AON Corp. Q3 2008 Earnings Conference Call Transcript

Aon Corporation (AOC)

Q3 FY08 Earnings Call

October 31, 2008, 8:30 AM ET

Executives

Gregory C. Case - President, CEO and Director

Christa Davies - EVP Global Finance and CFO

Analysts

Meyer Shields - Stifel Nicolaus & Company, Inc.

Brian Meredith - UBS

Jay Cohen - Merrill Lynch

Keith Walsh - Citigroup

Jay Gould - Barclays Capital

Daniel Johnson - Citadel Investment Group

Mathew Heimermann - J.P.Morgan

Presentation

Operator

Good morning ladies and gentlemen and thank you for holding. Welcome to Aon Corporation's Third Quarter 2008 Earnings Conference Call. At this time all parties will in a listen-only mode until the question-and-answer portion of today's call. I would like to remind all parties that this call is being recorded. And if anyone has an objection, you may disconnect your line at this time.

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 Reform Act of 1995. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those 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 over to Mr. Greg Case, President and CEO of Aon Corporation. Please go ahead, sir.

Gregory C. Case - President, Chief Executive Officer and Director

Thank you, John. Good morning everyone. And welcome to our third quarter 2008 conference call. Joining me here today is our CFO Christa Davies.

As just as we've done in the last few calls, I'd like to cover three areas before turning the call over to Christa for further financial review.

The first, area is our performance against key commitments to shareholders. The second is around continued areas of investments across Aon. And, the third is around our overall organic growth performance.

To begin, I want to offer that from our team's perspective the results posted for third quarter 2008 represent another quarter of continued progress and momentum. Irrespective of the economic conditions, significant disruption in the marketplace or other challenges outside our control we continue to execute on our plans to substantially strengthen our firm for long term and shareholder value creation.

On the first topic, our performance versus commitments, as we do each quarter, we measure our performance against three metrics we committed to shareholders; grow organically, expand margins, increase earnings per share. Our operating plans are committed to achieving all three outcomes over the course of each year, not necessarily every quarter. Further, we said we would not sacrifice one of these metrics for another.

As I have already commented our results reflect overall, a quarter of continued progress against our goals; despite soft market conditions globally, weak economic conditions in the U.S, and very strong performance in third quarter of last year. Organic revenue growth was 2% overall, with growth across most businesses in our brokerage and consulting segments. Adjusted pretax margin increased 114 basis points. And EPS, the third metric on an adjusted basis, increased 33%. When you look at our results across the organization and compare to the industry, they represent meaningful progress from Aon colleagues who are devoted to building our firm during an unprecedented time of turmoil and opportunity in the insurance industry.

On the second topic, further areas of investment; as we've discussed before, our team is excited about the industry. We believe long term, the aggregate level of risk continues to increase in complexity and size around the world. And as a result, neither our clients are increasing. Events over the last few months reinforce our conviction that demand for the advise and service we provide is expanding. During the quarter, we continued to build on industry leading global capabilities with significant investments across the organization. A few examples include, in retail brokerage we had a key hires in construction in our affinity business and expanded our geographical presence in Latin America and emerging markets such as China, India and the Middle East.

In reinsurance, our biggest news was the announcement on August 22nd, that we've agreed with Benfield to come together to build the reinsurance franchise of unique capability and skill. Over the last 70 days since the announcement, our team has been working closely with grandchildren and our new team members to shape our future reinsurance firm.

The reaction from clients and colleagues around the world has been exceptionally positive, which has reinforced our excitement to have team members from Benfield, join us later this year, once the transaction closes. And on that topic, we continue to expect to close by the year end and have management plans in place and detail immigration plan ready to go from day one.

In consulting, we had a leadership in our benefit business globally and emerging markets in Asia Pacific, and in our U.S leadership team. These categories highlight just a few of the investments we're making to further strengthen our capabilities and better serve our clients.

One key point that we covered in our last call, as investors it's important that you understand these investments are being made in the context of our overall margin improvement efforts as we continue to build our firm removing inefficiency in costs from non-client facing areas Finance, HR, IT to fund the client facing capabilities we have and simultaneously improving margin over the course of the year.

We can do this in ways other firms may not be able to given how we came together over the last 20 years. First we'll talk about our efforts in this area as we increased overall cost savings commitment by $60 million in the quarter. The key take away here is we continue to make new investment in our firm and remain excited about our, one fundamental client serving capability continues to strengthen around the world.

And finally on the third topic of growth I'll highlighted our organic growth for the quarter across each of our primary business segments, starting with brokerage. Overall organic growth for the segment was 2% despite tough market conditions globally. This marks the twelfth consecutive quarter of organic growth highlighting the strength of our global platform and industry leading product capability.

Pricing was down on an average mid to single digits globally in both retail and reinsurance. Retention rates were 90% or better on average, highlighting strong client satisfaction. We continue to benefit from investments in many areas such as faculty and reinsurance and in our emerging markets. And, we had strong double digit growth in new business in several areas across the firm including New York, Affinity, Latin America, Middle East, South Africa and African region.

These are particularly impressive results in a period of significant destruction in the industry. During the quarter we took unprecedented steps to support our clients globally with the establishment of the Aon situation room a 24/7 response group, staff of brokers in four locations around the globe to respond and provide advice to clients.

The situation room was accessed directly by over 10,000 clients and contacts and answered over 2000 questions from existing and potential clients. We held six conference calls with clients that included Aon leadership, US legislators and executive management from several insurance carriers. And we developed ten new product ... capital products from scratch that provided solutions around career insolvency, pre-brokered market placements, captive funding solutions and credit raps; just to name a few.

