capability against that demand is also quite strong based on all my colleagues' leadership. We're optimistic, and we don't think about it product-by-product.
Thank you.
Thank you. Our next question comes from Ryan Byrnes from Janney. Your line is open.
Great. Thanks for taking my call. Just had a couple of questions. You guys recently closed on the Flood acquisition. Just wondering if you guys could give any parameters there or maybe the size of the transaction and maybe also the margins, because I know one of your competitors recently purchased a flood company and had very strong margins in that business.
Firstly, just a technical thing. We have signed, but we have not completed closing yet. We haven't disclosed the price. I think we're very proud of the content and capabilities that we've acquired to deliver value to clients. Greg, you may want to talk more about the actual acquisition.
Yeah. I think, again, just another example of sort of building capability and content in an area we know well and that we like a great deal. This really is a group that's going to strengthen our ability to provide outsourcing services, really flood placement and claims to insurance carriers, as part of a broad range set of programs. We're very excited about it, and feel like it's going to add content and capability in terms of sort of what we're doing. It is in the back of the context, we completed seven acquisitions in 2014. Again, all of these have the same theme. How do we strengthen content and capability or broaden our geographic footprint to the extent that strengthens content and capability? NFS, National Flood Services, was just one example around that.
Okay. Lastly, you guys mentioned that there was a higher cash tax payment that was a headwind for free cash flow. Just wanted to figure out what caused that and should we expect that to go away going forward?
Yeah, I would describe that as just lumpiness quarter to quarter, and it really is a timing item related to prior years. I would not expect that to continue.
Okay, great. Thanks.
Thank you. Our next question comes from Meyer Shields from KBW. Your line is open.
Okay, thanks. Good morning, everyone.
Hi, Meyer.
Good morning.
Greg, you talked about a number of areas, I'm thinking like US Retail, that are doing very well in terms of generating growth. Are the areas that are underperforming, have they been consistent over the past year or so, or is this some sort of shift?
Yeah. I would say from our standpoint, again, one of the things that we're very proud of and we're excited about is really the global capability of Aon. If you think about it, in many respects, we're a global focus group. We're in every country in the world, 122 countries. We serve a range of all the segments, large, medium-size, smaller, all types of sectors, all types of clients, et cetera. That really does, Meyer, in our respect, sort of create a level of stability that we think from an investor standpoint should be very much a positive for you. Things ebb and flow in some areas, strong in some respects, less in other respects. You think about it, two and a half, three years ago, we were talking about the strength of Europe and the weakness of the U.S., and now that's kind of shifted.
When you look at sort of underlying insured values, a little stronger in the U.S., a little weaker in Europe. It really does create for us a truly stable set of, relatively stable set of opportunities. It's why, as we reflect on the year and the progress for the first six months, we feel very good about the progress. It's very consistent with what we thought it would be. We pushed in the first six months, grown, improved margins in the context of an up and down market. You can pick any specific area around the world, but we've essentially, as Christa described, we increased margin by 70 basis points, including 40 points of FX. That's over 100 basis point improvement. For us, certain things do ebb and flow. If anything stays down for a long time, you can expect me to address it.
Overall, I feel really good about Risk Solutions and some of the progress we're going to be able to make.
Okay, thanks. Christa, when we look at the intangible asset amortization schedule, there were increases in the forecast for Risk Solutions in 2015 and beyond, really. Is that related to the Flood acquisition, or is that a change in sort of anticipated future acquisitions?
Yes. No, it's not related to Flood acquisitions. We've not yet closed that. It is related to other acquisitions that we've made in the first half of the year, as Greg described.
Okay, when you put out this number, this doesn't anticipate acquisitions that haven't been closed yet?
No, it does not.
Okay, thank you.
Thank you. Our next question comes from Adam Klauber from William Blair. Your line is open.
Thanks. Good morning, everyone.
Adam.
Of the growth in consulting expenses in the first 6 months, how much of that growth would you attribute to the healthcare exchange investment? Can you give us more of a detailed idea what that investment is actually going to?
Overall, a large portion of the expense investment really is bringing online a number of our clients on the healthcare exchange side, as we said before. There really is a match that's sort of different. It really is across overall Aon Hewitt as we think about sort of what we're doing. It was what I'm describing. That's the biggest part of the investment across Aon Hewitt in the second quarter, getting prepared for year-end.
