Good morning, thank you for holding. Welcome to Aon plc's third quarter earnings conference call. At this time, all participants are in a listen-only mode until the question-and-answer session of today's call. If anyone has any objections, you may disconnect at this time. I would like to remind all parties that this call is being recorded, and that the information to note that some of the comments in today's call may constitute certain looking 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 for those anticipated. Information concerning risk factors that could cause such differences as described in the press release covering our third quarter results, as well as being posted on our website.
Now it is my pleasure to turn the call over to Mr. Greg Case, President and CEO of Aon plc. Sir, you may begin.
Thank you, Catherine, good morning, everyone. Welcome to our third quarter 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. 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 three metrics we focus on achieving over the course of the year: grow organically, expand margins, and increase earnings per share. Turning to slide three.
In the third quarter, organic revenue growth was 4% overall, driven by improved rate of organic growth in both Risk Solutions and HR Solutions. Operating margin increased 30 basis points as savings related to our restructuring programs and operational discipline absorbed continued investments we're making in new growth opportunities and in key talent across our businesses. Finally, EPS increased 8% to $0.95, reflecting solid operating performance and effective capital management. Overall, the focus remains on annual performance and achieving these metrics over the course of the year. However, I would note that our third quarter reflects improvement in each of our three metrics for the first time since the beginning of 2009 that we delivered this result in a single quarter.
Christa will provide further and additional financial commentary in a few minutes, reinforcing that we're on track with our long-term targets and have continued to take significant steps to further position the firm for long-term growth, strong free cash flow generation, and increased financial flexibility. Turning to slide 4, 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 3% compared to 2% in the prior year quarter, 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 90% or better on average, highlighting strong client satisfaction.
New business generation of more than $230 million across our retail business, with double-digit new business growth in many markets globally across Asia and Pacific regions. Investments in new product and service capabilities with the rollout of GRIP and Aon Broking globally. In our core treaty reinsurance business, net new business trends have now been positive for 6 consecutive quarters. Reflecting on the individual businesses. In the Americas, organic revenue growth was 2%, similar to the prior year quarter. Exposures are relatively stable, and the impact on pricing was modestly positive on average, reflecting a steady pace of improvement over the last 12 months. We saw strong growth in the renewal book portfolio in Latin America and in our affinity business. U.S. retail was stable as growth in health and benefits and property casualty markets were offset by continued weakness in the commercial construction market.
In international, organic revenue growth was 3%, also similar to the prior year quarter. Exposures are relatively stable, and the impact from pricing was flat on average, with firmer pricing in cat exposed regions. We saw strong growth in emerging markets, New Zealand, and in many regions across Asia, including double-digit growth in areas such as India and Taiwan. In the U.K. and Continental Europe, macroeconomic conditions remained fragile across many core markets. However, our leadership positions across this region, where we saw strong retention rates and management of our renewal book portfolio delivered modest growth. Overall, solid performance given the economic headwinds. In reinsurance, organic revenue growth improved to 7% compared to a decline of 1% in the prior year quarter. The results reflect solid growth across each business.
In treaty, as mentioned before, net new business won was positive for the 6th quarter in a row, including a favorable impact from market pricing in the near term, primarily due to losses incurred in the prior year from property cat exposed regions. Additionally, we saw solid growth from facultative placements and capital markets transactions and advisory services, which tend to be lumpy quarter to quarter. Overall, this level of performance and strength in new business generation reflects Aon Benfield's compelling value proposition for clients of strengthening operational performance and reducing volatility through unmatched data, analytics, and advisory capability. I would note that our Q4 2011 in reinsurance benefited from significant level of capital markets transactions that we do not expect to repeat in Q4 this year. Caution that excess capital continues to build in the industry and cedents continue to retain more risk.
Absent any events in the industry, macro factors may return as a headwind that we're going to have to overcome as we move into 2013. Turning to HR Solutions, overall organic growth improved to 4%, compared to a decline of 1% in the prior year quarter. We saw the rate of organic growth improve across both consulting and outsourcing, despite weak discretionary spend globally and continued economic pressure in continental Europe. Performance also reflects growth rates in areas where we're making significant investments in the business, in areas such as investment consulting, pension risk management consulting, and HR BPO. These investments reflect Aon Hewitt's 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 that are delivered at a local level. In addition, 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 seven years, clients are just beginning to renew their focus on talent, retention, development, and engagement to prepare themselves for potential renewed growth long term. Turning to the individual businesses. In consulting services, organic revenue growth was 5%, compared to a decline of 1% in the prior year quarter. The results reflect strong demand for delegated pension risk management and investment consulting services, strong growth in talent rewards, and solid growth across our businesses in Asia. The results were partially offset by a decline in discretionary spend for actuarial services and core retirement consulting internationally.