And we were recognized by the insurance insider for our quote; notable success and quote; in providing proactive communication to clients. The recognition for an effort we believe creates substantial value for clients.

Turning to the individual regions across retail brokerage and reinsurance in the Americas, organic revenue increased 1%. It was represented strong performance of Latin America and Canada with improve results in new US retail. Overall retention rates were strong at 90% or better. However, our premium financing business, Cananwill had a difficult quarter, as available credit tightened making this add-on service for our clients less attractive.

Excluding this impact, organic growth in this region would have been 3%. And going forward, we're evaluating alternatives for this business. And this follows, our continued focus on strengthening core assets, and is similar to the agreement we announced to exit our personal line auto insurance business AIS.

Overall, we believe our results in the Americas don't fully reflect the underlying strength of improvements we're seeing in productivity and collaboration across the core businesses within this region. The underlying trends continue to strengthen, and we like the prospects in the Americans. In Europe, Middle East and Africa, yet another strong quarter of organic growth of 5%. Retention rates were above 90% on average driven by our number one position in most markets. Pricing is relatively less typical on average in the near region. And we saw double digit growth in emerging markets such as Africa and the Middle East, and solid growth across most countries in continental Europe.

We are getting early benefits from deployment of our revenue engine and local marketing campaigns, and we continue to invest across the region and in the emerging markets. In Asia Pacific, organic growth was 1%. We had double-digit growth in emerging markets such as China and Hong Kong. However, results continued to be affected by weakness in a specific part of Japan around certain regulatory changes. And we have a set of an issue that we're driving here and expect to have the issue resolved by year-end.

Overall, solid platform of leadership positions in Australia, New Zealand, China, and across the region as we continue to invest in the emerging markets. Turning to the U.K, organic revenue decreased 1%. We had very solid retention rates at 90% plus, but we saw weaker trends in our network business offset by modest growth in our U.K retail business.

Finally in brokerage turning to reinsurance, organic growth of 1%, was driven by growth in faculty replacements and wins in new business treaty. To-date, much of that progress has been offset by higher seat and retentions in soft pricing. Our colleagues who joined us from Gallagher are performing very well, and meeting all of our expectations. We're very excited to have this group on Board. Our efforts in reinsurance continue to provide our clients with a unique integrated solution around capital management, number one in treaty, number one in facultative and the number one broker in capital markets.

Turning to our consulting segment, overall organic growth was 6%, a solid quarter. Growth in our core services business is 8%, with solid results across most practices including health and benefits, retirement and most notably, our compensation practice. During the quarter, we benefited from strong demand for compensation surveys that are normally offered during the fourth quarter. In outsourcing, we saw a modest growth in our benefits outsourcing business offset by a decline related to previously announced termination of a significant outsourcing contract overall, a good quarter of progress in the consulting group.

In summary, as our team reflects on results, quite simply it's a quarter of continued progress against our goals. Despite difficult market conditions, risk is increasing. We're in a position of strength to continue delivering progress in each of our key three performance metrics, while investing strategically throughout operating results and a balance sheet to provide significant financial flexibility. We are working hard to build on our leadership position with our clients and markets, and the team feels good about our continued progress for the third quarter and the outlook going forward. I am now pleased to turn the call over to Christa for further financial review. Christa?

Christa Davies - Executive Vice President Global Finance and Chief Financial Officer

Thanks, Greg. Good morning everyone. As Greg noted, our third quarter results reflect continued progress with improvement across our three key financial metrics despite a difficult market environment. We continued to invest in building our global capabilities with the announced acquisition of Benfield and we also believe that we are effectively managing capital, as we returned more than $400 million of capital to shareholders through our share repurchase program.

Regarding our definitive agreement to acquire Benfield Group, we have received shareholder approval and regulatory approval from the FSA in London. We continue to believe the transaction is on track close by the end of 2008. In October, we signed a definitive agreement to sell our personal lines automobile in insurance business AIS for $120 million in cash and potential earn out of $34.7 million, highlighting our continued focus on streamlining core assets around risk advice and human capital management. The result of this business was placed into discontinued operations during the quarter and the transaction is expected to close in the first quarter of 2009.

Turning to continuing operations, EPS was $0.52 a share for the third quarter up 27% from the prior year quarter. There are several items that we have highlighted, which we think are important to understand in assessing core performance. First, restructuring charges in the third quarter with $54 million or $0.13 per share, second; we recorded $6 million or $0.02 per share to the previously disclosed review in compliance activities related to the Foreign Corrupt Practices Act. Third, we incurred $6 million or $0.02 per share of transaction cost related to the acquisition of Benfield. Consequently, we reviewed the core EPS performance of our continuing operations of $0.69 a share up 33% over the prior year quarter. Also included in the results, foreign currency translation had a favorable impact of approximately $0.04 per share, due to the fluctuations in the U.S. dollar against most major currencies.

Before turning to the business segment, let me spend a moment on the 2005 and 2007 restructuring programs. Key initiatives that are enabling concurrent funding in investments and delivering meaningful margin expansion. Related to the 2005 program the actions necessary to generate the savings are complete. We achieved approximately $6 million of incremental savings in the quarter versus Q3 '07 and are on schedule to realize our $270 million savings target in 2008, which would reflect incremental savings of approximately $45 million for the full year 2008 compared to 2007.

With respect to 2007 restructuring program, we incurred $52 million of charges and achieved approximately $29 million of savings in the third quarter. As a result of opportunities to further streamline support functions globally, we now expect that we'll incur an additional $90 million of costs to achieve an additional $60 million of annualized saving. The majority will be achieved in the brokerage segment through workforce reduction.

