Arthur J. Gallagher & Co. (AJG) 2010 Q3 法說會逐字稿

Good morning, welcome to Arthur J.

Gallagher & Co.'s third quarter 2010 earnings conference call.

Participants have been placed on a listen-only mode.

Your lines will be open for questions following the presentation.

(Operator Instructions).

As a reminder, 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 meaning of the Securities laws, such as any observations regarding future results.

These forward-looking statements are subject to certain risks and uncertainties, described in the Company's reports filed with the Securities and Exchange Commission.

Actual results may differ materially from those discussed today.

It's now my pleasure to introduce J.

Patrick Gallagher Jr., Chairman, President and CEO of Arthur J.

Gallagher & Co.

Mr.

Gallagher, you may begin.

Thank you, Operator.

Pardon me.

Welcome, everybody.

Thank you for joining us on our third quarter conference call.

I appreciate you being here with us this morning.

This morning, I'm joined by Doug Howell, our CFO, as well as the operating leaders of our operating divisions.

I think our growth in the quarter continues to prove that our strategies for building the business are working.

I was pleased with our quarterly results.

I will address both segments, our Brokerage segment and our Risk Management segment and let me start with the Brokerage segment.

Brokerage revenue and EBIT-DAC are both up in what I will tell you continues to be a very, very challenging environment.

I think we're making good progress.

Rates continue to fall.

If you look to the CIAB, that's the Council of Insurance Agents and Brokers, quarterly survey, rates were down about 5.2% in the quarter.

We believe that the property casualty rates are now back to pre-2000 levels.

With regard to exposure units, we think that we're really now seeing a kind of flat environment.

We're not seeing exposure units growing to any extent, but it feels like they're kind of not continuing to decline.

As you can see on page 2 of our press release, organic revenues were flat and our brokerage business, an improvement over the negative 3% we posted in the second quarter, a couple of things contributed to this.

Three things, actually.

A number of good efforts around organic revenue.

We had a good new business quarter, which I think is a credit to our sales culture.

Everyone is out every day working hard to bring new customers aboard.

Our retention in the quarter improved a bit.

We worked very hard to take care of our clients and we expect them to renew with us, and our international operations contributed nicely.

Our UK operations continue to show double-digit revenue growth and our Australian operations are performing very well.

Gallagher is clearly becoming a more global Company.

We closed four acquisitions in the Brokerage segment in the quarter and we're very pleased to welcome our new teammates to Gallagher.

These firms all had a choice and I am very glad that they joined us.

Again, I think this is a testament to the culture of the Company.

Our strategy is to bring our resources to the new partners and to bring new sales opportunities to the Company.

Hopefully one plus one can somehow equal five.

Merger and acquisition activity by the way is ticking up a bit in the fourth quarter as I think some sellers are wanting to complete before a possible tax change in 2011.

We have a number of very nice transactions that we're working on, and we hope to close those before year-end.

Our pipeline for acquisitions remains very strong.

Our benefits team is working hard to help our clients understand the impact of the new healthcare legislation.

We spent a considerable amount of time and effort to understand the law and to prepare timetables for compliance, along with frequently-asked questions and calculators to show our clients and prospects how they will be impacted financially.

This law is complicated, and it's going to keep our benefits consultants busy for some time.

As an aside, our benefits teams are hosting various seminars and webinars regarding the new legislation.

At one seminar recently, when the sessions ended, we picked up three new accounts on the spot.

This is complicated and our people can help these clients navigate this.

Let me move to Risk Management.

You can see the impact of the economic times and the decrease in claim activity.

It's a simple fact, fewer employees equals fewer claims.

Revenues were down in the quarter and year-to-date, but I think our team has reacted very well to this by watching expenses and fighting to maintain what we believe are industry-leading margins.

But the real story at Gallagher Bassett and our Risk Management segment in the quarter was the completion of GAB Robins transaction.

We purchased GAB's contracts claims business.

We're excited and what motivated us in this regard was primarily twofold.