Okay. Another question in HR Solutions. I know in the past you've talked about you've had some success helping corporations de-risk their pensions. How does the pipeline look to do more of those type of transactions?
Yeah. As we've said before, Christa can talk about this as a client as well, in terms of sort of what we've been able to do, it's more than a little success. We've actually had substantial success. One of the exciting parts about what we're doing on the consulting from a growth standpoint really is our retirement business really across the board. That's in delegated investment solutions, investment consulting overall, but also in sort of the pension de-risking world, that really has been quite exceptional. So we've got a broad range of clients, as we've said before, all of whom have the issue around making sure they meet their obligations for employees, but doing it in a way that helps them address obviously the capital challenges, the expense challenges, and the substantial volatility challenges which come with that.
Our team's just done an exceptional job there, and it's why we've done so well in the space.
How's the pipeline of business going forward those, how's that looking?
Well, it turns out it's very strong. If you travel the world, there's still a whole range of underfunded pension funds that have to be addressed by companies. The priority for them is as high as ever around trying to get that done, and we see tremendous opportunity in that going forward.
One of the other things we'd say is that the pace of regulatory changes is accelerating, and that's creating opportunities to work with our clients on the impacts of their pension plans. The U.S., the U.K., and Canada have all had recent regulatory changes proposed or implemented. We're addressing areas such as the pension risk, as Greg described, lump-sum windows, liability-driven asset allocations, and plan design. I can certainly say, as a client, it's one of the best parts of the Aon Hewitt acquisition is having the team from Aon Hewitt actually help us navigate through our pension challenges, and they've done an exceptional job.
Great. Thank you very much.
Thank you. Our next question comes from Paul Newsome from Sandler O'Neill. Your line is open.
Good morning, and thanks for the call. I was hoping you could talk a little bit more about your financial leverage as we look out over the next couple of years and maybe the relationship between coverage ratios. It looks like, and tell me if I'm wrong, that you will probably be raising more debt as the pension liability goes down as well. Is that a fair assessment?
Yeah. Paul Newsome, we would say that we certainly, as we grow EBITDA and grow free cash flow, we do expect to sort of grow leverage over time. Obviously as the pension unfunded liability comes down, that creates further opportunity. We're very proud of the fact that we're able to take advantage of the market and increase leverage during the quarter. In particular, do $550 million of that $800 million U.S. debt placement at 30-year, which is managing liquidity in a very good way for shareholders. We will continue to manage our current investment-grade rating. It's very important to us, for our clients and for future financial flexibility around leverage and coverage ratios to ensure that we continue to manage those.
As you said, as free cash flow and EBITDA grows and as the unfunded pension liability comes down, we expect to increase leverage over the coming years.
Just to be careful, on the reinsurance front separately. Last quarter, I think you said that you expected organic growth through reinsurance for the year to be sort of flat to positive. Has that outlook changed?
Yeah. I think from our standpoint, as we reflect, sort of think about where pricing was, market pressure was in the midterm renewals. We would see slightly more negative than that at this point in time, just given the way things have played out. We'd still step back and say, be really clear. In Risk Solutions overall, that hasn't. Essentially, we're going to grow that business organically across the board, improve margin. This is really back to a question from before and sort of our overall portfolio. At some point in time, we'll be talking about the robustness of reinsurance and pressures elsewhere. At this point, a little more pressure than we expected, but not unmanageable. We expect, as I said, to have growth in Risk Solutions throughout the year with improved margins.
Thank you very much.
Thank you. Our next question comes from Michael Nannizzi from Goldman Sachs. Your line is open.
Thanks. Greg, can I try and square, you mentioned North America new business was very strong, and you talked about retention there. It looked like organic. Organic was 2%. That was a little bit less than kind of we were looking for. I'm just trying to square lower organic growth with really strong new business and nice retention. Maybe there's.
Maybe there's a plug missing there. Thanks.