In total, the 2007 restructuring program is now anticipated to incur approximately $450 of total cost. To achieve $350 million ... sorry $300 million of annualized savings in 2010. This is the same return as the previous program with larger savings. We've only just begun to realize the benefits of this program with $46 million or $0.15 of the total annualized savings achieved today.

The increase in savings related to the 2007 restructuring program is separate from the 65 million pounds of cost synergies we expect to achieve once we complete the acquisition of Benfield Group.

Now let me talk about each of the segments. In our brokerage segment, adjusted brokerage pre-tax income increased 1% or $3 million to $247 million. Adjusted pre-tax margin decreased 50 basis points to 16.8%. As a result of an $8 million decline in the investment income, a $7 million decline in our Cananwill premium financing business, continued investments in key talent, partially offset by benefits related to restructuring. Both investment income and Cananwill have been affected by turbulent financial credit markets and we are currently evaluating strategic incentives [ph] to Cananwill. The impact of both lower investment income and Cananwill had a negative 80 basis points impact on brokerage margins during the quarter.

Overall, we remained pleased with our core operational performance and are fully on track with our long term target to brokerage. I would point out that adjusted brokerage margins for the nice months year-to-date excluding certain litigation cost has increased 70 basis points, even as we are now just beginning to ramp up savings related to the 2007 restructuring program.

Moving to consulting segment adjusted pre-tax income increased 36% to $53 million. And the adjusted pretax margin increased 370 basis points to 15.7%, a really strong for performance for the quarter as total operating expenses decreased 1%, reflecting solid expense discipline, and benefits related to the 2007 restructuring program.

Additionally, as Greg previously noted, the group benefited from strong growth in certain compensation products that are normally distributed in the fourth quarter. We would expect the business to remain a mid teens margin business on an annual basis.

Now, let me discuss a few items within the unallocated section. Unallocated investment income for the quarter was $40 million, an increase of 21% million from the prior year quarter. Primarily reflecting a $13 million increase in distributions received from our pep securities, and higher interest income generated from an increase in cash balances.

Distributions related to pep securities are subject to completed transactions in the underlying portfolios. As we've said previously, these distributions are inherently uncertain in planning. For Aon Corporation overall, we continue to invest significantly in building our capabilities to drive future revenue growth, while managing expenses, and concurrently driving margin improvement.

As Greg said, we're committed margin improvement over the course of each year. I would note that total adjusted pretax margin for the nine months year-to-date is up a 110 basis points. Lastly, the effective tax rate on continuing operations was 27.8% in the quarter, including a 29% underlying tax rate on operations. For 2008, we anticipate that the effective tax rate on continuing operations will be 29%, as compared to previous expectations of 30%, due primarily to changes in geographic distribution of income.

Now let me turn to capital management. During the third quarter, we repurchased $9.3 million shares of $426 million of common stock. Shares of actual common stock outstanding at the end of the quarter declined $8 million to $270 million at September 30, compared to $278 million at June 30.

As of September 30, the company had approximately $850 million of remaining share repurchase authorization. We do not expect to repurchase shares during the fourth quarter, due to the pending transaction of Benfield Group. However, we anticipate completing this program by the end of calendar year 2009.

Cash and short term investments were approximately $2.4 billion at September 30, compared to $3 billion at June 30. Cash and short term investments declined primarily, due to $426 million of share repurchase, and approximately $363 million of tax payments associated with the Zaca [ph] transaction, offset by cash flow from operations during the quarter.

Total debt outstanding at September 30 was $2 billion, and debt-to-capital was 24.8%, reflecting a solid balance sheet with significant financial flexibility regarding capital allocation.

As we've discussed before, capital allocation decisions are driven by our risk adjusted return on capital process for potential uses of capital that may include share repurchase which has been our primary use of capital, acquisitions, organic investments, dividends and pensions.

On the topic of pensions, we realized that many of you may have questions regarding what the impact of year-to-date asset performance could have on our overall pension plans. Please realize that there are many factors which can influence the ultimate outcome. None of which is certain until we go through our official measurement date, at 12/31/08.

I am going to talk through the unfunded status, pension contributions and pension expense. Starting with unfunded status; at the end of 2007, the unfunded status of the combined pension plans was $983 million. Combining weak asset performance with widening credit spread to the liabilities and changes in foreign currency, we believe the estimated unfunded status as of October 24, was approximately a $1 billion; relatively unchanged since the beginning of the year.

Pension contributions, we expect to contribute approximately a $182 million of contributions in 2008. This number is subject to change for 2009, depending on management discretion to contribute additional cash or non-cash funds to the pension plan, changes in actuary assumptions, or changes in regular sort of requirements. Pension expense; pension expense for 2008is expected to be $75 million. Regarding 2009 pension expense there, is uncertainty in this number due to market segment [ph].

The three major market variables that drive pension expense year-over-year are number one, asset returns, number two FX rates, and number three, discount rates. Our major plan sensitivity is market variables as of 12/31/2007 were number one asset returns. A 10% decline in asset returns, increases pension expense by approximately $55 million. Similarly, a 10% increase in asset returns, decreases pension expense by approximately $55 million. Number two, the U.S. dollar pound exchange rate, a 10% appreciation in the U.S. dollar versus the pound, decreases pension expense by approximately $5 million. Similarly, a 10% depreciation in the U.S. dollar versus the pound, increases pension expense increases pension expense by approximately $5 million.

Number three, discount rate; a 100 basis point increase in discount rate, decreases pension expense by approximately $70 million. A 100 basis point decrease in the discount rate, increases pension expense by approximately $80 million. Keep in mind that these are point and time estimate of market sensitivity, and can change materially, depending on market segment. All of these amounts are based on the measurement dates of 12/31/07.

