Thank you for standing by. Welcome to today's conference. At this time, all participants are in a listen-only mode. After the presentation, we'll conduct a question and answer session. In order to ask your questions, you may press star one on your touch-tone phone. Today's conference call is being recorded. If you have any objections, you may disconnect. I will now introduce your conference host, Mr. Mark Jones. Sir, you may begin.
Thank you. Welcome to our second quarter 2011 earnings conference call and webcast. Our call today is hosted by Joe Plumeri, Willis Group Holdings Chairman and Chief Executive Officer. A replay of the call will be available through September 4th by calling 866-458-4762 from within the U.S. or internationally, country code 1, then 203-369-1319. No passcode is needed. Alternatively, the webcast replay can be accessed through the investor relations section of our website at www.willis.com. If you have any questions after the call, my direct line is 212-915-896. As we begin our call, let me remind you that we may make certain statements relating to future results, which are forward-looking statements as that term is 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 estimated or anticipated. Please note that these forward-looking statements reflect our opinions only as of the date of this presentation. We undertake no obligation to revise or publicly update the results of any update to these forward-looking statements in light of new information or future events. Please refer to our SEC filings, including our annual report on Form 10-K for the year ended December 31, 2010, subsequent filings, as well as our earnings press release for a more detailed discussion of the risk factors that may affect our results. Copies may also be obtained from the SEC or by visiting the investor relations section of our website. Also, please note that certain financial measures we use on the call are expressed on a non-GAAP basis.
Our GAAP results and GAAP to non-GAAP reconciliation can be found in our earnings press release. With that, I'll now turn the call over to Joe.
Thank you very much, welcome, thank you for joining our call today. On the call with me are Grahame Millwater, our Group President; Vic Krause, CEO of North America; Michael Neborak, CFO of our company; Peter Hearn, who's the Chairman of Willis Re. As usual, there are other members of the management team who are also here with me today, obviously, they will be happy to answer any questions that you have. Let me review the second quarter for you. We set out clear targets for what we wanted to achieve this year, let me just remind you what that was so I can put this in context. We said that we would undertake an operational review to better align our resources with our growth strategies and generate meaningful savings.
We said we would take charge to implement these changes, we would roll out our growth initiatives and review our balance sheet. That is what we set out back in February when we told you what our goals and objectives for the year was. We also said that we expected these actions would help us deliver modest growth in both adjusted operating margin and adjusted earnings per share. Even as we knew costs would increase, we knew this at the beginning of the year, we said this back in February. We said that we're going to have higher retention award amortizations. We knew that the amortization of our retention award, which is the way we pay our people in this company, would be much higher. We told you what that would be.
The reinstatement of salary reviews, the reinstatement of 401(k), which, as you've seen, is the reason why the S&P has gone up. We knew that at the beginning of the year, that's one of the reasons for the operational review. I'm proud to say that we've delivered again on all these targets in the second quarter, achieving solid financial results, 3% organic growth in organic commissions and fees in a quarter that on a comparative basis was difficult because there were some things that hit last year on a credit basis that did not hit this year. That 3%, I think, is better than it appears to be. Modest adjusted operating margin expansion, 13% adjusted earnings per share growth. We continue to focus on implementing the revenue and cost initiatives associated with our 2011 operational review.
Grahame's going to talk about that a little bit later. The team is doing a great job, I think, of implementing these initiatives, the results are as we expected them to be. Through the first half of 2011, we've recorded $115 million of the expected total $130 million charge, we've realized around $23 million of the $65 million-$75 million in cost savings expected this year. We also wrapped up the redemption on the last piece of the Goldman debt, we're happy to say. Grahame reduced the total debt and further strengthened the balance sheet, all which was a part of this grand plan this year to review our operations. That was a major part of it. Turning now to the growth in the quarter.
Organic growth in commissions and fees, as I said, was up 3% over the prior year quarter, led by our international and global segments. North America was flat compared to prior year. I'm going to talk about that in a second. Our net new business was up 4%, driven by double-digit new business generation, and retention of existing clients increased about 1.3% to 92%. This was partly offset by 1% headwind from rate and other market factors. When I say 1%, I mean that kind of in the world. In some places, it was one to two. It varies depending upon where you are. The external environment hasn't changed much from the last time we spoke. You already know that. We continued to face familiar issues in the quarter with economic weakness and soft insurance rates in many countries and lines of business. That really has not changed.
In fact, we've seen economic conditions getting tougher in some of the European countries, including the U.K., while the U.S. economic recovery remains uneven, probably at best. In terms of the pricing, as I've said before, while we've seen some improvement in catastrophe-exposed property and some other specific lines, depending upon where you are geographically, there is still substantial capacity in the market. We don't expect the environment to change significantly anytime soon. I'd also add that exposures are basically unchanged. That is to say, the amount of insurance that people are buying is basically the same. That has not gone up. Let me talk about the various segments. North America, the operating environment in North America hasn't changed a lot.
