Good morning, and thank you for holding. Welcome to Aon plc's third quarter earnings conference call. At this time, all participants 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 the 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 third quarter results, as well as have 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 plc.
Thanks very much, and good morning, everyone. Welcome to our third quarter 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. We 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. And 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 third quarter, organic revenue growth was 3% overall, driven by strong growth across Risk Solutions. Operating margin increased 10 basis points as an increase in Risk Solutions margin was partially offset by a decline in HR Solutions. EPS increased 19% to $1.13, reflecting effective capital management and gains related to certain long-term investments. And finally, free cash flow increased 4%, driven by strong working capital performance and a decline in CapEx spend. Overall, in our seasonally weakest quarter, we delivered positive performance against each of our key metrics. Having made significant investments across the firm in both risk analytics and the most robust set of solutions for healthcare exchanges, we're on track for a solid finish to 2013 and continue to strengthen the platform for long-term growth, strong free cash flow generation, and increased financial flexibility 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, overall organic revenue growth was 4%, with growth across every major business. 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, a record level of performance in Q3, highlighting strong client satisfaction in retail brokerage. New business generation of approximately $235 million across our retail business, with double-digit new business growth in many markets globally across the Americas, EMEA, and Asia Pacific regions. Investments in new product and service capabilities with the growth of Risk and Aon Broking globally are delivering increased operating leverage.
In our core treaty reinsurance business, net new business trends have now been positive for 10 consecutive quarters. Reflecting on the individual businesses within Risk Solutions. In the Americas, organic revenue growth was 5%. Exposures are relatively stable and the impact from pricing was modestly positive on average, reflecting a steady pace of year-over-year increase. We saw solid growth across all regions, U.S. retail, Latin America, and Canada, and growth across all businesses, property casualty, health and benefits, and affinity. In U.S. retail, we delivered solid growth driven by strong management of the renewal book portfolio with record levels of retention and rollover. In international, organic revenue growth was 2%. Exposures are relatively stable and the impact on pricing was flat on average, with firmer pricing in cat-exposed regions and softer pricing across most areas in Europe.
We saw strong growth in emerging markets, New Zealand and many regions across Asia, including double-digit growth in areas such as Germany, Central and Eastern Europe, China, and the Middle East. In the U.K. and Continental Europe, macroeconomic conditions still remain fragile across many core markets. However, with leadership positions across this region, we saw strong retention rates and management of our renewal book portfolio deliver modest growth. Overall, a solid performance against economic and market headwinds. In reinsurance, organic revenue growth was 5%. We would note that the third quarter was favorably impacted by timing of approximately 2 points of revenue pulled forward from the fourth quarter. While this has no impact on the bottom line, we would expect a modest decline in organic revenue in the fourth quarter as a result of this timing.
Excluding the timing impact between the third and fourth quarters, underlying results continue to reflect modest organic revenue, with growth in both treaty and facultative placements. As we've noted over the last few quarters, record capacity continues to be available to meet demand and cedents are retaining more risk, driving expected negative market impact. 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 modest growth, highlighted by net new business won, which was positive for the 10th consecutive quarter. 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, while strengthening operational performance and reducing volatility through unmatched data, analytics, and advisory capability. Turning to HR Solutions. Overall organic revenue growth was flat.
We saw solid organic growth in consulting services despite weak discretionary spend globally and continued economic pressure in Continental Europe. This underlying performance reflects growth in areas where we're making significant investments in the business, in areas such as healthcare exchanges, investment consulting, and pension risk management consulting. These investments reflect Aon Hewitt's client leadership, understanding of market trends, and the long-term issues that face our clients as healthcare reform, healthcare costs, and the associated financial risks 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 a local level, managing and transferring risk 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 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 3%. Results reflect solid growth across our communications, compensation, and in our retirement business for investment consulting and delegated pension management service. Despite weak demand for discretionary services and overall economic weakness in continental Europe, for the full year, we are on track to deliver low to mid-single digit organic growth across the consulting services business. In outsourcing, organic revenue declined 1% compared to flat in the prior year quarter. Organic revenue reflects a modest decline in benefits administration, partially offset by modest growth in project revenue and discretionary services.
Benefits administration continues to reflect net client activity that began in the beginning of 2013, but become less of a headwind in Q4 and into 2014. 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 $1.8 million trades and more than $94 billion of bound premium.