Obviously, we have not been through the 12/31/08 official measurement date, and there are other variables that will also drive pension expense, such as mortality and plan changes. You should expect that we are doing everything possible to manage pension expense. We hope you find it helpful, and continue to reiterate these are only estimates that could change materially between now and our official measurement dates. However, we want to be clear that resulting changes in pension expense which could ultimately be up for 2009, will not deter us from reaching our 20 plus percent target margin in brokerage.

In summary, risk is increasing globally, and we continue to streamline our assets around two of the most critical issues facing clients today, risk and human capital management. We continue to drive solid results, against our key financial metrics, in a challenging environment.

We are accelerating the benefits of our cost saving programs, funding investments for long term growth, and delivering concurrent margin improvement. Our balance sheet is strong and our liquidity is excellent. As we continue to drive value creation through improved business results and effective capital management. With that I'll turn the call over to the operator and we'd be delighted to take your questions.

Question And Answer

Operator

[Operator Instructions]. And first got to the line of Meyer Shields with Stifel Nicolaus, please go ahead.

Meyer Shields - Stifel Nicolaus & Company, Inc.

Thanks. Good morning, everybody.

Christa Davies - Executive Vice President Global Finance and Chief Financial Officer

Good morning Meyer.

Meyer Shields - Stifel Nicolaus & Company, Inc.

You've expensed a lot of effort I think discussing I guess, the AIG situation, with clients. And I was wondering whether you expect any increase in long term remuneration from the current term that AIG is undergoing.

Gregory C. Case - President, Chief Executive Officer and Director

Meyer, as we've talked about, first of all obviously, there is trauma in the marketplace, not only with AIG, but other markets as well. And as we look at overall remuneration, our focus is, as it always is, on client value and delivering for clients. And we're going to continue to focus on that and drive that. I think that for us is best evidenced by what we've, in fact have done over the last few weeks. On the leadership of Steve McGill and Ted Devine, we pulled together this situation room, and spend a great deal of time and energy, really helping our clients understand what was going on in the marketplace, helped our clients make very important decisions that would support their businesses going forward.

And our view and our conviction is that, as we continue to do that and our clients succeed that Aon is going to ultimately benefit. And we'll always come back value the price. We will be the highest valuer of price in the world, in what we do. And we believe in the context of doing that helping clients understand the value we provide that we're going to get, we get paid for that. And that is in fact the case.

Meyer Shields - Stifel Nicolaus & Company, Inc.

I guess, on a related note, can you talk about why AIS is considered non-core?

Gregory C. Case - President, Chief Executive Officer and Director

Well AIS, as you look at it, the business overall, like many of the businesses we have, and have had at Aon that was a terrific business, much of it was combined in warranty and other businesses. We step back and think about what we do everyday, what we're really doing is focused on the ... on commercial lines, on commercial companies. And helping commercial firms, and insurance firms understand and mitigate risk. And take action that can help drive value in their firms, on the risk side.

Obviously, we also have the complement of efforts on the human capital side too. But on the risk side, we're really focused on commercial companies. In the case of AIS, we are described as a firm, which is a personal lines focused company. Not commercial lines focused company in one state California. S it was a much more narrow version of when you think about risk overall, which is why in our view, it was not part of the overall core focus of Aon.

Meyer Shields - Stifel Nicolaus & Company, Inc.

Okay and state somewhere to that in terms the non U.S., personal lines brokerage units?

Gregory C. Case - President, Chief Executive Officer and Director

I'm sorry again, I am sorry?

Meyer Shields - Stifel Nicolaus & Company, Inc.

When we look at non U.S. brokerage units, should we think that those are also detestable?

Gregory C. Case - President, Chief Executive Officer and Director

From the personalized, we actually don't have anything across Aon that is anywhere remotely close to what we would describe AIS as being. It was in fact a very contained, very focused effort around personal lines through one primarily, one market in California. So a very, very different situation than anything we believe we have across Aon.

Meyer Shields - Stifel Nicolaus & Company, Inc.

That's helpful. Thanks so much.

Gregory C. Case - President, Chief Executive Officer and Director

Sure.

Operator

And next the line of Brian Meredith with UBS. Please go ahead.

Brian Meredith - UBS

Hi, good morning.

Gregory C. Case - President, Chief Executive Officer and Director

Hi, Brian.

Brian Meredith - UBS

Couple of questions here, first Greg, can you talk a little about what's your view right now of what market conditions should look like you're going forward from a pricing standpoint, given all that's going on in the marketplace and the big loss in that portfolios et cetera?

Gregory C. Case - President, Chief Executive Officer and Director

Sure Brian, happy to do that. I think and obviously, everyone at this point is opining on this. So we'll provide our perspective. But from our view this is going to evolve over the next few months, and over the next year. But, if we really break you're question into two parts; one is the impact of price up through now in Q3 and then thinking about trends going forward into Q4.

Through Q3 what we've seen is, it's continued to decrease, slowdown. But the slowdown the decreases has been at a decreasing pace. So it's much like what we talked about last quarter, you're seeing market decreases, in the services 10%, 12% in Q3, which was down from 15%, 16% in the same quarter last year. For us what we saw was a decrease in mid single-digits across our broking operations and pricing down in most categories. Even things like D&O, where you would expect to see significant limits I would tell you we tracked a 191 specific situations, Mike Rice, he runs FS, he does this for us and it was down 5%.

So even in D&O overall price was still down in the third quarter, with some obvious notable exceptions, [indiscernible] serves us well, being one very clear one in D&O. But so net, net, up to now, trending down but at a slower pace when you think about where things are going, I would reflect, first of all, our role here is to get best value for our clients. And that's a function of price, terms and conditions everything else. And we're not going to see at any ground any time, when we think about that overall mission.

