Good morning, thank you for holding. Welcome to the Aon Corporation third quarter 2010 earnings conference call. At this time, all parties will be in a listen-only mode until the question and answer portion of today's call. If anyone has an objection, you may disconnect your line at this time. I would like to also 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 third quarter results, as well as having been posted on our website. Now it's my pleasure to turn the call to Greg Case, President and CEO of Aon Corporation. You may begin.
Thank you, good morning, everyone, and welcome to our third quarter 2010 conference call. Joining me here today is our CFO, Christa Davies. To begin, this was a very exciting quarter for our colleagues around the globe, highlighted by a tremendous effort to complete the merger with Hewitt Associates, creating a global leader in HR solutions. First and foremost, on behalf of Aon colleagues around the world, I want to extend a heartfelt welcome to our associates from Hewitt and thank them and all of our joint teams for the tremendous effort in bringing together our two firms. It has just been extraordinary work all around. Today, we're fully launched with our leadership and teams in place, working together to serve clients with greater capability and content than ever before.
The outcome of this work substantially strengthens Aon's position as a global leader in risk and people with Aon Risk Solutions and Aon Benfield in our brokerage segment and Aon Hewitt in our consulting segment, each a clear global leader in their own right. In addition to the close of Aon Hewitt, in the quarter, we began the official launch of our four-year partnership with Manchester United on July 12th, which will support connectivity across global Aon and substantially strengthen Aon's brand recognition around the world. Beyond these highlights, our team is delivering results that demonstrate continued progress and momentum. Irrespective of economic conditions, the soft market, or other challenges outside our control, we're executing on our strategy to substantially strengthen our firm. Consistent with previous quarters, I'd like to cover three areas before turning the call over to Christa for further financial review.
First is our performance against key commitments to shareholders. Second, continued areas of investment across Aon, including an update on the progress of Aon Hewitt. Third, its overall organic growth performance. On the first topic, our performance versus commitments. Each quarter, we measure our performance against the three metrics we committed to shareholders to achieving over the course of the year: grow organically, expand margins, and increase earnings per share. In the third quarter, organic revenue was unchanged on a percentage basis, an improvement from a -1% in the prior quarter, as consulting delivered its second straight quarter of positive organic revenue, and our retail brokerage business posted its third straight quarter of sequential organic revenue improvement. Adjusted operating margin decreased 30 basis points, as improved operational performance across our combined segments was offset by a decline in revenue related to our ownership in certain insurance investment funds.
EPS on an adjusted basis decreased 6% to $0.61, as improved operating segment results and effective capital management was more than offset by the unfavorable impact of a loss on the business, a higher effective tax rate, as well as the fact that the prior year quarter benefited from gains on certain investments. Overall, we would view the underlying results as a quarter of progress as we continue to build and strengthen our client-serving capabilities. We would also highlight that in looking at progress year to date, organic revenue overall is a -1%, but reflects three quarters in a row of sequential organic revenue improvement, from -3% in Q1 to -1% in Q2 and now 0% in Q3. Adjusted operating margin is up 30 basis points year to date, and EPS on an adjusted basis is up 5% year to date.
These results demonstrate continued progress against our annual commitments to shareholders as we strengthen the firm for long-term growth and value creation. On the second topic, further areas of investment. We believe Aon is in a unique position. Solid operating performance, combined with solid expense discipline and a strong balance sheet, continues to enable substantial investment in colleagues and capabilities. As we have significant opportunity remaining to deliver cost savings under our restructuring programs, we'll continue to build on our leadership position and industry-leading capabilities. A few examples include, in brokerage, we're investing in innovative technology such as our Global Risk Insight Platform and FAConnect to ensure that clients have seamless access to the best of global Aon in every region around the globe. In fact, GRIP has now completed over 650,000 trades, highlighting the unique value of this platform.
We're also investing in additional capability with acquisitions such as Allied North America and FCC Global, strengthening our industry-leading construction capabilities. Finally, we're investing in client leadership to drive greater productivity and efficiency with the rollout of the revenue engine in EMEA and Asia Pacific, our Aon Broking platform to better match client needs with insurer appetite for risk, and Client Promise, which is driving greater retention rates and ensuring clients understand our value proposition in a fully transparent way. While we're just beginning to realize the benefits related to these investments, we believe we'll begin to see increasingly greater benefits as we move into 2011 and 2012. Turning to consulting. We led off the call, of course, with our most significant investment, which was the recently completed merger with Hewitt to form Aon Hewitt. We are extremely excited about the opportunity this combination brings to Aon.
Hewitt, with strengths in consulting, benefits outsourcing, and HR business process outsourcing, and Aon Consulting, with strengths in employee benefits, retirement, and global compensation, to name a few, form a global leader in HR solutions under the newly created brand of Aon Hewitt. Since we spoke last quarter, we continue to make great progress. First, we announced that the senior leadership team for Aon Hewitt is in place, led by Russ Fradin, who has announced his long-term commitment to the firm. Second, the integration activities are well underway as we focus on delivering the $355 million of synergy savings we outlined in the original announcement, and Christa will provide an update on this shortly. Most important, the feedback and support for Aon Hewitt continues to be exceptional across middle market, large corporate, and Fortune 100 clients.
In fact, Aon Hewitt has already secured a number of new business wins across multiple product lines as clients fully recognize the breadth and depth of Aon Hewitt's product and service capabilities. While we're here today to take questions regarding Aon's third quarter results, we thought it was important to update you on the progress since we closed on October 1. Christa will update you briefly on recent quarterly results of Hewitt. We look forward to providing you with greater details on the consolidated Aon Hewitt results in the fourth quarter. In summary, across brokerage and consulting, our fundamental client-serving capability continues to substantially strengthen around the globe. These investments, fully funded in the context of continued market improvement, position Aon very well to take advantage of an improving global economy.
