Arthur J. Gallagher & Co. (AJG) 2020 Q2 法說會逐字稿

Good afternoon and welcome to Arthur J. Gallagher and Company's Second Quarter Earnings Conference Call.

(Operator Instructions) Today's call is being recorded.

If you have any objections, you may disconnect at this time.

Some of the comments made during this conference call, including answers given in response to questions may constitute forward-looking statements within the meanings of the securities laws.

These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially.

Please refer to cautionary statements and risks factors contained in the company's 10-K, 10-Q and 8-K filings for more detail on its forward-looking statements.

In addition, for reconciliations of the non-GAAP measures discussed on this call as well as other information regarding these measures, please refer to the earnings release and other materials in the Investor Relations section of the company's website.

It is now my pleasure to introduce J. Patrick Gallagher, Chairman, President and CEO of Arthur J. Gallagher & Company.

Mr. Gallagher, you may begin.

Thank you.

Good afternoon.

Thank you for joining us for our second quarter 2020 earnings call.

Also on the call today is Doug Howell, our CFO, as well as the heads of our operating divisions.

We delivered an excellent second quarter.

Despite the economic deterioration caused by COVID-19, our teams are executing at the highest levels while we continue to place health and safety first.

We are servicing our clients.

We're selling new business.

We continue to look at merger and acquisition opportunities, and our bedrock culture keeps our teams working together even while physically apart.

I would like to thank our 33,000 Gallagher professionals around the globe for their constant and tireless focus on delivering the very best insurance brokerage, consulting and risk management services to our customers.

More than ever, these are times when our global capabilities and resources support our local professionals as they help our customers navigate these challenging times and still generate strong new business.

That really truly is the Gallagher way.

Moving to our second quarter financial performance.

We grew our combined Brokerage and Risk Management revenues in the second quarter organically and through mergers and acquisitions.

And together with our expense control actions, delivered excellent growth in EBITDAC and net earnings.

This demonstrates that our investments over the last decade have enabled us to quickly adjust our workforce and expense base, increase the utilization of our centers of excellence, efficiently work remotely, improve our productivity while always raising our quality.

Let me break down our results further, starting with our Brokerage segment.

Reported revenue growth was a positive 6.2% and even a bit better at 7.6% when leveling for foreign exchange.

Of that, 2.1% was organic revenue growth.

Net earnings margin was up 364 basis points, and adjusted EBITDAC margin expanded by 635 basis points to 32.6%.

Doug will provide some additional details on our expense control efforts, which was primarily responsible as we drove net earnings up 38% and adjusted EBITDAC up 34%.

Clearly, a very strong quarter and pointed the team execute in a difficult environment.

Let me give you some sound bites about each of our brokerage units around the world.

Starting in the U.S., our retail P&C business held up very well during the quarter, delivering organic growth of about 4%.

Still strong new business generation, a small drop in retention and nonrecurring business, rate increases offset exposure unit declines, cancellations were not up over first quarter levels, and midterm policy modifications were still a net positive, but a bit lower than first quarter levels.

All-in, we are seeing similar trends in our domestic wholesale operations, but a bit of a tale of two cities.

Our open brokerage business had mid-teens organic growth benefiting from strong new business and rate.

Our MGA program binding businesses were backwards about 5%, resulting from a slowdown in programs like transportation, amateur sports and construction.

However, when we look at June alone, our MGA and program businesses were showing improvement over the lower in activity -- over the lower activity seen in April and May.

We had an excellent quarter in Canada at more than 5% organic driven by strong new business and higher rates.

The U.K. delivered 4% organic, and Australia and New Zealand were closer to flat, where we are not seeing as much tailwind from rate.

So exposure declines are weighing just a little bit more on our organic.

So overall, our global PC operations reported about 4% organic in a quarter, a really strong result in a difficult environment.

Moving to our benefits business.

As anticipated, we saw some second quarter weakness, down about 3% on an organic basis.

New consulting and special project work declined in addition to a decrease in covered lives on renewal business, but we are not seeing covered lives decreasing as much as the headline unemployment numbers.

