Morning, and thank you for holding. Welcome to Aon plc's fourth quarter earnings conference call. At this time, all parties will be in a listen-only mode until the question and answer portion of today's call. If anyone has any objections, 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 the 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 or those anticipated. Information concerning risk factors that could cause such differences are described in the press release covering our fourth quarter results, as well as have been posted to our website.
Now it is my pleasure to turn the call over to Greg Case, President and CEO of Aon plc.
Thanks very much, good morning, everyone, and welcome to our fourth quarter and full year 2013 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. I 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 is 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 fourth quarter, organic revenue growth was 4% overall, highlighted by strong growth in our HR outsourcing and Americas retail brokerage businesses. Operating margin increased 160 basis points, primarily reflecting significant margin improvement in our HR solutions segment. EPS increased 21% to $1.54, reflecting strong operating performance, a lower effective tax rate, and effective capital management. Finally, free cash flow increased 23%, driven by strong working capital performance and a decline in CapEx spend. If we turn to the full year, organic revenue growth was 3% overall, reflecting solid growth across both segments, despite pricing pressure in our reinsurance business and overall economic uncertainty in Europe. Operating margin increased 40 basis points, reflecting strong margin improvement and risk. EPS increased 16% to $4.89.
Finally, free cash flow increased 22% to $1.4 billion, driven by a record $1.6 billion cash flow from operations, a truly incredible effort from the team as we are well on track to double annual free cash flow in the next three to five years. Overall, our results reflect a strong finish to a solid year, with improvement across each key metric for both the fourth quarter and full year. Having made significant investments across the firm in both risk analytics and the most robust set of solutions for healthcare exchanges, we continue to strengthen our platform for long-term growth, strong free cash flow generation, and significantly increased financial strength in 2014. 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 3%.
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 through Client Promise and retention rates of more than 90% on average, highlighting strong client satisfaction in retail brokerage. Double-digit growth in new business generation, reflecting more than $335 million across our retail business, with strong growth across the Americas, EMEA, and Asia Pacific regions. Investments in new products and service capabilities with the growth of GRIP and Aon Broking delivering increased operating leverage. In our core treaty reinsurance business, net new business trends have now been positive for 11 consecutive quarters. Reflecting on the individual businesses within Risk Solutions. In the Americas, organic revenue growth was 4%.
Exposures are relatively stable, the impact from pricing was modestly positive on average, reflecting a steady pace of market impact. We saw strong growth in Latin America and solid growth in U.S. retail, including growth across all businesses, property casualty, health and benefits, and affinity. In U.S. retail, we delivered a record level of new business with solid management of the renewal book portfolio, including record levels of retention. In international, organic revenue growth was 2%. Exposures continue to be stable, the impact from pricing was flat on average. We saw growth in multiple markets, New Zealand, Italy, Spain, and Portugal, to name a few, with double-digit growth across Asia. In the U.K. and continental Europe, macroeconomic conditions still remain relatively fragile across many core markets. However, with leadership positions across this region, we continue to deliver modest growth against the same economic and market headwinds.
In reinsurance, as we noted previously, our third quarter was favorably impacted by the timing of revenue pulled forward from the current quarter, we expected a modest decline in organic revenue. Overall, organic revenue growth was flat for the quarter. Results reflect growth in our capital markets transactions and advisory business, as well as net new business growth and treaty placements, offset by the anticipated unfavorable impact of timing in the quarter. As we've noted over the past year, record capacity continues to be available to meet demand, cedents are retaining more risk, driving expected negative market impact, most notably in the U.S. Absent an event in the industry, macro factors will continue to be a headwind in 2014.
Against those headwinds, we expect results to continue to reflect flat to modest growth, highlighted by net new business won, which was positive for the 11th consecutive quarter, growth from investments internationally, and capital markets and advisory transactions business. Overall, this level of performance and strength in new business generation reflects Aon Benfield's unmatched level of investment and long-term value proposition for clients of strengthening operational performance and reducing volatility through unmatched data, analytics, and advisory capability. Turning to HR Solutions. Overall, organic revenue growth was 8%, with growth across both major businesses and in areas where we're making significant investments in the business, including healthcare exchanges, investment consulting, and delegated investment solutions. These investments reflect Aon Hewitt's client leadership, understanding and influence of market trends, and the long-term issues that face our clients.
As healthcare reform, healthcare costs, and associated financial risk continue to rise unchecked 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 across and against pension schemes that are increasingly frozen and largely underfunded. Finally, after continuing to work through the worst economic recession in the last 70 years, clients are just beginning to renew their focus on talent, retention, development, and engagement to prepare themselves for renewed long-term growth. Turning to the individual businesses within HR Solutions. In consulting services, organic revenue growth was 1%, compared to 8% in the prior year quarter, which benefited from certain non-recurring pension de-risking activities.
