Good morning, and thank you for holding. Welcome to Aon plc's second 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. 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 second quarter results, as well as having been posted on our website. If anyone has any objection, you may disconnect your line at this time.
Now it is my pleasure to turn your call over to Greg Case, President and Chief Executive Officer of Aon plc. Sir, you may begin.
Thank you. Good morning, everyone. Welcome to our second quarter 2013 conference call. Joining me here today is our CFO, Christa Davies. Consistent with previous quarters, I would 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, continued areas of strategic investment across Aon. On the first topic, our performance versus key metrics. Each quarter, we measure our performance against the four metrics we focus on achieving over the course of the year: grow organically, expand margins, increase earnings per share, and deliver free cash flow growth. Turning to slide three.
In the second quarter, organic revenue growth was 3% overall, driven by strong growth in consulting and retail brokerage. Operating margin was essentially flat as an increase in Risk Solutions margin was offset by a decline in HR Solutions and the unallocated section. EPS increased 9% to $1.11, reflecting effective capital management. Finally, free cash flow increased 20%, driven by strong working capital performance. Overall, solid performance against our key metrics as we strengthen our industry-leading platform for long-term growth, strong free cash flow generation, and increased financial flexibility. Turning to slide four, on the second topic of growth. I want to spend the next few minutes discussing the quarter for both of our segments. In Risk Solutions, organic revenue growth was 3%, with growth across every major business.
As we've 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 Aon Client Promise and retention rates of more than 90% on average, a record level of performance, highlighting strong client satisfaction in retail brokerage. New business generation of approximately $270 million across our retail business, with double-digit new business growth in many markets globally across the Americas, Asia, and Pacific regions. Investments in new product and service capabilities with the growth of GRIP and Aon Broking globally, delivering increased operating leverage. In our core treaty reinsurance business, net new business trends have now been positive for nine 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 increase over the last 12 months. We saw solid growth across all regions, including Latin America, U.S. Retail, and Canada. In U.S. Retail, we delivered solid growth driven by strong new business growth, including growth in property casualty, health and benefits, and affinity, as well as strong management of the renewal book portfolio with record levels of retention. In international, organic revenue growth was 3%. Exposures are relatively stable, and the impact from pricing was flat on average, with firmer pricing in cat-exposed regions and softer pricing in most regions across Europe. We saw strong growth in emerging markets, New Zealand, and many regions across Asia, including double-digit growth in areas such as China, Philippines, and Taiwan. In the U.K. and continental Europe, macroeconomic conditions remain fragile across many core markets.
With leadership positions across this region, we saw solid new business growth, 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 2%. 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 unfavorable market impact in the quarter. Absent an event in the industry, macro factors will continue to be a headwind in 2013. Against those headwinds, results reflect modest growth across all businesses. In treaty, as mentioned before, net new business won was positive for the ninth consecutive quarter, and we delivered solid growth in our industry-leading capital markets transactions and advisory 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 2%. We saw strong growth in consulting services despite weak discretionary spend globally and continued economic pressure in continental Europe. Underlying performance also reflects growth in areas where we're making significant investments in the business, in areas such as healthcare exchanges, investment consulting, pension risk management consulting, and HR BPO. 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 across 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 6% compared to 3% in the prior year quarter. Underlying results reflect solid growth across our retirement businesses for investment consulting and pension administration services, as well as communications consulting. Despite weak demand for discretionary services and overall economic weakness in continental Europe, for the full year, we continue to expect low- to mid-single-digit organic growth across the consulting services business.
In outsourcing, organic revenue was flat. Organic growth reflects net new client wins and demand for HR BPO, healthcare exchanges, and discretionary services, partially offset by a modest decline in benefits administration. As we noted last quarter, we continue to make great progress on our healthcare exchanges, and interest in the Aon Hewitt Corporate Exchange continues to be particularly strong. In Q2, we had excellent sales, which will drive strong growth in enrollments for 2014, and the client base represents a broad range of both new logos and existing clients across a broad range of industries. If you think about the Corporate Exchange, the progress of the team has been truly an outstanding accomplishment. We went from concept in 2011 to active enrollment of the industry's only active multi-carrier corporate exchange for large employers. Enrollment of roughly 100,000 employees, plus eligible dependents.
All participating clients are referenceable, with representation from both existing clients and new logos. Great progress from the team in serving existing clients on the exchange and building the pipeline, reflecting the strength of our industry-leading platform across employee benefits design, brokerage, and administration. 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, 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 to drive greater productivity and efficiency with the rollout of the Revenue Engine internationally, as well as the rollout of Client Promise, which is driving greater retention and rollover rates. We continue to invest in innovative technology, such as the Global Risk Insight Platform.