So when I bring our PC and benefits together, the 2.1% organic here in the second quarter came in pretty close to where we thought it would be at our June Investor Day.

Looking forward, so far in July, nearly every metric we are monitoring is trending better than the second quarter.

Accordingly, based on what we're seeing today, we think third quarter brokerage organic and expense saves will be similar to the second quarter.

As we move into the fourth quarter, if the economy continues to recover, feels like organic would equal or even be a bit better than the third quarter, and we should be able to continue to deliver cost containment as well.

Still a lot of economic and governmental uncertainty, but that is where we are forecasting today.

Before I leave the Brokerage segment, let me go a bit deeper on the PC pricing environment.

PC pricing continued to move higher around the globe, with most geographies reporting 5% or greater price increases, tighter terms and conditions and somewhat restrained capacity.

By line of business, property remains the strongest, up more than 10%.

Next is professional liability, up over 7%.

Other casualty lines are up 5% to 10%, with umbrella rate increases at least twice that level, and workers' comp is flat to down 2%.

By geography, Canada is seeing the greatest price increases up more than 8%.

The U.S. is up about 7%, followed by the U.K., including London Specialty at about 6% and Australia and New Zealand between 2% and 3%.

So PC pricing is up across the board, but client premium changes are more modest due to lower exposure units, higher deductible, reduced limits and clients opting out of coverages.

Looking forward, I see rates continuing to increase within an already firm market and early indications from July point to continued increases in the third quarter.

Before the pandemic began, loss costs were outpacing rate and I see just as strong a case for underwriters to push for even more rate in this environment.

It is certainly a more difficult market today, but not yet a hard market because most risks can still find a home.

Jumping to mergers and acquisitions.

We completed 4 brokerage mergers during the second quarter at fair multiples.

I'd like to thank all of our new partners for joining us, and I extend a very warm welcome to our growing Gallagher family of professionals.

While second quarter mergers were lower than normal, the number of conversations with potential merger partners is picking up so far in the third quarter.

Difficult market conditions and the pandemic are further highlighting the need for expertise and data-driven tools.

Our platform is an excellent fit for entrepreneurs looking to support their current clients, use our tools and data to grow their businesses and advance their employees' careers.

As I look at our M&A pipeline, we have about 40 term sheets signed or being prepared, representing around $300 million or so of revenue.

Based on the activity we are experiencing in July, we are optimistic we will return to more normal levels of merger activity later this year.

Next, I'd like to move to our risk management segment.

Second quarter revenue was in line with the guidance we provided at our June IR Day, with reported revenues down about 8.8% and organic down about 9.6%.

This reflects a dramatic pullback in new claims arising due to higher unemployment and a reduction in overall business activity, offset somewhat by an increase in COVID-related claims.

We think April was the worst of it, and I'm encouraged that claim counts in the latter half of the quarter and into July improved off the lows.

However, new claims arising are still well below pre-COVID levels.

Our risk management team also did a terrific job on cost containment.

Adjusted EBITDAC was only $2.7 million lower in the quarter relative to last year and margins held which is also right in line with our expectation.

It takes a little longer to turn this ship versus our Brokerage segment.

So we would expect to see third quarter EBITDAC improve relative to second quarter and then as our expense actions are fully realized, even greater improvement in the fourth quarter, leading to full year adjusted EBITDAC at least equal to 2019, just a fantastic job by the team to adjust our expense base and rebalance claim loads across adjusters while maintaining our client service and quality levels.

So when I combine our core Brokerage and Risk Management segments together, despite the unprecedented economic challenges, we grew our adjusted revenues 5.3% and grew our net earnings and adjusted EBITDAC about 30%.

That's truly an excellent quarter.

But before I turn it over to Doug, let me finish with some comments on our bedrock culture.

When times are tough, teams can either break apart or band together.

Since my grandfather started the company in 1927, we have consistently expected every leader in associated Gallagher to live our culture, talk about our culture and promote our culture.

Culture matters.

Culture prevails.

Culture is important in the best time, but even more important during challenging times.

Our team is together.

We respect and support one another.

No one is an island.

There are no second class citizens.

We learn from each other.

Everyone is important.