First, we added a number of terrific clients, which we're really proud to have the opportunity to work with.

In fact, there is 200 new clients.

And secondly, we added a very nice boost to our staff.

We had 400 new professionals joining our Company , so this is a great shot in the arm for Gallagher Bassett.

It's also a fact that in this business, scale matters.

It yields cost advantages and efficiencies and it enhances our ability to invest and maintain our edge over our competition.

Integration is underway, we welcome our new teammates to Gallagher Bassett and we hope they feel at home very quickly.

So a short synopsis, we're happy to have three quarters in the books, we plan on continuing our strategies to grow.

Our cross-selling efforts are focused and paying dividends.

We're almost fully rolled out and will be by year-end on our sales management system.

Our niche expertise continues to pay off in better account retention and new business, and our merger and acquisition teams are working hard on a strong pipeline.

Thanks, Pat.

Good morning, everyone.

You heard Pat comment on the operating environment.

So, like I did last quarter, I'm going to flip through the earnings release and highlight some items that might need some voiceovers and then I will move towards giving you some information that might be helpful in building your models.

On the first page, you can see we have broken out five items in an attempt to remove some of the noise in that EPF and EBIT-DAC numbers.

Items like book gains, severance and lease charges are self-explanatory, so I will focus on the other two items.

First in the Brokerage segment, recall that accounting standard 141-R requires us to continually re-estimate our acquisition earnout payables.

In the third quarter, we revised slightly slower lower our estimated earn-out, primarily for the Liberty/Wausau ideal.

To put this in perspective, recall that the earnout could technically be up to $125 million.

So a slight change in an assumption or two changes the earnout estimate by $5 million.

In my view, that is a net, so please don't jump to any incorrect conclusions.

This continues to be a great transaction, and we're pleased with how our teams are performing.

The second item is in the Risk Management segment.

It's an expense related to settlement rather than extended litigation involving an employment matter.

You will see flit flowing through the comp line this quarter because most settlement really relates to back compensation, not litigation expense, which would run through the operating expense line.

For the next thing, turn to the last paragraph on page 2.You will read that our brokerage, production and field management incentive compensation is up compared to the third quarter of last year.

Because we posted better organic growth, in the third quarter it became more likely that they will hit more of their threshold in 2010 than we previously thought.

That triggers accumulative increase in bonus expense of about $4 million to $5 million here in the third quarter.

Year-to-date bonus expenses consistent with 2009, so it's just a third-quarter catch-up item.

All right with that in mind, when you turn to page 3 and look at the brokerage adjusted EBIT-DAC table, if you adjust for that $4 million to $5 million bonus strengthening, it would make our third quarter brokerage adjusted EBIT-DAC margins about equal with the prior year.

Again, you don't need to do that for the year-to-date margins because that is just a third quarter item.

Turning to risk management, like Pat said, the big news in the quarter is that we bought GAB Robins.

We paid about $20 million for the business and assumed some run-off obligations.

We think it's a great deal that -- and we think that we can level Gallagher Basset's highly efficient infrastructure with very little additional fixed costs.

In the next couple of quarter,, don't expect much profit to hit the bottom line because we'll have integration costs.

But by mid-2011, we hope to be up to an annual run rate of about $9 million to $10 million of cash on the deal.

Okay, with those comments, let's move to some reminders as you build your models.

First, when modeling supplemental and contingent commissions, please use note 8 of this earnings release.

For supplementals, use the adjusted supplemental commission line, because that line puts 2009 and 2010 on a basis of how we think the supplementals will emerge in 2011.

And for contingent, note 8 also it helps you understand natural seasonality, and please bake that into your models.

Second, when you make your picks for the change in estimated earnout -- acquisition earnout payable line, you should show an expense of about $5.5 million per quarter in 2011.

This is assumes we have no adjustments to our estimates like we did this quarter.

Third, for the corporate segment, it might be more helpful for you to build your models using the shortcut table we provide on page 4 and the information we provide on page 5.