In outsourcing, organic revenue growth improved to 4%, compared to a decline of 2% in the prior year quarter. We saw strong growth in HR BPO from both new client wins and in discretionary products and services such as dependent eligibility audits. We also saw a modest growth in benefits administration, driven by net client wins and an increase in project-related revenue, partially offset by anticipated price compression. Overall, in HR Solutions, we delivered solid organic revenue performance in the third quarter and continued to execute on strategic investments that will drive additional long-term growth across our industry-leading platform. Slide five highlights the third topic, further 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 HR Solutions, we're making significant investments to strengthen our industry-leading position in healthcare exchanges, both in the retiree and active markets. Healthcare exchanges enable clients to begin the shift of their participants to a more market-based defined contribution model for healthcare, while addressing unsustainable healthcare cost increases and decreasing population health. While already a leader in the retiree market, we recently announced the launch of the industry's first and only fully insured multi-carrier corporate healthcare exchange with more than 100,000 participants. Really outstanding progress in this area as we look to scale it in 2013 and 2014. We're expanding our outsourcing offerings in high-growth areas such as dependent eligibility audits. We continue to expand our industry-leading benefits administration, solutions and technology from large market to middle market.
We're developing new delegated solutions in investment consulting and pension risk management that leverage our total capabilities across advisory and delivery services. A great example in this area was our recent advisory work for a large client around pension settlement and de-risking activities, which led to one of the largest insured annuity settlement transactions in U.S. history. Finally, we're strengthening our international footprint to support a global workforce with investments in key talent and capabilities across Asia and emerging markets. 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 Aon 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 more than 1.5 million trades, more than $76 billion of bound premium, and a growing client list of insurance carriers utilizing the platform for its analytics and servicing 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. Effective January 1, we aligned our global health and benefits platform to better capitalize on our global distribution channel and deep brokerage capabilities. Finally, we're expanding our footprint through tuck-in acquisitions that either increase scale in emerging markets or expand capabilities to better serve clients, as well as adding key talent across Asia, in specialty sectors, and in our GRIP services business.
Overall, we've proved the concept of these major investments and begun to scale these opportunities in 2012. As we complete 2012 and move into 2013, we are on plan to deliver greater scale and increased operating leverage. In summary, we delivered improved organic revenue growth across both Risk and HR Solutions, made significant strategic investments that will deliver greater long-term growth, and took important steps to strengthen our global firm, highlighted by the re-domicile from Chicago to London, completed earlier this year. With key members of the management team now fully relocated to London, and as a U.K.-headed multinational group, we're seeing increased interaction with international and emerging market clients, strengthening our relationship with London markets, increasing our international brand awareness, and driving financial benefits related to the transaction. With that said, I'm now pleased to turn the call over to Christa for further financial review. Christa?
Thanks so much, Greg, and good morning, everyone. As Greg noted, our performance reflects solid organic revenue growth and significant steps to strengthen our global firm. From a financial perspective, our third quarter results overall exceeded our previous expectations. We continue to drive a set of initiatives to improve operating performance, deliver savings from our formal restructuring programs, and generate strong free cash flow growth. We are effectively allocating capital, as highlighted by the repurchase of $275 million of ordinary shares in the quarter. I would note that this is more share repurchase than we've done in any quarter in the past year, and is a reflection in our belief in the strength of the firm. Now let me turn to the financial results, as highlighted on page six of the presentation.
Our core EPS performance, excluding certain items, increased 8% to $0.95 per share for the third quarter, compared to $0.88 in the prior year quarter. Results reflect solid organic growth, restructuring savings, a lower effective tax rate, and effective capital management in the quarter. Certain items that were adjusted for in core EPS performance and highlighted in the schedules on page 12 of the press release include non-cash intangible asset amortization, restructuring charges, and $4 million of redomicile costs, primarily for legal and advisory fees, with the completed redomicile on April 2. Foreign currency translation did not have a material impact on earnings per share in the quarter. If currency were to remain stable at today's rates, we would expect a very modest unfavorable translation impact to EPS in the fourth quarter of 2012. Let me talk about each of the segments on the next slide.
In our Risk Solutions segment, organic revenue growth was 3%, operating margin decreased 20 basis points to 20%, and operating income decreased 1% versus the prior year quarter. Included in operating income was a $10 million impact related to both unfavorable foreign currency translation and the decline in investment income from lower short-term interest rates globally. Organic revenue growth and restructuring savings primarily absorbed the significant investments we're making in our GRIP platform and in key talent across Asia and Latin America. Let me spend a moment on the formal restructuring programs, key initiatives that have enabled concurrent funding investments and long-term structural margin expansion. With respect to the Aon Benfield Plan, savings in the third quarter are estimated at $36 million, compared to $30 million in the prior year quarter.
The Aon Benfield Plan is expected to deliver cumulative expense savings of $146 million in 2012, compared to the cumulative savings of $122 million in 2011. Further, associated with the transfer of the health and benefits business at January 1, 2012, an estimated $46 million of restructuring savings under the Aon Hewitt Plan will be achieved in Risk Solutions. Approximately $33 million of the $46 million in cumulative savings have been achieved under the program, including an estimated $7 million of incremental savings in the third quarter. A breakout of restructuring charges is incurred in Risk Solutions associated with the Aon Hewitt Plan is detailed in the schedules on page 13 of the press release.
For the first nine months of 2012, Risk Solutions' margin is up 10 basis points, and Risk Solutions' operating income is up 2%, absorbing significant investments in the business, lower investment income, and unfavorable foreign currency translation. We continue to expect strong operating performance in the fourth quarter, driven by seasonal strengths, less investment spend, and increased return on our investments as we begin to scale long-term initiatives, resulting in margin expansion for the full year and placing us on track to deliver our long-term target of 26%. Turning to the HR Solutions segment, organic revenue growth was 4%. Operating margin increased 150 basis points to 17.5%, and operating income increased 11% compared to the prior year quarter. Included was a $5 million favorable impact from FX.