The economy continues to show signs of recovery. It's uneven, and it's not clear that the recovery will be sustained, if in fact, there's a recovery at all. I'll leave that up to you. Jobs growth is not fast enough, so unemployment is still high, and that affects obviously a couple of our main businesses, construction and employee benefits, which together combine about 34% of our business in North America. The overall insurance rate environment is still soft, although somewhat less of a headwind than it has been, and then I talked about exposures not changing much. Organic growth was flat in the second quarter with the rate headwind here about 1%. While growth was better than the first quarter, operating conditions for our middle-market clients are still difficult.
Against this, we still delivered new business generation in low double digits while client retention calculated on a dollar basis, not a client basis, remained a solid 91%. Even though I say solid, I think we can do better. In terms of geographies, we saw good growth from the Atlantic region and also Canada. Our employee benefits business, which is our largest practice, which as I said, is about 23%-24%, grew low single digits, which I think in this environment, when you're basically charging on a per-employee basis when unemployment is high, I think is outstanding and shows the virtue of our value proposition in North America with regard to employee benefits. We're also continuing to help clients work through the changes that are occurring in this area as a result of healthcare reform.
Construction, our next largest practice, remains down due to the economy and the lack of one-off stimulus related business, and that business is a 10% or 11% kind of business in terms of percentage of the revenue. Two of our bigger practices, again, affected by the economy, yet we're still flat in North America, which is, I think, an outstanding result given the conditions, and I'll talk a little bit more about that in a second on a comparative basis to give you a little bit more cover. Construction remains down due to the economy, as I said, and the lack of one-off stimulus related business. As we've said before, both of these practices should benefit when the economy improves and further jobs are added. Looking at our specialty business, we've talked at specialty businesses before.
The healthcare practice did particularly well, as we called out in the release and we mentioned in the release, one of our other specialty businesses was down in large part to a tough comparison with the second quarter of 2010 when it benefited from a $2.9 million one-time accounting adjustment. What I'm making reference to is our Loan Protector business, which does force-placed insurance, which we acquired as part of the HRH transaction back in 2008. While we really like this business, it was also negatively impacted in the quarter by lower foreclosure levels and some changes in compensation agreements, which will also impact this business over the rest of the year. If you exclude this impact of the one-time accounting adjustment, North America would have recorded positive organic growth.
With flat organic growth in commissions and fees, North America's operating margin declined by 108 basis points to 18.6%. I'm pleased at the fact that with the bad comparison with Loan Protector in the second quarter of last year, with the counter charge and lower commissions and the slowing down of foreclosures, not because of the economy, but I think the banks have just kind of given a little bit of a reprieve on that. That and the fact that EB and construction still are struggling because of the economy, and yet we're still flat on a comparative basis quarter by quarter, I think our colleagues in North America are doing a great job, and I just wanted to make you aware of the color and what that flat means. I think without the comparisons it would have been very positive.
On an international basis, international had another good quarter of growth reflecting the strength and diversity of our extensive network. Organic growth in commissions and fees was 6%. New business generation remained in the double digits against the rate headwind of 2%, while retention grew to 94%. You're seeing greater headwinds in the rest of the world than you are in the U.S., which is now catching up, if you will, and I wanted to make sure you understood that distinction. We're really proud of the 94% retention. Latin America, Eastern Europe delivered double-digit growth with strong contributions from Brazil, Colombia, and Venezuela in Latin America, and Russia in Eastern Europe. Asia grew nicely with strong double-digit growth from China. Very proud of our Chinese operation and the way that's growing.
Continental Europe grew low single digits, a good result given the economic pressures that you're all aware of in the number of countries in the region and what they face. Growth in the region was led by, believe it or not, Spain and Denmark, which is just outstanding because the economy in Spain obviously is well known for its problems, and Denmark as well. We're very proud of the results there. U.K. and Ireland business also grew low single digits with client retention higher, but again, we had good results even though there's pressure from weak economic growth in both countries. U.K. GDP growth was just 0.2% in 2Q after weakness in the two prior quarters, and Ireland is still under a lot of economic pressure. International operating margin was 21.5%. That's up 240 basis points from 19.1% in the year ago quarter.
Margin growth was supported by strong growth in organic commissions and fees, together with favorable foreign currency movements, although this was partially offset by higher incentive compensation as we continue to invest in future growth. Internationally, all goes well and continues to be a great contributor to this company. Our Global Business segment comprising reinsurance, Global Specialties, London Market Wholesale, and Willis Capital Markets performed exceedingly well, delivering 3% organic growth. A couple of those business really, I think, paved the way for great growth. A high single-digit growth, double-digit new business growth in North America with continued strong growth in our international and specialty businesses has been a lot of focus on the pricing environment for mid-year reinsurance renewals given the cumulative impact from global catastrophes.