Finally, on the third topic of growth, I want to spend the next few minutes discussing the quarter for both our brokerage and consulting segments. In brokerage, overall organic revenue for the segment declined 1%, a similar result to the prior quarter. In retail, organic revenue was unchanged on a percentage basis but continued to improve, reflecting the third quarter in a row of sequential improvement. Strong growth geographically in EMEA, Latin America, and the new products and services related to our GRIP platform was offset by the impact of pricing, which was down mid-single digits on average globally, and continued pressure from lower exposures and reduced discretionary spend. In reinsurance, excess capital and limited industry loss experience continue to drive soft pricing globally and higher cedent retentions .
Against these headwinds, which are primarily market related, we're driving a set of initiatives that continue to strengthen our underlying performance and give us confidence that our brokerage business is firmly positioned for long-term growth. With retention rates 90% or better on average, including U.S. retail, which posted its highest quarter ever at 93%, highlighting strong client satisfaction. Strong new business generation in our retail brokerage business across many markets, including Latin America, Central and Eastern Europe, Asia, Australia, Spain, and Portugal, highlighting just some of the strength of our global client-serving capability. Investments in new product and service capabilities with the rollout of GRIP, Aon Client Promise, FAConnect, and Impact On Demand across our brokerage platform. Turning to individual areas across brokerage. In the Americas, organic revenue increased 1% versus the prior year quarter.
We saw strong growth in Latin America and benefits related to the rollout of the GRIP platform, partially offset by a modest decline in U.S. retail. U.S. retail continued to improve its record level of retention, reflecting strong client satisfaction. However, the renewal book continues to be pressured from soft pricing, while new business continues to be pressured by construction-related weaknesses in the activity in the pipeline, which has been pushed out. Overall, underlying trends highlight the work put in place over the last year to drive improved performance through pipeline management and productivity improvements. Turning to Europe, Middle East, and Africa, organic revenue increased 4%. We saw strong growth in emerging markets driven by new business in areas such as Central and Eastern Europe, Middle East, and Africa. We saw modest growth across continental Europe, driven by 90-plus % retention rates and leadership positions across most markets.
In addition, a number of areas that have been particularly hard hit by the economic recession, such as Germany and France, posted improved results. As we noted the last few quarters, fragile economic conditions will continue to make results across the entire region uneven on a quarterly basis, but we expect continued modest growth going forward. Turning to the U.K., organic revenue declined 8%. Our U.K. business consists of both domestic retail and the wholesale network, and results for the third quarter were impacted by three factors. Approximately 200 basis points of the decline was driven by a one-time payment in the prior year quarter for a completed program in our affinity business. Approximately half of the decline, 400 basis points, was driven by soft pricing, continued weak economic conditions, and lower retention rates in areas such as construction, energy, and space in our wholesale business.
Lastly, the remaining 200 basis points was driven by business that was placed into the wholesale network in the prior year quarter, but in this year's quarter, was placed in the various geographies around our retail network. With the rollout of GRIP and our Aon Broking strategy, our wholesale strategy for premium placement becomes basically geographically ambivalent. As we focus on matching client needs with insurer appetite for risk, U.K.'s wholesale revenue will increasingly be recognized in various geographies across our retail network. In summary, the U.K. region was pressured by soft pricing, weak economic conditions, and the impact of a prior year item. However, excluding this prior year item, the underlying trends in our U.K. retail business continued to improve as new business was up double digits, and we would expect meaningful improvement from this quarter's performance going forward. Turning to Asia Pacific, organic revenue was +2%.
We saw strong growth in New Zealand as well as strong double-digit growth in China. Results were partially offset by continued economic weakness and political instability in Thailand and Singapore. Turning to reinsurance, organic revenue was down 4%. Excess capital and low industry loss experience continue to drive soft pricing globally and higher cedent retention. If we break down the organic performance for the quarter, market impact continued to be the primary driver, resulting in approximately 300 basis point decline. In addition, a modest decline in facultative transactions and leakage resulted in the remaining 50 basis points of the decline. Going forward, we'd expect to see continued pressure on the reinsurance book at a similar rate for the foreseeable future, driven by weak market conditions, partially offset by growth in facultative and capital markets transactions, which tend to be uneven quarter to quarter.
Turning to our consulting segment, organic revenue increased 4%, a solid improvement from the prior quarter and the second quarter in a row of positive organic revenue. We delivered strong growth from new client wins in our outsourcing business, particularly with one contract in the federal sector related to benefits outsourcing. In addition, strong participation for certain global comp surveys in our compensation consulting business and growth in our international health and benefits business drove improved results. As economic conditions stabilize around the globe, we'd expect to see continued modest growth driven by an encouraging pipeline in compensation consulting, an increase in discretionary related work and new services such as dependent eligibility audits.
Stepping back and in summary of our third quarter and year-to-date results, we're delivering solid progress against our core commitments to shareholders, while we continue to face headwinds from a challenging macro environment, we're driving a set of initiatives that are delivering strong core operational improvement and positioning Aon with greater client-serving capability to generate long-term growth. Finally, with the closing of Aon Hewitt, Aon now stands today with two truly distinctive platforms in risk and people. With Aon Risk Solutions and Aon Benfield in risk and Aon Hewitt in HR solutions. I'm now pleased to turn the call over to Christa for further financial review. Christa?
Thank you very much, Greg, and good morning, everyone. As Greg noted, our third quarter results reflect continued progress to strengthen our industry-leading position and client-serving capabilities across risk and people. The rate of organic revenue growth improved both in our retail brokerage business and our consulting segments. Expense discipline drove operating margin expansion, and we completed the merger of Hewitt with Aon Consulting significantly earlier than originally anticipated. Now let me turn to the results of the third quarter. Our core EPS performance is reflected in an adjusted EPS of $0.61 per share for the third quarter, down 6% compared to $0.65 in the prior year quarter due to three primary year-over-year variances outside of the operating segments. First, in the third quarter, we recorded an $8 million or $0.03 per share non-tax-deductible loss on the sale of a business and other expense.
Second, the prior year quarter included $16 million or $0.04 per share of gains related to certain investments. Lastly, the effective tax rate on continuing operations in the third quarter increased to 29.4% due to certain deferred tax adjustments, while the prior year quarter of 26.7% benefited from certain discrete items. Also included in the results, foreign currency translation had a favorable impact of approximately $0.02 per share on adjusted EPS results. As we look at translation impacts for the fourth quarter, we would anticipate a relatively neutral impact on EPS subject to movements in foreign currency. Now let me talk about each of the segments. In our brokerage segment, against an organic revenue decline of 1%, we delivered an adjusted operating margin of 17.9%, down a modest 10 basis points from the prior year quarter in our seasonally weakest quarter, which is the third quarter.