Organic revenue growth of 4%, $20 million of incremental restructuring savings, and an increase in costs that were deferred related to the timing of large client implementations more than offset our significant investments in long-term growth initiatives and an unfavorable revenue mix shift. With respect to the Aon Hewitt restructuring program, we incurred $16 million of charges in the quarter. Cumulative savings related to the formal restructuring program in the third quarter are estimated at $64 million, compared to $37 million in the prior year quarter, of which approximately $7 million of the incremental savings were achieved in the risk segment. At the beginning of the year, we provided specific comments regarding the outlook for HR Solutions in 2012. Number one, we expect improved organic growth in both businesses in 2012.
Number two, we would invest approximately $35 million in new growth opportunities, primarily our healthcare exchanges, HR BPO, investment consulting, and pension risk management. Number three, approximately 75% of the restructuring savings would be realized in adjusted operating income. Number four, expected performance would improve in the second half of the year, primarily as investment spend decreases in the second half from the first half. Overall, our results reflect a solid performance in the third quarter, and we are on track with the plans that we had laid out at the beginning of the year. We are always cautious not to overplay the results of one quarter. For the fourth quarter, we expect continued organic growth to deliver on restructuring savings and make further progress against key investments, resulting in operating income and margin up modestly, similar to our previous guidance, placing us on track for improved performance in 2013.
Turning to the next slide on our long-term operating margin targets. We continue to drive a set of initiatives to improve operating performance on an annual basis. While we've improved operating margins 500 basis points over the last six years, our long-term operating margin target of 26% for Risk Solutions reflects significant opportunity for further margin improvement in the following five ways. Number one, deliver $20 million of remaining restructuring savings and deliver other operational improvements. Number two, continued rollout of the revenue engine internationally. Number three, Aon Broking and GRIP-related initiatives. These three are fully within our control. In addition, there are two additional macro drivers that provide significant operating leverage based on improvements in the external market. Number four, increases in short-term interest rates. Number five, industry improvements driving higher insured values or insurance pricing.
Similarly, for HR Solutions, while we've improved operating margins nearly 1,200 basis points over the last six years, our long-term operating margin target of 22% reflects significant opportunity for further margin improvement in the following three ways. Number one, deliver $56 million remaining restructuring savings after the transfer of savings for health and benefits. Number two, growth in the core business and return on incremental investments, including healthcare exchanges. Number three, improvements in HR BPO. Now let me discuss a few of the line items outside of the operating segments on the next slide. Unallocated expenses were $46 million, including non-recurring costs for certain employee benefit plans and increased operating expenses related to the redomicile. Interest income decreased $3 million due to lower average interest rates and average cash balances. Interest expense decreased $3 million due primarily to a decline in the average rate on total debt outstanding.
Other expense had an unfavorable impact of $7 million, including a $16 million loss on the unfavorable impact of exchange rates on remeasurement of assets and liabilities in non-functional currencies, partially offset by gains on certain company-owned life insurance plans and other long-term investments. Going forward, we expect a run rate of approximately $1 million per quarter of interest income, $40 million of unallocated expense, and $60 million of interest expense per quarter. Turning to taxes, the effective tax rate on net income from continuing operations decreased to 23.2% in the third quarter, compared to 28.9% in the prior year quarter. The effective tax rate in the third quarter of 2012 was favorably impacted by certain discrete tax adjustments. We currently anticipate an effective tax rate of approximately 26% in the fourth quarter of 2012 and going forward, excluding any discrete tax adjustments.
Lastly, average diluted shares outstanding decreased to 331 million in the third quarter compared to 336.9 million in the prior year quarter, due primarily to our share repurchase program. The company repurchased 5.4 million Class A ordinary shares for approximately $275 million in the third quarter and has approximately $4.5 billion of remaining authorization. Actual shares outstanding on September 30th were 318.7 million, and there are approximately 10.4 million dilutive equivalents. Now 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 $1 billion, and total debt outstanding was $4.4 billion. Overall debt to capital was 34.6% at September 30, compared to 35.7% at December 31. Cash flow from operations increased 63% to $598 million, compared to $368 million in the prior year quarter.
Despite a higher organic growth rate, lower working capital requirements more than offset an increase in cash taxes and cash contributions to the major pension plans in the quarter. Furthermore, we continue to operate with elevated levels of invoicing and cash collections, approximately $375 million, related to a delay in invoicing at Aon Hewitt, which began in the second half of 2011 with the conversion of certain order to cash systems. Free cash flow, as defined by cash flow from operations less CapEx, increased 66% to $526 million, compared to $316 million in the prior year quarter. The increase in free cash flow reflects a 63% increase in cash flow from operations, partially offset by a $20 million increase in CapEx. Turning to the next slide to discuss our long-term financial flexibility.