For those of you that have followed Gallagher since we came public more than 35 years ago, you'll recognize those statements as just a few of the 25 tenets of the Gallagher way.

This document puts our core values in new words, which shapes and then guides our culture, and we believe in it because it matters to us.

We live it every day, and it's guiding us through these challenging times.

I believe we will emerge on the other side even stronger than we were before.

Okay.

I'll stop now and turn it over to Doug.

Doug?

Thanks, Pat, and good afternoon, everyone.

Like Pat said, solid top line growth and truly remarkable bottom line performance.

Our combined Brokerage and Risk management adjusted EBITDAC is up nearly 30% over second quarter last year.

Many thanks to all of our colleagues around the globe for continuing to (inaudible) on our cost control efforts, all the while continuing to deliver unique insights and high-quality service that our clients need even more in these times.

Today, I'll spend most of my time on our expense savings, give you some comments using the CFO commentary document and then finish with thoughts on cash, M&A and liquidity.

All right.

Let's go to the earnings release, Pages 4 and 7. You'll see both the Brokerage and Risk Management segments expanded adjusted EBITDAC margins this quarter.

Our Brokerage segment reduced compensation and operating costs by about $60 million versus prior year when you adjust that for roll-in impact of mergers closed after March 31, 2019.

In the Risk Management segment, the savings amounted to about $14 million.

So in total, we were able to adjust our expense base by about $74 million during the second quarter.

That's at the top end of our estimates that we provided in April and again at our June IR Day.

Let me give you a breakdown of these savings.

We reduced travel, entertainment and advertising by about $24 million.

We reduced technology consulting and professional fees, $14 million, reduced outside labor and other workforce actions, saved about $13 million.

We saved on office supplies, consumables and occupancy costs of about $12 million and lower medical plan utilization by our employees saved about $11 million.

When I look towards the third quarter, I think savings will be in the $65 million to $70 million range relative to last year, again adjusting for roll-in mergers.

This is a bit lower than second quarter, simply because our production staff is beginning to travel to see clients and prospects.

We are increasing our advertising costs again.

And in June, we did see a reversion to pre-pandemic levels of our employees utilizing our medical plan.

As for the fourth quarter, that all depends on what happens with organic.

If we're at plus 2% or plus 3% organic, then our producers are likely traveling more and we may restart some of our postponed investments, and thus, we wouldn't see as much savings in areas like technology, consulting and professional fees.

But if organic is flattish, we'd expect to see a similar level of savings as the third quarter.

Okay.

Let's go to the CFO commentary document that we posted on our IR website.

On Page 2, most of the items are fairly straightforward and consistent with what we provided to you in our June IR Day.

There's 2 items to highlight, which basically offset one another.

First, foreign exchange in our Brokerage segment was slightly unfavorable this quarter, call it about $0.01; and second, in the Brokerage segment amortization, that came in about $0.01 favorable, again, offsetting the FX.

Flipping to Page 3 to the corporate segment table.

Relative to the midpoint of the guidance we provided at our June IR Day, interest in banking came in about $0.01 or so favorable.

The acquisition line came in just a little bit less than $0.01, but still favorable.

The corporate line is about $0.01 unfavorable, but you'll read in footnote 3, that was simply due to foreign exchange rates bouncing around.

In the quarter.

Finally, clean energy was $0.01 below the midpoint of the range due to mild temperatures, more use of natural gas and weaker electricity consumption due to COVID.

Hot July has started off a strong third quarter, but we are still seeing natural gas prices on the lower end and lower economic activity could likely dampen generation later in the second half of the year.

So we have lowered a bit our full year range to $60 million to $70 million net after tax earnings.

But let's not forget the $1 billion of tax credit carryforwards we have on our balance sheet.

That's effectively a receivable from the government that should allow us to pay lower cash taxes for many years to come.

All right.

Let me wrap up with some comments on cash, M&A and liquidity.

Our customer cash receipts were strong during the quarter, rebounding in May and June after a slight slowdown in early April.

So far, in July, we're tracking back to prepandemic levels.

So we don't see any concerns at this time.

As of today, we have more than $1.3 billion of liquidity, consisting of available cash on hand of nearly $275 million and we have access to over $1 billion on our revolving credit facility.