There isn't too much. Again, there's not that much of a difference in terms of the overall decline as you're describing, a point. We look at a couple of things as we lay them out, Michael. One is the underlying what's the quality, what's going on in the business. That's what we said before, new business was as all-time high, was up reasonably substantially. Renewal was also strong. We look at something called rollover, which is literally not just retaining the client, retaining the business, but also how much is bought and what it looks like. If you think about that, with rollover, it's declined slightly. If you look at pricing, as overall, we basically look at exposure times rate, gets you to something we call market impact.
Market impact is down a bit, not hugely, but if you think about the last four quarters, just to be precise, we can be with GRIP, this is exactly what's reflected in our system. It's actually across our entire system. I'll just go in that direction. We were at 0.83 in Q3 2013. In Q4 2013, 0.92. In Q1 2014, 0.24. We're down a little bit in Q2 2014. Roughly the same place. In essence, we're seeing a bit more on market impact. It's not substantial. It's not like we're seeing on the reinsurance side, but it's there and it sort of affects our overall performance.
Got it. Then, I guess you mentioned GRIP a bit there as well, I'm just curious, over this period of time where we've seen some softness, particularly on the reinsurance side, how much has insurer take-up of GRIP increased? I would imagine that potentially, as insurance companies are maybe more aggressive about trying to get business that platforms like GRIP could see bigger take-up. Have you seen any of that corresponding or has it just been sort of a continuation of an adoption trend that you saw two years ago or something like that?
It's been a continued trend. We haven't tried to push it. What we do is with GRIP, it's very clear. We've got more than 30 markets who are fully engaged on the GRIP platform now. This is very much around matching their capital with client need. Obviously, we guarantee nothing, but we do is we put them in a position where they can actually add value to our clients in a more precise and sustained way, and that actually creates significant opportunity for them. That's the value proposition behind GRIP. That's worked very well, continues to work very well, and our carriers get, we believe, tremendous value out of it because our clients get tremendous value out of it. From our standpoint, we continue to grow the business.
We continue to add an advice component around it to truly help carriers add value, not just areas around coverage and new nuance of what they provide to the marketplace. From our standpoint, we're very pleased with the progress of GRIP. It continues, and we think it's a way to use data and analytics to help clients make choices that would be different and help markets bring things to bear on behalf of clients that are different. For us, it's been positive. We think it will continue.
How relevant of a tool is that to potentially offset the negative impact of pricing in certain markets as far as your own margins are concerned?
Well, from our standpoint, as Christa said, the margin improvement for Aon is really a function of we've created greater operating leverage for our business. We've done it through Aon Broking and all the things we do, and it's how we think about placing premium on behalf of clients. We've done it through GRIP. We've done it through the expense reduction. From our standpoint, all things sort of contribute to this. These are fundamental investments to change the way we go about the business, and in turn, help our clients, and in turn, help Aon improve margins at lower overall growth. In the end, for us, that's why we believe this is really an opportunity to see our investments pay off.
It's why, as I said before, Risk Solutions, we believe will grow organically and will improve margins in the face of whatever headwinds are out there. Specifically, though, to your question, the biggest driver or one of the biggest drivers of margin improvement is going to be a component like GRIP.
Great. Thanks. Thank you very much.
Thank you. Our next question comes from Josh Shanker from Deutsche Bank. Excuse me.
We got one from Deutsche Bank now. Hello, everyone. How are you?
Hey, Josh. We'll get that name right.
No worries. Look, I understand that Christa is not going to give any guidance around discrete tax movements, but maybe you could educate me a little bit on cash taxes versus GAAP taxes. Are the numbers coming through on the tax line related to cash paid and there's a steadier number if we looked on a GAAP basis or incurred basis? I'm no tax expert, but maybe you can teach me a little bit.
Here's what I would say, Josh. As you think about the cash taxes we're paying, you really need to look at it over a multi-year period of time because a lot of what we're paying out in cash taxes today are resolution of prior years. There always is going to be a lag between what gets reported in GAAP taxes and what gets reported in cash taxes. I hope that helps.
Net, can you tell me if the deferred tax liability on the balance sheet is rising as you have these low tax quarters?
I actually am not sure I can answer that question.
Okay. Well, that was my only question. I appreciate it. Thank you.
Thank you.
Thank you. Our next question comes from Kai Pan with Morgan Stanley. Your line is open.