Regarding our underfunded pension plans, we've taken significant steps to reduce volatility and liability as we've closed plans to new entrants, frozen plans from accruing additional benefits, and continued to de-risk certain plan assets. In 2011, we contributed approximately $477 million to our plans. In prior quarters, we've noted that 2012 contributions were expected to be $541 million before any discretionary contributions, primarily reflecting a decline in discount rates from 2011. On September 30, we completed a merger of five of the seven legacy Aon and Hewitt U.K. pension schemes into a single plan. In addition to decreased management time and improved governance, additional benefits are expected to be derived through improved operating efficiencies, reduced advisor and asset management costs, and a higher level of control over investments. In conjunction with this transaction, we made a discretionary contribution of approximately $80 million.
As a result, we now expect pension contributions to be $641 million in 2012 and would expect contributions to decline annually beginning in 2013, despite the decline in discount rates year-to-date, resulting in fully funded plans on a GAAP basis in 2016. Regarding our restructuring plans, cash payments were $178 million in 2011. As our restructuring plans continue to wind down, we would expect cash payments to decline $29 million to approximately $149 million in 2012, before declining further in 2013. As we continue to grow, improve operating performance, and our required uses of cash decline over the next several years, we expect our strong free cash flow to be a significant source of value creation for shareholders. As an important step in unlocking that value for shareholders, on April 2, the company completed its change in jurisdiction of incorporation from Delaware to the U.K.
We believe the transaction will help drive shareholder value through, number one, providing greater global access to expected increases in future free cash flow. Number two, enable us to access roughly $300 million of excess capital held internationally on our balance sheet. Number three, increase future cash flows through a significant reduction in our global tax rate over the long term, more than we've done over the last five years, which was approximately 500 basis points. In summary, we are on track for stronger growth in 2012, and we have significant leverage to an improving global economy. 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, is continued growth and operating margin improvement towards our long-term targets. Second, declining uses of cash for pension and restructuring.
Third, greater capital flexibility and increased cash flow from a lower effective tax rate resulting from our redomicile to the U.K. Combined with a strong balance sheet and greater 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.
We will now begin our formal question-and-answer session. To ask your question, you may press star one on your touchtone phone. To withdraw your question, you may press star two. Our first question is coming from Adam Klauber of William Blair. Your line is open.
Thank you. Good morning, everyone.
Good morning.
Could you tell us how much to date have you invested in the healthcare exchanges, and how much, I guess, total do you expect to invest? Could you talk about, I realize it's a very long-term process, but what's the potential ramp-up in clients in the different exchanges?
Well, Adam, on the healthcare exchange front, as we've made a number of investments we talked about and very excited about the overall platform. To date, we targeted, as we said before, about $75 million in the investment, about $40 million of which was last year and $35 million this year in 2012. Pleased to say we were able to launch our first ever, as we described before, corporate exchange, which is coming live in the fourth quarter. It's the first time it's ever occurred, 100,000 lives. Very excited about that. As you know, we've got a very strong retiree exchange as well in our Navigators exchange. Just for context, if you think about it, there are 48 million eligible retirees out there. Additional context on the corporate side, 122 million active employees today.
All of those are in an environment in which increasing healthcare costs are clear everywhere. Employers are looking for ways to actually sort through that complexity. Not only are costs going up, but health is actually deteriorating. We see a substantial amount of opportunity in this over the long term. That's why we made the investments and are very excited about these platforms and what they can mean for us. As we said in the first quarter, we see the real impact happening more in 2014, 2015, et cetera. We're going to see impact in 2013, but it's really going to happen in 2014 and 2015, so these are investments for the long term. Would say, much like the overall story for Aon Hewitt, we feel very good about these.
These are stable, on track, and actually progressing just as we thought they would, and are excited about the overall investment.
Okay. Just one follow-up. HR margins were clearly good. Were there any one-time or favorable items that helped the margins this quarter?
What I would say is, it was a little better than our expectations. A lot of things moved in the right direction. We do believe that we're on track with previous guidance, with operating income up modestly in Q4 and continued progress in 2013.
Okay. Thank you very much.
The next question is coming from Jay Cohen, Bank of America, Merrill Lynch. Your line is open.
Yes, thank you. A couple questions. I guess sticking with HR and the margins, you did refer to some, I guess, deferred expenses, which sound like it helped the earnings. Can you explain what that is? And if they're deferred, does that mean higher expenses in later periods?
Right. Great question, Jay. Deferred costs are really related to the timing of large client implementations. When clients go live, we defer those costs from the P&L onto the balance sheet. That's essentially the way the mechanics work. It's really just related to the timing of when clients go live. That was a significant impact on the quarter, and continues to be a part of the way we operate the economics of the business.
I think overall about just how margin's going to progress, Jay, as we described before, we intend to make progress year to year. Third quarter is an indication, and we step forward. As we reflect on 2012 when we finish Q4, we believe we'll have made modest progress, as Christa described, and we believe we're well positioned to make modest progress in 2013 and continue on the march to the 22% target.
Just one other note, Jay. We are deferring revenue that's matching those deferred expenses, so we're matching revenue and expense, so you're not going to get some incremental expense going forward without the incremental revenue.
Got it. No, that makes sense. Separately, if you can give us an update on GRIP. I don't know if you can talk about how many insurance companies you've got signed up to the platform and what your goals are for that product.
As we described before, when you think about GRIP in the context of what we're trying to accomplish on the overall Risk Solutions platform, what we said before, if you think about how we grow the business, we can increase the number of clients, increase the wallet share we've got with them, or increase the yield per dollar of premium placed. That's exactly squarely where the GRIP world fits, increasing yield per dollar of premium placed. For us, it's about how we put the platform in place and how we build it over time. As you described, Jay, we've made very good progress with it. We've got, as I described before, almost $80 billion of premium sort of in the GRIP system. We've talked before about multiple carriers who've signed onto this, substantially proven the concept, as we described before.