Results in the quarter reflect solid growth across our compensation consulting business and in our retirement business for investment consulting and delegated pension management services, partially offset by a modest decline in demand for actuarial services and retirement consulting. Despite weak demand for discretionary services and overall economic weakness in continental Europe, for the full year, we delivered low to mid-single digit organic growth across the consulting services business and would anticipate similar levels of growth in 2014. In outsourcing, organic revenue increased 11%. Organic revenue reflects substantial growth in our healthcare exchange business as we recognize revenue related to the majority of enrollments that take place during the fourth quarter in our active and retiree exchanges.
Results also reflect modest growth in our HR BPO and in benefits administration for discretionary services, partially offset by unfavorable net client activity that we saw in early 2013 but became less of a headwind starting in Q4. Slide five highlights the third topic, areas of investment. We believe Aon is in a unique position. 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, capturing roughly 1.9 million trades and $ 100 billion of bound premium.
We continue to have a growing client list of insurance carriers utilizing the platform for its analytics and services capabilities. In addition, we're driving our Aon Broking initiative 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. We're investing in the further development of data and analytics capability at Aon Benfield to strengthen our already industry-leading client-serving asset. Finally, we're expanding our footprint through tuck-in acquisitions that either increase scale in emerging markets or expand capability to better serve clients. In HR Solutions, we're making significant investments to strengthen our industry-leading position and comprehensive portfolio of health solutions, including healthcare exchanges.
Healthcare exchanges, as Aon Hewitt's unique business model reflects, enable clients to begin transitioning their participants to a sustainable, full-service solution based on expanded choice and a competitive marketplace. Clients continue to reinforce the value of Aon's industry-leading vision for private health exchanges, as we're seeing increased interest from a broadening spectrum of industries and geographies. In Q4, we were very pleased with our enrollment results and the excellent service experience we delivered for our clients and their employees and retirees. In the Aon Active Health Exchange, employer participation was six times higher, and employee covered lives tripled. We delivered on our Q4 anticipated enrollment numbers of more than 600,000 lives, including eligible dependents. On the Aon Retiree Health Exchange, we served more than 300,000 of our clients' retirees to evaluate the best Medicare options for their needs.
Overall, we're excited about our robust pipeline of clients for the 2014 enrollment, continue to see increased interest from a broadening spectrum of industries, and look forward to updating you on progress later this year when our primary sales cycle has ended. Separately, across our HR Solutions portfolio, we are expanding in high growth areas with innovative solutions to de-risk pension plans, and our delegated investment solutions are opening relationships in new markets. We're also providing a broader set of advisory and advocacy solutions to our clients' employees to enable greater choice and improve decision-making on their retirement and healthcare options. We continue to expand our industry-leading benefits administration solutions and technology platforms. Finally, we're strengthening our international footprint to support a global workforce with investments in key talent and capabilities across emerging markets.
In summary, for both the fourth quarter and full year, we delivered positive performance across each of our key financial metrics. In addition, we strengthened our industry-leading platform with strategic investments across data, analytics, and solutions that we expect will drive long-term growth and greater operating leverage in 2014. With that said, I'm now pleased to turn the call over to Christa for further financial review. Christa?
Thank you very much, Greg, and good morning, everyone. As Greg noted, we delivered positive performance against all four key metrics while continuing to position Aon's industry-leading platform for long-term growth, strong free cash flow generation, and significantly increased financial strength in 2014 and beyond. Let me turn to the financial results for the quarter on page six of the presentation. Our core EPS performance, excluding certain items, increased 21% to $1.54 per share for the fourth quarter, compared to $1.27 per share in the prior year quarter. Results for the quarter reflect strong operating performance in our HR and Risk Solutions segments, a lower effective tax rate as we deliver long-term benefits related to the company's re-domicile, and effective capital management reflected in the company's share repurchase program.
Certain items that were adjusted for in the core EPS performance and highlighted in the schedules on page 13 of the press release include non-cash intangible asset amortization and restructuring charges related to the Aon Hewitt restructuring program. All charges for the formal restructuring programs have now been completed. Foreign currency translation had a $0.03 unfavorable impact on EPS in the quarter, due primarily to a stronger dollar, US dollar versus the Australian dollar, Canadian dollar, and Brazilian real. If currency were to remain stable at today's rates, we would expect no material impact in the first quarter. Let me talk about each of the segments on the next slide. In our Risk Solutions segment, organic revenue growth was 3%, operating margin increased 40 basis points to 23.6%, and operating income increased 2% versus the prior year quarter.