We continue to have a growing 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. As 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 channels and deep brokerage capabilities. We're investing in the further development of data and analytics capability at Aon Benfield to strengthen an already industry-leading client-serving capability. 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.
We have the industry's most robust set of solutions across large, middle, small, and retiree market, covering the full spectrum of benefit strategies as an increasing number of our employers are faced with decisions at a critical time in healthcare. 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. In the third quarter, we announced strong growth and enrollment on Aon Hewitt's corporate exchange for 2014, a further validation of our vision of private healthcare exchanges. Employer participation is six times higher, and employee enrollment is expected to triple to 330,000 employees or more than 600,000 lives, including eligible dependents.
Of the 18 clients participating during this enrollment, more than half are new logos to Aon, representing a broad spectrum of industries, including retail, business and professional services, healthcare, financial, and a private equity-held firm, just to name a few. Tremendous progress in this area. Separately, across our HR Solutions portfolio, we're expanding in high-growth areas for both current clients and new markets. Innovative solutions to de-risk pension plans are in high demand with our existing retiree retirement client base, and our delegated pension 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 are strengthening our international footprint to support a global workforce with investments in key talent and capabilities across emerging markets. Overall, we proved the concept of these major investments in 2012, and we're fully on track to drive greater scale and increased operating leverage in 2013 and 2014. In summary, we delivered financially across each of our key metrics while continuing to strengthen our industry-leading platform through significant strategic investments that will drive greater long-term growth and operating leverage into 2014. With that said, I'll now please turn the call over to Christa for further financial review.
Thanks so much, Greg, and good morning, everyone. As Greg noted, we delivered positive performance against all four key metrics in our seasonally weakest quarter. We continue to position Aon for long-term growth, strong free cash flow generation, and increased financial flexibility, as highlighted by the repurchase of $500 million of ordinary shares in the quarter. Now let me turn to the financial results for the quarter on page six of the presentation. Our core EPS performance, excluding certain items, increased 19% to $1.13 per share for the third quarter, compared to $0.95 in the prior year quarter. Results reflect a strong performance in our Risk Solutions segment, effective capital management in the quarter, and approximately $0.10 from gains on sales of certain long-term investments as we monetize unproductive capital.
Certain items that were adjusted for in the core EPS performance and highlighted in the schedules on page 12 of the press release include non-cash intangible asset amortization and restructuring charges related to the Aon Hewitt restructuring program. We expect that all remaining charges for the formal restructuring programs will be complete and final in 2013. Foreign currency translation had a $0.02 unfavorable impact on earnings per share in the quarter, due primarily to a stronger dollar versus most major currencies. If currency were to remain stable at today's rates, we would expect a slightly higher unfavorable impact in the fourth quarter than we experienced in the current quarter. Let me talk about each of the segments on the next slide.
In our Risk Solutions segment, organic revenue growth was 4%, operating margin increased 110 basis points to 21.1%, and operating income increased 8% versus the prior year quarter. Organic growth across retail and reinsurance, driven by our investments in GRIP and analytics, as well as $9 million of restructuring savings, were partially offset by a 30 basis point unfavorable impact from foreign currency translation and a decline in investment income. Let me spend a moment on the formal restructuring programs, key initiatives that have enabled concurrent funding investments and long-term structural margin expansion. Under the Aon Hewitt program, approximately $90 million of estimated savings will be achieved in Risk Solutions within the health and benefits business that was transferred in 2012. Approximately $60 million of accumulative 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 13 of the press release. In Q3, we delivered strong operating performance in Risk Solutions despite continued economic uncertainty in Europe, an unfavorable impact from foreign currency, and a decline in investment income. Year-to-date, Risk Solutions margins are up 100 basis points, placing us firmly on track for solid operating 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 flat. Operating margin decreased 210 basis points to 15.4%, and operating income decreased 11% versus the prior year quarter. A $12 million unfavorable impact from the timing of certain expenses, continued investment in healthcare exchanges, and an unfavorable revenue mix shift more than offset incremental restructuring savings in the quarter.
With respect to the Aon Hewitt restructuring program, approximately $242 million of the $288 million in total cumulative savings have been achieved under the program, with the remaining $46 million to be achieved by the end of 2014. As discussed in previous quarters, we provided commentary regarding the outlook for the HR segment in 2013, and that outlook remains unchanged. We expect to, number one, deliver continued organic growth. Number two, drive greater scale and improve return from investments. Number three, deliver savings related to the restructuring program. Number four, deliver performance modestly down in the first half and up in the second half of the year, resulting in mid-single-digit operating income growth for 2013.