Our performance for the quarter continues to demonstrate strong operational discipline, positioning the segment for greater operating leverage as economic conditions begin to improve around the globe. Adjusted brokerage operating income decreased 1% or $2 million to $266 million. The year-over-year margin performance was impacted by a 60 basis point decline related to the decrease in organic revenue. A 50 basis point decline related to the launch of our Manchester United sponsorship and a 30 basis point decline related to recent construction acquisitions, offset by significant savings related to our restructuring programs and operational improvements. Let me spend a moment on each of the restructuring programs, key initiatives that are enabling concurrent funding of investments and delivering further long-term margin expansion. With respect to the 2007 restructuring program, we achieved approximately $125 million of savings in the third quarter, primarily in the brokerage segment through workforce reduction.
This compares to $113 million in the second quarter and $68 million in the prior year quarter. We incurred $3 million of charges in the quarter and have now completed 100% of the charges necessary to deliver the remaining savings. With respect to the Aon Benfield restructuring program, we achieved approximately $27 million of savings in the third quarter, primarily through workforce reduction. This compares to $24 million in the second quarter and $14 million in the prior year quarter. We incurred $5 million of charges in the quarter and have now completed 84% of the $155 million of total costs necessary to deliver the remaining savings. Overall, we continue to be ahead of the original schedule on our restructuring programs.
We have completed 97% of the charges as of the end of the third quarter, yet we still have approximately $102 million of incremental brokerage savings still to achieve under these two programs between now and the end of 2011. I would note in the first nine months of 2010, against a decline in organic revenue of 2% in brokerage, operating margins have expanded 70 basis points to 19.9%, placing us firmly on track to continued progress towards our long-term brokerage margin target of 25%. There are five key initiatives that will drive growth in brokerage margin to 25%. Number one, restructuring savings and other operational improvement initiatives. Number two, the continued rollout of the revenue engine. Number three, Aon Broking. All three of these are within our control. In addition, there are two initiatives that will improve margins based on the external market improving.
Number four, improvements in the economy, specifically short-term interest rates and GDP growth. Number five, improvements in insurance pricing. We are on track to delivering our long-term margin target of 25% for brokerage. Turning to the consulting segment. Organic revenue increased 4%, and we delivered an adjusted operating margin of 17.1%, a 150 basis point increase from the prior year quarter. Adjusted consulting operating income increased 15% or $7 million to $55 million. The increase was driven primarily by an improvement in organic revenue to 4% in the quarter and savings related to the 2007 restructuring program. I would note in the first nine months of 2010, with 1% organic revenue growth, our industry-leading operating margins have expanded 70 basis points to 16.5%. While the fourth quarter is typically our seasonally strongest quarter for Aon Consulting, we would note that the prior year fourth quarter was a particularly strong quarter.
In addition, Aon Consulting results will now be consolidated with Hewitt and reported as Aon Hewitt. Included in the back of the press release we issued today are quarterly results for Hewitt's fiscal fourth quarter. While we are not here today to discuss Hewitt's quarterly results, I thought I would give you a brief overview. Hewitt posted organic revenue growth of 3%, primarily driven by strong organic revenue growth in consulting of 10%, partially offset by flat growth in outsourcing of 0%. Consulting organic revenue growth of 10% was driven by strength in all businesses, including investment consulting and pension advisory work and retirement, healthcare reform related advisory in our healthcare business, and a modest improvement for discretionary project spend in communications. Outsourcing organic revenue was unchanged, driven by modest growth from new clients in HRBPO, offset by expected price compression and a decline in project-related revenue and benefits administration.
Operating income increased 4% to $110 million, and operating margin increased 10 basis points to 14.1%. Operating margin increased modestly, driven by strong organic revenue growth in consulting and an improvement in HRBPO, primarily offset by higher incentive-based compensation overall, as well as expected price compression and a decline in project-related work and benefits administration. To the consulting segment, I wanted to briefly comment on the Aon Hewitt restructuring program we formally announced subsequent to the close of the quarter. The Aon Hewitt restructuring program is expected to result in cumulative costs of approximately $325 million through the end of the plan, primarily encompassing $180 million in workforce reduction and $145 million in real estate rationalization costs. Cash costs are expected to be approximately $275 million.
We expect to deliver total annual savings of $355 million in 2013, including approximately $280 million of annual savings related to the restructuring plan and additional savings in areas such as information technology, procurement, and public company costs. These restructuring savings, in addition to declining intangible amortization expense and improvement in the HRBPO business, are expected to deliver an operating margin of 20% for Aon Hewitt over the long term. Let me discuss certain line items within our unallocated income and expenses. Unallocated revenue declined $9 million, as the prior year quarter reflected revenue related to the company's ownership in certain insurance investment funds. Interest expense increased $4 million due to the early placement of $1.5 billion of unsecured notes related to the Hewitt merger.
Other expense in the quarter included an $8 million non-tax deductible loss on the sale of a business, while other income of $13 million in the prior year quarter included gains from investments and the sales of certain businesses. These year-over-year variances, driven primarily by miscellaneous gains and losses outside of the operating segment, had an unfavorable impact on EPS of approximately $0.07 year-over-year. Going forward, we would expect a more normalized run rate of approximately $5 million per quarter of interest income, $35 million of unallocated expense, and $60 million of interest expense per quarter, including the incremental interest expense on debt related to the Hewitt merger. Turning to taxes. The effective tax rate on continuing operations increased to 29.4%, compared to 26.7% in the prior year quarter, due to certain deferred tax adjustments.