What we see in 2012 is we're really rolling that out. It's really having substantial impact, not only with our carriers or with our clients. This is having substantial impact in helping us really match capital with client need in a very substantial way, and it's increased our level of service. We're very positive on the GRIP platform, and it really is the reason. As we said in Q1, we've seen so much progress with it. We've proved the concept, and now we're scaling up that concept as we roll out the platform.
No disclosure on how many insurance companies are on the platform at this point?
It's really not about the number. It's really about what we're trying to do and how we're actually increasing the yield per dollar of premium placed. You're going to see the impact of GRIP show up in that yield, show up in margin over time, and it's much deeper than just literally market by market, because we're actually seeing benefits beyond just signing up insurance markets.
Got it. Thank you.
The next question is coming from Brian Meredith of UBS. Your line is open.
Yeah, thanks. Just a couple of quick ones here. First, Krista, is it possible to give us what the capital markets benefit was for the reinsurance organic revenue growth rate this quarter?
Hang on. Just looking for that. I think it was 100 basis points roughly.
Okay. Excellent. Then, Krista, another quick question here. On the tax rate guidance at 26% for the remainder of the year, when I think about your 500 basis points that you're going to get over, or more than 500 basis points from the redomestication, is that kind of the baseline I should be thinking about?
We did start before the transaction, our effective tax rate was 29%. You can see we're making progress on the benefits of the move to the U.K. already with the tax rate decline from 29 to 26 this quarter. We did say this quarter that the tax rate benefits from the transaction would be more than 500 basis points. What I would say in regard to that is we had an overall plan in place, and as we continue to execute on that plan and we get more certainty on it, we'll continue to update you.
Got you. Just lastly, I just wanted to follow up on Jay's question. Is there any way that you could actually quantify whether the deferral and revenues and expenses were in the quarter with respect to the HR Solutions business? Just so we can kind of look at the different ratios and how they're really kind of working.
We did say it was significant. We haven't revealed that number. Look, we would say it's related to the timing of large client implementations in both our BPO and benefits administration business, and it will be lumpy by quarter as client implementation phase in.
Okay. All right. Thanks.
The next question is coming from Ray Iardella of Macquarie. Your line is open.
Thanks. Good morning. I guess two questions for me. First, maybe talk a little bit about the construction business. Mentioned some weakness there, I think, in the U.S. Curious, one of your competitors suggested it might be getting a little bit better. Curious what you guys are seeing.
Yeah. As you know, we've got a very strong construction business, not only across the U.S., but really globally, the most significant in the industry. It is a sector which we like a lot for the long term. In fact, irrespective, you kind of look at the analysis a lot of different ways, but you're in the trillions when you think about sort of the infrastructure build that's going to be required around the globe. We estimate it's $10 trillion-$15 trillion over the course of the next couple of decades. We love the sector, we love the space, and we've simply made the most significant set of investments in this space. In that regard, this has been a headwind for us for the last number of quarters, with a headwind for us this quarter. We definitely see some potential positive signs.
For us, this is a very substantial bet, bigger than anyone else's. As we start to see benefits, we think they will be substantial. For now, we see progress, and we see good pipeline, but we haven't seen it in the quarter yet.
I just wanted to follow up with Brian's question earlier on reinsurance revenues. The capital markets impact on the quarter was closer to 200 basis points of organic revenue growth. I would want to note that Q4 2011 was a significant capital markets quarter. As we think about Q4 2012, that will be a difficult comparable.
One other follow-up, if I could. In terms of M&A, just curious, do you guys kind of see going out the pipeline still looking pretty good? I believe you talked about in the past $200 million or $300 million of cash kind of allocated towards M&A.
That's exactly where we continue to be. For us, really, it's taking a step back, Ray. We like the platform and the portfolio we put in place. It's taken us six to seven years to get here, as you think about the addition of Benfield, the addition of Hewitt to the mix, and a number of acquisitions that have been really tuck-in to build content and capability for us. For us, the M&A strategy is not about size. It's about adding true content capability that will support our clients. In that regard, we really continue to see the $200 million-$300 million investments in these smaller tuck-in acquisitions around the world, really being a formal part of the strategy.
Okay, thanks again.
Sure.
The next question is coming from Michael Nannizzi of Goldman Sachs. Your line is open.
Thanks. Just quickly, Krista, on the reinsurance piece, I imagine that the guidance that you've put out there contemplates the reinsurance trend that you're talking about. Is that right? For 4Q?
Yes, it does.
Okay. One question was on the buybacks. How much of the buyback in the third quarter was funded from the additional funds made available via redomestication? How much is left, I guess?
As we think about buyback for calendar year 2012, we are on track to buy back more in 2012 than 2011. Obviously, we gave guidance at the beginning of the year that was close to $150 million a quarter, plus use of the international cash on the balance sheet. We just think about it as an overall pool, including the cash flow of the company and the cash and short-term investments on the balance sheet.