Insured losses over the past 16 months have cost reinsurers approximately $48 billion and insurers $86 billion, and the RMS v11 model changes. The reinsurance market as a whole has reacted reasonably logically with a differentiated approach driven on a case-by-case basis. Catastrophe renewal rates in Japan in the quarter saw significant rate increases, obviously, and U.S. property catastrophe pricing has improved, although client differentiation is key. Reinsurer's renewal pricing was a function of individual insurance company exposure change, geographical spread, and program restructure. Still very limited evidence of price stabilization or increases in classes outside of natural catastrophe. Our Global Specialties and our reinsurance business, having said all of that, is doing very well and growing very nicely in the high single digits.
Global Specialties, mid-single digit growth driven by aerospace, FINEX Global, marine and energy, and growth from strong new business and improved client retention with continued overall rate softness. Willis Capital Markets & Advisory has been a terrific business for us. A good quarter on the back of M&A advisory activity, including advising Chaucer on its sale to Hanover Insurance. As you know, it's a choppy business in terms of revenue, and capital markets had a tough comparison with the prior year as 2Q 2010 included a significant benefit from the Harbor Point transaction, which is a very large transaction, which we booked in the 2Q last year. Another comparison that even though capital markets did well in the quarter, it doesn't compare favorably to the quarter of a year ago, another unfavorable comparison.
That's why I said that 3% is better than it appears, and we're very happy with the way our businesses are going. Our London market wholesale, good growth in our global markets international business, offset by weakness in Faber and Dumas, which reflects continued softness in the wholesale market. The operating margin was 32.5%. That's down 220 basis points from last year, but the biggest driver was unfavorable foreign currency movements. It wasn't the operation of the business, particularly the strengthening of the pound against the dollar. This was partly offset by organic commissions and fee growth and lower pension expense. The operational review that I made mention of at the beginning of this call is something that we're very excited about because it's the thing that will differentiate us and position ourselves for significant growth in the future. That's what this year has been all about.
I'm excited with what we're doing to deliver our value proposition. The Willis Cause to all of our client segments in a differentiated and more efficient and consistent way is what I think will propel us into the future. I believe that delivering the cause to our clients, together with the efficiencies we're achieving from the operational review and the charge, which to align our resources and our delivery mechanisms so that we can deliver the cause, is moving well as the year progresses. And will position us, I think, to drive accelerated operating margin and earnings per share growth in 2012. Remember what we said, that this year we would expect modest growth in margin and earnings per share, and next year, we would expect significant growth in earnings per share and margin.
With all of that as a backdrop, I'll turn it over to Grahame Millwater to update you on the initiatives and The Willis Cause. Grahame?
Thanks, Joe, and good morning, everybody. On the last call, I outlined The Willis Cause and how that's become the framework around which we're building our differentiation and driving our organic growth engine. I just want to highlight today some of the detailed progress we've made with a number of the important initiatives that underpin the cause. Let me start firstly with Global Solutions. Just to remind you, this is the unit that is spearheading our attack on the largest global companies in the world. Here we are targeting the world's largest 1,000 public companies, and we've chosen another 220 private and/or complex companies that we think also fit into this category. To give you an indication of the opportunity, currently, we're the lead broker on less than but approaching 10% of these companies.
We have a secondary position on approximately another 20%, leaving around 70% where we have very little or no involvement at all. It's also clear that there is a real appetite amongst this target market for a new offering and a new player in a segment that is dominated by our two larger competitors. Initially, we're focusing on 450 of these potential 1,220 companies, and we've targeted them either because of the expertise we have in their particular industries or because we feel we have a distinct offering that will be attractive to them. We're developing detailed account plans for those 450 with clear accountabilities, and we're engaging the totality of the Willis organization in that approach. This is obviously a very integrated organization. I want to emphasize that on these companies, we're taking a truly global group approach, not a divisional approach.
Much of this will be led by our significant risk analysis skills. We believe Willis is the only broker who can make serious inroads in this segment outside the other two major global players. Frankly, the smaller brokers just do not have the geographic presence and/or breadth of capability to make any significant headway here. The success of this approach is already reflected in some very significant recent wins, notable wins. Winning, as you know, breeds confidence and more winning. We're very excited about the pipeline of opportunity we have in this particular segment. Secondly, let me turn to our sales push in the mid-market, which represents about two-thirds of the group's business. This sales push, we're calling Sales 2.0.
Sales 2.0 will provide a consistent approach to sales and growth through industry-driven specialization and encompassing a much more consultative sales process and local delivery of our truly global expertise. After a detailed gearing up phase, we started rolling this out in May in the U.S., which is our pilot geography, and are now extending into our U.K. and European retail businesses. Again, to give you some detail about that rollout. In North America, we've initially focused on 6 industries and identified nearly 5,000 prospects, and we have already trained over 650 of our associates. We plan to roll out a further 2 industries in the U.S. in September as momentum builds. In the U.K. and Ireland, we've initially focused on 4 industries and commenced training again our associates. We have plans for further associate training in 2 additional industries in September.