As for M&A, as Pat mentioned, we did complete 4 acquisitions during the quarter.

A couple were tax-free exchanges.

So we used a little of our stock but even then with an average multiple paid below 8x, there was a nice arbitrage to our own trading multiple.

More importantly, our pipeline is really heating up.

So we could have a strong finish to the year and a strong start early next year.

Okay.

Those are my comments.

A great quarter by the team for them to continue growing revenues and executing on cost containment.

Let's keep the economy from another clench we should pull off an excellent full year.

Back to you, Pat.

Thank you, Doug.

Operator, let's go to questions and answers.

(Operator Instructions) Our first question is coming in from Elyse Greenspan with Wells Fargo.

My first question, Pat, or maybe this is, I guess, for Doug, is on the expense saves.

So I guess I have a few questions here, but the first one is, you guys expanded your brokerage margin by 6.2%.

So what I think maybe gets a little bit lost in the numbers and if we adjust out the save on 2% organic revenue growth, if my math is right, you saw around 120 basis points of margin improvement.

So am I thinking about that correctly?

And then I guess there's just some pretty good just margin improvement in your business away from just the base.

Or am I missing something there?

No, you have it about right.

I think that's right.

We had -- no, we didn't give raises this quarter.

So that would have dampened to 1.2% a little bit, but you're looking at it the right way.

Okay.

And then I think you guys -- you just provided some good color in terms of the save that we could see in the third and potentially the fourth quarter.

If I remember from your June Investor Day, you had said that kind of post-COVID that about half of the saves, I believe, could persist on an ongoing basis?

I just -- given you provided some updated figures, I wanted to make sure that guidance still exists today?

Yes.

I think probably when we looked at it 6 weeks ago, that probably would have been about right.

I think right now, we are learning a lot as a result of this crisis, and we are finding ways to deliver service and advice clearly more cost effectively than prepandemic.

But I think what matters in the end is what we spend will be highly correlated at least to how our clients' prospects and underwriting partners expect us to do business.

That will determine really how much we travel, how much we communicate virtually.

Do they want to be entertained anymore?

How much do we advertise?

And how do we advertise in the market?

And then also it drives what investments in technology and technical resources we are -- that we need in order to service and compete in the market.

It also goes further when you look at what it takes to attract and retain talent.

That will dictate a lot on how we leverage our work-from-home capabilities, maybe where we locate our offices, how we configure them.

And then also a little impact how we train, develop and mentor our folks.

So that will influence the ultimate cost savings.

And then also, one thing I have to say as being experts in employee benefits, we truly hope that our employees get back to utilizing our medical health and welfare plans.

We need everybody to be doing their prevented exams and getting the services they need.

Nothing good comes from delays in getting your medical treatment.

And that saved us several million dollars this quarter.

So when I bring it all back together, over the long term, could we be saving $30 million to $40 million a quarter after we adjust the real estate footprint as we adjust postage express, office occupancy cost, maybe hire some of the external resources that we were using externally.

Yes, maybe we could get to that number.

So it wasn't far off as a guess, but it will really depend a little bit on how our clients' prospects and underwriting partners want us to do business.

Okay.

That's helpful.

And then on the organic side, Pat, I think you said that the third quarter brokerage organic seems to be trending in line with the Q2, which is a little bit better than your June Investor Day.

And then we've been hearing from some peers that there are some lags in some of the businesses, right, so the third quarter could be worse than the second quarter?

And (inaudible) is that business mix that's helping the Q3?

Is it incremental pricing?

Just a little bit more color on how you see the third quarter transpiring.

Well, first of all, Elyse, as you know, July is a very big month for us.

So it's a good bellwether.

And we had a very, very strong July.

And so I think as we sit here today, if things don't completely fall off the table in August and September, we feel just exactly the way we phrase it today.

And now our next question is from Mike Zaremski with Crédit Suisse.

First question.

What -- in terms of leverage levels, where could you go to temporarily with the rating agencies if there was kind of something chunkier or larger?

Could you go to a -- kind of a materially higher level for a year or 2 and then kind of work its way down if something became available?