GRIP is the world's leading global database of risk and insurance placement information. We now have roughly 1.7 million trades, more than $88 billion of bound premium, and a growing list of insurance carriers utilizing the platform for its analytics and service 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. A great example of this, among many, is our structured portfolio solutions effort in health and benefits. Another example is the continued alignment of our global health and benefits platform, better capitalized on our global distribution channel and deep brokerage capabilities. Further, a substantial investment and development of data and analytics capabilities at Aon Benfield to strengthen an already industry-leading client-serving capability.
We're expanding our footprint through tuck-in acquisitions that either increase scale in emerging markets or expand capability to better serve clients, as well as adding key talent across Asia, in specialty sectors, and in our GRIP Solutions business. In HR Solutions, we're making significant investments to strengthen our industry-leading position in healthcare exchanges. Healthcare exchanges enable clients to begin transitioning their participants to a market-based defined contribution model for healthcare that gives participants more choice while addressing unsustainable healthcare cost increases and decreasing population health. As a growing leader in the private healthcare exchange market for post-65 retirees and the leader in the private exchange market for active employees, we're focused on driving greater scale in 2013 and improved returns in 2014. We're expanding in high-growth areas for our current clients and new markets.
Innovative solutions to de-risk pension plans are in high demand with our existing retirement client base. Our delegated pension solutions are opening relationships in new markets. Finally, we're providing a broader set of advisory and advocacy solutions to our clients' employees to better 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, including extensive mobile solutions. Finally, we're strengthening our international footprint to support a global workforce with investments in key talent and capabilities across Asia and emerging markets. Overall, we proved the concept of these major investments in 2012, and we're fully on track to deliver greater scale and increased operating leverage in 2013 and 2014.
In summary, we delivered organic revenue growth across both Risk Solutions and HR Solutions, continued to ramp up significant strategic investments that will drive greater long-term growth and operating leverage, delivered solid earnings, and strong double-digit free cash flow growth. With that said, I'm now pleased to turn the call over to Christa for further financial review. Christa?
Thanks so much, Greg. Good morning, everyone. As Greg noted, we continue to position Aon for long-term growth, strong free cash flow generation, and increased financial flexibility. Our performance in the quarter reflects continued progress against our key financial metrics, with solid earnings and 20% free cash flow growth, highlighted by the repurchase of $225 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 9% to $1.11 per share for the second quarter, compared to $1.02 in the prior year quarter. Results reflect a strong performance in our Risk Solutions segment, a lower effective tax rate, and effective capital management in the quarter.
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, re-domicile costs, primarily for legal and advisory fees to complete the transaction, and restructuring charges related to the Aon Hewitt restructuring plan. We expect that all remaining charges for the former restructuring programs will be complete and final in 2013. Foreign currency translation had a $0.02 unfavorable impact on EPS in the quarter, due primarily to a stronger dollar versus the AUD and JPY. If currency were to remain stable at today's rates, we would expect a similar impact in both the third and fourth quarters. 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 60 basis points to 22.5%, and operating income increased 5% versus the prior year quarter. Organic growth, including benefits from our investments in GRIP and Aon Broking, as well as the $6 million of estimated restructuring savings, were partially offset by a -20 basis point unfavorable impact from a decline in investment income and unfavorable 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 $90 million of estimated savings will be achieved in the Risk Solutions segment, primarily related to workforce and lease consolidation within the health and benefits business that was transferred in 2012.
Approximately $51 million of the $90 million in cumulative savings have been achieved under the program, with approximately $39 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 the second quarter, we delivered solid operating performance in Risk Solutions despite continued economic uncertainty in Europe, an unfavorable impact from foreign currency, and a decline in investment income. For the first six months, Risk Solutions margins are up 90 basis points, placing us firmly on track for margin improvement for the full year and continued progress towards our long-term target of 26%.
Turning to the HR Solutions segment, organic revenue growth was 2%, operating margin decreased -50 basis points to 14.9%, and operating income was essentially flat to the prior year quarter, in line with expectations we'd provided at the beginning of 2013. Modest growth and $15 million of incremental restructuring savings were offset by investments in long-term growth opportunities and an unfavorable revenue mix shift. With respect to the Aon Hewitt restructuring plan, approximately $288 million of estimated savings will be achieved in HR Solutions, primarily relating to workforce and lease consolidation. Approximately $227 million of the $288 million in cumulative savings have been achieved under the program, with the remaining $61 million to be achieved by the end of 2014. Incremental savings opportunities were identified as we completed the final analysis of the Aon Hewitt program.