If you assume that fourth quarter interest expense, M&A costs and other corporate costs are similar to the third quarter, and you assume we make about $1 million after tax from our clean energy projects, you will end up with about $0.6 to $0.7 of net loss for the corporate segment in the fourth quarter.

As a wrap-up comment, even in this difficult environment, the Gallagher team is working really hard to grow both our top and bottom line and bring operational efficiencies and higher quality to the business.

Alright, those are my comments, back to you, Pat.

Operator, we're ready for questions and answers.

Questions, anyway.

Thank you.

The call is now open for questions.

(Operator Instructions).

Thank you.

Our first question is coming from Michael Grasher of Piper Jaffray.

Please state your question.

Good morning, everyone, congratulations on the quarter.

Thank you, Mike.

A couple of questions around some of your comments, Pat, and your initial remarks around the deal activity.

Interesting that concern around the tax policy, in that are you thinking ahead to the election this week and perhaps some of the noise coming out of Washington in recent weeks just in terms of the tax policy maybe not changing as much as it has?

Have you seen any sort of push-back at the table since some of those comments have come about?

No, we haven't.

In fact, as I said, we're seeing activity tick up -- I think activity for us over the last three quarters has been kind of slow, frankly.

We have had people, I think, that are looking at the both the economy as well as the rate environment, sort of playing a wait-and-see game, and just coming into the fourth quarter, we have seen activity tick up a little bit as people are saying, I want to get this deal done.

I don't know what is going happen, obviously, with tax policy.

Frankly, it would be good for us if the tax situation were to stabilize and not change.

I think our deal activity would be stronger in 2011.

I think if the tax policy does change and go back to the pre-Bush era, I think it will hurt our merger and acquisition activity.

Okay, and anything around the bid ask spread between -- or I guess what you have seen over the past couple of quarters, any change there at all?

No, it's pretty stable, actually.

Pricing, I think, is stable.

There are those people who believe their business is going come back stronger at some point in the future, that are holding off and, yet, we're seeing deal flow be pretty consistent right now.

Okay, appreciate that.

And also your comments around the healthcare bill and the unintended benefit to Gallagher out of that law.

Where are you in terms of thinking about your value-add to clients along the way?

Is it still very early and there is a lot more to work through, or you can expect more winds as you were highlighting here in this quarter?

Mike, I have been very public in my statements that I don't believe this is a good law for America, okay?

So let me start there.

But this is a good law for Gallagher.

I mean -- our competition, if you don't have the capabilities and the talent that we have on our team, you can't compete right now.

Our people have spent the time and effort, we're doing e-learning exercises.

All of our benefits professionals are being tested on their knowledge of the law, and that's happening right now, we're already on top of this.

We're going out to meetings with our clients, both prospects and clients, and I will tell you that the level of frustration by employers, and I'm not talking huge employers, I'm talking that 100 to 500 life case, the frustration that they're beginning to feel with regard to this legislation is palpable, and our people can really help them through this.

It's a wonderful time for us in terms of being able to get close to clients and to help them through what is a labyrinth of compliance and questions and timing and our -- and calculating the cost impact on them.

This law is complicated and we're the ones, along with very few others, that can really help our clients through this and we're seeing the benefits of that.

So it's just taking take off then, in reality, for you?

Just now, and it's taking off like a jet engine.

Okay.

And what about to the extent that maybe there is some reform on it that maybe lies ahead?

Again, it is one of these things I have to balance the answer.

First of all, I'm not in favor of the legislation.

I told our people that, we wrote to our senators and congress people and told them we didn't think this legislation should go forward, not that we're not in favor of health reform.

But I can't speculate what is going to happen in the near-term elections.

Fair enough.

Thanks very much.

Thanks, Mike.

Our next question is coming from the line of Bob Glasspiegel with Langen McAlenney.

Please state your question.

Good morning.

Morning, Bob.