Organic growth, driven by investments in GRIP and analytics, as well as $9 million of restructuring savings, were partially offset by a $16 million, or 40 basis points, unfavorable impact from foreign currency translation. Let me spend a moment on the formal restructuring programs, 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 $69 million of the cumulative savings have been achieved under the program, with the remaining $30 million to be achieved by the end of 2014. A breakout of restructuring charges incurred in Risk Solutions associated with the Aon Hewitt program is detailed in the schedules on page 14 of the press release. We would note that 100% of the charges have been incurred, and the Aon Hewitt restructuring program is closed.
In Q4, we delivered solid underlying operating performance in Risk Solutions, despite an unfavorable impact from foreign currency, continued economic uncertainty in Europe, and unfavorable market impact in reinsurance. For 2013, Risk Solutions operating income grew roughly 6% and operating margin increased 80 basis points to 22.5%, placing us firmly on track for improved operating income performance in 2014 and further margin expansion toward our long-term target of 26%. Turning to the HR Solutions segment. Organic revenue growth was 8%, operating margin increased 440 basis points to 21.4%, and operating income increased 36% versus the prior year quarter, in line with management's guidance. Significant growth in our healthcare exchange business and $18 million of incremental restructuring savings were the primary drivers of our anticipated strong fourth quarter performance.
With respect to the Aon Hewitt restructuring program, approximately $260 million of the $303 million in total cumulative savings have been achieved under the program, with the remaining $43 million to be achieved by the end of 2014. As Greg noted, we made tremendous progress in 2013, delivering on both our operational and financial goals that were laid out at the beginning of the year. This performance is exactly in line with our long-term outlook for the HR segment and places us firmly on track for improved performance in 2014. For HR in 2014, we expect to, number 1, deliver organic growth. Number 2, generate greater scale and improve return from investments. Number 3, deliver remaining savings related to the restructuring program. Number 4, deliver in 2014 greater than mid-single-digit operating income growth and further margin expansion toward our long-term target of 22%.
The patterning will be similar to 2013, down in the first half, both Q1 and Q2, up in the second half of the year, flat in Q3, and up substantially in Q4. Let me discuss a few of the line items outside of the operating segments on slide nine. Unallocated expenses increased $6 million to $54 million, reflecting an increase in long-term employee incentive compensation programs. Interest income decreased $1 million to $3 million. Interest expense increased $2 million due to costs associated with certain derivative hedging programs. Other income of $14 million primarily includes gains on sales of businesses and certain long-term investments as we monetize our long-term investments and put the capital to better use for shareholders. Going forward, we expect a run rate of approximately $1 million per quarter of interest income, $45 million of unallocated expense, and $60 million of interest expense per quarter.
Turning to taxes, the effective tax rate on net income from continuing operations was 24.2%, compared to 25.2% in the prior year quarter. The effective tax rate in the fourth quarter of 2013 was favorably impacted by changes in the geographic distribution of income and certain discrete tax adjustments. Lastly, average diluted shares outstanding decreased to 311.4 million in the fourth quarter, compared to 327.5 million in the prior year quarter. The company repurchased approximately 1 million Class A ordinary shares for approximately $77 million in the fourth quarter. The company has 2.9 billion of remaining authorization under its share repurchase program. Actual shares outstanding on December 31st were 300.7 million, and there are approximately 9 million additional dilutive equivalents. Estimated Q1 2014 beginning dilutive share count is approximately 310 million, subject to share price movements, share issuance, and share repurchase.
Let me turn to the next slide to highlight our significant financial flexibility and strong free cash flow on page 10. At December 31st, 2013, cash and short-term investments were $1 billion, and total debt outstanding was 4.4 billion. Overall debt to capital decreased to 35% at December 31st, compared to 37.7% at December 31st. Cash flow from operations increased 18%, to $649 million in the fourth quarter, due primarily to growth in net income and a decrease in pension contributions. Free cash flow, as defined by cash flow from operations less CapEx, increased 23%, or $110 million to $594 million in the fourth quarter, driven by strong cash flow from operations and a $13 million decrease in CapEx.
For the full year, cash flow from operations was a record $1.6 billion, up 15%, due primarily to growth in net income, strong working capital performance, and a decrease in pension contributions. Free cash flow increased 22%, or $254 million to $1.4 billion, driven by a record cash flow from operations and a $40 million decrease in CapEx. A truly outstanding performance. 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. As you can see from this chart, based on current assumptions, we would expect free cash flow to increase by over $600 million annually over the next five years, based only on a reduction in cash used for pensions and restructuring.