Based on the consolidation of Hewitt results in the fourth quarter, we would anticipate an underlying tax rate on continuing operations of 30% going forward. Turning to shares. Average diluted shares outstanding decreased $9.9 million to 282.3 million for the third quarter due to the company's share repurchase program. Actual shares outstanding on September 30 were 270.9 million, compared to 269.7 million at June 30. Subsequent to the close of the quarter, as a result of the merger with Hewitt, there are an additional 64 million diluted shares outstanding. The company has approximately $165 million of remaining authorization under the 2005 share repurchase program and $2 billion under the 2010 share repurchase program. While we do not provide guidance on future share repurchase, we would be free of restrictions to continue with share repurchases following the end of our regular blackout period for quarterly earnings.
Now let me turn to the balance sheet and cash flow statement to discuss our financial flexibility. Cash and short-term investments, excluding funds held in escrow at 9/30 for the Hewitt merger, were approximately $950 million. Total debt outstanding as of September 30 was $2.3 billion, excluding Hewitt debt, and debt to capital was 28.1%, up modestly from 26.6% in the prior quarter. Turning to cash flow from operations, we exclude the impact of change in funds held on behalf of clients because it has no impact on cash. Cash flow from operations for the first nine months of 2010 was $307 million, a significant increase compared to cash flow from operations of $135 million in the prior year first nine months. In summary, Q3 showed organic revenue improvement in both our retail brokerage business and consulting segments, despite economic weakness and continued soft market conditions.
Against these headwinds, we executed against our restructuring plans that have substantial savings yet to deliver. We continue to invest in long-term growth opportunities, and we are well underway with the integration of Hewitt. Our balance sheet and strong cash flow continue to provide excellent liquidity and significant financial flexibility as we drive value creation through improved business results and effective capital management. With that, I'll turn the call back over to the operator, and we'd be delighted to take your questions.
Thank you. If a party would like to ask a question, please depress the star key and then the number 1 on your touch-tone phone. Before asking your question, please state your full name and company name. If you wish to withdraw your question, depress the star key followed by the 2 key. If you need operator assistance, depress the star key and then the number 0. Our first question. Give one moment. Our first question is from Keith Walsh. Please state your company name.
Good morning, everyone. Keith Walsh at Citi. Two quick questions for Christa and then one for Greg. I guess first, Christa, when you guys announced the Hewitt deal in July, you did give implied guidance, I guess. The first call was 355 at the time. You said 1.2% accretion. That gets me to close to 360. The first call right now for 2011 is about 348. How should we be thinking about that?
Keith, at the time of the transaction, we did give guidance that in terms of the transaction, that the transaction itself would provide an accretion on an adjusted basis of 1.2%. We did say that consensus estimates at that point were 357. We won't be updating that estimate on an ongoing basis. However, we are committed to our accretion dilution numbers, but won't get into specific EPS numbers. As you know, we don't give official guidance. We are focused, however, on our growth pattern in 2011 and very committed to growing on all three of our metrics and commitments to shareholders, organic growth, margin expansion, and EPS growth.
The thing I would point out, as Greg mentioned in his opening remarks, year-to-date in the first nine months of 2010, despite organic revenue growth being down, operating margins have expanded 30 basis points, and EPS is up 5%.
Okay, the second question just on cash. I just want to make sure I heard the numbers right. You said did Hewitt have $950 million on the balance sheet? Is that what you said? I'm assuming if that number is correct, that's readily available for you to use in share purchase or whatever you see fit. Is that accurate?
No, what I said was if you look at cash and short-term investments on our balance sheet.
Yep
at the end of the third quarter, excluding funds held in escrow for the Hewitt merger, that equals $950 million. You need to basically take out of the $2.1 billion the funds held in escrow to get to the $950 million, which is cash and short-term investments according to Aon, which does not include anything on the Hewitt balance sheet. The Hewitt debt, you should assume, was paid off with Hewitt cash.
Okay. You have liquid for $950 million in cash post the deal. Am I understanding that right?
Yes, that's right. What I would say is as you think about that and uses of capital going forward, at the end of Q3, we had approximately $200 million in borrowing on the Euro facility. You should think that we would pay that off during the fourth quarter. That leaves us with about, let's call it $750 million. That's roughly split 50/50 between the U.S. and international. If you think about the U.S. cash, sort of $375 million, because I think your question is leading to share buyback, Keith. Of the $375 million in the U.S., you should assume a portion of that is required for minimum operating capital, and the rest of that is available for corporate use.
I would observe in Q4, we are going to have significant cash related to the ramp-up of the restructuring program for Aon Hewitt, as well as the continued restructuring plans for Aon Benfield. Q1, as you know, Keith, is our seasonally weakest quarter in terms of cash flow.
Okay, that's really helpful. Thanks. Just for Greg, more of a philosophical question, but there's no question Aon is a better company than since you joined in May of 2005. We're five years now into adjusted earnings, and with another couple to go. I guess the question would be, why should investors give you credit for non-cash earnings? And why should you be getting compensated on that? Thanks.
Keith, as you take a step back, first, to point out, I was fortunate to come to a firm that had incredible global capability around the world and came with high expectations from my standpoint. In fact, they were exceeded as I sort of understood the capabilities of global Aon. I'd reflect back and say, as you think about what we've done over the last five years and how we've collectively progressed, you stand today with a firm, Aon Risk Solutions, Aon Benfield, and Aon Hewitt, three, literally right now, the most pristine platforms in the world in terms of what we do. Against that the team has done great work of pulling that group together, getting a position for growth not only on the EPS front, on the margin front, but also on the top line.
As you think about that progression, and you look at that progression, there's been basically a plan in place that we just keep marching forward on. In fact, quarter to quarter to quarter, we continue to march forward, some higher, some lower, some above expectations, some below expectations. Frankly, as you look at what's happened, we've improved across each one of those metrics, and we continue to do that. Even now, as you look at where we stand, and reflect over in 2010, from the revenue standpoint, we continue to improve with a focus on growth in 2011. Just look at the last three quarters, negative 3% in Q1, negative 1% in Q2, and zero in Q3. Retail brokerage, negative three in Q1, negative one in Q2, and zero in Q3. Consulting started at negative one, is now at plus four.
