Aon Unveils Q2, Six Months 2003 Results

August 6, 2003

Chicago-based Aon Corporation reported second quarter and six months 2003 results.

Net income for the second quarter was $146 million or $0.46 per share compared with breakeven results in the year ago period. Six months results increased to $298 million or $0.94 per share from $160 million or $0.57 per share in 2002. Excluding an expected $9 million ($0.02 per share) unusual World Trade Center (WTC) charge initially noted in first quarter 2003, net income per share was $0.48 for the second quarter. Six months net income per share, excluding unusual WTC charges ($0.09 per share) was $1.03.

Consolidated revenues grew 15 percent for the second quarter and six months to $2.4 billion and $4.8 billion, respectively, versus the year ago periods. Continued demand for Aon’s services and products and improved investment income drove the increases. Foreign exchange translations accounted for 5 percent of the growth for both the quarter and first half.

Patrick Ryan, chairman and CEO of Aon Corporation, noted, “Second quarter results showed steady improvement in our risk management and insurance brokerage operations, much better results in insurance underwriting, and good core performance in consulting given the current economic climate. Client demand for our services and products continues to be robust, as evidenced by our solid organic revenue growth, and I am encouraged by the progress we have made in our businesses.”

Ryan added, “We are working diligently to increase our operating margins by further tightening our expense management, and I believe we can increase our productivity as we continue to grow revenues.”

Second Quarter Segment Review
Risk and Insurance Brokerage Services second quarter revenue grew 17 percent to $1.424 billion. Organic revenue growth for the total segment was 11 percent. Within the segment, organic revenue growth was 14 percent for the Americas (up from 13 percent in first quarter 2003), 10 percent for International, 13 percent for Reinsurance and 2 percent for Claims Services.

Pretax income increased 22 percent to $175 million from $144 million in second quarter 2002. Pretax margins improved to 12.3 percent from 11.9 percent. Excluding a previously reported $6 million special credit, pretax income in second quarter 2002 was $138 million and the pretax margin was 11.4 percent.

As expected, defined benefit pension costs increased by approximately $28 million year-to-year in the segment. Claims services second quarter pretax income declined approximately $19 million from the prior year. Investment income was $8 million lower in the second quarter compared with a year ago, and second quarter 2002 results included $7 million of transition costs related to the business transformation.

Ryan commented, “Margins were up, despite increased pension costs and a decline in claims services results, which shows that most of our brokerage businesses have performed better than last year. Excluding the claims services decline, the second quarter brokerage margin was in line with our original expectation. There is seasonality within the year, and our brokerage margins are highest in the fourth quarter. Given our current outlook, we continue to expect that the 2003 brokerage margin will exceed full year 2002.”

Reinsurance operations, particularly in the U.S., had excellent results and U.S. retail brokerage and managing underwriting improved significantly from a year ago, driven by higher retention rates and new business development. International brokerage continued to have solid results. In claims services, actions have been and are being taken to improve the financial performance of this business.

Consulting revenue rose 19 percent to $294 million, or 9 percent on an organic basis. Human resource outsourcing was the principal growth area with 26 percent organic revenue growth. Non-outsourcing business grew 5 percent on an organic basis, mostly due to slower hiring and less discretionary spending by clients in response to challenging economic conditions.

Pretax income was $21 million compared with $23 million one year ago, and the pretax margin was 7.1 percent versus 9.3 percent. An increasing mix of lower margin outsourcing business factored into the comparisons; however, the profitability of these multi-year contracts is expected to improve in future periods.

Insurance Underwriting revenue was $692 million compared with $750 million in second quarter 2002. The decline in reported revenues was primarily the result of the “back-to-basics” strategy within A&H underwriting that was announced in fourth quarter 2002. Additionally, investment income decreased $11 million, primarily from the runoff of guaranteed investment contracts.

Organic revenue growth, based on written premiums, was 8%, driven by credit and select property and casualty premiums.

Pretax income was $64 million compared with $2 million in second quarter 2002. Pretax margins grew to 9.2 percent from 0.3 percent. Excluding a previously reported $3 million special charge in second quarter 2002, pretax income was $5 million and the pretax margin was 0.7 percent. The “back-to-basics” focus in accident and health (A&H) underwriting significantly improved the benefits payout ratio, which contributed to the margin increase.

Second quarter 2002 results included a $15 million pretax non-claim litigation reserve and a $36 million pretax expense related to the termination of NPS, an independent managing general agent.

Corporate and Other segment revenue of $44 million improved from a negative $91 million in second quarter 2002, due mostly to lower impairment write downs and increased income from equity securities. Investment income in second quarter 2003 included $21 million from an increase in the value of Endurance Specialty Holdings Limited warrants. Aon co-sponsored the formation of Endurance in 2001 and made an initial investment of $227 million.

The Corporate and Other segment pretax loss was $15 million compared to a pretax loss of $153 million a year ago, principally due to improved revenues. A $9 million unusual WTC charge was incurred in the quarter. This previously anticipated charge, originally noted in Aon’s first quarter 2003 earnings release, relates to temporary office space secured in Manhattan following the WTC disaster. Aon has included these costs as part of its WTC property insurance claim, which continues to be processed.

Financial Strength Highlights
Total debt decreased to approximately $1.76 billion at June 30, 2003 from $1.79 billion at Dec. 31, 2002. Preferred securities outstanding were $752 million for both periods. Stockholders’ equity was approximately $4.3 billion at June 30, 2003, up from $3.9 billion at year-end 2002. At June 30, 2003, Aon’s total debt and preferred securities as a percentage of total capital improved to 37 percent from 40 percent at Dec. 31, 2002.

Approximately 90 percent of Aon’s investment portfolio at quarter end was in short-term and fixed maturities. More than 95% of the fixed income securities were investment grade.

Aon’s senior debt is rated “A-” by Standard and Poor’s and Fitch, and Baa2 by Moody’s. Aon’s principal insurance underwriting subsidiaries are rated “A” by A.M. Best for their claims paying ability.

Accounting and Disclosure Changes
In May 2003, the Financial Accounting Standards Board (FASB) issued FAS Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This Statement establishes standards for classifying and measuring as liabilities certain financial instruments that embody obligations of the issuer and have characteristics of both liabilities and equity.

Beginning third quarter 2003, in accordance with FAS 150, Aon will reclassify as liabilities its Redeemable Preferred Stock ($50 million) and Trust Preferred Capital Securities ($702 million). The amounts reclassified will be at fair value.

The difference between fair value and book value at July 1, 2003 will be reflected on the condensed consolidated statements of income as a cumulative effect of change in accounting principle, net of tax, in third quarter 2003. Changes in the fair value after July 1, 2003 will be reflected in interest expense. Dividends paid on the Capital Securities (currently shown as minority interest, net of tax on the condensed consolidated statements of income) and the Redeemable Preferred Stock will also be included in interest expense in future quarters.

Future Outlook
“We had solid organic revenue growth in the quarter and brokerage margins have improved year-over-year,” Ryan said. “We have recruited some excellent new talent into our organization, and our franchise has never been stronger in terms of delivering valuable services and products to our clients. Margin expansion is a key focus, and we are working to improve margins in each of our operating segments.”

Ryan added, “Based on our current outlook, we remain comfortable with a 2003 earnings per share range of $1.90 to $2.00, excluding unusual WTC charges and the impact of FAS 150.”

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