Continued growth in the core business, further margin expansion, and a reduction in the overall effective tax rate would generate additional free cash flow growth that puts us well on track with our goal of doubling free cash flow to more than $2.3 billion annually within the next three to five years. 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. Our overall unfunded status improved to $1.6 billion and 91% at year-end 2013, compared to $2.3 billion and 82% at year-end 2012. We currently expect contributions to decrease by roughly $138 million to $385 million in 2014 and continue to decline thereafter. Additionally, non-cash pension expense was roughly $21 million in 2013, and we would expect non-cash pension expense is zero in 2014.
Regarding our restructuring plans, cash payments were $152 million in 2013. As all charges related to restructuring programs have now been incurred, we would expect cash payments to decline by $60 million to approximately $90 million in 2014 and decline further each year thereafter. In summary, we finished the fourth quarter and full year 2013 with solid performance across all four key financial metrics. We continued to make substantial investments to support clients and drive future long-term growth in both risk and HR solutions. We delivered 22% free cash flow growth and are focused on three primary areas that will each contribute substantially to a doubling of annual free cash flow more than $2.3 billion annually over the next three to five years. Combined with a strong balance sheet and significant financial flexibility, we've positioned the firm for improved financial performance and 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, to ask a question, you may press star one, please. Our first question comes from Adam Klauber of William Blair.
Good morning, everyone. Thank you.
Hey, Adam.
A couple questions on exchanges. Number 1, has the sales cycle for benefit admin exchanges started earlier than normal, and is it active? The second question, you've obviously put on a big jump in new clients this year on both the active and retiree. Do you have more capacity as you go into next year to onboard even more clients than you did this year? Two different questions. Thanks.
First, Adam, on your question on the sales cycle, I would say this is part of an ongoing conversation with our clients around literally how they serve their employees and support them in a more effective way. As we completed the cycle last year, it's really been a continuous set of conversations with clients. We're obviously in the middle of a sales cycle now, but it's been a really continuous set of conversations that I must say have been building in momentum. More clients are interested cutting across a broad set of geographies and industries and all sizes and shapes. Sort of very active set of conversations. As we said before, for us, we have plenty of capacity. This has been about building in a very thoughtful, methodical way. On the active side, initially with three companies, the cycle with 18 companies.
The pipeline is exceptionally strong, and we have capacity and fully anticipate adding the next set of clients. Most important is serving them in an impeccable way, which we were very pleased to do this last cycle. The same is holding on the retiree side, too. Very positive set of developments, and it's within the context of what we do in benefit admin anyway. We serve nine million employees in benefit admin across the board now on the active and retiree side. It's part of a natural progression, and it's proceeded very well.
Great. Thank you.
Thank you. Next question is Brian Meredith of UBS.
Yeah, a couple of questions here. First, Greg, I'm curious, could you give us some insight into what you see happening in the emerging markets right now? Could that have any impact on your business here in 2014, the economic slowdown there?
Well, I would say, Brian, for us, first of all, put in overall context, about 15% of our global business overall, we've seen continued strong growth on the emerging market side. I was just actually back, I was in Beijing and Shanghai and Suzhou, it was just tremendous opportunity everywhere. When you think about it's obviously tied to GDP. That might be a bit of a headwind, but when you think about the level of incidence of insurance, sort of a coverage across per dollar or GDP, the growth opportunity in the emerging markets is just, for us, from our standpoint, is substantial. So we're seeing very strong growth across Asia, across Latin America, with particularly very high growth, well into the double digits, in a number of countries.
From our standpoint, this continues to be a very positive area of investment development for us, and we don't see that changing. If it's great and it's a little less great, it's still in the great category.
Great. Christa, I'm wondering if I could just clarify your comments with respect to margin guidance in the HR solutions business. Do you say that you expect margins to actually be down again in the first half of the year in 2014, then flat third quarter then up in the fourth quarter? If so, why?
Yeah. I was actually providing operating income.
Got you.
guidance as opposed to margin guidance. Operating income overall, we think will be greater than mid-single digit growth in 2014.
In terms of the patterning, it will be similar to 2013, down in the first half, both Q1 and Q2, flat in Q3, and up substantially in Q4. It's really reflecting the continued investment we make to support our clients in healthcare exchanges in 2014. As you know, we incur expenses in all four quarters of the year in our healthcare exchange business and recognize the revenue in Q4. As we continue to scale more clients, really because of the success we've had in the 2013 cycle, we are continuing to invest throughout the calendar year in 2014, and that's why that patterning is continuing to occur.