While we've experienced some one-time items and have incurred incremental expenses as we invest in certain areas of our business, we fully expect to deliver a strong Q4, resulting in mid-single-digit operating income growth in 2013, expanding to stronger operating income growth in 2014 as we generate an improved return on our investments. Let me discuss a few of the line items outside of the operating segments on slide nine. Unallocated expenses decreased $3 million to $43 million, reflecting a decrease in expenses related to the company's redomicile to the U.K. Interest income increased $2 million to $3 million due to higher average cash balances. Interest expense decreased $4 million due to a decline in both the average rate and the total amount of debt outstanding in the quarter.
Other income of $39 million primarily includes $42 million of 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 a million dollars per quarter of interest income, $45 million of unallocated expense, and $55 million of interest expense per quarter. Turning to taxes, the effective tax rate on net income from continuing operations was 25.1% compared to 23.2% in the prior year quarter. The effective tax rate in the third quarters of 2013 and 2012 were impacted by certain discrete tax adjustments. Lastly, average diluted shares outstanding decreased to 312.9 million in the third quarter compared to 331 million in the prior year quarter. The company repurchased 7.3 million in Class A Ordinary Shares for approximately in the third quarter.
The company has $1.1 billion million of remaining authorization under its share repurchase program. Actual shares outstanding on September 30 were 301 million, and there are approximately 10 million additional dilutive equivalents. Estimated Q4 2013 beginning dilutive share count is approximately 311 million, subject to share price movement, share issuance, and share repurchase. Let me turn to the next slide to highlight our strong balance sheet and cash flow. At September 30, cash and short-term investments were $726 million, and total debt outstanding was $4.6 billion. Overall, debt to capital increased to 37.7% at September 30 compared to 37% at June 30, primarily driven by an increase in total debt outstanding.
Cash flow from operations was flat at $597 million in the third quarter, due primarily to a decrease in pension contributions and strong underlying working capital performance, offset by an increase in cash paid for taxes and the timing of certain interest expense payments. Free cash flow, as defined by cash flow from operations less CapEx, increased 4% or $19 million to $545 million in the third quarter, driven by a $20 million decrease in CapEx. Turning to the next slide to discuss our long-term 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 expect free cash flow to increase by over $500 million over the next six years, based only on a reduction in cash used in pensions and restructuring.
Growth in the core business, further margin expansion, and a reduction in the overall effective tax rate would generate additional free cash flow growth. 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 continue to de-risk certain plan assets. We currently expect contributions to decline by $85 million to $463 million in 2014 and continue to decline thereafter. Regarding our restructuring plans, cash payments are anticipated to be $159 million in 2013. As our restructuring plans continue to wind down, we would expect cash payments to decline $81 million to approximately $75 million in 2014 before declining further each year thereafter.
We continue to grow, improve operating performance, and our required uses of cash decline, we expect our strong free cash flow to be a significant source of value creation for shareholders. In summary, we are on track for a solid finish and improved performance for the full year. We continue to focus on three primary areas that will each contribute to substantially stronger free cash flow over the next several years. First, continued growth and operating margin improvement towards our long-term targets. Second, declining uses of cash on pension and restructuring. Third, greater capital flexibility and increased cash flow from a lower effective tax rate. Combined with a strong balance sheet and increased financial flexibility, we've positioned the firm for significant shareholder value creation. With that, I'd like to turn the call back over to the operator for questions.
Thank you. At this time for questions, press star one, please. Thank you. We have our first question from Michael Nannizzi, Goldman Sachs. Your line is open.
Thank you. Christa, can I just maybe dig in a little bit into the mid-single-digit operating earnings growth on the HR side? Let me know if this math is right. I think in order to get to a 6% increase in operating earnings, you would need either 600 basis points of margin in the fourth quarter, or I think you had insinuated maybe in the last quarter that it might be like 400 basis points, in which case you would need top line to come in 15% higher. Is the number for 4Q, is it just the margin number, or is there a revenue component that's going to help to drive that number into that range? Thanks.
Yeah. There are really three things that are driving the Q4 timing being more seasonally Q4 oriented than previous years. The first is the seasonality of exchanges, and we've described previously that almost 100% of the exchange revenue gets recognized in Q4.