Good morning. Thank you for taking my call. Just following up with the tax, you said in 2013, the effective tax rate is about 200 to 300 basis points higher if you exclude the unfavorable discrete items. That put the underlying tax rate about 22%. In the first half, without these discrete items, your tax rate is 18%. I just wonder if you look back, since you redomiciled to the U.K., your tax rate at that time is like 28%. You said you could improve more than 500 basis points. By now, you are already exceeding that target. Just wonder going forward, will that 18% ex discrete item be a run rate or could it be improved further?
Yeah. What we said at the time we moved to the U.K. in 2012 was originally more than 500 basis points. If you took our 29%, you subtract the 500 basis points, you get to 24, then you do more than 23, more than 22, which as you pointed out, is roughly the underlying rate for 2013. Really what we've said for 2014 is that 18.3%, which is the first half tax rate, it's more than likely that we'll expect unfavorable discrete tax adjustments in the second half that could cause the rate to be higher for full year 2014. That while we're not giving guidance for 2014, the full year 2013 rate did have 200 to 300 basis points of unfavorable impact from discrete items. In terms of future year guidance, unfortunately, Kai, we are not giving out future year guidance.
Thanks for that. Then on the acquisition, looks like it's picking up a little bit since the 2010. I just wonder, has that changed your capital management priority between buybacks and acquisitions?
Absolutely not. As we said earlier, we evaluate all forms of capital usage based on return on capital. Share repurchase remains the highest return on capital usage for the company, which is why you saw us do $650 million in Q2 and $1.25 billion of share repurchase in the first half of the year. It's some of the highest amounts of share repurchase we've done in the company's history. As Greg said, we've actually returned $1.4 billion of capital to shareholders through share repurchases and dividends in the first half of the year. Really what you see us doing is, for us to actually allocate capital at M&A, it has to have a higher ROIC than share repurchase. We have found some fantastic content and capabilities to deliver to clients.
NFS, Lorica, Employee Benefits, there are some terrific content and capabilities out there that have substantial return on capital associated with them. Under no circumstances has our capital allocation process changed.
In many respects, Kai, what you really see is within the context of exactly the priorities Christa described, our ability to actually return capital and actually strengthen our business is pretty strong. Highlight the seven acquisitions that are really across the board in the U.K. and New Zealand, really, in the U.S., Australia, really across the board. Our ability to strengthen the business and return substantial capital to shareholders, given our view on where we are in valuation and opportunity, we think is actually quite high.
Well, thank you. Last question is, I just wondered if you could offer your opinion on the recent rulings on the ACA subsidies and what potential impact on the private exchange side.
From our standpoint, as we said before, our focus really is on serving clients day in, day out, and doing it sort of on the private side. We think the demand for that is actually quite high and will continue to be. By the way, the demand is a function of clients just want to do the right thing on behalf of their employees and do it in a way that they create greater transparency, greater choice, and really changes in behavior that actually hopefully improve the health of their employees. In doing so, actually strengthen the capability of companies to sort of fund that in a reasonable and productive way. That's our maniacal focus. That's the area that Aon Hewitt spends all their waking hours thinking about as they think about exchanges.
As I said before, a lot of other things we do across the business, and we're not going to comment sort of on the public sector input on that, because in our view, the private sector demand is going to be quite high, and that's our focus.
Thank you so much.
Thank you, Kai.
Bye.
Thank you. At this time, I am showing no further questions. To remind the participants that is star followed by one on your touch-tone phone for any further questions or comments.
Okay with-
I do apologize. One moment for your next question. Thank you. Our next question comes from Al Copersino from Columbia Management. Your line is open.
Thank you very much for fitting me in. I appreciate that. Just to follow up on Kai's question, the normal, and I know we can't really be precise about this, but the normalized tax rate was something like 22.5% last year. I think if I have right, the first half discrete items in the tax rate, it sounds like the normalized first half tax rate is something on the order of 21%. My first question is that right? Secondly, we're still seeing tax rate decreases. When you all made your tax plans and guided to 500 basis points or more, I guess there were certain activities you had in mind, certain strategies you had in mind. Have you essentially completed those activities, or are there more things you can do?
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