Got it. Okay. Then, can you elaborate a bit on your comment, maybe Greg, in the press release about the Europe impact on discretionary consulting, and maybe also on a related note, the increase in discretionary demand for BPO? Just want to understand how that fits with the macro in Europe.
Really the overall macro point, which is really the key one here, raising Michael, is really we see certainly pressure around the world as you read about every day, and we see it really from every corner of the world, but it's different. Right now, as we look at the global landscape, there's certainly pressure in the European quadrant. It happens to be a place where we have substantial, very strong installed bases, and it's just part of how Aon was built over time. In that context, what we're seeing is essentially if you're a client in that context, if you've got something you can defer, you can push back from a discretionary standpoint, you're going to do that. That really is the comment on discretionary spend and the pressure we're seeing in the context of that.
Having said that, the platform we've got is exceptionally strong, and this is not a B2C business. This is really B2B. At the end of the day, at the heart of it, clients have risk issues and people issues. It's why even in the context and if you think about what's happened over the last number of years, Aon has grown the business every year, except for one. That was, we were, I think, down 1%. We've essentially been able to, in the face of very strong economic headwinds, continue to grow the business and build the business. That's really one of the hallmarks of the overall platform of Aon. It's one of the things we build upon.
There's a lot of pressure, and it had impact on the quarter, but there are also a number of things we can do against that. From a BPO standpoint, this is really about the HR topic more broadly. Just overall, when you think about things we are looking and taking to clients to combat this issue of discretionary spend are things that can truly have impact for them in the near term. Things like dependent eligibility audits, leave of absence reviews, things like that, project revenues that we can really help them improve the operating performance of their business in the near term. These are the things we're actually bringing to them now that are different. The mix has changed a bit. The pressure's real, but Aon's got a very strong platform to deal with it.
Great. Just lastly, the retail U.S. in risk, what happened there? You mentioned a little bit about exposures, and we've heard a little bit about pressure on exposures in U.S. risk. Can you talk a little bit about what you're seeing there, and maybe the balance of that versus the other aspects of North America? Thanks.
I would step back. As we talked about on the retail side, 2% growth in the Americas in the quarter, that really cuts across all the Americas. We would reflect, overall, Michael, 3% year to date. That's the number I'd have you think about. That's roughly where we expect the year to play out. We obviously aspire for more across the board, and we're making substantial investments to achieve that, and those are starting to really make a difference, all out of the GRIP question from before. That's roughly how we're looking at it. Remember, we've got a few sectors on the. We talked about construction before and a few others that we've made particular investments in that we like a lot, but have particular headwinds for us in the near term, and that really is what constrains us a bit.
We feel like the growth profile that we've achieved year to date is meaningful and will continue going forward.
Great. Thanks.
The next question is coming from Matthew Heimermann of JPMorgan Chase. Your line is open.
Hi, good morning, everybody.
Hi.
Hi. A couple of questions. First, just on the BPO business, when you guys acquired Hewitt, that was a business that basically had no margin whatsoever, and I think one of the goals was to, one, reprice that business, and as you put new business on and old business rolled off, you get margin gains. I guess my question is, at this point in the game, have we seen any material margin contribution from that, or is that to come when we think about some of the implementation revenues that you were talking about earlier?
Yeah. Look, we're very pleased with the improvement in that business. It now does have positive margins, so we continue to improve margins over time. We're working very hard to get them to a 15% margin by 2015, as we originally outlined as part of the transaction.
Okay. Still more to go when we think 2013 versus 2012 and 2014 versus 2013, 2015 versus 2014.
Absolutely. Yeah. Continued improvement year-over-year.
Okay. Just with respect to the timing issue on margins. There's some expenses that don't show up, but there's also revenue that doesn't show up. When we think about the margins you reported in the quarter, you implied that was a positive. If you had had both the expenses and the revenue show up, should we have thought about margins differently than what we saw this quarter?
Yeah. Look, I think I wouldn't over-index too much from one quarter. I'd look more at the year, because things do move, and there were a few things that moved in our direction in Q3. As you look at the overall year, that's a good indication. Deferred expenses and deferred revenue both happen and match, you're right. Deferred costs did have a positive impact on the quarterly result. Again, look at the overall year, and we really think that operating income and operating margins will continue to improve in 2013.
Okay. I just was following up from the standpoint that when you first answered the question, it sounded more negative than on the follow-up, it sounded neutral, and then it sounded a little negative again. The real takeaway is, there's always noise quarter to quarter, and it might have been a little bit positive, negative, but we shouldn't play that forward in any way, shape, or form.
That's exactly right, Matthew. Yep, that's right.
Okay. The last question, just on exchanges. The right way to track your progress in this business over the next couple years, I'm assuming it's going to be more about the lives you have in the exchanges than the client wins, but obviously they're linked. Wanted to just, one, make sure that that was correct, and two, obviously we need client wins to drive lives, but give us a sense of how, from the outside perspective, what some of the data points on the client side we should think about over the next couple of years to measure progress here.
Matthew, you're exactly right. Again, what we're doing here is we've launched two exchanges, two businesses that one's been in place, the Aon Hewitt Navigators on the retiree side against a pool of 48 million eligible retirees over time. That's been in place for a number of years, is tracking well, and we're adding clients to that. We've launched the corporate exchange. As I described before, this is a different set against the set of 122 million active employees. You're exactly right. What we want to be able to do is these need to be up and running, which they are, running well, which they are, adding new clients, which we are, and you're tracking that over time and tracking the number of lives that we're actually able to serve.