You have quite a substantial portion of revenue, as you just outlined. The second is the unfavorable revenue mix shift we've seen related to benefits administration, as Greg described, is really declining at its impact in Q4. The third is the savings from restructuring are really increasing in Q4. Those three things are really driving Q4 timing being substantially higher than previous years.
Okay. There's a And do we have any notion in terms of what the revenue impact of that? Is this really all healthcare exchange that's driving this margin or revenue benefit in the fourth quarter, or are there other timing aspects that are contributing to that?
A very big portion of it is healthcare exchanges, Michael. I guess what I would also outline is you did see approximately $20 million of timing in terms of expenses and investments in Q3, that otherwise might have occurred in Q4.
Right. That's maybe like, 100, 150 basis points, but you still need considerable margin improvement. Okay, there's a revenue element as well as the margin piece. Can you give us any more granularity in terms of what the net margins on that business are and what sort of revenue could fall into the fourth quarter? Just because it's hard to model or to think about it. We just don't have a lot of clarity given it's so new.
Yeah. Look, what we've given, Michael, is really full year guidance in terms of mid-single digit operating income growth for the full year. We feel very confident about being able to deliver that, and we have full line of sight given we are actually in annual enrollment period for healthcare exchanges at the moment. That's really the level of guidance we've given so far.
Okay, great. Thank you.
Thank you.
Thank you. Next question is Meyer Shields, KBW, your line is open.
Thanks. This is, I think, a small numbers question, but I think, Greg, you mentioned that there were 2 points of carry forward of reinsurance organic growth in the quarter, but no impact on the bottom line. I'm just trying to understand how that works.
Yeah. Literally, it was just a match of timing in terms of expense versus revenue. Net for the year, Meyer, as we said, growth overall, low single digits as we sort of finish out the overall year, but no effect on the bottom line.
Oh, okay. Fantastic. With regard to the unfavorable HR revenue mix, is that driven by macroeconomic factors? I'm just wondering whether there's any way we can anticipate that ahead of time in either direction.
It's really in our benefits administration business, we've had price and compression in that business for a number of years. It's been exactly as we expected. That's really the main component of that.
As we said, Meyer, basically begins to roll off three and in the four more benefit and 2014 more benefit. I think the key theme, though, to come back to Christa's point, if you think about the business overall for the year, we're going to achieve what we hope to achieve, mid-single-digit operating income growth, the ability to invest strategically in a number of platforms which we're funding through the P&L.
The only other thing I'd add, Meyer, is clearly we're investing in high-growth areas like healthcare exchanges, we've openly said that we are losing money in healthcare exchanges this year. As you think about it, you've got a high-growth area that's losing money, that contributes to a negative impact on your margins. We feel really good about that business. We are incredibly well-positioned. We have complete end-to-end solutions across the healthcare spectrum for clients and employees. We feel like that investment will be one of our highest return on capital investments across the company.
Yep. Fantastic. That's very helpful. Thank you.
Thank you. Next question, Brian Meredith, UBS, your line is open.
Hey, good morning. A couple questions here. First, Greg, I wonder if you could talk on the healthcare exchanges, how much of that 330,000 is actually in the retirement exchanges, or is that a separate number?
Brian, the entire 330 is in the active exchanges. We talked before.
We were very pleased. You think about how we've developed that platform. Last year, we had three clients. This year, we have 18, 15 new. Half of that group coming on are actually new names to Aon and Aon Hewitt. In that context, it's 330,000 new employees and really 600,000 lives in total, if you include dependents.
Great. How are the retirement exchanges doing?
Retirement continuing to progress very well. In fact, if you look across the spectrum, it's really exactly as Christa described, in the context of we've got a full range of solutions. We've got the most complete range of solutions, whether you're talking across large corporate, middle market, small and retiree markets, it really is a broad set of solutions, we've been very pleased with the understanding, adoption, and now enrollment on both the active and the retiree side.
Great. Thank you. That's all. Thanks.
Thanks, Brian.
Thank you. Next question is Adam Klauber of William Blair. Your line is open.
Thanks. Couple follow-ups on the exchanges. How big of a barrier is it with the large group client to have an exchange with it hooked into your benefit admin and other technology components?
Not a barrier at all, Adam. Quite the reverse. We think it's a big opportunity. When you think about what it means to bring together an exchange, you've got to be able to understand, design it, the brokerage that goes into it, administer it, and frankly, also risk control on the back end when you think about what it means to pull together an integrated exchange. I've just described the fundamental capabilities of Aon Corporation, and Aon Hewitt. That's really what's been a huge benefit for us as we actually brought what is a true set of innovative concepts to market. For us, the exciting part has been the validation by very large corporate sophisticated clients who know this space exceptionally well. We were very careful to make sure we were actually refining this, evaluating this across industries.