These savings will, number one, overcome the one-time impacts in the first quarter. Number two, optimize our significant investments in long-term growth opportunities, such as healthcare exchanges and investment consulting. Number three, strengthen our outlook for higher operating income growth in 2014. As discussed in the previous quarter, we provided commentary regarding the outlook for the HR Solutions in 2013. That outlook is unchanged as results continue to be in line with expectations. We expect to, number one, deliver continued organic growth. Number two, drive greater scale and improve return from the 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 and margin expansion for the year.
Now let me discuss a few of the line items outside of the operating segments on slide nine. Unallocated expenses were $44 million, including certain expenses related to the company's re-domicile. Interest income was similar at $2 million. Interest expense decreased $9 million due to a decline in both the average rate and the total amount of debt outstanding in the quarter. Other income of $6 million includes a net gain due to the favorable impact of exchange rates on remeasurement of assets and liabilities in non-functional currencies, and net gains related to long-term investments. Going forward, we expect a run rate of approximately $1 million per quarter of interest income, $45 million per quarter of unallocated expense, and $55 million per quarter of interest expense. Turning to taxes. The effective tax rate on net income from continuing operations was 26.4% in the second quarter.
The company currently expects that its full-year effective tax rate for 2013 will be approximately 26%, but the tax rate for 2013 may change depending on discrete tax adjustments and the geographic distribution of income. The company currently expects that over time, the reduction in its effective tax rate on net income from continuing operations will be greater than previously anticipated. The actual effective tax rate in any particular period will depend on discrete tax adjustments and changes in the geographic distribution of income. Lastly, average diluted shares outstanding decreased to 317.1 million in the second quarter compared to 335.6 million in the prior year quarter. The company repurchased 3.5 million Class A ordinary shares for approximately $225 million in the second quarter. The company has $3.5 billion of remaining authorization under its share repurchase program.
Actual shares outstanding on June 30th were 307.5 million, and there are approximately nine million additional dilutive equivalents. Estimated Q3 2013 beginning dilutive share count is approximately 316.5 million, subject to share price movement, share issuance, and share repurchase. Now let me turn to the next slide to highlight our strong balance sheet and cash flow. At June 30, cash and short-term investments were $573 million, and total debt outstanding was $4.4 billion. Overall debt capital was 37% at June 30, compared to 37.6% at March 31. The decrease is primarily driven by a reduction in total debt outstanding. Cash flow from operations increased 17%, or $49 million, to $333 million in the second quarter, due primarily to improved working capital and a $43.5 million favorable impact from the settlement of a non-recurring one-time legal matter, partially offset by a $41 million increase in cash taxes.
Free cash flow, as defined by cash flow from operations less CapEx, increased 20%, or $45 million, to $271 million in the second quarter, driven by improved cash flow from operations. 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 $158 million in 2013. As our restructuring plans continue to wind down, we expect cash payments to decline by $83 million to approximately $75 million in 2014, before declining further each year thereafter. As we continue to grow, improve operating performance, and our required uses of cash decline, we expect our strong free cash flow growth to continue to be a significant source of value creation for shareholders.
In summary, we delivered solid earnings and strong free cash flow growth and are firmly on track to deliver improved performance in 2013. While we're investing to further strengthen our industry-leading portfolio, we're focused 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, primarily for pensions 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, if you'd like to ask a question, please press star one on your touchtone phone, unmute your line, and record your name. Again, to ask a question, press star one. To withdraw your question, press star two. One moment. Adam Klauber of William Blair, you may ask your question.
Thanks. Good morning, everyone.
Hey, Adam.
Sounds like you're getting good momentum on the company healthcare exchanges. I realize selling season probably isn't over yet, but could you, I guess, give us some idea if you had two clients
Last year, how many clients were with the range of potential clients you could have this year? If you had 100,000 lives, just any ranges would be helpful.
Yeah, happy to do that, Adam. As you would expect, we're going to always protect our clients.
Sure
Names will come out over time, it'll be clear over time, but this has just been, for us, an extraordinary selling season. We've been very excited about it. We had three clients, by the way, last year at 100,000 plus lives, recognizing one was Aon, but the two others, Sears and Darden, are public information and are known. Went exceptionally well and feel very good about it. This year, we're going to have a significant number of new clients, very significant, multiples of new participants, new logos. You're also going to see a real mix across industries as well as we are going forward looking at, and also more carriers who are now participating in the overall exchange. For us, it's just really been a very positive enrollment cycle this time, and we have a pipeline that's actually even more substantial for the coming year.