We're excited about, as we said before, with 100,000 lives in the corporate exchange, we're truly proving a concept. It's something that's never been done before that gives CFOs and heads of HR and business leaders the opportunity to really deal with increasing healthcare costs, but do it in a way that they can serve their employee base as well. We're quite excited about that. In many respects, we've got two highly viable new businesses up and running that really are changing the shape and the foundation of how businesses think about healthcare coverage over time. For us, it is making sure we've solidly proven those concepts and then growing those over time. You're exactly right.
For 2013, it's about how we add companies and clients to that list and then how we add lives to that list. That's exactly what we're on track to do.
Okay. I'm sorry.
As we think about the economic model of healthcare exchanges for us, we're earning a commission on the premium placed, which is a very attractive economic model. As we scale participants over time, that becomes more economic, and that's really how the return comes in sort of 2014 onwards.
I'm assuming you also get some economics from the administration piece of it, correct? Which is kind of an HR benefits administration like service, correct?
A little bit, yes.
I just wanted to just clarify one other issue. A lot of the conversations around this now with, who knows what's going to happen with the election, but obviously people are talking about possibilities that they weren't talking about maybe a month ago. Can you talk. I think there's a perception out there that your investment is basically a binary outcome on Obamacare. Can you tell us why that's not the case? I have my own view, but I'd like to hear yours.
Well, I really appreciate you raising that because the election, obviously of interest to everyone, but doesn't really have a particular impact directly on the investments we're making here. Again, if you step back, just think about the corporate exchange for a minute, 122 million active employees today. When you think about the companies and their opinions, we've actually surveyed, if you remember, we actually have access and connections to literally in top 1,000 companies around the world, all their heads of HRs and all their CFOs, 94% have committed to healthcare coverage. Overwhelmingly saying, we're going to provide some way. We're going to make sure there's coverage available. No one's going to walk away here. Only a third really have a strategy to do that.
There's a great opportunity for us to help them bring clarity to what that space looks like. We actually surveyed them, and even without an exchange in place, a full 43% of them have said they're willing to try an exchange. Just think about that in the context of sort of the overall corporate environment. A tremendous opportunity of companies saying, "My gosh, we have a problem." Remember, Obamacare or whatever you want to describe it, healthcare coverage as it currently exists, doesn't fundamentally address the issue of expense here at all, nor does it address the issue of wellness. Expense is going up and wellness is going down. That is a fundamental reality, and that's what we're really helping companies think through. It's really independent of political party, it's independent of policy.
It's a fundamental business set of reasons which are driving our investment in healthcare exchanges, and it's why we're so excited about them. Fundamentally, we win when our clients win, and in this case, there's a massive issue for them that they've got to address, and this is a very viable platform for them to address that issue.
Okay, thanks much.
The next question is coming from Greg Locraft of Morgan Stanley. Your line is open.
Hi. Thanks. Wanted to just clarify two things. One for Krista. You called out that the capital markets or the reinsurance comparable is a difficult one for the fourth quarter. You also quantified the impact for this quarter. Can you do the same for the fourth? Just give us the exact numbers.
Oh, for fourth quarter.
In terms of what it was last year, we can model accordingly.
Almost all of it was capital markets in Q4 2011, is a good way to think about it.
Almost all of the growth.
It's usually the smallest quarter for reinsurance.
Yeah, it's both a combination, really. Q4 is the smallest quarter for us, and we just had a very, it was a great client example for us, but a very substantial win in Q4 last year, and that's not going to be here this year. In that context, that's really the market comparable. This is really just the fundamental issue around the lumpiness of our fac business and our capital markets business. Be clear, we expect to grow this business over time. We expect modest growth of this business over time. The Aon Benfield platform is just done wonderfully well. As both Christa and I described, six consecutive quarters of treaty net wins. By the way, we see treaty growth positive in the fourth quarter, although it's our, as Christa has described, our smallest quarter.
It's just going to be offset by a substantial transaction that happened in Q4 2011.
Okay, great. Again, another clarifying question. On Risk Solutions, Greg, you mentioned, I guess, macro headwinds, macro concerns. Was your commentary directed towards just the HR Solutions business, just towards Risk Solutions or the entire corporation? Can you just expand a little as we think about the organic going forward, especially for Risk Solutions? That's where I'm most focused.
Well, let's stay on Risk Solutions. On the Risk Solutions front, we've seen positive pricing trends for the last number of quarters as we saw, as we described sort of from the GRIP analytics that have helped the overall industry. Against that context, you have an economy that creates the headwinds that come against that, around discretionary spend and all the pieces in the context of that. We're not going to change our view. It's basically, it remains fragile. We're going to work through it. We're going to grow organically in the context of it. Those are some of the macro headwinds I was trying to describe. Underlying that is just the capital buildup that continues to happen in the overall insurance industry, and we're always mindful of that. As we said before, we have an aim.
We're going to grow organically, we're going to improve margins, we're going to increase earnings per share, and we're going to do it irrespective of the environment. We expect to do that in Risk Solutions in 2013.