The investments we're putting in place, Keith Walsh, to build long-term value in the firm are really paying off. I take particular note in terms of if you look at the retention levels as I described, that really underscores the power of what we've got in our firm. Literally 93% retention in the U.S., in the current environment, the highest we've ever been. It's actually quite exceptional, and a credit to my colleagues around the world. We continue to make significant investments in the context of what we're doing. As I said before, whether it's GRIP or FAConnect or a whole range of investments, we've not stood back and essentially said we want to drive short-term financial performance. In fact, what we've done is said we want to build the strongest possible global firm we can.
Credit to my colleagues around the world, I think, in fact, we've done that and positioned ourselves very well for growth. Your point on cash versus adjusted earnings, we think you're exactly right. In fact, we are incredibly anxious to get to a place where adjusted equals reported. That's the place we're pushing toward. We're going to be extremely transparent so you can gauge exactly how we're doing quarter by quarter on that progress. We are absolutely focused on a firm that is a vibrant growing firm, earning a 25% margin on the brokerage front and a 20% margin on the consulting front, and we are absolutely on track to do that.
The last thing I would add, Keith Walsh, is clearly the restructuring in the brokerage segment is essentially done. We're 97% done with the charge. We would have been completed with all the restructuring, absent the acquisition, and merger with Hewitt, which we're very excited about.
Okay, thanks.
Thank you. Our next question comes from Brian Meredith. Please state your company.
Yeah, UBS. Morning.
Good morning.
A couple things here. First one, on the expense saves plan for the Hewitt acquisition, given that you've closed call it a quarter early, should we expect that may get pulled up a little bit quicker than expected?
What I would say is we've really announced sort of annual numbers. We haven't ever given kind of quarterly guidance. You should expect that, given we've announced the plans, that we're going to move forward on them as quickly as humanly possible to deliver the right results for shareholders and to focus on growing the business, which we are absolutely focused on doing.
Okay, we shouldn't expect any changes in when you expect expense saves to come through on an annual basis?
No.
Okay. Next quick one, pension. Could you tell us what your pension contributions have been to date and how much we should expect in the fourth quarter?
Yeah. Pension contributions as we sort of forecast for the year were $283 million.
Of those, we've completed approximately $222 million year to date.
Okay. Any thoughts on what pension expense might look at like going into next year?
Yeah, it's a very tricky question to answer.
Sure
It relies on so many variables, and there's obviously an annual process we go through where we do a formal measurement process. The thing I would observe is if you think about sort of three major variables that drive it, which are sort of asset returns, discount rates, and then sort of mortality. If you think about those things, asset returns are up slightly. Discount rate is down. Right now, I think discount rate is slightly a bigger impact than asset returns at this point. Pension expense overall for next year, we think is not going to be a material change.
Okay, great. Last question for Greg. Can we just chat a little bit more about the reinsurance business? I know you said the decline is largely due to pricing. If we look at your competition out there, they're continuing to put up some decent organic revenue growth. Is there any market share loss here as well?
From our standpoint, Brian, as we've reflected, to step back again, the negative 4% was a function, 3% really was around the market impact.
Right.
I said a modest decline, and really it was like 3.5%, but the way we report is we always round. We reported 4%, about 50 basis points was a little on facultative and a little on leakage. What I would describe is, from our standpoint, we really don't see market share loss here at all. We saw from a leakage standpoint, this is well within, in fact, much, much lower than our planned leakage when we actually took a step back and thought about the overall deal. What I would say, when you think about Benfield and Aon Benfield, look, we are just extremely pleased with the progress of Aon Benfield. The team has exceeded all expectations. Obviously, by the way, we wish we had better market conditions. The specific milestones we put in place, every single milestone, this team has actually hit and exceeded.
Again, even from a leakage standpoint, well exceeded what we thought we were going to be. Think about the three areas we talked about with Aon Benfield. On the restructuring side, we're ahead of our original targets. We set $122 million in 2011. We're ahead of that. We still have substantial opportunity for savings, as we've achieved roughly, I think, 70%-75% of that overall. On the retention of key colleagues, we highlighted 150 leaders. We've retained 95% of those. Remember we said there was going to be roughly 700 positions transitioning, so that created a lot of market noise, but we feel incredibly good about where we are with our colleagues. Most important on the client side, we tracked that very, very carefully. More than 95% of the combined global client base, we've retained.
The top 30, we've retained everybody as you'd expect, but we actually looked at it on an individual treaty basis. In fact, our number of treaties in the top 30 has increased. From our standpoint, we always looked at Aon Benfield as that platform. It's going to take 2 years as it comes together to stabilize the platform to build it for growth. The team's just done a phenomenal job in pulling that together. We feel great about where we are with Aon Benfield. It literally is the single most significant platform in the world in doing what we do with incredible analytic capability. It's 50% bigger than the next biggest competitor with incredible capability. Net-net, we feel very, very good about it.
Great. Is there any way to quantify the group benefits in the quarter?
What we said on the Global Risk Insight Platform is, as we pulled that together, that we're really focused on 2011 and 2012. We highlight that we've made some progress in 2010. We want to make sure you understand and all of our investors understand that this is coming in the past exactly as we hoped it would. We see it scaling up more in 2011 and 2012. We are not going to break it out, but there was impact in 2010, and we really see it, though, coming in 2011, 2012.
Great. Thank you.
Our next question comes from Dan Farrell. Your line is open. Please state your company name.
Good morning. It's Sterne Agee. Can you talk a little bit about the 50 basis point headwind from the Manchester United expenses and the 30 basis points from the other construction acquisitions and how we think about those on a go-forward basis? Also, can you talk about how you think about the return on the Manchester United investment and how you track that internally, and do you actually see visibility on business and revenues from that?
Yeah. Why don't I start with Manchester United overall, and Christa can follow up just the back re-breakdown of exactly the impacts on the margin for the quarter. We, again, want to make sure you all understand as we track forward, against our aspiration of improving margin as we proceed through the course of the year, that we're very much on track to doing that. On Manchester United, you take a step back, we had been looking for multiple ways, really over the last three or four years, to reinforce connectivity across our global firm and to build brand awareness. Candidly, didn't really think there was anything out there that could do that very well. Nothing really came close to meeting our expectations or seemed to be something that would be sustainable until we saw and uncovered Manchester United.