We're very pleased to report a range of industries, clients that represent a range of industries came on board, retail, wholesale, professional services, hospitality, et cetera. We would say, from that standpoint, really the strength of the assets of Aon really is what's helped brought this together. Also, remember, we already serve 6.5 million active employees on the benefits administration health side. That basis has been developed over many years, and the knowledge and understanding of that has served us exceptionally well as we've launched the exchanges.
Thanks. Actually, you answered the question, but I meant the barriers for others to come in the business. I think you answered the question.
You'll have to be the own judge of that. We're going to focus on our clients and on Aon, but this is an exciting set of platforms that are coming on board. As you're really indicating, they really do require a lot of expertise and capability across a range of areas.
One other follow-up on exchanges. As you were out talking with your clients this year compared to last year, what's the change in willingness of clients to listen to an exchange solution compared to a year ago?
Well, you come back to the fundamental principle. This is truly about client need and what they're trying to accomplish. Our clients, having facing a set of healthcare challenges and issues that just continue to increase, 8%-9% growth year-over-year. If you look over the last 5 years of 19% increase in pay versus an 83% increase in healthcare costs. The willingness, if you've got a solution that really helps their employees, because that really is the focal point for our clients, our companies, that helps their employees understand, have greater transparency, have greater choice, and really can start to think about ways they can modify their behavior and control their healthcare spend at the individual and company level. That's what's really created a set of opportunities for us, and it's been very positive.
As I said before, what we've done is we've introduced this to a very sophisticated set of clients and carriers. Understand, we've got 20 carriers represented on our exchange, 11 new this year. The uptake, to your specific question, was very strong early on, then after we actually launched the first three, as we did the first year, the interest was exponentially higher. Now having brought 18 new on, you can imagine the interest is also growing, only because we've got a solution that actually helps them succeed, and that's what we're excited about.
Great. Thanks a lot.
Thank you. Next question is from Michael Zaremski, Credit Suisse. Your line is open.
Good morning. Thanks. In regards to pension contributions, I was curious, if we thought about today's higher interest rate levels and capital markets levels, would it be fair to say the pension contribution would likely fall when it's recalculated at year-end?
Yeah. If you look at page 11 of the slide deck, we do have our estimated pension contributions for 2014 onwards. There obviously is sensitivity to those contributions based on market returns, interest rates, and FX. Obviously, rising interest rates could be upside to those. It's likely to be sort of still declining over time.
Okay. Christa, those are estimates as of 12/31/2012, right?
That's right
They'll be re-estimated at the end of the year, and they might change. Okay.
When we report Q4 earnings, we'll update these tables with the new measurement based on 12/31/2013, which is really the only official time we measure during the year.
Okay. Got it. Last question on the healthcare exchanges. It's my understanding, for the actives, the platform you offer is on a fully insured basis. Would that mean that fully insured employers are the main target because self-insured employers have a higher kind of hurdle rate to convert given the cost differentials?
Not at all. In fact, what we really want to emphasize here, there's a lot of discussion out there using the word exchange, and they mean very different things to different people. It's really important you parse it up and really understand the specific definitions. What we said is we've got a full range of solutions. We will cut across and actually focus on clients against their specific set of needs. What's exciting about the fully insured multi-carrier exchange is it does a number of things that just frankly don't exist in the market today. We're associated with it because we have the only one that exists in the market today, fully insured, multiple carriers.
If you're talking to a currently self-insured large employer, which most of them are, they've all actually made the decision, done the analysis themselves, and decided the fully insured option was in fact the best option to help them succeed. They saw opportunities to reduce their trend. They saw opportunity, trend rate, and cost, opportunities to reduce volatility. They saw something that actually created for their employees, something that would create greater transparency, had a very clear view on options that they would have. Then the sophisticated employers also saw that they were creating greater alignment between the carriers and actually bringing their innovative solutions to help their employees change behavior. You've really got a carrier now in the mix with their solutions to help employers become healthier, but they've really got a lot of emphasis and alignment behind that.
Really, we sat across the table from most of the larger companies are self-insured, have done the analysis, looked at it, and that's actually where the greatest interest is. As I said, we've got a full range of solutions, but this fully insured multi-carrier solution is the only one of its kind today, and that's certainly created a lot of interest.