Is that because there's expense in onboarding the clients in the first half of the year? Is that what's happening?
Yes, that's exactly right.
If anything, if I was trying to think about it, we've invested substantially, said we would achieve mid-single digit operating income in 2013, which we did. Christa guided to where we're going to be in 2014, which we will. Within that, we will have invested substantially in the exchange side. If you think about the categories of that, 2013 was about really a lot of the infrastructure, the things to get it up and running and really build all the components of it. What you're seeing in the discussion in 2014 is our anticipation of where the pipeline is and the indications we're getting and how that's going to evolve. That really is going to be about specific client investment in addition to continued investment around the client experience.
Great. Thank you.
Thank you. Next question is Jay Cohen of Bank of America Merrill Lynch.
Yes, thanks. A couple of questions. First, I may have missed this on the call, but can you give us a sense of what the tax rate will look like in 2014?
Jay, as we think about the tax rate, we've given long-term guidance on the tax rate of more than 500 basis points. As we think about the tax rate for 2014, we're not giving guidance going forward. We have given long-term guidance and will report updates on progress as we report our results.
Okay. Second question, on the reinsurance broking side, I was interested in your comments suggesting that you may be able to eke out flat or even up organic revenue growth in 2014, despite what appears to be some pretty stiff headwinds. I'm wondering why that is. Part of the question is, when you think about your compensation on the reinsurance side, how much is fees versus commissions?
Yeah. Jay, if we step back and think about what we've done historically, first of all, irrespective of what's happening on the pricing side, the exposure side, we've said we're going to grow the Aon Risk Solutions business. That includes the reinsurance business, and that's exactly what our goal is for 2014, and we believe we're going to be on track to do that. You're absolutely right. There is some substantial headwinds when you think about the capital. There's a record level of capital in the industry now, well above $500 billion. We've had a relatively light cat year, and then that's fully compounded by the continued influx of capital from non-traditional sources, which is kind of at the $45 billion-$50 billion level now, and we expect it to grow over time.
Having said that, from our standpoint, our view is that when you think about what we do on behalf of clients, we're really helping them understand how to create value with their balance sheet, reduce volatility, improve operating performance. That's right exactly in the wheelhouse of what we do at Aon Benfield. We've invested in data and analytics in ways no one else has ever done. We believe that's going to help us serve clients effectively, that's why we believe we can continue to grow that business over time and fully anticipate being able to do that.
The fees versus the commissions, is a decent part of this fee, does that help protect the revenue to some extent?
Yeah, no, it's a mix on both sides, fee and commission. We're about 70% commission and about 30% fee overall. We're doing a number of things on behalf of clients in addition to treaty placements. Some of it is related to adding advice and some of the things that come with data and analytics to help them think about their business overall. That's an increasing component. I would also say for us, when you think about our leadership position in the alternative capital area in cat bonds as an example, there's clearly an acceleration on that front. If you think about since 2010, give or take, probably been about 90, 93, 94 deals done over that period of time. We've been involved in over half of them. Now there's been an acceleration of the 93. 31 were done last year. Again, we're involved in over half of them.
From our standpoint, there's lots of aspects in how we help insurers improve their performance across Aon Benfield, and that is reflected in our historical performance. I would also just say, reflect on Aon over the last five, six, seven years. In virtually any economic environment, we've been able to grow the business overall. In fact, we've grown it every year except one, in which we were just down slightly. Our view is, we've seen the movie before and fully anticipate being able to grow and help our clients succeed.
Great. Thanks for that.
Thank you. Next question is Gregory Locraft of Morgan Stanley.
Thanks. Good morning. Again, on reinsurance brokerage. It looks like organic growth dropped in 2004, 2005, mid-single digits. Pricing in that environment was actually pretty bad. Can you compare the business for reinsurance today versus the 2004, 2005 when the pricing declines were similar? Why is it different? Why won't we be seeing negative organics in the future periods in this division?
As I was just describing to Jay, you can't really speak for the overall industry will be what it will be. I would just reflect on what Aon's been able to achieve in that exact environment. In that exact environment, we've been able to actually grow our position. Fundamentally, this is about, obviously, exceptional treaty placement as we described, but it really is more broadly about what we do on behalf of clients, insurers, to help them succeed. In our case, the investment around data and analytics is just quite substantial. We invest well over $120 million a year, real money, cash, in developing content capability to help our clients make better decisions that again, will improve operating performance, strengthen their balance sheet, reduce volatility. In that context, treaty placement is one aspect. It's very important. One aspect.