But there clearly are pressures now that didn't exist that weren't here, last quarter. And you mentioned a few, but we just wanted to tick them off, I guess. Ike and Gustav have probably come in at higher clients than we initially where there was initially estimated. We have the asset value deterioration that you've talked about. Investment returns are under pressure, capital costs are higher, combined ratios as we look at the markets have gone up.

But we still view those as, time is going to tell. We'll see how this evolves over the coming months. We clearly see more stability, in the overall pricing structure right now. There are still points, D&O, energy, specialty, et cetera that clearly is one we're going to movement on the price front it would be in these arenas. But from our standpoint and we're going to stay with its, continue to be decrease in our stable with an outlook that's to be determined.

Brian Meredith - UBS

Okay, great. And then next question, wonder if you could tell us how much of your business is placed with the AIG?

Gregory C. Case - President, Chief Executive Officer and Director

We ... given what we do around the globe, we move about $60 billion in premium overall, a year, which is more than anyone moves across the world. AIG is our most significant, one of our most significant markets. So we place a significant amount with AIG. And we're not going to give out the exact numbers, but you can, you can imagine we're up in the 8%, 9%, 10% arena.

Brian Meredith - UBS

Okay, great. Thanks.

Operator

Our next question is from Jay Cohen with Merrill Lynch. Please go ahead.

Jay Cohen - Merrill Lynch

Yes, thank you. Number of questions, let me start with the reinsurance market, obviously you're making a bigger investment, reinsurance timing may be quite good I know you didn't think about it when you made the acquisition. But were you seeing or expect to see, relative to reinsurance, regarding demand for reinsurance. Because a lot of what you talked about before, kind of you think would drive demand for reinsurance. I guess, I want to know what your discussions with clients are like and are you beginning to sense that demand for reinsurance is going up as you plan for these one, one renewals.

Gregory C. Case - President, Chief Executive Officer and Director

Well, what we see very much is a phenomenon out there that's very clear as we talk to our clients, which is the cost of volatility right now for our clients is at an all time high. You don't have to do anything more than just look at the analysts reports as they've come out, or the earnings reports that they've come out, to see the impact on stock, when earnings are missed. Just look at the ones that have come out over the last week.

So as we talk to our clients on a reinsurance side, there is very, very real discussions around, how we can help them, manage volatility, in ways that really are unprecedented. So in that context, we come back to what Christa and I have both talked about before on the calls, is that that the value of what we do, we believe that's continuing to increase in the global economy. We believe it's true on the retail side for large corporates, and for middle market firms and small firms. And it's never been more true, never been more true than it is right now on the insurance side.

So in fact the factors I went through on the pricing front, when you think about asset value deterioration, investment returns down, cost of capital up, combined ratios up, this is the time when capital management becomes most important. Then which really comes back to why we're so excited about a firm we have, Aon Re Global is the largest tree firm in the world, largest facultative, largest capital raising, which means we can have a very meaningful discussion with clients on the topic of integrated capital management. And now with our Benfield colleagues joining us, we truly are going to build a unique capability that we think can help ensure us be more and more successful, which will serve then very well, at a time of high need, and we believe it will serve us and our shareholders as well.

Jay Cohen - Merrill Lynch

That's great. And then just one follow-up if you don't mind, on the pension you mentioned the discount rate, obviously being one of the factors, what do you base your discount rate assumptions on, because if you'll ask me what interest rates are doing, I have to say which interest rates, risk free, risk adjusted. And I'm wondering what you look at, when you come up with your discount rate?

Christa Davies - Executive Vice President Global Finance and Chief Financial Officer

We obviously have our own propriety internal model with discount rates. So that's probably not particularly helpful for you. I mean, the discount rate for the U.S pension plan is really driven off the double AA rated bonds. And then obviously, we've got substantial assets in the UK. And the discount rate there is really based on the iboxx non gilt bonds on the Merrill Lynch bond index. So I hope that sort of helps you in terms of estimating that discount rate and how it might change overtime

Jay Cohen - Merrill Lynch

Yes more related to corporate bonds, it sounds like versus treasuries.

Christa Davies - Executive Vice President Global Finance and Chief Financial Officer

Yes, that's correct.

Jay Cohen - Merrill Lynch

Very good, thanks Christa.

Operator

And next from the line of Keith Walsh with Citi, please go ahead.

Keith Walsh - Citigroup

Hey good morning everybody.

Gregory C. Case - President, Chief Executive Officer and Director

Hi Keith.

Christa Davies - Executive Vice President Global Finance and Chief Financial Officer

Good morning.

Keith Walsh - Citigroup

The first for Christa just to get back on pensions. So if just and very helpful thank you for walking for those assumptions there. If I just use some simple quick math if I say, asset return is down least 20%, FX helps you guys a little on the discount rate up a 100 BIPs, we're looking at a $40 to $60 million headwind potentially for the next year, the year ended today, is ... would that be a fair statement?

Christa Davies - Executive Vice President Global Finance and Chief Financial Officer

It's in the ballpark Keith.

Keith Walsh - Citigroup

Okay. And then would it also fair to say that that the $40, $60 million could be partially offset by the increased expense saves next year as well as other changes and assumptions that you could do?

Christa Davies - Executive Vice President Global Finance and Chief Financial Officer

It's definitely true to say Keith. The increase in our restructuring program that we announced today which is increasing our savings from $240 million to $300 million for the 2007 restructuring program is improving the savings year-on-year.

So previously, we had $240 million program which was $50 million $70 million this year, $175 million, $200 million next year and $240 million in 2010. That's now increasing to $75 million to $80 million in 2008, $220 million to $245 million in 2009 and $300 million in 2010. So you can see the 2008 and 2009 really has an incremental $145m to $165 million in savings year-over-year and the majority of that as we described is going to be in brokerage.

