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13. Derivatives and Hedging
Aon is exposed to risk from changes in foreign currency exchange rates and interest rates. To manage the risk related to these exposures, Aon enters into various derivative transactions that reduce Aon’s market risks by creating offsetting exposures. Aon does not enter into derivative transactions for trading or speculative purposes.
Foreign Exchange Risk Management
Aon and its subsidiaries are exposed to foreign exchange risk when they receive revenues, pay expenses, or enter into intercompany loans denominated in a currency that differs from their functional currency. Aon uses foreign exchange derivatives, typically forward contracts, options and cross currency swaps, to reduce its overall exposure to the effects of currency fluctuations on cash flows. Aon has hedged these exposures up to five years in the future. Aon also uses foreign exchange derivatives, typically forward contracts and options, to hedge its net investments in foreign operations for up to two years in the future and to reduce the impact of currency fluctuations on the translation of the financial statements for foreign operations and to manage the Company’s global liquidity profile for one year in the future.
Interest Rate Risk Management
Aon holds variable-rate short-term brokerage and other operating deposits. Aon uses interest rate derivatives, typically swaps, to reduce its exposure to the effects of interest rate fluctuations on the forecasted interest receipts from these deposits for up to two years in the future.
Certain derivatives also give rise to credit risks from the possible non-performance by counterparties. The credit risk is generally limited to the fair value of those contracts that are favorable to Aon. Aon has limited its credit risk by using International Swaps and Derivatives Association (“ISDA”) master agreements, collateral and credit support arrangements, entering into non-exchange-traded derivatives with highly-rated major financial institutions and by using exchange-traded instruments. Aon monitors the credit-worthiness of, and exposure to, its counterparties. As of September 30, 2011, all net derivative positions were free of credit risk contingent features. In addition, Aon did not receive or pledge collateral for any derivatives as of September 30, 2011.
The notional and fair values of derivative instruments are as follows (in millions):
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Derivative Assets (1) |
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Derivative Liabilities (2) |
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Notional Amount |
|
Fair Value |
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Fair Value |
|
|
|
|
Sept. 30,
2011 |
|
Dec. 31,
2010 |
|
Sept. 30,
2011 |
|
Dec. 31,
2010 |
|
Sept. 30,
2011 |
|
Dec. 31,
2010 |
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|
Derivatives accounted for as hedges: |
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|
|
|
|
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|
|
|
|
|
|
|
|
Interest rate contracts |
|
$ |
1,452 |
|
$ |
1,326 |
|
$ |
15 |
|
$ |
15 |
|
$ |
— |
|
$ |
— |
|
|
Foreign exchange contracts |
|
1,328 |
|
1,522 |
|
135 |
|
157 |
|
172 |
|
157 |
|
|
Total |
|
2,780 |
|
2,848 |
|
150 |
|
172 |
|
172 |
|
157 |
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|
Derivatives not accounted for as hedges: |
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|
|
|
|
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|
|
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|
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|
|
|
|
|
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Foreign exchange contracts |
|
260 |
|
238 |
|
2 |
|
2 |
|
8 |
|
1 |
|
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Total |
|
$ |
3,040 |
|
$ |
3,086 |
|
$ |
152 |
|
$ |
174 |
|
$ |
180 |
|
$ |
158 |
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(1) Included within Other assets
(2) Included within Other liabilities
The amounts of derivative gains (losses) recognized in the Condensed Consolidated Financial Statements for the three and nine months ended September 30, 2011 and 2010 are as follows (in millions):
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|
Three months ended
September 30, |
|
Nine months ended
September 30, |
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|
|
2011 |
|
2010 |
|
2011 |
|
2010 |
|
|
Gain (Loss) recognized in Accumulated Other Comprehensive Loss: |
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Cash Flow Hedges: |
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|
|
|
|
|
|
|
Interest rate contracts (1) |
|
$ |
1 |
|
$ |
(12 |
) |
$ |
(1 |
) |
$ |
(10 |
) |
|
Foreign exchange contracts (2) |
|
(10 |
) |
41 |
|
(31 |
) |
(99 |
) |
|
Total |
|
(9 |
) |
29 |
|
(32 |
) |
(109 |
) |
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|
Foreign Net Investment Hedges: |
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|
|
|
|
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|
Foreign exchange contracts |
|
$ |
13 |
|
$ |
(131 |
) |
$ |
(4 |
) |
$ |
74 |
|
|
|
|
|
|
|
|
|
|
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|
Gain (Loss) reclassified from Accumulated Other Comprehensive Loss into Income (Effective Portion): |
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Cash Flow Hedges: |
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|
|
|
|
|
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|
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|
|
|
|
|
|
|
|
|
Interest rate contracts (1) |
|
$ |
— |
|
$ |
4 |
|
$ |
1 |
|
$ |
15 |
|
|
Foreign exchange contracts (2) |
|
3 |
|
22 |
|
(12 |
) |
(84 |
) |
|
Total |
|
3 |
|
26 |
|
(11 |
) |
(69 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
Foreign Net Investment Hedges: |
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|
|
|
|
|
|
|
|
|
Foreign exchange contracts |
|
$ |
— |
|
$ |
— |
|
$ |
— |
|
$ |
— |
|
(1) Included within Fiduciary investment income and Interest expense
(2) Included within Other general expenses and Interest expense
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Three months ended September 30, |
|
Nine months ended September 30, |
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Amount of Gain (Loss)
Recognized in Income on
Derivative (1) |
|
Amount of Gain (Loss)
Recognized in Income on
Related Hedged Item (2) |
|
Amount of Gain (Loss)
Recognized in Income on
Derivative (1) |
|
Amount of Gain (Loss)
Recognized in Income on
Related Hedged Item (2) |
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|
|
|
2011 |
|
2010 |
|
2011 |
|
2010 |
|
2011 |
|
2010 |
|
2011 |
|
2010 |
|
|
Fair value hedges: |
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|
|
|
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|
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|
|
|
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|
Foreign exchange contracts |
|
$ |
2 |
|
$ |
(2 |
) |
$ |
(3 |
) |
$ |
2 |
|
$ |
— |
|
$ |
10 |
|
$ |
1 |
|
$ |
(9 |
) |
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(1) Relates to fixed rate debt
(2) Included in Interest expense
It is estimated that approximately $27 million of pretax losses currently included within Accumulated other comprehensive loss will be reclassified into earnings in the next twelve months.
The amount of gain (loss) recognized in income on the ineffective portion of derivatives for the three and nine months ended September 30, 2011 and 2010 was inconsequential.
In both the three and nine months ended September 30, 2011, Aon recorded a loss of $9 million, respectively, in Other general expenses for foreign exchange derivatives not designated or qualifying as hedges. In the three and nine months ended September 30, 2010, Aon recorded a gain of $3 million and $7 million, respectively. |