New York Atty. Gen. Eliot Spitzer is circling Aon Corp., investigating possible wrongdoing and pushing for changes in the way the company does business.
And that may not be the worst of it.
Spitzer’s continuing, wide-ranging investigation is just the biggest headline in a list of problems and challenges that have beset the world’s second-largest insurance broker. At a time when Chicago-based Aon could be seizing on the legal troubles besetting its chief rival, Marsh & McLennan Cos., it instead is struggling to deal with a host of challenges:
– Succession
Aon’s search for a new chief executive, to replace company founder Patrick G. Ryan, has been stymied by concerns over Ryan’s plan to remain as chairman despite giving up the CEO title.
– Revenue losses
Aon has not laid out a plan to recover the money it will lose by giving up controversial payments that will reach $167 million for Aon. Profit margins already lag industry rivals.
– Strategic floundering
Past attempts at restructuring have faltered, leading to losses of brokers and clients. And Spitzer’s probe likely will force more wrenching changes.
– Litigation explosion
A costly settlement with Spitzer is likely. Other private lawsuits abound.
Add it up, and Aon is facing its most crucial period since Ryan formed the company by merging his Ryan Insurance with W. Clement Stone’s Combined Insurance in 1982.
“The potential uncertainty is as high as it’s ever been,” said Adam Klauber, an analyst with Cochran, Caronia Securities in Chicago.
The biggest question mark arises from Spitzer’s probe. Spitzer and other critics question whether Aon and other brokers have steered business to favored insurers in exchange for lucrative “contingent commissions,” incentive pay that rewards brokers for hitting volume and profit targets.
In October, Spitzer rocked the industry by charging the biggest broker, Marsh & McLennan, with rigging bids to in order earn contingent fees.
Some investors remain optimistic Aon will avoid such a lawsuit.
“We think it’s unfair and inappropriate to paint Aon with the same brush [as Marsh],” said Spencer Chen, an analyst at Pzena Investment Management, which held 9.4 million Aon shares as of September. “Thus far, there’s been absolutely nothing concrete that’s come out that showed that Aon acted in such an unethical manner.”
Still, Ryan last week for the first time acknowledged that some Aon employees have violated the firm’s ethics code. He stopped short of acknowledging any illegal conduct, but his statement nevertheless gave weight to expectations that Aon ultimately will reach a settlement with Spitzer.
In Aon’s case, Spitzer also is investigating whether Aon illegally steered business to insurance companies in return for a payoff: Those companies would turn to Aon for their own insurance, called reinsurance.
The Tribune has found one instance in which Aon’s insurance and reinsurance brokerage businesses came into conflict.
The case involves ISMIE Mutual Insurance Co., Illinois’ largest medical malpractice insurer, a client of Aon’s reinsurance business. When Aon brokers in the mid-1990s began taking their clients away from ISMIE and directing them to buy insurance from competing firms, ISMIE complained.
According to two former Aon employees with direct knowledge of the situation, ISMIE’s chief operating officer met with representatives of Aon’s reinsurance brokerage and threatened to fire Aon as its reinsurance broker unless Aon brokers stopped taking their clients to ISMIE’s competitors.
After the meeting, Aon’s insurance brokers were told to stop redirecting their clients away from ISMIE, the sources said.
Ryan said he was not aware of the situation, and he found the circumstances hard to believe. “That would be something I would have heard about,” he added.
But Ryan has long been open about his desire to see Aon’s reinsurance brokerage benefit from the company’s insurance operations.
In the 1992 acquisition of Frank B. Hall & Co., a reinsurance pact was part of the deal. Ryan wouldn’t do the deal unless the seller, Reliance Group Holdings, promised to generate reinsurance commissions worth $270 million over 15 years.
The deal “could not have been done without it,” Ryan said at the time.
The Spitzer probe might have affected Aon’s decision to uncouple from reinsurance firm Endurance Specialty Holdings. On Dec. 3, Aon sold a $320 million stake in Endurance, which it had formed in 2001, after the Sept. 11 terrorist attacks had caused many reinsurers to stop writing new policies.
Changes in the aftermath of the Spitzer probe will hit Aon’s income.
Contingent commissions alone will total $167 million in 2004, some 60 percent of it pure profit. Like most other brokers, Aon is dropping its contingent fees in response to Spitzer’s probe.
Many insurance industry experts believe contingency fees will return, under a new name with better disclosure to customers. Insurance customers will soon see contingent fees “come back into the cost stream,” predicted Edward Liddy, chief executive of Northbrook-based Allstate Corp.
But Ryan contradicted the conventional wisdom during a recent interview with the Tribune. “They won’t reappear under another label,” Ryan said. Aon has no intention of rebuilding fees based on production and profitability. Given Aon’s size, that means “Aon and other market forces will drive them out,” Ryan said.
The loss is a tough hit. While representing less than 2 percent of Aon’s $9.8 billion in revenues last year, contingent commissions make up about 16 percent of Aon’s profits, said Klauber of Cochran, Caronia Securities.
Client payments an issue
Another revenue stream may be at risk. A lawsuit in California challenges Aon’s policy of holding its clients’ insurance payments for as long as 60 days, making money by investing those funds. Finley Harckham, the New York lawyer who brought the lawsuit, claims this tactic produced up to $100 million in income in 2002.