We have targeted over 700 prospects within the initial implementation and are focused on 2 further industries for the fourth quarter. In Europe, we are targeting the initial rollout on 9 territories and 5 industries. Again, we started this rollout in May and have trained approximately 50% of the target associates. We aim to complete this training in October and the first wave of associates are already starting to use the approach. Whilst it's still very early days for Sales 2.0, again, we are very excited by this initiative in this segment. Thirdly, we continue to roll out our franchise model for independent retail brokers in the small commercial market. We call this the Commercial Network, after the model that's been so successful for us in the U.K., where we have 120 network members.
Let me just list for you the numbers of network members we have signed up in the other countries, where we've only just started rolling this out in 2011. I think it's a reflection of the attractiveness of this model. We've signed up 32 members in Italy, 22 in Spain, 10 in Germany, 13 in Brazil, eight in Colombia, 12 in Austria, and 23 in China. This is a great start. This is our first year of rollout, and the momentum will really build as we add more members into the network, and they start selling our products through the access that we give them to global markets. Fourthly, I wanted to outline how well we're positioned on the risk analysis front, a key part of The Willis Cause. This is key, in particular to our offering in the Global Solutions segment, large account, and mid-market.
We've built a very sophisticated risk analytical capability in Willis Re over the past decade. Two years ago, we started building a similar capability to this in the large retail segment under the heading of Structured Risk Solutions. This capability has been key in many of our largest wins in the past 12 months. Alongside that, we've also built over the past three years, a unique entity called the Willis Research Network. This is a unique collaboration with some 50 universities and public science institutions globally to understand and research risk issues from earthquakes through to tsunamis, windstorms, and also areas like supply chain risk and cyber. We believe the Willis Research Network will be a key enabler in positioning ourselves as the broker who has the deepest insight into risk issues around the world. This work is now really coming on stream.
Finally, I just wanted to outline how successful Willis Capital Markets & Advisory business has been. Joe touched on this earlier. From a unit we started two years ago and from our core teams now based in London and New York, we are really at the center of many deals in the insurance segment. Obviously, some of these deals are already public. Joe mentioned Harbor Point. We've got CBC, Brit, Chaucer, to name just a few. Many remain private and or in development as we're engaged in a rich pipeline of potential deals. The unique knowledge and access to insurance entities that comes from being aligned with a broker like ours, combined with extremely talented insurance capital market experts that we've brought in, has been a truly great combination.
Excuse some of the detail in this update, but it does give a flavor of the systematic activity underway to underpin The Willis Cause and drive the organic growth of the company going forward. I'll now turn over to Michael Neborak, CFO, to review the financial results. Michael?
Thank you, Grahame. Good morning, everyone. As Joe mentioned, our second quarter results were strong. Let me begin by updating a few important components to those results. All comparisons are to Q2 2010 unless otherwise noted. The first area is the operational review. As described in our press release, we recorded a charge of $18 million in the quarter related to the operational review, bringing total recorded charges in the first half to $115 million. The $18 million charge was recorded $10 million to our S&B line, $7 million to other expenses, and $1 million was recorded to depreciation. We still expect the total charge in 2011 to be approximately $130 million. The remaining $15 million or so will be recorded in Q3 and Q4. Expected cost savings realized in 2011 are estimated at approximately $65 million-$75 million. We've made substantial progress against that already.
In the second quarter, we achieved savings of approximately $20 million, of which $11 million was recorded against the S&B line and $9 million in terms of the other expense categories, bringing total savings for the year to approximately $23 million. Full year cost savings in 2012 are estimated at $95 million-$105 million. Early in the second quarter, we redeemed $35 million of our remaining 12 and seven eighths% notes that were outstanding at March 31st. The costs associated with this redemption were accrued last quarter, there's no cost associated with that in the second quarter here. Following all the changes that we've made to our capital structure, interest expense going forward for the next few quarters in 2011 should be approximately $34 million per quarter.
With more in-the-money stock options, average diluted shares outstanding increased to 176 million during the quarter versus 171 million in the year ago period. If our stock price remains in the low 40s, average diluted shares outstanding will be approximately 176 million for the full year 2011. Turning now to second quarter 2011 results, reported earnings were $85 million or $0.48 per diluted share. These numbers were negatively impacted by $18 million in costs from the operational review and the $11 million FSA regulatory settlement costs. After adjusting for these items, net income was $108 million or $0.61 per diluted share, up 13% from the second quarter of 2010. Adjusted EPS benefited by $0.01 from FX movements.
Foreign exchange impacted our results compared to the second quarter of 2010 by increasing revenues by approximately 5%, largely due to the U.S. dollar weakness against the euro and the Australian dollar, and increased our operating expenses by approximately 7%, largely due to U.S. dollar weakness against the pound sterling. These movements resulted in a 100 basis point decrease in adjusted operating margin. Our total reported revenues increased 8% to $863 million. Reported commissions and fees also grew 8% to $854 million, while organic growth was 3%. Total investment income of $8 million was down slightly from the year ago period. We continue to estimate that full year 2011 investment income will be approximately $30 million. Included in fiduciary assets on the balance sheet was fiduciary cash of $2 billion, up from the $1.8 billion at the end of the first quarter.