Now, obviously there are a lot caveats around that sort flowing through the margin as we reinvest some of that and there are a lot of other factors that could impact our business.

Keith Walsh - Citigroup

Okay. And then just on FX hedge, I know I have read in your guys Qs, you always put in there, that you use some forward contracts and then may be if you could just talk to that a little bit, what exactly you guys do to mitigate some of the movements in currency?

Christa Davies - Executive Vice President Global Finance and Chief Financial Officer

Yes, Keith one of the things we have talked about before is that we do hedge in particular, transaction exposures where we have them across the firm. And we obviously operate in a 120 countries and the revenue and income in these countries is in local currency.

There are a couple of exceptions to this, the largest of which is the UK where we have a portion of our revenue around 30% in U.S. dollars. We have a pound expense base and we hedge this mismatch. And we do have this mismatch using options so we can lock in the downside of weakening U.S. dollar but participate in the U.S. dollar strength. And as you think about FX rate going forward, obviously we view today's rates as the best indication of future rates. But on the income side if you think through the impacts, there are really four major currencies we have exposure to; the euro, the pound, the Canadian dollar and the Australian Dollar.

Keith Walsh - Citigroup

That's great. And then one for Greg, just on Benfield, in the context of a stronger dollar and what you're paying for it but then also in, when you guys price this deal, what were the ... in the accretion estimate that you gave us, what were your assumptions for market pricing at that time and then may be if you can give us some sensitivity or may be you don't want to do that, but like if ever lot of people talk about market hardening going on, it would seem there is significant upside in this deal based on that, thanks?

Gregory C. Case - President, Chief Executive Officer and Director

Well Keith, I'll start with the overall pieces on Benfield and then Christa can talk a little about the impact of the exchange rates over the last few weeks.

I really want to emphasize that the rationale and everything that went into the decision to partner with our colleagues in Benfield was very much around building capability for the future and what I was describing before helping clients succeed, obviously before the trauma. At that point as you might recall, everything was trending down and something we might say down at a decreasing pace but down. And those are in fact exactly the assumptions we built in to everything we did around the Benfield partnership and the Benfield transaction. And that's how we continue to think about it.

We believe the benefits of this are going to come ultimately in the value we provide the clients, but the impact on our financials as Christa and I described, were very much around a pricing environment which was downward trending. And whatever happens beyond that that will happen.

Christa Davies - Executive Vice President Global Finance and Chief Financial Officer

And then in terms of the FX movements related to the Benfield transaction price, we did hedge a substantial portion of the transaction currency exposure associated with the transaction. We hedged the majority of the transaction and it was really based on how we structured the transaction on which currency are actually being used to purchase Benfield. We did hedge this with options, so we've locked in the downside of a weakening U.S. dollar, but we are participating in the upside of U.S. dollar strength.

Keith Walsh - Citigroup

Great. Thank you, guys very helpful.

Gregory C. Case - President, Chief Executive Officer and Director

Sure.

Operator

And next from the line of Jay Gould with Barclays Capital. Please go ahead.

Jay Gould - Barclays Capital

Thanks and good morning.

Gregory C. Case - President, Chief Executive Officer and Director

Hey Jay.

Christa Davies - Executive Vice President Global Finance and Chief Financial Officer

Good morning, Jay.

Jay Gould - Barclays Capital

On the dislocation with AIG, given they're one of your largest trading partners, should we view that as a headwind for margins in 2009, as a fair amount of that businesses is likely to be replaced.

Gregory C. Case - President, Chief Executive Officer and Director

See Jay, I wouldn't at all. Partly, this is to again what we come back to first principal that's about Aon and mostly about our clients and serving our clients in a way that truly provides value for them, at a time of their highest need. We believe in doing that Jay. We're going to be rewarded very, very well.

And in the context of the situation room, all the stuff we set up and four client centers around the room, how we've interacted with clients, we feel very-very good about our position, and how we've helped clients in the time of difficulty. And as I've said before, it's not just AIG, there is difficulty around the entire around the set of markets with tremendous turmoil. Some emerging and taking steps forward. Some more neutral and some more negative. And in that context we believe we're very, very well-positioned to help clients succeed. But also, just to remind there is still ... even though we're talking about the stresses on capital, there remains a significant amount of capital around the world and in essence what we are doing is helping clients match needs with capital. And we believe that opportunity is and remains quite substantial.

Jay Gould - Barclays Capital

I understand the foremost effort in terms of helping clients meet the need, and I'm just trying to understand what that means for Aon. It figures ... if that's the reason there's going to be a lot more work to place the same amount of coverage in say 2009, versus 2008 or 2007 is that reasonable to expect?

Gregory C. Case - President, Chief Executive Officer and Director

I would say a couple of things. As everything in the current environment is there is lot's of puts and takes. There is potentially a significant amount of movement, which will require of work. But that's not anything new. We do lots of work on behalf of clients and that's fine.

I think being compensative for the work we do, we fully expect will be the case. And that has implications. I would also say it is when we think about all the efforts that we put in over the last year or so on commission list, and everything we've talked about, I would observe that in the current context, you can imagine where AIG is on that spectrum, in terms of compensation and commission and you might summarize they're not at the high end, they maybe at other end of spectrum.

So there is lots of implications that are kind of puts and takes in terms of implications for Aon that we believe we're actually ... we feel very good about. Again that's not the focus that's not what we're going to spend our time, well they're going spend their time on clients. But as you do the analysis again we're the biggest broker in the world. We move more flow than any one else. AIG happens to be our one of our largest markets. And they have to be at the one end of the spectrum on compensations. So I'll leave you to surmise what the implications might be.