Okay. I guess along the same lines, are the actives versus the retiree platform, should we expect the economics to be similar? Thank you.
Yeah. What we said before overall is the economics on both sides are going to be beneficial, and they're going to continue to evolve. As I said, if you step back, go where Christa was at the beginning, think about we're going to be able to put this up, get it going, really build a platform in a very, we think, a significant high growth area and deliver mid-single digit operating performance in 2013 and greater than mid-single in 2014. It's, we think, a very positive set of developments. Thank you.
Thank you. Next question is from Jay Gelb, Barclays. Your line is open.
Thank you. For the health exchanges, we've conducted an analysis of the potential upside from that market, I just wanted to confirm a couple of our own assumptions. The commission rate on the private exchanges, what level does that come in at?
Jay, we haven't disclosed that number, I'm sorry.
Okay. Then pre-tax margins for healthcare exchange relative to the average for overall HR Solutions. I guess if you're assuming faster operating earnings growth for the entire segment, that would imply at least the average level of margin.
We actually think, Jay, at scale, the margins in this business are far more attractive than the average margins across our HR business. Hence, why we've invested so much in this area and why we believe it's one of the highest return areas across the company.
All right. That's helpful. Thanks. At what level would scale be achieved? Is that revenue? Is that insured lives?
It's really about number of active participants in the exchange. Really what happens, Jay, is you have a cost of customer acquisition in year one, then you get improved margins in year two based on renewal. Really you have sort of some level of fixed investment on which you need to get a return based on the number of employees. We expect margin expansion and greater return on that investment in 2014.
What level of scale would you need to achieve on that number of active participants? It's around, what, 330,000 now of insured lives?
We've got 330,000 active employees enrolled this year, which covers approximately 600,000, including dependents. We feel like we're well on track to get to scale.
Okay. Separately, Christa, the pace of share buybacks picked up pretty significantly in 3Q, $500 million. That was largely consistent with what you did in the entire first half. How should we think about the pace of buybacks going forward?
I would say that buyback is a reflection in our confidence about the outlook for the company. As you know, Jay, we allocate cash based on the highest return on capital options across Aon, and share repurchase is the highest. As we look out over the next five years, we think that free cash flow could double over the next five years as we look at hitting our long-term margin targets, decreased cash on pension and restructuring, and decreasing the global tax rate. As we think about that, we're not giving specific guidance, but you can look at history as a guide.
Right. In terms of anchoring expectations, that $500 million for the quarter, that probably should not be viewed as a run rate. Is that right?
I would not use it as a run rate, Jay. I would say as we get excess capital, we deploy it to the highest use of cash we can find, and that's what happened this quarter.
Okay. Thank you.
Thank you. Next question is Paul Newsome of Sandler O'Neill. Your line is open.
Good morning. Just a couple of cleanup questions here. One is, could you talk a little bit about the businesses that were sold in the quarter and maybe kind of add on to that, sort of the strategic vision there in terms of what you're interested in selling and getting rid of?
Yeah. Paul, they were really primarily investments we had under long-term investments on our balance sheet, you can see that number coming down over time. If you reflect back two years, that number was over $300 million. It's now closer to $100 million. We're really just trying to sell off investments to receive the cash, to actually put the cash to better work for shareholders.
Really just reflects our focal point and our goal is risk and people. When clients understand measure, mitigate risk and everything around people, pensions, retirement, health and benefits, talent rewards. This portfolio of investments, while been on the books for a long time, isn't directly connected to that strategy, and therefore, in the appropriate times, we'll divest and invest that cash back into the business.
What are those investments?
Yeah. They're really sort of long-term investments and percentage ownerships in things that have been on the books for a long time.
No, I'm sorry. Maybe I wasn't asking the question. How would you characterize those investments? Are they actually strategic investments in equities?
No, they're definitely not strategic investments, otherwise we wouldn't be getting rid of them.
Well, venture capital. Are they-
Oh
equities? Are they
Some examples were, we've made a number of acquisitions over the years. Some of those acquisitions comes with partial ownership in other companies that aren't on track at all. That's one example of one. Again, our evaluation was we had a $300 million portfolio that wasn't helping us succeed day-to-day in the risk and people mission of the firm. We said, when there's an appropriate time and an opportunity, we'll exit those investments and invest it back into the business. It comes, as Christa said, from an entire range of things, different private equity holdings over time, again, subsidiaries of companies that we bought. We've just made a concerted effort as we invest back into risk and people to focus everything we can on that.
