Why did reported net income decline in 1996 even though operating results improved?

Reported net income fell to $335 million from $403 million mainly because of $90 million of pretax special charges in 1996, covering an early retirement program and the restructuring of European brokerage operations. The 1995 comparison also included discontinued operations income of $99 million, versus $22 million plus a $21 million one-time gain on sale in 1996. Excluding special charges and realized gains, operating income from continuing operations rose to $346 million from $295 million.

How significant is the Alexander & Alexander acquisition for Aon?

It is transformative. The roughly $1.2 billion deal closed in early 1997 and, based on 1995 insurance services revenue, made Aon the world's fourth-largest insurance broker. It expands Aon's presence in Latin America, Asia, Africa and Australia and strengthens its London reinsurance and specialty broking franchise. Management expects a purchase accounting treatment that will significantly increase intangible assets, and it anticipated a restructuring charge in the first quarter of 1997.

What risks does the new debt and acquisition strategy create?

The company funded the A&A deal partly with $800 million of 8.205% trust preferred capital securities, which carry a fixed cost, and with commercial paper that is sensitive to short-term rates. Aon had $335 million in back-up credit lines at year-end 1996. Integration of two large brokers across many countries, pricing pressure in U.S. property and casualty and reinsurance, and the larger intangible asset base are the main risks. Management stated that it expects sufficient cash flow to meet its needs.

Is the company still an insurance underwriter, and how important is that business?

Yes, but it is becoming secondary to brokerage. Insurance underwriting generated $1.77 billion of revenue and $252 million of pretax income in 1996, while brokerage and consulting generated $2.0 billion of revenue and $182 million of pretax income after special charges ($257 million before them). Underwriting is concentrated in Combined Insurance (supplemental accident, health and life) and Virginia Surety/London General (extended warranties). Management described its strategy as focusing resources on brokerage and consulting.

What is the dividend and share count outlook?

The 1996 dividend was $1.42 per share, up from $1.34. Common shares outstanding were about 110.9 million at year-end, and 3.2 million treasury shares were held. The 8% preferred stock, 5.446 million shares outstanding, can be redeemed at $25.00 per share starting November 1, 1997, and management said it would most likely redeem all remaining shares. The three-for-two stock split payable May 14, 1997 would increase the share count by roughly half.

AON 10-K FY1996 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 26, 1997. Cited figures are marked; the original filing is the authoritative source.

Aon Corporation's 1996 10-K (fiscal year ended December 31, 1996) shows a company in the middle of a major strategic pivot toward insurance brokerage and consulting.

Total revenue rose 12% to $3.9 billion^a, with brokerage commissions and fees up 16% to $1.9 billion, driven by acquisitions (Bain Hogg Group plc, closed October 1996 for about $260 million) and internal growth. Net income fell to $335 million ($2.87 per share) from $403 million ($3.48) in 1995, largely due to $90 million of pretax special charges (early retirement program and European brokerage restructuring) and the one-time $21 million gain on the April 1996 sale of Union Fidelity Life and Life Insurance Company of Virginia. Income from continuing operations was $292 million ($2.48 per share), down from $304 million, while operating income before special charges and realized gains rose to $346 million ($2.97 per share) from $295 million ($2.49).

The balance sheet shrank sharply, with total assets falling to $13.7 billion^b from $19.7 billion, reflecting the divestitures of the discontinued life insurance businesses. Stockholders' equity rose to $2.83 billion, or $24.31 per common share. Management's bigger story is the January 1997 closing of the approximately $1.2 billion acquisition of Alexander & Alexander Services Inc., which made Aon the world's fourth-largest insurance broker by 1995 revenue.

It was financed with $800 million^c of 8.205% trust preferred capital securities, commercial paper and internal funds. Management also flagged an expected restructuring charge for the A&A integration in the first quarter of 1997, and the company announced a three-for-two stock split payable May 14, 1997.

For investors, the key questions are execution on A&A integration, the leverage added by the acquisition, and whether the underlying brokerage growth can offset soft insurance pricing. The underwriting businesses (Combined Insurance and Virginia Surety/London General) generate steady cash flow, but the investment thesis rests increasingly on the brokerage and consulting franchise.

02—Key points

Key Highlights

Revenue grew 12% to $3.89 billion in 1996; brokerage commissions and fees rose 16% to $1.92 billion, with roughly half the growth from acquisitions.
Net income fell to $335 million ($2.87/share) from $403 million ($3.48/share), held down by $90 million of pretax special charges; operating income before special items and realized gains rose to $346 million ($2.97/share) from $295 million ($2.49/share).
Total assets fell to $13.7 billion from $19.7 billion after the April 1996 sale of UFLIC and LOV for about $1.2 billion in after-tax proceeds.
The approximately $1.2 billion acquisition of Alexander & Alexander Services closed in early 1997, financed by $800 million of 8.205% capital securities, commercial paper and internal funds.
Stockholders' equity reached $2.83 billion, or $24.31 per common share, up from $22.77 a year earlier.
A three-for-two stock split was approved in March 1997, payable May 14, 1997, and per-share data in the filing is not yet adjusted for it.
Combined Insurance and Virginia Surety/London General continue as the underwriting base, with more than five million accident and health policyholders and a leading position in consumer extended warranties.

03—Questions

Frequently Asked Questions

Why did reported net income decline in 1996 even though operating results improved?
Reported net income fell to $335 million from $403 million mainly because of $90 million of pretax special charges in 1996, covering an early retirement program and the restructuring of European brokerage operations. The 1995 comparison also included discontinued operations income of $99 million, versus $22 million plus a $21 million one-time gain on sale in 1996. Excluding special charges and realized gains, operating income from continuing operations rose to $346 million from $295 million.
How significant is the Alexander & Alexander acquisition for Aon?
It is transformative. The roughly $1.2 billion deal closed in early 1997 and, based on 1995 insurance services revenue, made Aon the world's fourth-largest insurance broker. It expands Aon's presence in Latin America, Asia, Africa and Australia and strengthens its London reinsurance and specialty broking franchise. Management expects a purchase accounting treatment that will significantly increase intangible assets, and it anticipated a restructuring charge in the first quarter of 1997.
What risks does the new debt and acquisition strategy create?
The company funded the A&A deal partly with $800 million of 8.205% trust preferred capital securities, which carry a fixed cost, and with commercial paper that is sensitive to short-term rates. Aon had $335 million in back-up credit lines at year-end 1996. Integration of two large brokers across many countries, pricing pressure in U.S. property and casualty and reinsurance, and the larger intangible asset base are the main risks. Management stated that it expects sufficient cash flow to meet its needs.
Is the company still an insurance underwriter, and how important is that business?
Yes, but it is becoming secondary to brokerage. Insurance underwriting generated $1.77 billion of revenue and $252 million of pretax income in 1996, while brokerage and consulting generated $2.0 billion of revenue and $182 million of pretax income after special charges ($257 million before them). Underwriting is concentrated in Combined Insurance (supplemental accident, health and life) and Virginia Surety/London General (extended warranties). Management described its strategy as focusing resources on brokerage and consulting.
What is the dividend and share count outlook?
The 1996 dividend was $1.42 per share, up from $1.34. Common shares outstanding were about 110.9 million at year-end, and 3.2 million treasury shares were held. The 8% preferred stock, 5.446 million shares outstanding, can be redeemed at $25.00 per share starting November 1, 1997, and management said it would most likely redeem all remaining shares. The three-for-two stock split payable May 14, 1997 would increase the share count by roughly half.

04—Continue

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