You're adding to that now all the capital markets choices they have, as well as just very clear views around how analytics, data insight can actually help them make better decisions. That's really the broad-based value proposition, which is unique about Aon Benfield. It really has been what they've been able to do and colleagues have been able to do over many years. If you look at new business generation, again, it's been net positive for 11 consecutive quarters through multiple types of environments, and we fully expect it'll continue to do that as we help insurers succeed at Aon Benfield.
Okay. Basically, you have a more robust product offering today than you did in the mid-2000s. Is that fair?
I would say it's continued to evolve.
Because-
We have a quite more substantial product offering. Again, if you're investing 120 million+ a year on content capability, it's broader, it's deeper, it's more connected globally. Equally important, we believe it's highly differentiated. There aren't many players in the industry doing what we do, can invest in content capability the way we do on behalf of clients and have it have the impact that it's had on behalf of clients. In the end, that's what really is what generates client leadership. Are you helping clients succeed? We've been able to do that, and we believe that capability has strengthened substantially, really every year, for the period of time you described, and that's why we believe we're in a very advantaged position as we move forward.
Okay. Then again on reinsurance brokerage. The reported revenues flow kind of linearly through the year, while as the renewal cycle for the industry is January 1, June 1.
Can you kind of tie the two? The reason I'm asking is, do you have great visibility on your revenues for the reinsurance division already based on what was bound on January 1?
Of course. Just as you said, obviously there's a substantial number of renewals that happen on a percentage or chapter on January 1, and then in April and in June. We have a good visibility on the treaty front and see how that evolves. Although we would recognize revenue over the course of the year, that's why you see that flatten out. As I said before, there's a lot of activity you do on behalf of clients in addition to the treaty portion of the equation. All those are now part of the discussion, interactive and ongoing. You're absolutely right in terms of how the treaty evolves, and we certainly have a visibility on how the January 1s played out for sure.
Perfect. Last is just on reinsurance again. Can you just talk about your ability to flex the margin? Let's just say you get 6 months out and the world breaks to the negative a bit versus plan, or perhaps it breaks to the positive a bit versus plan. How do you flex the margins in this? What's your ability to toggle the P&L?
Yeah. I'll tell you how we think about it's less about the margin, it's really about the value we provide to clients. Fundamentally, this is the absolute focus of Aon Benfield and my colleagues in this arena. When you think about as we add value to clients, and it turns out, by the way, oftentimes the greatest value you add for them, particularly when you're adding advice, data analytics on top of what you do in treaty, in other arenas, in times of stress, it's actually the biggest opportunity to help clients succeed. Our ability to actually provide value, have clients recognize the value and then get paid for value, we believe continues to increase, and that gives us the ability to actually think through the ability to get a return out of the business, which we've been able to do.
Just one set of facts to reinforce what Greg just said. If you look at the reinsurance revenue growth in 2012, it was 5%. In 2013, it was 2%. Despite a decline in reinsurance growth year-over-year, Risk Solutions margins are up 80 basis points. We feel very good about our ability to grow Risk Solutions margin despite the macroeconomic headwinds we're facing.
Okay, great. Thanks again.
Yep.
Thank you. Next question is Meyer Shields of KBW.
Thanks. Good morning.
Morning.
I think this may be more directed towards Christa. If we look at the uses of cash on slide 11, it looks like the pension contribution and CapEx forecasts came down pretty significantly from the last update that we had. I was hoping you could explain what's going on there.
Yeah. That's absolutely right, Meyer. I think pension contributions came down commensurate with our unfunded pension liability, which declined from year-end 2012 of $2.3 billion to $1.6 billion, a $700 million decline in unfunded pension liability, which is decreasing our cash contributions. You can see the pension contributions will continue to come down over the following years. That's really driven by improved long-term rates. Then CapEx, you can see we finished 2013 at a lower level than we expected, and we expect CapEx to grow in line with revenue going forward, albeit from a lower base.
Okay. Switching gears a little bit, the share purchases slowed in the quarter compared to what we saw in the third quarter. Is there anything underlying that or is that just the way things shake out?
No. As we think about share repurchase, we think about return on capital and cash on cash returns. Share repurchase remains our highest return investment. Hence the fact that we repurchased $1.1 billion of shares during the course of 2013, despite providing guidance at around the $800 million level. If you think about it, we did $1.1 billion in 2012 as well, but of that, AUD 300 million came off the balance sheet. As we think about share repurchase, we expect share repurchase in 2014 to be similar to 2013. Then obviously excess cash will deploy on a cash on cash return using return on capital as the metric we use to allocate all excess uses of cash.