Just a point of note, fiduciary cash balances typically are the highest at the end of the second quarter. Let me talk about expense management, which is an ongoing focus here at Willis and one that receives significant attention in every business unit. Simply put, our goal is to keep expense growth below revenue growth and expand the operating margin. In that regard, I want to go into some detail this quarter in explaining our expense growth. Total reported expenses were up $76 million, or 12%, to $706 million. This increase included the $18 million of costs associated with the operational review and the $11 million related to the FSA regulatory settlement. When you exclude those two items, adjusted operating expenses increased to $49 million, or 8%. Of that 8% increase, 7%, or 7/8, was related to foreign exchange movements.
When you exclude the benefit of the $9 million legal reserve release, underlying expense growth was 2.6%. That's the big picture. Let me spend some time on each major expense component. First, salaries and benefits, which were up $50 million to $506 million and represented 58.6% of total revenues in the current quarter. That 11% increase in S&B includes $10 million of costs associated with the operational review severance. When you exclude those costs, S&B growth was approximately 9%, and the ratio of S&B to revenue was 57.5% compared to 57.1% a year ago. Of that 9% growth in S&B, 5%, or more than half, came from foreign exchange. The remaining 4% underlying S&B growth came from the reinstatement of salary reviews, which were effective April 1st, the 401 match, new hires, higher amortization expense related to cash retention awards.
In the second quarter of 2011, that figure was $44 million compared to $32 million in the second quarter of 2010. Those items were offset by lower pension expense. Pension expense was $8 million lower in the current quarter versus the year ago quarter, realized expense reductions from our operational review, which were $11 million here in the second quarter. The second component, other operating expenses, were up $29 million, or 21%, to $164 million. Those expenses included $11 million related to the FSA regulatory settlement and $7 million of operational review costs. Excluding these costs, other operating expenses increased 8%. After you eliminate the impact of FX and you exclude the benefit of the $9 million legal reserve release, operating expense growth was 1%.
Finally, depreciation was approximately $19 million in the quarter, representing a $3 million increase from the comparable period in 2010. $1 million of that increase related to systems rationalization costs associated with the operational review. For modeling purposes, depreciation should run approximately $17 million per quarter throughout the remainder of 2011. In summary, underlying expense growth was 2.6%, comprised of a 4% increase in S&B and a 1% increase in other operating expenses. Turning to operating margin, adjusted operating margin was 21.6%, up 20 basis points. As I mentioned before, FX hurt the operating margin by 100 basis points in the quarter. On the tax line, our book tax rate for the quarter was 25%. After adjusting for the net effect of non-recurring items, the underlying tax rate for the quarter was also 25%.
For all of 2011, we now estimate that our effective tax rate will be approximately 25% versus the 26% that we've been running historically over at least the past six quarters. Income from associates was a loss of $3 million compared to a loss of $2 million in the year ago quarter. Currently, we expect associates' income in the second half of 2011 to be similar to the second half of 2010. On the pension side, our U.S., U.K., and international defined benefit plans had a combined surplus of approximately $82 million at the end of June, up from approximately $15 million at the end of the year. Pension contribution payments during the quarter were $30 million. As we've stated before, for the full year 2011, we expect that figure to be just shy of $130 million.
On the balance sheet, our total debt was $2.4 billion at the end of the second quarter, down from $2.6 billion at the end of the first quarter. This reflects a reduction of $100 million usage on our revolver, the redemption of the remaining $35 million on our 12 7/8% notes, and a $27 million repayment of our term loan. The leverage ratio, as calculated under our bank term loan agreement, was approximately 2.5 times at the end of the quarter versus 2.7 times at the end of March. Cash and cash equivalents were $317 million compared to $432 million at March 31st. Finally, during the second quarter, we generated approximately $119 million in cash from operations, bringing the total cash recorded from operations in the first half to $126 million. With that, I'll turn it back to Joe.
Thanks, Mike. I just want to wrap up by saying that we're very disciplined and continuing to do what we said we would do this year. Our objectives are clear in terms of what we want to achieve Through this year. Through the first half, we've completed the operational review. We're implementing the associated cost and revenue initiatives. We've improved our debt profile, and we've delivered modest adjusted operating margin and earnings per share, which is exactly what we said we'd do. Everything we are doing is aimed at differentiating Willis in the eyes of our clients, retaining those clients, and growing the business. We believe that this, along with the actions we've taken, will allow us to achieve accelerated growth in adjusted operating margin and adjusted earnings per share in 2012.
At the beginning of the year, I said we're doing all of this because we just don't want modest growth. We wanted significant growth, that's what we're aligning ourselves up this year to do for the future. I'd be glad to answer any questions that you have.
We will now begin our formal question and answer session. If you would like to ask your question, you may press star one on your touch-tone phone. To withdraw your question, you may press star two. The first question is coming from Adam Klauber of William Blair. Your line is open.
Thanks. Good morning.
Hi, Adam.
A couple questions on the restructuring program. I think you said you're up to $20 million in cost savings from the second quarter. Your target is $65 million for the end of the year. Will those ramp up evenly over the next two quarters?