Jay Gould - Barclays Capital

Fair point. And then separately on Benfield, my understanding is that seasonality of Benfield's earnings is much more driven towards the first half of the year than the second. Will there be more of a smoothing out in terms of the recognition of that once it's acquired by Aon?

Gregory C. Case - President, Chief Executive Officer and Director

Yeah, we're going to work that out as we get into it. And we'll describe to you how that's going to play out. Let us get this, get everything closed, which is very much on track and working very-very well, and we'll describe kind of the implications the next time we're together.

Jay Gould - Barclays Capital

Thanks again.

Gregory C. Case - President, Chief Executive Officer and Director

Sure.

Operator

And next go to the line of Dan Johnson with Citadel Investment Group. Please go ahead.

Daniel Johnson - Citadel Investment Group

Hi, thank you and good morning.

Gregory C. Case - President, Chief Executive Officer and Director

Hi Dan.

Daniel Johnson - Citadel Investment Group

Hi. Good morning. Greg, 3% organic in America, that was purely if we take the Cananwill situation out of math?

Gregory C. Case - President, Chief Executive Officer and Director

That's correct.

Daniel Johnson - Citadel Investment Group

Okay. It was I believe slightly down in the prior quarter, and I realize things can bounce around from quarter-to-quarter, but sort of 400 basis points sequentially its reasonably large. Is there anything you need to driving those particular numbers or how would you explain that? And I've got a couple of follow-ups as well?

Gregory C. Case - President, Chief Executive Officer and Director

Well, I would ... first thanks for the observation. Your analysis is right. That's roughly the quarter-to-quarter movement. But I would ... we don't get too excited or too excited either way. I think, we still think the organic growth numbers aren't where we want them to be. What I would say to suggest for us is, the thing we are ... we remain excited about is what we're putting in place, that's going to help build our firm long-term. So all the efforts around the revenue engine that have been put in place over the course of the last year, year and half, in the U.S., in Europe, across the world we believe are truly starting to have impact to pay dividends.

And our ability to ... if you think about what you just described a sequential quarter-to-quarter impact that was done in the context of very little to no PE and M&A, and obviously a tremendous amount of pressure on construction, which is a very, very important area for us.

And our colleagues are now able to actually understand exactly what's going on literally at the micro level city-by-city, product-by-product level, and react to that. So what we have begun to see is, as we think about the marketing efforts we put in place, the implications on new business, how we put efforts in place on retention they're really starting to have some real benefit for us and starting to pay off.

And we saw that really at the tail end of the quarter, in the third quarter, and we see it going into the fourth quarter. So for us it is starting to get the structural items in place that really help coordinate global Aon. When we coordinate our global firm, we're unbelievably impactful, and the efforts to date around the global ARS with Steve and Ted driving, with the efforts around marketing within the context of that. We're having benefits really around the world, and that's clearly showing up in the U.S.

Daniel Johnson - Citadel Investment Group

Did the turmoil in the third quarter, help or hurt organic growth. And importantly margins as well, turmoil being obviously carrier issues I am speaking about?

Gregory C. Case - President, Chief Executive Officer and Director

Yes, from our standpoint in the third quarter I would ... the third quarter we view as more of an investment from the standpoint, and that's not a huge impact on margins, just in terms of what's happening. But there is a tremendous amount of activity, you think about the client connections we made, 10,000 clients coming into the website, 2000 clients interactions, six calls, these calls by a way down head, in the order with 1,000, 1500 clients on them. These are very significant events. And so there is a tremendous amount activity, and more investment in the third quarter versus benefit.

Daniel Johnson - Citadel Investment Group

Okay. And then finally, the expense saves, can you help me a little with the amount for were around I think is a $29 million from the '07 plan. It seems like we need to have a pretty meaningful step up to get to the '09 total savings. Can someone walk through the math about what we need to be seeing and how quickly will we what seems like a pretty big expense save step up begin to show in the numbers, thank you?

Christa Davies - Executive Vice President Global Finance and Chief Financial Officer

Sure Dan. So the first thing it's a $29 million was the savings in Q3 2008 and we are expecting to achieve $75 million to $80 million of savings throughout the calendar year 2008. And then as I mentioned, $220 million to $245 million of savings in 2009 and the full $300 million in savings realized by the end of calendar 2010.

Daniel Johnson - Citadel Investment Group

So what does that imply, actually I don't have all those numbers here in front of me, what does that imply for the fourth quarter of '08 in terms of savings needed to hit your new revised targets?

Christa Davies - Executive Vice President Global Finance and Chief Financial Officer

It's about $15 million incremental savings. So it's $50 million savings in total in the fourth quarter.

Daniel Johnson - Citadel Investment Group

Up from 29 in the third?

Christa Davies - Executive Vice President Global Finance and Chief Financial Officer

Yes.

Daniel Johnson - Citadel Investment Group

Okay. Thank you very much.

Gregory C. Case - President, Chief Executive Officer and Director

Sure.

Operator

And with a line of Mathew Heimermann with JP Morgan. Please go ahead.

Mathew Heimermann - J.P.Morgan

Hi. Good morning everybody.

Gregory C. Case - President, Chief Executive Officer and Director

Hi Matt.

Christa Davies - Executive Vice President Global Finance and Chief Financial Officer

Good morning Mathew.

Mathew Heimermann - J.P.Morgan

Hi. Christa I was hoping that ... all the discussion of FX has been helpful, but I guess simplistically am I hearing you right that at the end of the day with very little differential between revenue and expenses where basically at the end of the day translating back the income. And so, there is kind of a one-for-one impact therefore on year-on-year changes in currency exchange?