The investment from our standpoint, has really picked up, and we're quite excited about it. The last thing I would just say on this is, it's really the employee experience that's really driving us. As we've tracked and watched how employees have engaged in the exchange over the last cycle, it's really been a powerful tool to talk to future companies about thinking about this, because not only are they able to actually control costs more effectively now, and manage their healthcare cost situation more effectively, they're also able to provide an enhanced experience for their employee, which is obviously quite important as well. You'll see this evolve over the coming months, but it's just been an exceptionally strong cycle for us and we're quite excited about this.
Okay. Great to hear. With the employer mandate being pushed off, did that push off some of the decisions of potential clients?
It really hasn't had that much impact. Overall, if anything, it raises the specter and clients want more insight and advice in terms of how to deal with the evolving healthcare world. As we've said before, the Affordable Care Act fundamentally doesn't address employee health and doesn't address unit costs of healthcare. What the exchanges do is give companies a chance to at least get a handle on how to think about that more effectively for their company. So for us, it hasn't had a huge impact. As I said before, it's just been a very robust season, and we expect to continue into the next season as well.
Okay, just finally on the topic, you signed a joint venture with eHealth, if I understand that correctly, to help with potentially temporary or lower paid employees and also potentially early retirees. Do you think that joint venture will have visibility at the end of this year, or is that more of a long-term type venture?
Yeah, it's going to come in over the long term, but just another example of one of the things we want to try to do is really try to communicate the opportunities on how to think about this very important choice at the company level and at the employee level, and eHealth helps us do that. It's a great solution for clients, but also for individuals as they think about trying to evaluate a very complex space.
Okay, thanks a lot.
Sure.
Our next question comes from Brian Meredith with UBS. Your line is open.
Yeah, thanks. Good morning. Couple questions. First, a quick one here. Christa, just curious, why will interest expense go back up since you reduced your debt?
Yeah, there was a one-time item in the quarter, there's also just timing of our debt in terms of when we brought the new debt on, which happened during the quarter. So as you get to run rate numbers, it will increase.
Okay, great. Greg, I wonder if you could talk about what you think the impact right now on organic revenue growth is from the weak European economy. Let's assume we can go back to some kind of a normalized 3% nominal GDP. How would that impact your organic growth in the international as well as the HR Solutions business?
First, as you saw, Brian, in the end, we want to emphasize that it is uneven. It has been a challenge. Europe is really not Europe. It's a series of individual countries with individual situations. We've got very strong franchises in each of those. As you saw, we had 3% growth on the retail side in Europe, international, this quarter as well. Roughly 20% of our revenues overall, if you think about it. There's obviously upside as the economy strengthens over time. We've been able to actually weather the storm quite well. We anticipate continuing to be able to do it to the extent it exists and continues. At its core, clients need what we're providing. They need to understand how to measure and mitigate risk.
They need to understand how to deal with these important issues around their people on retention or on retirements, pensions, and healthcare. All these issues remain fundamental. For us, we believe we've got real growth opportunities both domestically and around the globe.
Right, you did say in your opening comments that the weak economy is actually having an issue on organic growth.
You're absolutely right, it is. As you know from us before, we're not going to use that as an excuse. We're going to grow organically irrespective of that. Turns in that to the extent they become any kind of a tailwind, we haven't seen it in a while, obviously has substantial positive economic impact on us. In the meantime, clients have needs. We're going to address them. We're going to grow organically irrespective of the economic situation.
Just quickly, lastly, could you break out your comments or give a little more detail on the healthcare exchanges and kind of break it out between how the retirement exchange is going versus the corporate exchange?
Yeah, both have actually progressed well. The retirement exchange navigators have been in place a little bit longer. Strong program, series of investments there. Really love the platform and really getting strong reception from companies around the world. The newer one brought on the corporate exchange, the first ever multi-carrier, fully insured exchange with three companies last cycle. Now we have many this cycle, as I said before, both going very well. Again, we love the value proposition for companies and for their individual employees. We think it's going to have a lot of power going forward, and we just want to build it in a very incremental, straightforward way that lets us really build a sustainable business long term. This year has really been a great step forward in that.
Thanks.
Our next question comes from Meyer Shields with KBW. Your line is open.
Thanks. Good morning, everyone.
Morning.
This is a simplistic question, if all of your traditional healthcare clients renewed on the exchanges instead of the older systems, can you talk generally about what the impact would be on revenues and margins?
They would have both improved.
Okay. Second, this is completely unrelated. The capital expenditures that you provided seem to be increasing at about 5% a year. I was just hoping you could talk us through where that number comes from.
Yeah. The largest area of capital expenditure for us is IT. If you think about our business, we're increasingly differentiating through data and analytics, whether that's GRIP on the retail brokerage side, it's the incredible series of data and analytics we have in Aon Benfield, where we spend over $100 million a year. It's healthcare exchanges or pension de-risking or investment consulting. There's significant investments in data and analytics across all of our businesses. It's a little bit less than organic growth, is the way we think about CapEx growth.