Okay. Thank you.
Thank you. Next question is Elyse Greenspan of Wells Fargo.
Hi. Yes. Thank you. I was hoping we could spend some time highlighting more what you're seeing going on within the U.S. economy. I know you pointed to stable exposures in your prepared remarks and kind of how you see the economic conditions in the U.S. impacting what you expect to see with your organic revenue in 2014.
Yeah. As we said, a couple of things as you think about overall. First of all, just the broad-based macro trends right now we described was pricing environment, which has really been stable around kind of flat overall with an exposure change which has been modestly positive. For us, from the U.S. standpoint, you can start to see aspects of the U.S. economy strengthening. Not strong, but strengthening overall. That's sort of the macro view where we are. I would say, though, in that context back to our ability to make investments in the business and improve margin.
We continue to make investments in the business, and that really has helped us from the standpoint of just, and this is really around Aon Client Promise and what we do on Revenue Engine and all the different pieces of it, really helped us generate a level of new business, $336 million across our retail business, really driven across the U.S. as well. That is a record level for us. We feel very good about what we have in place, the investments we've made, and the impact we're going to have over time as we grow the business organically really irrespective of what happens on U.S. GDP. In the end, if you look at the components, we've got a big construction book, and that's obviously trending a little more positive. Energy is a little more positive. Tech track's a little more positive from that standpoint.
The exposures overall against those pieces are up a bit, as I said before. That really is sort of how we see the U.S. playing out with some positive overall macro implications and amplified by what we do from an investment standpoint.
Okay, thank you. One other question on the reinsurance broking business, you pointed to your presence within the alternative capacity market. How big is that as compared to your overall book?
It's very small overall, as we said before. The largest piece obviously is our treaty book. This is a smaller percentage overall, 5%-10%, let's say, but growing. What I'm going to highlight is, if you think about alternative capital, this we believe is a reality. It's an option for clients. It's highly viable, about $45 billion or so in the context of, call it a $550 billion capital base for the insurance world. We are primary in it, overall, it turns out to be 5%-10% of our overall book.
Okay, thank you very much.
Thank you. Next question, Michael Nannizzi of Goldman Sachs.
Thanks. Christa, maybe following up on Meyer's question on the kind of sources or the uses of cash, slide 11. It looks like pension contributions went down on the forward or are going to decline. CapEx looks like it's going to decline. The cumulative increase to free cash flow doesn't seem to be increasing by as much as those two things are declining. If we had sources of cash, what would that look like, I guess?
Yeah. Look, maybe the best way to start that question is, Michael, is to sort of start with free cash flow in 2012, which was $1.15 billion.
Okay.
The free cash flow number in 2012 is the number we're anchoring from to double to get to $2.3 billion over the next three to five years.
Okay.
Included in that free cash flow, our free cash flow definition is cash from operations straight from the cash flow statement, less CapEx. Included in cash from operations is pension contributions and restructuring. Then obviously the less CapEx means this CapEx number is also included in the free cash flow number. If you think about it, and your starting point obviously for free cash flow now is $1.4 billion because that's what we produced in 2013. As you look at this cumulative increase, you can basically take the $1.15 billion, add $600 million, you get to $1.75 billion, which is just from these three line items by themselves. That includes no improvement in operations of our business, our revenue growth and continued margin expansion or decline in tax rates.
You can see that we are making good progress towards doubling free cash flow over the next three to five years.
Got it. Okay. I'll take it offline, I guess. If I look just from 2014 on, because 2013 is behind us, if I look at 2014 on and I compare it to, it looks like you're a couple hundred million dollars better on pension, maybe a little more, a couple hundred million dollars better on CapEx. The cumulative free cash flow is up by about $20 million over that period. Is that
The way to think about it is if you look at the 2014 number and say it's $333 million as the cumulative increase, then you look at the $602, then from 2014 to 2018, you've got a $300 million increase in free cash flow just from the line items above. You add that to $1.4, which equals $1.7.
Got you. Okay. I'll take it offline. Thank you for that. Greg, I guess, or maybe Chris as well, on the risk segment, you had margins were about 80 basis points on three points of organic. Where do you need organic to be overall? Do you think about it that way in order to continue to expand margins? Because of GRIP and Aon Broking, do you feel like you have levers to continue to expand margins even if organic falls below that level?