The partnership we announced with Manchester United, we believe, is a once in a lifetime opportunity to create connectivity around global Aon, but also to build brand recognition. If you think about it, this is the number one sport in the world, the number one club in the number one sport in the world. For us, the power of this is not the U.S. If you think about Manchester United, there's 90% brand recall in China, 100% in Korea, 90% in India, 90% Latin America, 90% across Europe. This is a phenomenal platform that's actually quite unique. 330 million discrete fans. This is basically, sort of put your U.S. hat on, this is a team that actually sells, if you think about number of jerseys, sells three times the number of jerseys of the entire National Football League combined.
The Super Bowl that is played at the end of the year is very interesting. Manchester United for us is roughly a Super Bowl a week. It is actually a quite stunning platform that we were able to hook up with at a very, very unique time. This is both Manchester United and Nike, as you think about that overall platform. For us, though, as you would expect, as we typically do, we look at things very quantitatively. For us, we absolutely see a payback on this. You are not going to see reported Manchester United impacts on the margin on an ongoing basis. We felt like we wanted to show it to you as we literally just launched it, and it did have an impact up front. Over time, we see this as fully paying for itself with a real return. Specifically three or four areas.
First, in terms of overall marketing spend. As you might expect, 120 countries around the world, we spend a lot in marketing on a local basis. We are going to redirect and already have begun to redirect a significant amount of that marketing spend into the payback on Manchester United. I emphasize a lot of marketing spend we are going to be able to redirect into that, into the local efforts. One of the things about Manchester United, it is this single platform that virtually everyone in the world could rally around. Whether it is in Asia or it is in Latin America or it is in Europe, everyone rallied around the excitement of, I will give up what I do locally so I can actually together invest in Manchester United. A huge amount of redirected marketing spend. Second, affinity. We have got a $700 million affinity business, as you are aware.
We have full access to a 12 million person database in Manchester United that we are going to be able to market into. We see significant economic return there as well. In addition, we are tracking literally every single client lead that comes up around the world and have already booked and banked over six million before we even started. We believe there is a significant set of opportunities from a client development standpoint that could be very good. In essence, we see this as a zero-cost option to connect the firm and build brand value as we have looked at it. Christa, do you want to talk about the rest of some of the other pieces on the margin piece?
Yes. The other thing I think you asked about was the impact on the construction acquisitions. As you know, we did two significant acquisitions in Q4 2009 in the construction sector, being Allied and FCC. We absolutely believe in the long-term value of those investments, see significant value creation. However, during the course of 2010, the construction sector is down, and they are having an impact on margins. I hope that clarifies that.
Okay. Thank you very much.
Thank you. Our next question comes from Adam Klauber, Macquarie
Good morning, Macquarie.
Morning.
Two questions. Assuming in brokerage, the organic stays pretty close to the same, maybe flat, a little negative, should we see margin expansion in the near term?
Yeah. The thing I would point to is that in the first nine months of 2010, brokerage organic has been down 2% and margin's been up 70 basis points. You can absolutely see that we can expand margin in a negative organic revenue environment. Yes.
I would add, Adam, as you think about progression into 2011, just look at the trends in the first three quarters, what we've done on brokerage. We anticipate with the investments we've made, the trends over the last three quarters in organic growth in 2011.
Great. Second question, consulting numbers, growth numbers were definitely positive. What's changed in the last three, six months, and I guess how confident are you going forward in the near term we'll see continued good organic in consulting, both in your business?
We do see, as you've observed, positive organic trends in both Q2 and Q3. We expect those trends to continue in Q4 and 2011. I would put them at the low single-digit levels. Really, it's been across the board. It's been all practice areas and all geographies. As confidence comes back and people are reacting to either healthcare reform and planning their healthcare efforts or engaging in pensions and figuring out their pension plans and managing risk and decreasing costs there, or investing in talent to grow their business.
Great. Thank you very much.
Our next question comes from Cliff Gallant. Your line is open. Please state your company.
Yes, this is Cliff Gallant, KBW. Just a quick numbers question. The margin in third quarter of 2009, the brokerage margin, I know when you initially reported it was an 18.4%. Today, you said it's an 18.1%. I'm sorry if I missed it, but what was the cause of the restatement? Probably more pertinently, last year in the fourth quarter, you reported a 21.4% for brokerage. Is that the right base from which I should be making my assumptions for the next fourth quarter?
The difference was it was a PTI margin. We're now reporting an operating income margin. Q4 2009 basically had fiduciary investment income in the brokerage segment. It now is excluded from that segment going forward as we converted from a PTI margin to an operating income margin, which is much more consistent.
Okay. What is the fourth quarter margin of 2009?
What's reported in the press release.
Oh, okay. All right. That was one of the switch outs. Okay.
Absolutely.
Okay. Thank you.
Jay Gelb, your line is open. Please state your company.
Barclays Capital. I want to circle back to Hewitt. Greg or Christa, can you talk about what type of customer retention and pricing as well as competitive trends you're seeing in the business now that it's closed?
Yeah. Jay, we have actually, not just in the close, in the process from July 12th when we announced, it's actually up through the close October 1st. We just had an incredibly positive reaction both from colleagues around the world and from clients. It's actually been very positive on the specific transaction. From our standpoint, if you step back and look at Aon Hewitt, as we said before, the economics of this are incredibly compelling as we talked about, whether it's the value creation, the cash flow generating capability, the investment grade we are able to maintain, the target margin of 20%. It really is the strategic rationale on top of that that's got us so excited. It really, from our standpoint, the industry looks like it's ticking up a bit. We're seeing some things change. We're seeing a little more certainty on the healthcare front.
The certainty, by the way, creates anxiety because there's certain things that are going to change. Therefore, how do we actually adjust as a company? We're seeing some opportunity there. With our position now as the leader in HR solutions and the global brand with Hewitt, we're seeing lots of opportunity. On top of that, we're seeing chances. Something we didn't build into the economics of the model at all as we talked about Aon Hewitt was the cross-sell opportunity across the business. We're actually seeing great opportunities there as we've got the ARS, Aon Risk Solutions client base really understanding the capability of Aon Hewitt and vice versa. We're seeing lots of opportunity there that, again, we didn't put into the economics of this transaction at all. In the end, the thing that I personally have been most excited to see was really the execution.