Okay. Thanks very much.
Our next question comes from Jay Cohen with Bank of America, Merrill Lynch. Your line is open.
Yes, thank you. A couple questions. On the corporate healthcare exchanges, you mentioned there were some new carriers that you put on the platform. Have any of the major carriers decided to leave the platform because of their experience in 2013?
We didn't have anybody exit, and we added multiple, as I said before, Jay. No one exited.
Okay. Second question. You had mentioned the benefits administration revenues were feeling some pressure. If you could go into more detail, what's happening in that business?
Well, just as you think about some of the overall business, it's a competitive business, and as it continues to evolve, we've experienced some price compression historically. We're continuing to do that, although that's mitigated quite a bit of late. That's been a headwind for us as we've faced into 2013, and we think about 2014, offset by the investments we're making to grow in other areas. That's going to mitigate that over time, but that's been a headwind.
Mostly pricing pressure then.
Well, it's pricing, but it's also kind of terms, conditions, things you're doing, servicing, et cetera, that sort of come into play. Overall, it's been a headwind. It's something we're mitigating against. As I said, it's decreased, but it's been a meaningful headwind, which is why we wanted to call it out.
Very good. Thank you.
Our next question comes from Paul Newsome with Sandler O'Neill + Partners. Your line is open.
Couple questions, not related. The first one should be easy. You mentioned that you thought that the tax rate would be lower than expected. Is that purely a function of the geographic location of where you think earnings will be and that's changed over time, or is there something else there?
It is exactly that, Paul. It's related to improved visibility around the geographic distribution of income and discrete tax adjustments.
Simply more earnings in lower tax countries.
That's right.
I wanted to ask sort of more of a philosophical question on the property casualty brokerage side and get your perspective on it. I'm curious about whether or not there's a lot of conversation here about pricing and whether or not we're seeing a deceleration in the hard market, at least in North America. I was wondering if you think that the traditional linkages between reinsurance and E&S and some other lines that tend to lead the cycle have changed, if we have more of a delinkage between those types of markets or if we should be paying a lot of attention to what could happen to primary because of what's going on with reinsurance.
As we said before, I alluded to it in my comments at the beginning, we look very factually at kind of what's happened on the retail side in pricing against what is our GRIP platform, $80 billion of premiums. This is not concept. This is literally looking exactly what Aon has done and has in place. There hasn't been that much change since the prior quarter. Up slightly, but stabilizing. As you highlight on the reinsurance side, more pressure, it's coming from clients increasing the amount of retention that they keep. Also pressure from outside sources of capital. We see that continuing, absent some significant event, will be a headwind on the reinsurance side. That's just how we see it. It will evolve over time, and we're obviously quite active in both marketplaces.
Generally, the story on pricing hasn't changed much since the first quarter. It's really continued the same trends into the second quarter.
Thank you, thanks for the call.
Sure.
Our next question comes from Michael Zaremski with Credit Suisse. Your line is open.
Hi, good morning, thanks. First question, HR Solutions segment. I noticed there was some commentary in the slide deck about unfavorable revenue mix shift. Could you elaborate? I thought consulting was the higher margin contributor within the segment. I guess related as well Consulting organic growth picked up. I'm just curious if you think Aon is taking share there or growing at the market's organic pace.
In terms of the unfavorable revenue mix shift, it's really about getting revenue growth in areas in which we're investing. If you think about the areas in which we're investing, we're investing in BPO through the partnership with OmniPoint. We're investing in healthcare exchanges. Those are lower margin businesses right now, which we expect to get to much higher margin over time. What you're seeing is substantial revenue growth in lower margin businesses, hence the unfavorable revenue mix shift. I think Greg's going to take the second part of your question.
On the point on share, the way we think about the overall market now, we've got a set of platforms that are unique, we're investing behind those in ways that have never been done before. We're investing more in content capability on the risk side both retail and in reinsurance. We're doing the same, obviously, on the Aon Hewitt side in consulting and in outsourcing. We think this gives us a very strong platform to develop clients. You're seeing it in new business generation in risk. You're seeing it as well on the consulting side now as you raised. For us, it's not about just taking share. It's winning for clients every day. It's doing a very systematic, thoughtful approach. It's creating new demand as well, helping clients understand issues they might not have seen before and helping to address those productively.
For us, we want to just keep investing behind value propositions that are understandable and valued by clients, the things that they will pay for that will benefit our shareholders as well as our clients, and do it in a systematic, thoughtful way. That's what you're seeing evolve really across the businesses, on the risk side and on the consulting side.