Just one follow-up there. I know you've talked about this in the past, but just can you remind us, in Risk Solutions, what's sort of your minimum organic that you need to grow the operating margin? It sounds like almost in any world you think you can do it. How do we think about that sensitivity of whatever organic we come up with relative-
Yeah, but-
Your ability to drive the margins?
I would give you two ways to think about this, Greg. The first is, in the depth of the economic recession, where insurance rates were 5%-10% down real, and we had declines in insured values, which were a much bigger impact on the firm. The worst we saw in 2009 was minus 1% organic revenue growth. The investments we're making allow us to sort of outgrow that. The other way, I guess I would say is we have a natural, if you think about sort of the margin expansion, we have a natural inflationary push on the expense base. Let's call that sort of 2% that we need to sort of grow over to expand margins.
Okay, great. Thank you very much.
The next question is coming from Michael Zaremski of Credit Suisse. Your line is open.
Hey, good morning. Quick follow-up on the exchange. One of your competitors recently acquired an active exchange. Will the economics of your corporate exchange be similar to that one if we studied the one that Towers Watson owns?
Well, remember the Extend Health that I believe you're talking about with Towers Watson is a retiree exchange. This is really analogous to our Aon Hewitt Navigators business. We have had that in place for a number of years, and I said before, love the platform, love the progress that the team's made with it, and that continues to build and grow. That would be more of a direct competitor from that standpoint. We then would separate an additional platform we have that doesn't exist anywhere else, and that's the corporate exchange. This is two separate businesses, two separate initiatives we're taking sort of in the context of this and building both of those businesses.
The corporate exchange, as described before, is really the first of its kind, and it really is the first of its kind that addresses the pool I described, the 122 million+ of active employees. It's really two separate businesses.
In terms of the economics, I would say obviously Extend Health is a good proxy for our retirement exchange business. As we think about our corporate exchange business, it's leveraging the platform we already have in benefits administration, and we're selling to the same client base. We already have a scale platform to operate that business.
I know you guys are doing, I think, a mini teaching on this in a month, so we'll learn more there. Next on the pension
I was just curious, given the drop in interest rates in both the U.S. and Europe this year, could your 2013 pension contribution cash flow projections change? Related, I know there's been a couple large corporate pension plan solution transactions announced recently. I think you guys were actually involved in the one with Verizon and Prudential. Is Aon exploring a solution as well for its pension deficit? Thanks.
What I would say is we've taken steps already over the last couple of years to mitigate volatility and the size and risk of our pension plans. We've closed the plans to new entrants, we've closed them to benefits, and we've de-risked a portion of the plans. I did note in my earlier comments that on September 30, we made a move to aggregate five of the seven Aon and legacy Hewitt plans into one plan in the U.K. As a result of that, we've substantially decreased the costs of running those plans. We made an additional contribution of $80 million that was discretionary. Our contributions in 2012 will be $641 million, and they will decline in 2013 despite the decline in discount rates in 2012.
The other thing I would note is that pension expense will also decline in 2013 as a result of the move we've made. Our pension plans are much less volatile. They're de-risked, and if rates go lower, potentially, there's also upside if they go higher.
Okay. That makes sense. In regards to a solution, is that something you guys always are thinking about?
You should think we think of everything, and we look at everything.
Okay. Thank you.
The next question is coming from Paul Newsome, Sandler O'Neill. Your line is open.
Thank you, good morning.
Good morning.
I missed the description of the discrete benefits on the tax. Could you give us a little color on that? As well as could you talk about perspectively, is the decline in the effective tax rate that we're looking at principally due to the elimination of the extraterritorial taxation, or is there other stuff going on there as well?
As we think about the overall effective tax rate and the decline from 29% at the beginning of calendar year 2012 to the 26% we've announced for Q4 2012 and going forward, we are making progress on the benefits of the move to the U.K. with that effective tax rate decline. We have an overall plan in place, and as we continue to execute on that plan and get more certainty on it, we'll continue to update you. With respect to the quarter and the tax rate from continuing operations, it did decline to 23.2%, and that was a result of certain discrete tax adjustments, principally from our tax return in 2011. As you think about your model going forward, 26% is the right go forward rate.
Okay. Separately, just more the curiosity than anything, the cash restructuring payments that you talked about go out as far as 2015. What are the characteristics of those kind of cash restructuring charges that you'd see that far out from when you renegotiate.
Yeah, it's mostly lease payments. As you think about restructuring leases and closing down activities. If you refer to page 11, it gives you those restructuring cash payments out over time, and it is mainly related to leases because the people costs happen fairly quickly.
All right. Then finally, the $300 million in cash that was going to be freed up from the change in domicile, has that been moved up to the parent, or is that something possibly in the future we'll see?
Yeah, we think about it, as I said earlier, as one cash pool, we access that, we think about the returns on that cash pool maximized through return on capital, measured on a cash-on-cash basis. We are disproportionately allocating it towards share buyback, given we believe we're substantially undervalued, hence the $275 million of share buyback you saw in Q3, which is the most significant we've done in a quarter over the last 12 months.
Great. Thank you very much.
No further questions at this time. I will now turn the call back to Mr. Greg Case for closing remarks.
Well, thanks, Catherine, and I just want to say to everybody, thank you very much for your interest in Aon, and we look forward to the next quarterly call. Thanks very much.
This will conclude today's conference. All parties may disconnect at this time.