Okay. That certainly squares with what you are doing. The tax benefit in the quarter, can we get a little bit more about that?
I would describe the Q3 tax rate as including discrete items. As we think about the tax rate going forward, we're not giving guidance on tax rate going forward. We've said previously that we expect the tax rate over the long term to decrease by more than 500 basis points from the point at which we re-domiciled the company to the U.K. That's really the level of guidance we're giving.
The discrete items were?
Really just true-up from our previous year's tax filings, certain regulatory changes, things like that.
Terrific. Thank you very much.
Sure.
Thank you. Next question is Joshua Shanker of Deutsche Bank. Your line is open.
Yeah, thank you. Good morning.
Hey, Josh.
I appreciate all you guys give great information. Thinking into the future, I'm sure you thought about 2017, when Obamacare will allow large employers to send their employees to public exchanges. Is that a competitive threat for the private exchange? If it's not, why not?
Again, we would come back, Josh, to the fundamental principle, helping companies help their employees. I really want to stress, if I reflect on the conversations with the current and companies that have decided to come onto our exchange, fundamental to their discussion was how do we help our employees? Because no one, I think, would describe the current healthcare system as efficient. If you look across that system and say, how can it become more efficient, fundamental to that is actually giving employees greater choice, but also providing incentives and accountability for them to change behavior and hopefully become healthier. This is really what the companies are focused on, and this is really what our private exchange gives them.
The fully insured multi-carrier exchange for large companies really provides that benefit and then creates alignment in ways I described before that really puts the insurance carriers behind that mission. It creates cost opportunity as much can have a cost advantage. Really, the companies are thinking about their employees and also the ability to help them make better decisions. From our standpoint, we feel very good about that value proposition. I would also say the complication and all the different aspects that have to come together to make that viable and meaningful and compelling are quite substantial. In our view, we hope the public exchanges succeed. We collectively need them to succeed. For our companies and who we serve every day, obviously a different group, we feel very comfortable about our current value proposition.
As Christa has already described, we're investing very heavily behind it. Our level of innovation is going to be substantial over the coming years. Feel good about what that value proposition is going to look like today, and I suspect we'll even feel better what it looks like in 2017.
When you have your strategic talks on exchange among yourselves, do you expect that while you'll keep most of your customers, there will be some customers lost to public exchange in 2017?
It's possible. When we come back, if you look at the fundamentals, there are 122 million active employees out there today. Those employers have literally said they're going to continue to really take on the responsibility of providing coverage. A large portion of those are really going to be looking at exchanges. We've seen that actually grow over time. Really for us, the large employer has really been the focal point and the set of solutions. They're going to make a choice on the best outcome, the best set of solutions, and we feel very good about the program we've got right now and the platform we pulled together.
You think about it, 18 companies really did the evaluation, very thorough, all the pros, all the cons at the forefront of this opportunity and felt very comfortable and comfortable enough to bring their employees on it today. These are very sophisticated companies who've actually looked ahead and made all the trade-offs that you're asking about. We feel good about where we are, but we've got to keep innovating and investing, and we've got to keep up with our companies to help their clients succeed or their employees succeed, I should say.
A great answer. Just one following on what Brian had asked on retiree versus active exchanges. One of your competitors is putting out various lofty successes they've had on their retiree exchange, but they haven't nearly met your successes on the active exchange. We haven't heard the same kind of success level on your retiree exchange as your active exchange. What's the timeline for that to be equivalently attractive, or what do you think is going on there between those two types of products?
Well, I would say, again, back on the corporate exchange, again, part of what's happening is the definition of exchanges are very widely varied. I want to really emphasize that. If you go back to kind of what an exchange means, we have really the only fully insured multi-carrier exchange at this point in time. There are lots of other exchange options around self-insure that'll be talked about, but it's kind of apples and oranges at this point from a value proposition. On the retiree exchange, our navigators group has done an exceptional job. We've got 46 clients now serving approximately 300,000 folks, and that'll continue to grow and expand, and we're very excited about where we are, the platform we've got in place right now, and how that's going to develop over time.
It's just that, as you said, the public, the media's picked up much more on the corporate exchange than the private exchange, and that's probably why you've seen a bit more about it.
Well, good luck with this in the future.
Thank you.
Thank you. Next question is Charles Sebaski, BMO Capital Markets. Your line is open.