The lawsuit, which is on appeal after being initially dismissed on technical grounds, notes that Aon negotiates with insurers how long it can hold on to its clients’ money. The result, says Harckham, is that Aon has an incentive to steer business to companies that allow it to hold on to funds the longest.
The incentive might at first seem incidental. But a source in the New York insurance commissioner’s office says the size of Aon’s profits is not the issue.
“It doesn’t matter if it’s a little money or a lot of money. That’s not the test,” the source said. “If it means that a customer paid too much or got different terms than they should have, there’s a conflict. That’s one of the things we would be interested in.”
Among other legal challenges is a suit brought by an Aon client in Cook County Circuit Court that alleges inadequate disclosure of contingent commissions. The Illinois case has been certified as a class action and is proceeding. Shareholder lawsuits have also popped up since Spitzer’s investigation began.
Aon declined to comment directly on any of its legal matters.
The sudden onslaught of legal challenges is a sharp turnaround for Aon and Ryan. The 67-year-old Ryan has long been a fixture in Chicago’s business, civic and philanthropic circles, with a virtually unblemished reputation.
But Ryan’s talent for dealmaking–Aon has made more than 35 acquisitions since 1992–has not transferred into a skill for managing the Aon empire. Indeed, Ryan’s hands-off style might have made it easy for brokers to succumb to temptation without fear of being caught. Some former Aon brokers say it also fostered an anything-goes mentality among Aon’s competitive, hard-driving brokers, despite Aon’s formal reliance on codes of conduct.
For years, Ryan has tolerated a system in which successful brokers–“producers,” in Aon parlance–were treated as knights of the realm. In the New York office of the 1990s, in particular, big producers routinely arrived via chauffeured cars, and some crossed the Atlantic Ocean on the supersonic Concorde, former employees say.
Al Diamond, the former head of the New York office, says the producers paid for many such extravagances out of their own pockets, and he does not recall anyone flying the Concorde. But other former brokers say the showy style fostered a sense that there were different sets of rules for different sets of employees.
Transformation fell short
Ryan said he intentionally kept a loose hand on his acquisitions, believing they knew how to run their businesses.
The lack of integration caught up to the company in 2000. With profits falling and Wall Street complaining, Ryan announced a new “Transformation Plan” that was supposed to streamline business and make it more profitable.
The plan, which cost roughly $300 million to implement, established four large regional customer-service centers staffed by employees who were supposed to attend to most client needs. Aon’s brokers would be freed to prospect for new business.
But brokers rebelled for fear that their income would drop. Dozens of Aon’s big producers left, often in groups with specialties in highly valued sectors including aviation, energy and construction.
Transformation also was supposed to help Aon cut 3,000 jobs, or 6 percent of its workforce. But the layoff target proved elusive, in part because Aon had to staff the service centers with new hires. Aon declined to comment on whether the plan resulted in a net reduction.
“Aon definitely never achieved the initial cost savings,” said Mark Lane, an analyst with William Blair & Co. in Chicago. “But transformation was so disruptive that it also disrupted the revenue side.”
Ryan acknowledges that the transformation plan was painful. “We put too much change into the organization too quickly,” he said.
Now Aon’s business outlook is clouded. The company had to withdraw its earnings guidance after announcing the plan to drop contingent commissions.
Ryan can no longer count on new acquisitions to create an impression of health. Growth from Aon’s existing brokerage operations, or so-called “organic growth,” fell 3 percent during the third quarter, following a 1 percent decline in the second quarter. In contrast, competitor Arthur J. Gallagher & Co. reported organic growth of 2 percent, and Willis Group Holdings Ltd. was up 4 percent.
Costs remain high. At the end of 2003, Aon’s profit margin was 15.1 percent, compared with 25.5 percent at Marsh, according to data provided by William Blair & Co. In the third quarter, margins fell to 10.7 percent, well below expectations.
Engineering a turnaround will fall to a new chief executive. Aon’s stock jumped 3 percent on the day Ryan announced his plan to step down. It has dropped 17.8 percent since Spitzer sued Marsh on Oct. 14.
But Ryan’s plan to stay on as chairman of the board is complicating Aon’s recruitment effort.
“Everyone who has been contacted views the ability to settle [any Spitzer allegations] as an opportunity to look like a hero,” says a source knowledgeable about the matter. “But they’re balking because it’s a situation where the founder who will still be the chairman and who’s the source of the problems is still on the scene.”
Still, a source knowledgeable about the work Aon’s board is doing to recruit a new chief executive said no prospective candidate has turned the company down because Ryan plans to stay. “We have not had any prospective candidate, not one, say I’m not interested because Pat is staying on,” the source said.
Aon is targeting “late January or early February” to name a new chief executive, the source added.
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PROFILE
Aon Corp.
Headquarters: Chicago
Employees: 51,000 in more than 120 countries
What the name means: It is Gaelic for “oneness”
2003 revenues: $9.8 billion
2003 net income: $628 million
Makeup by revenue
Risk and insurance brokerage services: 58%
Insurance underwriting: 30%
Employee benefits consulting: 12%
Historical highlights
1964: Patrick Ryan forms Ryan Insurance Group
1982: Ryan Insurance merges with Combined International Corp.
1991: Acquisition of Hudig Langeveldt Group pushes company into Europe
1992: Acquisition of Frank B. Hall & Co.
1996: Acquisition of Alexander & Alexander Services Inc.