Yes.

I think they'd be receptive to that.

I think we've seen that with other brokers.

So that would seem reasonable that they would be willing to accommodate that.

Do we have the appetite to do that?

We probably won't push our debt ratios very much at all, but I think they could be willing to listen to that.

Okay.

And along the same lines then, like -- so in terms of kind of making inroads into maybe the mid- to large account space as a result of the merger that's taking place.

Is it more of kind of winning RFPs as the clients look for a new potentially to find another broker because they've consolidated to one?

Or is it more hiring or both?

And if it's the RFP process, is that taking place more kind of next year when the account comes up for renewal after the merger?

Well, Mike, this is Pat.

I think you touched on a very good subject.

But let me go back to our genesis.

I mean Gallagher Bassett was started in 1962, basically, to take care of the claims for Petrus Foods with a Fortune 100 company at that time.

So we've been in the large account risk management business since the 60s.

Now over the past number of years, we've gotten much, much stronger in that business as well, both on the claims service side as well as on the brokerage side.

And yes, I think that the fact that the 4 top players are going to consolidate to 3 is clearly giving us more opportunities.

And as I said, our capabilities have gotten stronger and stronger, and we feel really good about our chances to expand that business.

Okay.

Great.

And just lastly, back to Elyse's question, given just a phenomenal quarter in terms of margins.

So again it sounds like, Doug, to your answer about kind of -- there was margin improvement beyond just the expense savings.

And Doug, it sounded like you were saying that there was over 100 basis points of margin improvement beyond it.

And it sounded like that could recur unless business kind of gets back to usual in terms of entertainment and more people feeling comfortable, employees feeling comfortable going back to the doctor's offices.

And so it sounds like that kind of underlying net of expense save positive trend could continue?

I guess it's just -- it's, I think, sell-side estimates, as we know, haven't come up enough because it's just -- it's such a great margin improvement during what is fairly muted organic growth times.

So I want to make sure we're understanding.

All right.

So first of all, let's go back.

What do we think in the future?

In the third quarter, we think they're going to be $65 million to $70 million of savings.

We won't give some of that back up because there are some costs coming back into the structure.

In the fourth quarter, might be closer to a $60 million to $70 million.

We might have to give back another $5 million there somewhere.

But that's the way we sit today.

The margin expansion that Elyse talked about is 2 things is we did have some strength in our supplementals and contingents this quarter, which probably drove a little bit of that margin expansion.

Longer term, we think we're learning a lot about our business.

And so I think there could be opportunities here for us to do things differently because our clients' expectations have changed in this 4 month period.

And the question is, will they stay that way?

Or will they expect to see 5 people showing up for a meeting for an hour?

Or are they okay with our industry experts not getting on a plane, traveling a day for a half hour presentation.

We're finding some really good success in that, that we can put our niche experts at the point of sale, and our customers are much more willing to accept a virtual face-to-face versus a real face-to-face.

So there is going to be some savings on that, that survives.

So margin expansion, we've always said it's hard to expand margins if it's below 3%.

And we are okay at 2% with a little strength in supplementals and contingents.

We got a point of margin expansion out of it in the near term.

I think it would be pretty hard to post 2% organic growth for the next 3% and expand margins a percentage point a year.

I think that would be difficult.

Get us over 3%, we can hold in there, get us over 5% -- 4% or 5%, we'll expand them.

So I don't see that changing much from what we provided in the past.

But there's opportunity there, but -- yes, I think that this in the near term, 1% organic -- or excuse me, margin expansion on 2% organic is a pretty darn good quarter.

Our next question is from Phil Stefano with Deutsche Bank.

Yes.

I was hoping you could give a little thoughts on contingents and supplementals to the extent that you have any forward view into them.

I guess were there any catch-ups in first quarter or second quarter that we should kind of try to normalize out?

In my mind, in this 606 world, the contingents and supplementals will be a bit more flat than maybe what we've seen or at least actual versus what I've expected.

Yes.

I think there's probably a little bit -- a small, little bit of catch-up in the second quarter.

A lot of these things get paid in the first quarter.

We have like hundreds and hundreds of contingent commission contracts and even several hundred supplemental contracts.