Got it. Lastly, in terms of leverage levels, I see the debt to cap up a couple points quarter-over-quarter. I was curious if you can refresh us on how Aon thinks about its leverage tolerance levels. I believe the rating agencies might also be a factor, and they make a number of adjustments when calculating their own ratings. Thank you.
Yeah. Debt to capital is actually down slightly. It's 37% at the end of Q2, whereas it was 37.6% at the end of Q1. That's really just because debt came down slightly during the quarter. As we think about overall leverage levels, we definitely look at the amount of our unfunded pension liability and leases, your point on how the credit rating agencies look at this. We're very comfortable with our leverage levels as they are today.
Thank you.
Our next question comes from Joshua Shanker with Deutsche Bank. Your line is open.
Yeah, thank you very much. I want to talk a little bit about Lloyd's. Maybe it's just coincidental this quarter, but there's some chatter out there that there are some syndicates who are your clients who are disappointed with the quota share arrangement with Berkshire and might not want to use Aon Re as their broker next year. I noticed that reinsurance volumes obviously are a little bit soft than they were a year ago. I'm wondering if it's related and if you have a response to that rumor in the market.
We haven't seen that, Josh, at all. In fact, if you step back, as we said before, we've seen now nine consecutive quarters of net new business growth on the reinsurance side and really strong across the board in traditional as well as on the cat bond side for many of these clients. It seemed very positive from that standpoint. I would just say on the transaction you're referring to, pleased with the overall progress, seeing positive results for clients. They've shown interest in really 75%-90% of the situations depending on the line of business. Interestingly enough, by the way, basically one of three orders both existing and new clients have increased their share in the London market or Lloyd's as a result of this overall joint venture. It's actually been positive from that standpoint.
I would say quite the contrary to what I think it sounds like you're picking up. Steve McGill and team have had very positive conversations with the senior leadership of Lloyd's and many of the syndicates around, frankly, how we can continue to work together to strengthen the value proposition for clients. In the end, that's really what this is all about. How do we help clients succeed? In that regard, I think it'll actually be a catalyst to help Lloyd's really meet their Vision 2025 mission, which is a very aspirational set of objectives for Lloyd's overall. From our standpoint, we see good progress here.
You think there's a positive outcome for reinsurance buying clients?
Yeah, absolutely. In the end, by the way, these reinsurance buying clients are also the primary clients as well in terms of what we're doing. Overall, we're strengthening relationships across Lloyd's, which is really the 87 syndicates within Lloyd's.
All right. Looking at maybe I get some scale here. Of course, consulting up a very strong 6%, outsourcing revenues flat. It's interesting because in the commentary you talk about doing well in discretionary services and healthcare exchange, but it's offset by benefits. When we think about the size of contribution from each of those areas HR BPO and healthcare quite small and benefits quite large. I know we talk about healthcare exchanges as a large part of the story here, but it suggests that it would be a number of years before it was a meaningful contributor to results. Can you sort of parse the size of the opportunity now versus maybe three years from now to help us understand where it is in terms of the arsenal of what Aon has to offer in the future?
Well, basically, if you think about the overall portfolio of investments that we're making, they're not only on the healthcare exchanges, they're in some real wheelhouses in the investment side of the business and the retirement side of the business, on investment consulting and other areas. There's a whole range. There's a whole portfolio of areas that we've invested heavily in that are impacting performance. In 2013, the exchanges, as we said before, are going to be more like 2014 and 2015 from a bottom-line standpoint, closer to 2015, but they're certainly going to impact top line overall. We feel very good about the progress on these investments. Net-net, when I would come back to where Christa was, which is, if you think about what we committed to as we came the year, mid-single digit growth.
By the way, absorbing all the investments we described before on the healthcare exchanges and the investment side, we feel very good about achieving that exact commitment, mid-single digit growth, and stronger in 2014. That's the progress.
When we think about benefits administration, a modest claim benefits administration persisting, would that be a drag on that outlook?
No, it doesn't change the outlook at all. We're essentially absorbing the outlook. All we want to do is, as we always do, fully transparent, call out sort of the puts and takes. Admin has been a headwind. It's diminished, it's mitigating, but it's been a headwind offset by other areas of the business. By the way, fully absorbing across the business all the investments we're making too. We are absolutely where we started the year, which is a mid-single digit growth. That's where we're going to end up.
Well, thank you for the color. Appreciate it.
Sure.
Our next question comes from Gregory Locraft with Morgan Stanley. Your line is open.