More or less evenly over the next two quarters, yes.
Okay. I think you mentioned there have been a reduction of 600 positions. Is that the total amount, or are there potentially more positions that will be reduced?
There are a few more positions that will be reduced. Most of the remaining work that we're doing is moving positions from a high-cost location to a low-cost location. The headcount won't necessarily go down, but the cost will.
Okay.
That's a part of the alignment and the operational review of aligning the resources with where the efficiencies and the service is delivered.
Finally, the Harbor Point transaction, did that take two or three points off the global growth?
It took at least a point.
Okay. Thank you very much.
Thank you.
The next question is coming from Keith Walsh of Citi. Your line is open.
Hey, good morning, everybody.
Hey.
First question for Joe and/or Mike, just around the cash retention program. I'm looking at this program. It's basically tripled since 2008, and I appreciate this year the amortization is higher. It should be even higher than the $44 million a quarter if the program was expensed like normal comp and not amortized over three years. The question really is why expense this program through the P&L in the year that it's earned, like Marsh & Aon do? The program, it simply makes your margins look better than they are.
Well, I disagree with that. First of all, it's not a bonus. It's a retention award. We talked about this and full disclosed it well over a year ago. We pay retention awards so that when the years when things were tough, we didn't pay people over a three-year period of time like most people did in terms of deferred comp or paying in stock or paying in options and all the things people did to reward their people, we came up with retention awards. Retention awards are just that. We wanted to retain our people while finding a way to pay them. The amortization for that goes forward. When we pay retention awards, they sign a document that says that they will stay with us over a three-year period of time or give up the retention award.
That's why we book it on an amortized basis going forward. When you increase it over time, the amortization schedule shows a big increase. We suggested, Keith, at the beginning of the year that that increase would be significant this year because it's caught up in the third year, it's much higher. We don't pay bonuses. We pay retention awards, and therefore we don't accrue them. We pay them on a go-forward basis. The effect on the P&L at one point in time is the same. It goes through the expenses when it's amortized in the future. We thought we came up with a program that has been very effective. It's retained our people. Our retention is much higher than it's ever been. We found a way to pay our people in difficult times, we pay retention awards. We don't pay bonuses.
We amortize going forward, and therefore we don't accrue it. The expense going through the P&L is effectively the same. We said at the beginning of the year that it would increase significantly this year because the amortization schedule would be higher. I even said it was $65 million higher than it would be the year before, which is why you see the S&B line going up. Its effect on margins becomes basically the same when it's amortized forward in any given year and when it's accrued.
I understand that, if we keep the award at a steady state, it'll waterfall in, and it won't be an issue going forward, you continue to increase the award. In the first half of this year, you paid out $206 million, and last year it was $185 million. When do we get to a steady state so this doesn't become an issue as far as the amortization?
I think we're talking about $20 million differential. I don't know. When you're having good years and you're growing your revenue and your people are doing a good job, our revenue grew 4% last year, and our margins did very well, and everything was going well, you reward your people. We figured out a way to reward our people for the good job that they do. I'll let you know at the end of the year how well we do, and whether that's a steady state or not. I would assume that the number would be around the same, and therefore the amortization schedule will be fairly around the same amount of money. Again, we're very happy with the program. We're very happy with the way we do it. It's retained our people. We figured out a way to pay our people.
We amortize it going forward. We talked about this ad infinitum. With the beginning of the year, we went into this in great detail, which is why the S&B line has gone up because of the combination of much higher amortization, a 401 that we're starting to match again, and because we're paying salaries again, that's why the S&B is up. It's going quite well.
Just for Grahame, I apologize if I didn't hear his comments correctly. I thought with Sales 2.0, he talked about pushing to win business in the large case market from Aon and Marsh, if I heard that correctly, I apologize if I didn't. I guess the question then is, I saw in 2005 and 2006, you guys, when Marsh was struggling, took the comp ratio up to 60%, recruited people to take business from them, that really didn't appear to work well. Why is now different?
Sales 2.0, Keith, it's not a recruitment strategy. It's taking our existing resources and actually arming them in a way that differentiates them at point of sale. That's not a major recruitment program. As I explained, we trained in North America, 650 associates. They're our existing associates. It's a program to make their productivity and their effectiveness that much better. It's a completely different angle.
Thanks.
It has nothing, Keith, to do with recruiting. It has to do with making the people we have more productive.
Our next question is coming from Mr. Jay Gelb of Barclays Capital. Your line is open.
Thanks, good morning.
Hi, Jay.
I want to switch gears a bit to the forward-looking aspect. You've talked about the expectation for significant growth in earnings and margin improvement in 2012. Given all the noise that's in the year-to-date results, especially from foreign exchange, even on an adjusted basis, I think it'd be helpful to get a baseline of what level of improvement you're anticipating.