So we probably will have some positive development in our second quarter a little bit, but might be targeting a couple million bucks on announcement.

So the team does a really good job of making estimates.

I think what happens in the future because of the pandemic, loss ratios are hanging in there pretty well.

So -- and it's -- our cost and value that we deliver right now.

I think that we're earning our contingents and earning our supplementals, and I think we've got a pretty fair series of contracts.

I think the carriers -- yes, that will hold up well with the carriers.

So I don't see anything out of the ordinary in this.

Okay.

Look, just to go back to the expense saves, and I don't want to beat this too much.

But I guess, in my mind, thinking about the $60 million to $70 million we can expect third quarter, fourth quarter and then the idea that bringing this all together, maybe we could be $30 million or $40 million a quarter, who knows what the normal looks like moving forward.

Can you give us a sense for how quickly that gap closes?

And is 2020 a pivotal year where things back come back relatively quickly?

Or does it really depend on the economy and shelter-in-place and the fallout of COVID in all those ways?

Probably more of the second.

It is highly dependent on that.

I wish I had a crystal ball, and I think all of us would kind of hope that they come back a little bit faster because that means the economy gets back to zooming, people are back to work.

I don't mean zooming face-to-face.

I mean, the economy is moving fast and forward.

Guys, I think you want to have some expenses coming back in to our number.

Phil, let me hit that too, this is Pat.

We haven't gone to see a client in 3 months.

That isn't going to hold up.

So there will be bump in your models full of no travel, no face-to-face, no entertainment, no new people.

We're writing a lot of new business, and we're going to service that business.

And there is pressure in the field to take a trip to see a client.

We do have clients that are back at work now saying to come see us.

And we've got very stringent restrictions for health and safety reasons about whether we're even letting our people do that.

Believe me, we get a vaccine, and our people are going back (inaudible), myself included.

I haven't been on the ground this long since I was 11 years old.

Our next question is from Ryan Tunis with Autonomous Research.

I guess just thinking about the third quarter organic thinking it's going to be somewhat similar to this.

Behind that, what are you assuming organic revenue growth is going to be for employee benefits to get about 2% again?

I think it'd be much the same as what we've got now.

I don't see a lot of difference between the third quarter and the second quarter for our P&C business or our benefits business.

So it was back about 3% this quarter.

And at this point, workers' comp revenues were down what, you said 10% through mid-June, correct?

Rates are down 2-ish, maybe 3%, something like that.

But if you talk about exposure units being down, I can probably dig that out here for you in a second, but let me work on that.

So what I'm getting at is I'm just trying to understand why ultimately you're not going to have some convergence of the employee benefits, which is only down 3%.

And obviously, you're still collecting on furloughed workers, COBRA, that type of thing in the workers comp, that's just based on level of payroll.

So we're down like 10 on exposures in workers' comp, I'm trying to understand why we wouldn't think that health and benefits will be down a bit more in the third quarter.

Well, I think that it might have to do with the mix of our business, too.

As you know, we look at this in high, medium and low impact industries.

And when we look at that, and stack it up.

We have a lot of business that's in very low impact industries.

So right now, you're not seeing the decreases in workers' comp and benefits in those industries at this point, even the medium categories, we're not seeing it.

So there could be a convergence on it.

A big part of the drop in benefits is also related to project work and onetime stuff that we do when the economy is robust.

Then people are willing to spend and come in and help me communicate with my people.

Right now, they're more willing to not necessarily communicate as well.

They'll take that burden on themselves.

So it's projects and things like that, that also diminished in the quarter that we'll have to see a return to prior growth to get that kind of project work back.

But the underlying health and welfare business does probably look more like work comp.

Got it.

And then, Pat, I guess my follow-up is, is it still safe to say that pricing increases are offsetting exposure declines?

Yes.

So is it fair to say then that essentially, on average, accounts are renewing at basically a flat premium?

Or down because one of our key jobs is to help those clients in a difficult environment navigate what they spend.

So people will take limits down.

You had a $100 million umbrella this renewal or this expiration.

Do you need $100 million next year, maybe it should be $50 million.