Thanks. Good morning. Just wanted to follow up on the HR segment. You mentioned in the last response several times, mid-single digit growth is where you're confident. You did show a surge in profitability in the division last year. What I'm wrestling with is because of the decline in op income in the first half, it's a big bogey for the back half. Yet, you're obviously very confident. Where is that confidence coming from? What do you see that we can't? Is it expense management? Is it compensation? Is it other expenses? Is it accelerating organic? It implies a very big back half on the profitability line.
We patterned the year that way from the beginning. The guidance we originally gave in Q4 2012 was that we were going to deliver performance modestly down in the first half and up in the second half, resulting in mid-single digit operating income growth and a margin expansion for the year. One of the things that's driving the patterning much more towards Q4 for us is healthcare exchanges, where revenue recognition means that when you place the policy, which really happens all in Q4, you recognize the revenue entirely in Q4. We do have sort of revenue patterning and therefore profitability patterning of that investment towards Q4. We also have savings flowing through throughout the year, and that continues to improve during the course of the year. We have improvement in our core performance.
As Greg described, we do have some headwinds in benefits administration, which impacted more the first half than the second half. That's improving during the course of the year. They're really sort of the three big things that lead to patterning in the second half. All of those things will also lead to improved performance in 2014.
That line of sight that Christa just described was the exact line of sight we described Q4 last year for the year, and that's exactly what's progressed through the first half this year.
I guess my pushback is that the outsourcing division, the organics coming out of the outsourcing are just not. You might have been sitting in the fourth quarter thinking they'd be a bit better than they are right now. I believe you. It sounds like you guys are going to hit the guidance. It's just, it seems like the revenue isn't coming in like you might have thought six months ago, or am I wrong? Is it actually coming in exactly where you thought on the organic line when you first looked at it?
It's coming in exactly as we thought. I think one of the things we have with our outsourcing business is very long contract terms. It allows us to get very good visibility to revenue and therefore profitability.
Okay. Then last just on this, it looks to me like the math, unless the organic just is going to come in incredibly bigger, just raw dollars, you're going to spend less dollars year-over-year in the back half 2013 than you did in 2012. Is that correct in this division?
It's that you get a return on the investments. In particular, the revenue shows up in the fourth quarter. You could describe it as less expenses. You could also describe it as the revenue or the return on that investment shows up particularly in healthcare exchanges. That's really the phenomenon that's occurring.
Okay.
Yes, we're getting reduced expenses through savings improving. There is some of that going on as well.
Okay. My apologies, just last on this. It sounds like then, Christa, the fourth quarter is when we're going to get the biggest bang in the margins. Third quarter should be better. Fourth quarter is really where we're going to see as we're modeling. Is that how we should be doing it?
That's exactly right.
Okay, great. Thank you very much for the color.
Sure.
Our next question comes from Michael Nannizzi with Goldman Sachs. Your line is open.
Thank you. One question, Greg, if you could, on the capital coming into the reinsurance market, can you talk a little bit about the fees that you're generating from those types of placements and what the growth has been like from a structuring perspective as you guys engage in those activities. I am also just curious, just generally, what do the fees to you to Aon look like from a traditional reinsurer versus one of these structures? Just lastly, another carrier mentioned that they were seeing a lot of growth in the traditional market from pent-up wins. The capital markets were there, and opportunities were potentially coming, but that was not a big net change for them so far. I am just curious if I could get your thoughts on those things. Thanks.
I will try to answer this. We can come back if I am missing anything.
Yep.
Back up, Aon Benfield, roughly 85% treaty overall, 10% FAC, about 5% on the investment banking or the capital market side that you were describing before. While you can break it out in these categories, we really look at it as how do we help clients improve their capital efficiency? How do we actually help them think about improving return on invested capital and driving value from the standpoint of improved operating performance, a stronger balance sheet, or reducing their volatility? That really is the fundamental thesis behind what we do, and we actually bring a range of solutions in each of these categories to actually help clients do that.
In the context of doing that, you can imagine if you can sit across the table from a client, look them in the eye, and tell them you can increase their return on invested capital, the remuneration to Aon Benfield takes care of itself. That is really fundamentally how we built the business. It turns out, we are the number one position in each one of these categories, number one in treaty, number one in FAC, and number one in capital markets. From the standpoint of just the insurance-linked securities piece, this is something we have been involved in for a long time. Everyone talks about data and analytics, and it is kind of the nouveau for most people. It is not for Aon Benfield. We have been doing this for 10 years. We invest over $120 million a year, hard dollars on content capability, and ILS is an example.