We clearly, from an Aon Benfield standpoint, know the importance of execution. The fundamentals that drove the decision are obviously important, but really what drives the value is the execution. We've really got great alignment around our team. As Christa described, we closed this in 80 days. By the way, that is great alignment. With Russ Fradin and the team, we're literally in lockstep across the board in every way. Worked exceptionally well. The commitment of Russ and his team and our team, it's already led to a great reaction from colleagues. By the way, that's in the context of restructuring. Everyone knows we've got to, too. Russ and I have probably talked to the better part of 15,000, 20,000 Aon Hewitt colleagues around the world. The reaction's been great and very positive.
Most important to your question, interactions since we've closed, probably between Russ and I, between 50-60 clients directly, and literally talked to every client in some way, shape, or form around the world. I was at a proposal with a large legacy Hewitt client last week with Russ, and it was great to see the reaction and what they wanted to understand across our risk platform. Was also in a large Aon Risk Solutions client, the reaction was very positive in terms of understanding what we can now do and the capability across Aon Hewitt. From our standpoint, Jay, we've got a long way to go, a lot of work to do. Don't take anything for granted, we love the platform with Aon Risk Solutions, Aon Benfield, and Aon Hewitt right now.
To what extent does dislocation get created with existing competitors looking to perhaps shake some things loose?
Well-
Is there any pressure to hold on to existing business?
Yeah. Sorry, I want to make sure I understand your question. In terms of other competitors in the space, or just-
Yes
generally the competitive nature of what's going on?
Right, in the space.
Yeah. Look, from our standpoint, there's already was lots of turmoil out there. In fact, the Towers Watson combination created lots of turmoil in the marketplace. We actually haven't seen pressure we thought we would see early on, we haven't seen yet. In fact, what we've done is we were very proactive as we thought about how we're going to attack the overall marketplace. Really, if you think about it, there's just very limited overlap when you think about overall client bases. Hewitt with an incredibly strong position in large corporate, our position in middle market. Hewitt more U.S.-based, we're more global. We can take the Hewitt brand global, great opportunity. We can take Hewitt to the middle market, great opportunity. We can leverage our large corporate position, great opportunity.
If I look at the consulting space grew 10% in the middle market in the context of all that just happened, it's really been, for us, again, early days. We don't want to overplay anything. If you think about what's happened, typically, firms kind of freeze up in the context of a merger. In our case, Hewitt delivered 10% organic growth in the quarter, is actually quite exceptional. Look, again, early days, but we feel very good about the commitments we made and what we're going to be able to achieve with Aon Hewitt.
Thank you.
I just wanted to clarify Cliff's question. If you look at the Q4 2009 press release, Cliff, you'll have seen all the restatements related to moving fiduciary cash out of the segment. In Q1 2010, you'll see we began focusing on operating income as opposed to pre-tax. The Q4 2009 number you should use is 21.3% margin for brokerage, and we're happy to help you work through your model.
Next question is from Mel Hammerman. You may state your company. Your line's open.
Hi, Mel Hammerman, JP Morgan. Couple questions. First, with respect to the strong revenue growth in outsourcing this quarter, I guess, could you just give a little color on what type of outsourcing contract that is? Also whether or not that was a disproportionate contributor to the margin gain in the quarter?
Yeah. The outsourcing growth of 19% was due to new federal government work, as Greg described, which was project related. It won't necessarily be sustained at this level. It was also new business wins across the board in the U.K. and Canada. In terms of contributing to margin expansion, revenue grew organically, both in consulting and outsourcing, overall organic revenue growth contributed to margins, as I described. In addition, restructuring savings from the 2007 program flowing through contributes to margin expansion.
When we look at, absolute expenses were up. Was that absolute increase the function of the new government program rather than drift in some of the other? That's kind of what I'm trying to isolate.
Yeah. Look, there are sort of quite a few lumpy things going in. What I would say is outsourcing growth of 19% is not the right sustainable rate going forward because there are some project-related items in there. Low single digits is probably the right long-term growth rate as I described.
Okay. Just building on your comments, Greg, on Hewitt. A lot of the things you talked around healthcare and the like, I'm assuming that's demand that's helping the traditional HR consulting portion of Hewitt, correct?
It is. I would say early days as that's just now starting to firm up. If you think about sort of the opportunity across the board on healthcare, first there was a lot of anxiety because there was a lot of uncertainty what was going to happen. There's a bit more clarity, I want to emphasize, if you think about it, the healthcare reform is really very much I can describe maybe as a journey, not an event. This legislation spans 2010-2018. It affects multiple segments in different ways. It's going to be administered by a number of agencies, Health and Human Services, Department of Labor, IRS.
There's just a tremendous amount of complexity that's sort of on the horizon for our clients, and they're going to need professional advice and the best capability in the world to try to navigate through those choppy waters. That's the opportunity we see, and it's going to be much more on the consulting side. Although I would say, it permeates everything that's going to happen across Aon Hewitt.
Okay. On the outsourcing side of Hewitt, just following up with your comments as well. Traditionally, that's a business where the revenue trends tend to lag the employment trends a bit. I guess when we think about employment, we're clearly off the bottom. We're not at a point yet where it would be reasonable to expect outside of new business wins, dramatic acceleration in the revenue base, correct?
I think that's absolutely correct. I would note that these are sort of five to seven year contracts. So as you think about the growth in revenue, you can really see it quite a long way out. We would think that the growth in outsourcing going forward is sort of flat to slightly positive.
Okay.
An overall perspective, when you think about Aon Hewitt, if you think about Aon Hewitt overall, and all the things that go into it, as Christa described, it's kind of low single-digit organic growth, we absolutely see growth in the business in 2011.
Okay. Just following up on the outsourcing piece, I guess, I'm thinking of, I know this is going to be different the way that you report it relative to the way that Hewitt used to report it. If we look at what used to be the benefits outsourcing business for them as well, how much of the revenue base actually is up for renewal this year? If we just kind of wanted to think about that piece.