Your retention was $150 million, should we take it to $250 million.

There's a lot of work that we do around that, that helps our clients mitigate the cost of their insurance, while at the same time, protecting their future.

I am jumping on too.

Our workers comp business was down 2% in the quarter, so -- and if our benefits business is about 3%, we're seeing it there, but it's...

Got it.

So, Pat, do you think it's sustainable that pricing can continue to offset exposure declines.

Does that feel like something that can happen if we really are in a recession?

Yes, I do.

I mean, for now, if you'd ask me that maybe March 30, I might not have been as bullish.

Our next question is from Yaron Kinar with Goldman Sachs.

My first question is with regards to the cost saves.

I just want to understand when you're looking at $60 million to $70 million in the third quarter, I think, Doug, you highlighted a few bad guys there.

Are there other kind of positives that you haven't yet achieved in the second quarter that you think you can still dial up?

Or is that $60 million to $70 million, simply a decline in the positive that you had the second quarter without any offset?

Just a couple of clarification.

We can't wait for our employees to get back using their medical plan.

So I wouldn't call that necessarily a bad guy.

We want our folks to access our medical plans.

Fair, fair.

I apologize for the use of words.

No, that's okay.

I just want to make sure we -- but we all know -- we don't want a severity problem coming out at the end of the year because people aren't getting their annual exam.

So if that costs us a $5 million to $10 million a quarter, we're happy to spend it.

I think that other bad guys, I wouldn't call travel bad, so I won't quibble on that.

Do we have some other good guys that could come through?

I think that we've done a pretty good job in the near-term of getting down to a number that's going to be harder to keep than it is harder to create more of them.

So I think that we're about where we are in this environment.

So I wouldn't expect too many good guys to offset the bad guys using your terminology coming through in the third and the fourth quarter.

So I think our estimates are pretty close.

And if you think about it, we gave you an estimate between $50 million and $75 million when we came out of the gates here in April, 30 days into it, and we hit $74 million so I think we've got a pretty good insight about where we're spending money and what's going to stick and what's going to come back in.

Right.

Okay.

And again, I apologize for using that terminology.

No, no, I know.

I just wanted to make sure you...

Yes.

And then my second question just goes back to the buckets, kind of high impact, medium impact, low impact.

Six months into this situation, as you look back, do you think -- how much of those buckets shifted?

Like how much of the -- what you initially felt was a high-impact bucket ended up being in a low-impact bucket or vice versa?

Right.

So if you look at it, let's say, there were 25 SIC codes in there what we picked in the second quarter.

Of the high-impact 25, we got 20 of them right -- excuse me, 21 of them right, and then we had 3 of them in the medium category that probably moved up to high.

When you get to the low kind of the same thing, and the medium, not much.

So our pick on low, medium and high coming out of the gate, 3 weeks into this thing, I would say, is pretty damn good.

And so I feel fairly comfortable that those are the impact businesses that we forecasted in the near term.

We'll see what happens over the next longer-term and whether our picks are going to be right again.

But we did a pretty good job of it.

So I think that we've got a good insight into the nature of our business.

So...

Our next question is from Mark Hughes with SunTrust.

Yes.

Just another crack at the expense question.

When we think about 2Q next year, do we -- is this the kind of right run rate on a go-forward basis, kind of a step function on 2Q.

And so next year, we go back to your usual template of 3% or better.

We get some margin expansion.

Is that the right way to think about it?

Yes.

I think you've got to go back and reset and take us basically.

If you think about, we were expanding margins about 1 point a year, and we've been doing that 70 basis points a year for the last 5 or 6 years.

If we get into a 5% organic growth environment, you're going to see us give back some of these savings, and then you're going to also see us just our natural continued margin improvement programs, you would be back into kind of that 50 to 70 basis point margin expansion on 5% organic growth.

So you're looking at it the right way.

But would there be a reset compared to second quarter next year?

Probably because if we're back to -- if you put in $30 million or $40 million of expenses, and you're taking 70 basis points on $6 billion, you get in $40 million.

It's about a push, maybe a little expansion.

Okay.

And then on the benefits business, it sounds like most measures are improving.