Well, I'm not going to get into the definition of significant. Obviously, when you grow modestly, 20 basis points in margin is modest, 5%-10% in earnings per share is modest, we think that anything, we want to grow significantly. I'm not going to define significant, but I have said that the whole idea of the operational review and everything we're doing is to grow significantly. I said at the beginning of the year that when you have 23% margins, it's not easy to grow those margins at significant levels, 100, 200 basis points a year. If it was easy, everybody would be at 23%.
To look back at that conversation, we had to then look at our business and kind of reorganize the way we looked at things so that in the future, we could begin to take the 23 and make it much higher than that, rather than 23.2, 23.4, 23.5. We wanted to significantly grow that. To do that, we said to step back, take the charge, do the operational review, align our resources with our services, do all the things that Grahame was talking about, so that we can significantly grow in 2012 or beyond, assuming that the world is going to stay the same. We feel like we're on course to do that, and this presentation has given you some insight into that.
Understood. On the next issue, overall organic revenue growth, there were some tough comparisons in the second quarter versus a year ago. You mentioned things like Harbor Point.
Right.
Going forward, if reinsurance rates are higher, if the economy does recover to some extent, do you think you can get back to that 4% organic revenue growth level in pretty short order and take it higher from there?
I think higher, to be honest with you. That's not a prediction. I told you that in North America, I was proud of North America. I'll give you the color. You're flat, you got your two best businesses that are affected highly by the economy, you're still flat. We took Loan Protector, which was a big contributor to our business a year ago because of foreclosures and because of commission structures and agreements we had. The accounting adjustment that was made. That was $2.9 million, not considering the commissions that have been adjusted down in that business and the fact that there are less foreclosures and there's more basically escrowing of those monies. That was a big contributor in 2010. Not as big this year. Still, we were flat in North America.
You add to that Harbor Point a year ago versus what is still a good quarter for capital markets. You put all those things together, you're well beyond 4% on a relative and a comparative basis. I guess the answer to the question is yeah. You throw a good economy in there, you throw firming of rates, especially given a company where 70% of our revenue comes from commissions, I think it's a pretty good answer to say that yes, greater than 4%.
All right. Thank you, Joe.
You're welcome.
The next question is coming from Thomas Mitchell, Miller Tabak. Your line is open.
I have two questions. One is kind of trivial, but I just wanted to follow up. It was very clear that the release of the legal reserve was laid out very clearly. I'm sort of wondering, is that something that is a continuing thing, or should we have considered that a one-off item similar to the FSA and other factors that were there, like the claims expense ?
The FSA was obviously a one-off. We expect it to be a one-off. We hope it's a one-off. That's over and done. As it relates to putting reserves up Taking reserves down, that's an ongoing thing that we do. We have reserve committees that we have. We look at our reserves. We put reserves up, which is an expense. Obviously, when we put them up, they affect margins and they affect earnings per share. When we take them down, it's because the reserve committees with our legal department suggest that the settlements have taken place, that as we review these cases, that we find that they are less onerous than the reserve that we put up, and we release those reserves. That's an ongoing part of doing business.
In this particular case, we released these reserves because we felt that they were no longer necessary to keep up. That's an ongoing way of running a business, and we do that as part of the due diligence of the process that we go through with all the cases that we have. When we put them up, they hurt margins, and they hurt earnings. When we take them down, it's a good thing, but they obviously negate each other, and it all comes out in the wash. I think it's just as good that we should be punished for putting them up because something bad happened, and we should be given credit for taking them down because we found out that they weren't as bad as we thought, and that's good governance.
Okay. Secondly, totally different, is the issue of whether or not in competing for the large account business against Marsh, McLennan, and Aon, which sounds like a very exciting initiative. Does that business offer the same profit margin opportunities as your existing base of business, or would it be likely that you would have an impact from competition that would drive margins lower than what your existing base would have?
I'll answer that because it's a profit question. There's always been this conception or misconception that large accounts obviously take more servicing, therefore, they cost more. As a result, the profits are less. We felt from a strategic point of view, that because most of our business came from the middle market, it's 70% is commissions worldwide and 30% is fees, that we had all the elements in this company to be able to compete in the large account sector. We already have the expense of analytics. It's housed in reinsurance. We all have the expense of specializations in London and the U.S. These expenses are already embedded inside the company. We already have people who look after large accounts anyway.
We thought that we had a great opportunity to gain market share since, as Grahame said very well, we have such a low base with regard to large accounts, and we have all of these resources sitting here as good as our competitors do. Why not take advantage of it and why not give it some leadership? Martin Sullivan came in to give it that leadership. I think we're making great progress. We look at it as an augmentation to our business by using the services that are already there that we pay for.
Okay. Thank you.
You're welcome.
The next question is coming from Mr. Mark Hughes of SunTrust. Your line is open.
Thank you very much. The employee benefit sounds like you're getting at least a little bit of a boost from healthcare reform. How long do you think that lift should continue?
Well, if you say a lift from healthcare reform, Mark, meaning people are in a quandary as to what to do, I don't know that that's a lift. I would rather them not be in a quandary, the economy be better, and we grow it better than low single digits. I think that as the economy gets better, our sweet spot is our companies where there's more than 50 employees and less than 1,000. That's where the sweet spot is for us in the middle market. As the economy at one point, we all hope and pray that improves, and as that happens, there's more employment, and as there's higher employment, there is obviously a greater ability for us to do what we do very well and get paid more for it.