We're not really going to sort of go into detail on Hewitt's earnings because we obviously closed the transaction on the 1st of October. We'd be delighted to go into detail on that at the end of our Q4 results.
Okay.
What we have said is that they're on average five-year contracts, and so you can think about 20% renewing in any one period.
Okay. There's no lumpiness. Given people are concerned about integration risk and things like that, I just wanted to make sure there was no disproportionate.
We have seen a reaction.
Okay
from clients being across the board, extremely positive, surprisingly so.
Yeah. I would, again, the conversation I sat in with Russ, in fact, last week, with a large benefit admin client, the message is really clear to this client, which is, listen, October 1st, we closed. The following Monday, our capability to invest back in the business went up. Our capability to serve you, this happened to be a very global client with a global supply network. Our ability to service that network just went up. The capability to bring people to bear on behalf of your issues just went up. They looked at it and went, "Wow, this is great." More capital to invest back into the business to build capability, a stronger global network, and a real commitment across overall Aon to make sure this works. Their reaction, and as Christa said, the reaction of other clients has been surprisingly positive.
Okay, one last one just on the BPO business, which hasn't been a good margin business for them due to some of the historical pricing turned out to be maybe a little inadequate. I guess, how should we think about the contract roll-off on that old stuff on a go-forward basis in terms of thinking about the timeframe for margins in that business getting up to a more reasonable level?
I think what we have said is that HRBPO was one of the contributors to margin expansion in this quarter. When I describe Hewitt's results. Going forward, we are going to report two business lines within the Aon Hewitt segment, consulting and outsourcing, and we'd be delighted to go into more detail on that in the fourth quarter this quarter.
Okay. I will follow up again. Thanks.
At this time, our final question comes from Nicole Nicholas . Please state your company.
Sorry. Thanks. Nicole Nicholas. Christa, I want to start with one question directed towards you. When you were talking about the long-term 25% brokerage margin, one of the issues you mentioned is that we'll eventually be in a better rate environment. I think that's true, but it's probably not going to be a steady state. I think the industry has disproven all of the assumptions that it's smarter and more disciplined fundamentally than it has been in the past. Is the 25% margin something that we should think about as only achievable when we're in a positive or peak pricing environment?
Yeah. Great question, Meyer. The thing I would say is the first three factors are restructuring operational savings being number one, Aon Broking being number two, and the continued rollout of the revenue engine being number three. All of these three are within our control, and we can get to a 25% brokerage margin just through the factors inside our control. We do not need the pricing environment to turn around for us to grow organically. In fact, we grew in four of the last five years organically in a negative pricing environment, and brokerage margin for us increased 500 basis points over the last five years in a soft market environment. We do not need the insurance pricing market environment to turn around to meet our 25% long-term brokerage margin target.
Okay. That's very helpful to clarify that. With regards to construction and the acquisitions that you've made, I guess I'm far from an expert in that, but there are a lot of gloom and doom type folks out there saying that the residential construction markets are going to be sort of dead in the water for the next few years. How should we think about that with regards to the recent acquisitions and their impact on margins?
Well, first, as Christa said, is overall, the impact of the acquisitions over the course of the last year on the construction side on obviously organic revenue and margin have been negative. Take a step back from that, Nicole. For us, we've got what we believe to be the strongest construction business in the world. Globally, this is in excess of $400 million, and we've made significant investments in it. We love the team we've got. They've got tremendous capability all around the world. When we talked about the acquisition of Allied and of FCC, we said, look, these are long-term investments for us to build capability and content on behalf of our business. In fact, they've done just that. If you look at what's going to happen in the next 12-24 months, it's hard to predict exactly what's going to happen.
I would say in the context of what Christa and I have described this morning, we've essentially been able to overcome that, and we continue to make progress in overcoming that. We've essentially said that in 2011, when you look at Aon overall on the brokerage side, we intend to grow in 2011, just as we do in Aon Hewitt. We're assuming that the construction world is going to continue to be very difficult over that period of time. We're going to overcome that. I would say as that market begins to shift. The power we've got in the construction arena is unmatched, and it's a $7.5 trillion market right now. You can take whatever growth rate you want to put on that. We've seen between 50%-70% over the next decade.
If that $7.5 trillion market goes to a $10, $11, $12 trillion market globally, we're talking about infrastructure, not just residential, but commercial and infrastructure, which is really what we focused on. Allied is a tour de force on the infrastructure side. We think the opportunity in construction for us and our shareholders is quite substantial. We're fully willing to accept and deal with the headwinds we've got right now.
Okay, one last question, if I can. You talked a little bit about the reinsurance leakage following the acquisition. Clearly, one of your competitors is still active in recruiting Aon reinsurance brokers. What's the time lag in terms of leakage? In other words, if and when that recruitment stops, how long will it take before the associated leakage slows down?
Well, it really depends. I would sort of come back. It is interesting. Around a transaction, this is always a topic du jour, particularly for certain publications who like to write about these things. For us, this is just a way of life. Again, Aon Benfield sits today with what our colleagues have built, is just an extraordinary platform. It's always going to be under attack for talent because we've got incredible talent that sits in Aon Benfield. It's going to be part of what we do overall. The actual mechanics, when you think about a treaty, it really is a 12-24-month lag in terms of overall impact, depending on some of the mechanics of how it came on and how it works and how it rolls off.
Step back from our standpoint, as we think about Aon Benfield, as I said before, we had a set of assumptions which drove that decision. Those assumptions have, in every single case, been surpassed substantially, and we've been able to operate over the last 24 months, really stabilize the platform, credit to colleagues all around the world, and done it in an environment which probably couldn't have been any worse in terms of market headwinds and what we're trying to do. We're convinced it was a high return on invested capital for our shareholders in the original model, and we are convinced it's now much higher than that. We feel very good about the overall platform and where we are and fully expect we're going to have talent competition. That's the world we live in.
Okay. Thank you. That's very thorough.
Thank you. This concludes today's call. Mr. Case, do you have any final remarks?
Just thank you to everybody for joining. We appreciate you taking your time today, and I look forward to the next call. Thanks very much.
Thank you all for attending today's conference. You may now disconnect.