It's something that we focus on, and we do very well. If you think about all the transactions since 2010, we've been involved in almost 50% of them, 47% of them. 29 transactions. That's 10 more transactions than number two or number three, who happen to be investment banks. If you think about year to date in 2013, I think we've done nine deals, which by the way is half of the deals. This is something that we're very involved in. It's still a modest part of our overall business, but something that's very important in what we do. We don't think necessarily about the economics one-off. We think about it for a client when we think about the treaty complement, the ILS complement, and the FAC complement, how do we improve return on invested capital for them?
For us, it really is a broad-based complement and a suite of capabilities being brought to the table with the horsepower of data and analytics that is very unique in the industry today. I know that I didn't answer it exactly the way you asked it, but I really want you to understand philosophically how we think about the business and why we see the opportunity here so positive over time.
Does a growing alternative capital base coming in, do you think it makes your position more relevant as a market leader in that market?
Well, again, we've got the strongest platform of anyone in the world in that category already, philosophically, what we're essentially saying is to our clients, "Hey, there are other sources of capital that can actually help you improve your efficiency on your balance sheet." We're in an excellent position. I would argue the best position to help clients continue to take advantage of other sources of capital to help them improve their business. For us, this is not about a diminished opportunity or an increased opportunity. It's about a changing opportunity that we're in a very good position to take advantage of on behalf of our clients.
Great, thank you. Christa, if I could really quickly. It looks like there's some changes to the restructuring math in that last slide of the presentation before the appendix. It looks like restructuring spend a little bit higher. When I did the math on the increases about $90-ish million, the increase in total operating cash over cumulative operating cash was just about $7 million. I was just trying to square those two.
Yeah. We have increased savings by $100 million through the end of 2014. We've increased the total costs and actually, I think what you're seeing is just the timing of the actual cash payouts has changed slightly. You've seen the cash payouts increase slightly in 2013, and it's flowing through future years as well.
Okay. Because when I just, and maybe this is wrong, I just added up all of the restructuring cash, and that was about $190 million more through 2018. The change in the incoming cash, the free cash flow cumulative went from $513 to $506 or so. I'm not exactly sure what it was, but I would think that the more spending would lead to the more savings down the road.
Yeah. The cash is just the charge.
Okay.
The savings is showing up on the P&L. You're seeing the restructuring cash is really related to the charge or the expense, and it's not netting the savings here on page 11.
I see. Okay, great. Thank you.
Sure.
Our last question comes from Charles Sebaski with BMO. Your line is open.
Good morning. Thank you for taking my call.
Hey, Charles.
Two questions. One, I was hoping to get a little bit more color on the organic growth in the brokerage or the Risk Solutions segment. How much is coming from rate versus how much is coming from new client activity?
We said before, overall rates had a modestly positive impact across our overall book. Very low single digits, very low. Roughly the same story as we had in the first quarter. A very modest impact. Substantial impact, as we said before, on retention, renewal, and new business. The retention rates we've been able to achieve have been extraordinary, record highs. The team's done an exceptionally strong job there, as well as new business generation with $270 million in new business across the firm in this quarter. A very strong performance up substantially from the same quarter last year. That's really been the driver.
I know you don't disclose specifically, how does, conceptually, Aon GRIP and Broking play into that new business? Any kind of color on how does that affect that business and just towards the opening doors or anything else?
Well, at the end of the day, what we've essentially said is what we're trying to do with Aon Broking, GRIP fits into that context, is essentially this is really about yield on per dollar premium placed across the system. As we think about each dollar that we're able to place, what is our remuneration against that? Aon Broking in particular helps us sort of understand yield across the book and do things that, by the way, help strengthen the value proposition for clients. In doing so, we get increased yield. That really is the story of GRIP as well, which is really helping carriers match capital with client need very effectively around the world. In essence, when you put all that together, that actually increases yield per dollar of premium placed. That really is how it shows up in the P&L.
Okay. Christa, one follow-up, I think, for you and a balance sheet question. When I'm thinking about the CapEx spend, and you guys spend, you have a couple, maybe $200 million of CapEx or at least a decent portion of your CapEx going into IT spend. Where is that showing up on the balance sheet? Because if I look at intangible assets, it sort of seems that it's amortizing off in sort of the listed $99 million of intangible amortization. I would expect it, I guess, to be going up as you're in turn reinvesting in IT.
Yeah, it's showing up on the balance sheet in other assets.
Okay. All the new investment shows up in other assets then.
Right. Pretty much.
Okay. That was it. Thank you very much.
All right. Thank you.
Thank you.
Thank you. I would now like to turn the call back over to Greg Case for closing remarks.
Just want to say to everyone, thank you very much for participating, we look forward to the discussion next quarter. Thanks very much.
Thank you. That concludes today's conference. Thank you for your participation. You may disconnect at this time.