I would also tell you that irrespective of healthcare reform, employers are going to have to find different and better ways to take care of their people. Usually, the trend is to be on a voluntary basis. The trend has to be toward wellness and putting programs into place. We're very good at telling people how to do that. I think it can only get better, actually, from here where we specialize. Vic, you want to add anything to that?
Yeah. Thank you, Joe.
Vic Krause, Head of North America.
I think our value proposition certainly gives us an opportunity to take advantage of the volatility that healthcare reform has brought on. We are seeing some pressure from medical insurance companies in terms of how they pay brokers as they look to conform to the regulations that have been imposed upon them. There's a mixed bag in this area. We just think that our value proposition will give us an opportunity to take advantage of those people who don't have a platform.
Thanks, Vic.
Any quick thoughts on the pipeline in the Willis Capital Markets business?
Yeah. As Grahame said earlier, and said very well, it is robust. The problem, Mark, is you don't know with these deals, it's not ongoing business that happens every day. It's choppy. I have to tell you that the pipeline is robust. We're involved in lots of conversations. We're involved in representing one side, another side, the advisory business. It's just across the board, Tony Ursano and our capital markets group are just outstanding. They've been doing this a long time. They did this well before they joined us from Bank of America. We couldn't be more proud of what they do. It's a choppy business. It just doesn't happen every day, but look very confident that things will occur, and when they will occur, obviously, you'll see it.
Thank you.
Thank you.
The next question is coming from Ms. Donna Halverstadt of Goldman Sachs. Your line is open.
Good morning. Thanks for taking my questions. You talked a lot about income statement objectives, the growth, the margins, et cetera, which is all very helpful, and I was hoping we could complement that with a balance sheet objective. For purposes of this question, if we completely set aside the credit agreement and the financial covenants therein, what do you personally think the optimal leverage ratio is in terms of debt to EBITDA, where you would like to run this business?
Our immediate objective is to get our leverage ratio down to about 2 times, and then at that point, kind of based on the current environment, take a look at it. I think longer term, we like to get it down lower. Getting it down lower gives us more flexibility in terms of our future. The immediate objective is get it down to around 2, then longer term, probably about 1.5, but obviously that depends on kind of the current environment and other opportunities that exist at that point in time.
Okay. The other question I wanted to ask brings the credit agreement back into it. With the recent changes to the restricted payments covenant, presumably that was done to facilitate share repurchase. Can you give us some color on how you're thinking about that topic?
Sure. What you're referring to is we changed the restrictive payments covenant, which limited share repurchases if our leverage ratio was at above 2.5. We've increased that to 2.75 times. As we sit right now, we have some room, but it's not a lot of room. We did that to give us flexibility. I don't think kind of where we are today at 2.5 and where we could be at 2.75 gives us much room to buy back stock. Later in the year, as we get down into the low 2s, there is some room, and we'll take a look at it at that point in time given market conditions and other factors.
Great. Thanks for the input.
Thank you.
Once again, if you do have a question, please press star one on your touchtone phone. Currently, the last question is Meyer Shields of Stifel Nicolaus. Your line is open.
Thanks. Good morning, everyone.
Hi, Meyer.
I know we've talked about this a little bit, but when you talk about targeting the largest accounts, I guess the opportunity cost is that you have a little bit less time to go after smaller accounts, and I'm thinking that Marsh & McLennan are reasonably well-resourced. Wouldn't it be easier to compete for smaller accounts that are being serviced by smaller brokers instead of sort of fighting your way upward?
Let me clarify that we like the mix of 70/30. This is not an attempt on our part to go to 50/50, which is commissions versus fees. We like being on commissions. We like where we are. This is an attempt to simply increase our capability or our impact in the large account area because we have all the resources sitting here. Instead of them being fallow and not being used or being directed specifically to reinsurance or specializations, et cetera, we want to simply say we got all of this sitting here with the right organization, with the right direction, and the right kind of focus. We can grow this business while not changing our emphasis, I repeat, while not changing our emphasis on the middle market or the small account business. The small account business will be gotten through our networks, as Grahame articulated very well.
The middle market, we will grow, not by recruiting necessarily, by Sales 2.0, which is a highly specialized focus and sales process that with diagnostics that nobody else has, to my knowledge. The larger accounts are simply icing on the cake because we already got all the ingredients of the cake.
Okay. No, that's very helpful. I appreciate it. Last question, I guess. Is there any way of identifying which segment the legal reserve release impacted?
Well, that was recorded at Corporate. If you look in our press release in the back where we have the segments and then we have Corporate, that reserve release was down in the corporate area.
Okay. No influence on any of the segments.
Okay, Meyer?
Yes. Thanks so much.
You're welcome. Okay. Thanks, everybody. Have a great day.
This concludes today's conference. All parties may disconnect at this time.