Yeah, I would just start at the top line. Our view is we are going to continue to expand the risk margin overall. If you look across time, I've made investments available to do that in largely multiple types of organic growth environments. That's in fact exactly what we intend to be able to do. A lot of the investments around GRIP, what we've done in the analytics have really helped create leverage, operating leverage in the business, which is more substantial. Our ability to improve margin on lower growth rates is real, and you're starting to see that actually play out in the improvement this year. You'll see that play out over time. If we happen to get continued big pickup in the global economy or we happen to get rate improvement, et cetera, not something our management team has actually ever experienced, we'd love that.
That'd be great, but that's not what we require in order to actually improve the margins of the business. That's really been part of the strategy over a multi-year period to invest in the business so that we could in fact improve margins irrespective of the overall rate or exposure environment.
Great. Last one, just on the exchanges, how much capacity do you have on the exchange right now? I mean, without investing more in terms of number of covered lives that you could put on the exchange. Where do you expect to be at the end of next year, just given whatever investments you plan to make during the year? Thank you.
We have substantial capacity. Again, our goal here is to serve clients in an effective way. First and foremost, making absolutely certain that the experience that our client has and their employees have is absolutely pristine. As we've said before, we've done that through the last two cycles, feel very good about that. Now is the opportunity to continue to react and help our clients in a much broader, more robust pipeline. We have capacity to do that, and we'll update you when we get through the next sales cycle. It'll be the second or third quarter. We have that behind us. We'll take you through kind of what the overall picture looks like at that point in time, and then move forward from there. We've got a lot of capacity as we planned it out to help our clients succeed.
Okay. Thank you.
Thank you. Our last question comes from Michael Zaremski of Credit Suisse.
Hi, thank you. In terms of revenues in HR solutions, consulting services slowed down, outsourcing clearly picked up a lot. Should we be thinking about a shifting dynamic which is due to healthcare exchanges? Or are they independent of each other?
They're independent of each other. As we look at our consulting business, we say it grew 3% for calendar year 2013, and we'd expect something similar for 2014. In terms of the Q4 number, we really had a very strong comparable in Q4 2012, as Greg mentioned, that was really what was happening there.
I'd add one other piece. As you think about the overall business, as I said, we feel very positive, very pleased on how our efforts on the exchange front are evolving. Within the context of broad-based Aon Hewitt and all the things we're doing there, we've made some tremendous investments on the talent solution side and what we're doing to help clients think about really transitioning to the cloud-based approach on HR, and really the idea of software as a service space for HR, tremendous investments. On the retirement solution side, done a lot of work in the pension space, which is very interesting, very dynamic. A number of investments there, really thinking about our delegated pension management services and what we can do and accomplish to help clients really think about overall oversight, management of their pension plans.
Certainly on the defined contribution side, we've got a couple of efforts, something called DC Nexus and some savings you're going to hear a lot about over time. I want to emphasize the exchange story we believe is compelling, powerful, and emerging, but it's really within the context. It's a small part of Aon Hewitt overall. In fact, it was a continued investment in the bottom line in 2013. We hope it'll be slightly positive in 2014 from a bottom-line standpoint. There's a lot going on across Aon Hewitt we're very excited about, and a lot going on inside the consulting business we're very excited about in terms of the overall picture.
Okay. That's helpful. I realize it's a small piece of revenues, but operating income clearly was terrific in HR solutions this quarter. Would you say a good portion of that was due to the healthcare exchange impact?
No, as I said before, if you think about what we said, is we're going to be able to invest in the business and actually improve operating income mid-single digits, which is exactly what we did. It was actually negative from the exchange side for 2013, and we expect it will be slightly positive for 2014. The real operating leverage that comes from the exchanges shows up in 2015 and 2016. As we continue to evaluate the pipeline and think about what really has been a tremendous set of conversations coming through there, our view is that we will be in a very good place from an operating leverage standpoint in 2015 and 2016. I just would say again, what Christa laid out for you is that we're going to have greater than mid-single digits operating improvement growth in 2014.
Okay, got it. Finally, for Christa, back to the tax rate. Is it long run, the tax rate falls below, you said five points. Is that below 24, 23? Is that how we should be thinking long term?
No. When we started 2012, we had a tax rate of 29%. We filed a statement which basically said that our tax rate would be more than 500 basis points starting at 29%, and we expect that to happen over time.
Got it. You got the 24 this quarter, but we should be thinking to stay at this level will be done in the longer run. Okay, thank you very much.
The thing I would say is quarterly tax rate numbers get impacted by certain things like discrete tax numbers, and the 25% for the full year is the rate I would look at for the full year.
All right, thank you. I would now like to turn the call back over to Greg Case for closing remarks.
I want to say to everyone, thanks very much for participating, and look forward to our discussion next quarter. Thanks very much.