Good morning. Thanks for taking my call.
Hey, Chuck.
I've got one question, Christa, regarding the guidance and the HR Solutions business. As of last quarter, there was two pieces of guidance. It was mid-single-digit organic growth or earnings growth, and it was year-over-year margin improvement. There wasn't any mention of the margin improvement story. Is this a change?
No change.
Will be margin improvement year-over-year?
Yep.
Excellent. I also have a question about CapEx and how you guys look at that if the growth parameters that you're expecting change. Is there any potential that there's more CapEx needed, that healthcare exchanges or the other technology platforms really take up that you need further investment to manage that process or manage a growth track? What kind of variability there might be in that?
We obviously give an outlook for capital expenditure on page 11 of the slide deck. What I would say is we manage CapEx like we manage any other investment across the business. We manage it on a return on capital basis. We do have a capital-light business, and the capital we spend is primarily on sort of IT, and investments in software. Obviously we are making investments in data and analytics, and that does have CapEx related to it, and we expect that to continue. We'll continue to evaluate our CapEx spend and invest as we get great return from it.
Okay, great. Thank you very much.
Thank you. Next question is Elyse Greenspan of Wells Fargo. Your line is open.
Hi. Yes. Thank you. I just had a couple of follow-up questions. One, just looking at the healthcare exchanges again, I guess comparing the number of lives you've seen, the 330,000 on the active and then 300,000 on the retiree exchange this year, how does that compare to your expectations kind of heading into the enrollment season?
It would meet our expectations. Again, when you think about it, this was not about numbers and volume for us, it's about quality and experience for employees. What we wanted to do in the first year, we brought three companies on, as you know, truly proved the concept, in this case, of the fully insured, multi-carrier exchange, went through second renewal with those three , then brought now 15 additional on. Our focal point was really beginning to scale up, which we've been able to do, but do it with the highest quality, seamless execution for our clients. For us, again, it's not about the number. Because there's been tremendous interest and the pipeline is quite strong. It's about quality of experience, and that's been very positive.
About the 15 new employees that you took on, how many other companies have you kind of started conversations with or spoke to about potentially joining your exchange?
The pipeline's been quite substantial. You can imagine, again, the interest out there now is quite high and the media has amplified it. So we're having many conversations, and we're confident that we're going to continue to grow the exchange very robustly, and the interest, as I said, is quite high.
When looking out at past commentary, you kind of pointed to starting to have some positive earnings in 2014 and then growing even further into 2015. Is that still what you're thinking in terms of you'll see some positive contributions starting next year from the healthcare exchanges?
Elyse, what we think is, as you know, we are making a loss this year. We will improve our performance in terms of profitability next year. Really what you should look for is the HR Solutions operating income growth, which is mid-single digits in 2013 and greater than mid-single digits in 2014.
Okay, thank you. One question. You guys announced an arrangement with Lloyd's earlier this year, and you've, I know in the past, spoken positively about it from your point of view and then also from your clients. Earlier this week, we saw Willis announce a kind of similar arrangement within the London market. If you could just update us on kind of what you're seeing with your own deal, also if you have any kind of views on what Willis has announced.
I'll just direct my comments to the work we've done and did with the joint venture with Berkshire Hathaway is really what it was. Really what it is, provided our clients with very fast, efficient access to double A plus capital. Very positive. Our clients were very excited about it. We linked it to Lloyd's, so that really was the capacity, and the opportunities going into Lloyd's. Our clients have received it very well. We said that before, it hasn't changed. If you think about the placements into Lloyd's, we are privileged. We're the largest provider into Lloyd's. In that context, the clients that we engage to think about Lloyd's, 75%, 80%, 90% of them wanted to actually access this capacity, which is fantastic.
We said publicly, and Lloyd's has confirmed that our volume into Lloyd's in the first part of the year through the first nine months is up double digits. I think as we said, we thought the clients would be interested in it. We thought it would reinforce Lloyd's and reinforce their overall strategy, Vision 2025 strategy. We think it's done that, in the context of this. They've actually confirmed that overall. I'll leave the Willis program to Willis on their call.
Okay. Well, thank you very much for the answers.
Thank you.
Thank you. I would now like to turn the call back over to Greg Case for closing remarks.
Just want to say thanks to everybody for joining, look forward to next quarter. Thanks very much.
Thank you for your participation. That does conclude today's conference. You may disconnect at this time.