Christa Davies - Executive Vice President Global Finance and Chief Financial Officer

That will be a fair implication Mathew.

Mathew Heimermann - J.P.Morgan

Okay. Just want to make sure I had that right. The other question I had and this is kind of falling against question was, is there any business in 3Q or 4Q, I guess in more 4Q from cancel and rewrite, will that impact in any way how will we think about organic growth over the next 12 months?

Gregory C. Case - President, Chief Executive Officer and Director

We haven't ... Matt you've seen a tremendous amount, we'll highlight that to the extent it becomes relevant so you understand it, so you understand kind of ongoing organic growth, but that certainly wasn't the case in Q3 and we'll see how Q4 plays out.

Again, our focus here is not on the markets AIG or any specific market, it's really around delivering for our clients and we will keep you fully apprised to the extent there are specific implications for anyone or other quarter.

Mathew Heimermann - J.P.Morgan

Okay. And then I was hoping Greg that you could talk a little bit about how the change in the cost of capital broadly financial markets may impact specifically the pricing and availability of alternative capital providers and capital markets products broadly?

Gregory C. Case - President, Chief Executive Officer and Director

Well look, you don't know for sure Mathew, ... excuse me as how all these things are going to come together and I ... there is danger in picking one or two areas and in drying the correlation from one data point to what the overall implications going to be.

But look when you put all the pieces together, not relinquishing any ground on that what the overall impact is going to be, when you put the pieces together, with cost to capital increasing, the combined ratios increasing, investment returns coming down, what you really talking about is a capital position in the insurance, which is becoming more and more difficult and the alternative sources which had been robust till now given what's happening to overall capital markets are also under some constraint.

So you've got scenario in which you've got a high need for capital and constraints around that. From our standpoint, I've got to tell you we are indifferent in terms of the source. We're all about capital management for our clients which is why the positions we've got are quite privileged. Number one in 3D, number one in fact, number one in capital rising from a brokerage standpoint, so for us its really all about talking to clients about how to improve your return on capital and all the different sources to do that. But the implications are a higher need and it turns out the market place is become more difficult for alternative sources that you're afford been easier.

Mathew Heimermann - J.P.Morgan

And is it fair just to say simplistically as opportunity cost rise because of what's happening in financial markets that the price ... if leverage is down, opportunity cost is up for some of these providers at the price at which a product ... the pricing for a product to clear in '09 will be significantly higher than '08, just regardless of how traditional moves?

Gregory C. Case - President, Chief Executive Officer and Director

That would be a ... if one put those assumptions together, that would be absolutely correct.

Mathew Heimermann - J.P.Morgan

Okay. I appreciate, thank you.

Gregory C. Case - President, Chief Executive Officer and Director

Sure.

Operator

And we do have a follow up from Meyer Shields, please go ahead.

Meyer Shields - Stifel Nicolaus & Company, Inc.

Thanks. Really quickly, can ... I guess specifically can you quantify the amount of consulting business which is related surveys and move from fourth quarter to third quarter just for modeling purposes?

Christa Davies - Executive Vice President Global Finance and Chief Financial Officer

We can't, but it was reasonably small.

Meyer Shields - Stifel Nicolaus & Company, Inc.

Okay. And then a broader question, I know that the New York interest firm it's obviously been distractive with AIG, has there been any movement with regard to the ... the differences in compensation practices between the brokerage collecting contingence are not ... I know that [indiscernible] was working on that before AIG kind of imploded?

Gregory C. Case - President, Chief Executive Officer and Director

Meyer we haven't ... Steve McGill talked about it on our behalf as did a number of other leaders across the industry at the time we applied to the New York State Department of Insurance and the attorney general of New York for continuing the hearings. We think they're at exactly the right sort of topics around transparency what's right for clients. Again, its not about us, its about our clients. The clients certainly have a right or a benefit to understand whose working for them and what they're getting paid et cetera. But we haven't seen any movement since then, we're hopeful for a movement, we haven't seen any.

Meyer Shields - Stifel Nicolaus & Company, Inc.

Okay, thank you very much.

Operator

And we have a follow up from Jay Cohen. Please go ahead.

Jay Cohen - Merrill Lynch

Yes, if you could talk about how big the premium finance business is from an earnings standpoint. That'd be helpful. Because is hasn't sort of broken out, none of that visible. But clearly, we may expect to see a change going forward?

Christa Davies - Executive Vice President Global Finance and Chief Financial Officer

Yes, so Cananwill is obviously is our premium financing business providing short-term collateralized finance to businesses for the purposes of ... for the purchases of insurance. It's a fairly small business for us at around $40 million to $50 million in revenue today. It acts as a sales channel between our clients and bank institutions, and we're typically paid a fee for introducing our clients. The reduction in PCI during the quarter, included a one time cost related to an increase in our cost at funds, essentially our mark-to-market for the renewed pricing facility across the entire book.

We believe that PCI situation improved going forward, as we restructured the business and pushed through pricing increases. And longer term, we're evaluating strategical tenure to the business.

Jay Cohen - Merrill Lynch

That's really helpful Christa. Thank you.

Christa Davies - Executive Vice President Global Finance and Chief Financial Officer

Thanks Jay.

Operator

And with no further questions, I'll turn it back to you Mr. Case for any final remarks.

Gregory C. Case - President, Chief Executive Officer and Director

No final remarks. Just thank you everybody for taking part today. Christa and I very much appreciate it. Thank you.

Christa Davies - Executive Vice President Global Finance and Chief Financial Officer

Thank you.

Operator

Ladies and gentlemen that does conclude your conference for today. Thank you for your participation. You may now disconnect. .

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