Pat, you talked about July being very, very strong.

I'm not sure if that was completely focused on P&C.

But it sounds like 3Q organic in benefits has the prospects of being better?

Is that a fair read?.

I'd say that -- I think I was referring more to PC in my comments on July, Mark, it's only fair to say.

I think what you're seeing in benefits now is systemic, and I think that will continue.

Now I will tell you from getting into the sales force data, et cetera or what have you, we did have a good July in new business.

So people are still looking at needing help around both their health and welfare and retirement and all the other aspects.

So I think new business will be good.

But I do think you have an underlying softness in what's going forward with employment, et cetera.

So I would not be predicting a stronger third quarter.

One thing we are seeing, Mark, we're seeing a lot of people on our webinars.

We're doing a lot of joint webinars with -- between the benefits in our P&C business.

So there is interest in learning.

We did a back to work, safety in the workplace, webinar.

So we are getting customers that are interested in thinking about how their 2021 medical plans and health and welfare plans should look in this environment.

So that could lead to some better growth in the fourth quarter or first quarter next year as people are trying to redesign their plans.

Third quarter, I don't know if you'll see it quite yet.

Mark, you know that you've heard us say this 1,000 times.

90% of the time when we compete, we're competing with smaller local brokers.

And believe me, they're wondering now what else is out there.

And those relationships are strong, for sure.

I mean, our new business would even be higher.

We don't win all the time.

But just to put this in perspective, in the second quarter, our webinars, where, as Doug said, we combined property casualty and benefits in many of them around things like return to work.

Unprecedented attendance, with 60,000 people attend webinars in the second quarter on content and material that we're putting out.

We haven't had 60,000 people attend in 10 years.

Yes.

Interesting.

One final question.

This question about furloughs.

Once maybe some of these stimulus packages, furloughs expire, maybe businesses just won't hire and they'll cut the -- lose the number of employees at that point, and that will impact your employee benefits business.

Do you have any perspective on that?

Yes.

One of the things, we don't have that many people that actually have been technically furloughed.

Maybe there's 100.5, something like that, that we've furloughed.

So I think that what will happen after furlough, we're hoping we're bringing them back.

No.

I think, Mark, were you talking about our clients?

Correct.

That's right.

I think -- yes.

I think that, that is a possibility.

I think that when the furlough support and the unemployment support erodes, yes, I do think you could see those people actually have their jobs disappear.

Any sense on the magnitude of the risk there?

No.

And now our next question is from Meyer Shields with KBW.

Two questions on reinsurance.

One is the big picture question.

And Pat, you talked to, I don't know, gazillion insurance company CEOS.

And I'm wondering whether you could give us their sense on concerns over reinsurance brokerage consolidation.

And then second, just hoping you could update us on how Capsicum performed over the course of the second quarter?

Well, let me take number 2 first.

I think I've said this publicly a number of times.

Capsicum is the single best start-up I've been involved with in my career.

And we were very pleased to get the final acquisition of the remaining equity over the line.

That team is an excellent team.

They've had an excellent first half and continue to do just a terrific job of expanding that business.

And so what we started with 5, 7 years ago, literally from dead scratch today is really -- it's remarkable.

So that team is doing a great job.

And they'll continue to.

The opportunities, I guess I've been -- in my career, I've seen an awful lot of consolidation.

I've gone through -- if you look at who is out there competing with us, 30 years ago, 20 years ago, and how many of those have consolidated down, consolidation offers this opportunity.

And I think Capsicum is very well positioned to take advantage of that.

And I'll be blunt with you.

The big buyers of reinsurance don't like it.

And Meyer, we are well over 10% year-to-date organic growth in Capsicum.

Okay.

Operator, I think that's it.

And let me just make a quick comment, and we'll say good evening.

Thank you again for joining us this afternoon.

As we said over and over, we delivered an excellent quarter.

It's a difficult economic environment, but I remain confident that we have the right platform and strategy in place to successfully navigate these challenging times for the rest of this year and hopefully, in better times next year.

Thank you all for being with us this afternoon.

We really appreciate it.

This does conclude today's conference call.

You may disconnect your lines at this time, and thank you for your participation.