It seems, Pat, that the contingent commission is kicking in faster in 2010 than you had said going in to 2010, which I thought it was, this is more a 2011 heaven beneficiary.

Is that function of the underlying profitability in the business is better than maybe we thought, or that you're able to get the contracts to work more favorably sooner?

One of the reasons we're breaking this out, Bob, we want all of you that are building models out there to understand that this is volatile income.

Both of our supplementals and contingents are based on what we can negotiate year-to-year and the profitability of our book.

The contingent income that you're seeing run right now has been stronger than we thought it would be, and primarily it's coming from our wholesaling operation.

And just expand on it, is it because the business is more profitable or the contracts have gotten in sooner?

The business is profitable.

Okay.

So we want to -- if we're modeling that, it's more a function of how the underlying business is doing than how many more new contracts you can write to have them?

Yes.

Okay.

Doug or Pat, it seems like you hinted that the third quarter bonuses are higher because the growth is coming in better than you thought, yet your commentary on the marketplace is not very inspiring.

Can we pinpoint sort of where in the Company things are coming in better than you thought in your budget?

Bob, yes.

We didn't hint the bonus expenses up, it's up $4 million to $5 million, first of all.

Right.

And that is good work by the team of getting to the point of growing such that they can hit their threshold.

Right.

And so that's -- you're exactly right in reading those tea leaves.

In terms of where we see better organic growth than expected, it's kind of across the board.

Right.

I think when you look at sequentially each of our regions, each of our units, and then, like Pat said, international's performing pretty darn well.

So we're seeing up and down the line improvement relative to where people were in the last couple of quarters.

Nothing is standing out in one particular region or one particular unit.

Okay, last question.

Pat, I'm sure you've had a chance to absorb Bill Berkley's optimistic reporting what is happening and what may happen shortly.

Is he looking at different lines of businesses than you are?

Where do you think you and Bill part company?

From his lips to God's ears.

Okay.

I was hoping for a little bit more than that.

Well, I mean (inaudible -- multiple speakers).

I have great respect for Bill.

I think he's a stand-out performer in our industry.

He's a risk taker.

I kind of get -- I kind of flow down the river.

I go where the market goes.

And so I am not being facetious.

I think that I -- I mentioned in my prepared remarks that we're seeing rates that are pre-2000 level, and those rates were not sustainable in 1999, and I don't see any reason why they would be sustainable today.

I look and say this is my fourth cycle.

I was a bad predictor of a change in the middle 1990s but the market changed, and I don't know when this market is going to change, but I can tell you, I am pretty sure it will.

I'm with your reporting, Pat, for what it's worth.

Thank you.

Thanks, Bob.

Our next question is coming from Keith Walsh of Citigroup.

Please state your question.

Good morning, gentlemen.

Good morning, Keith.

Pat, just first question, exposures, I think clearly from your commentary continues to incrementally get better, and I think that is pretty consistent what we're hearing out there.

But maybe you could talk to by geography a little bit.

Are you seeing any -- is this a broad-based incremental improvement, for example Brown last week on their call mentioned the Midwest was particularly weak for them.

So if you can maybe talk to that and then I have a couple of follow-ups.

I would be glad to speak to it.

I think we're seeing a flattening, Keith, in terms of exposure units around the entire country.

Internationally, we're seeing, I think, actual organic exposure growth.

I had a chance last night to spend some time with a number of our young professionals that are out on the street every day, and it was interesting.

We have a captive insurance Company that we do for contractors and the people who are involved in infrastructure projects.

I don't know about you, but it's hard for me to get to work in the morning with all the road work being done.

Those people are up nicely.

Payrolls out there look to be flattish but not going down.

We had one trucking client who was an intermogul client who does the early -- moves stuff off the railroad tracks kind of early.

They've already had a good Christmas, which is interesting.

Not a huge client, this is a client who has 65 units, told us to expect that hopefully by the end of next year, they'll be up to 90 units.

So I think it's pretty broad based around the country.

We're not seeing the decrease in the Midwest that was mentioned on the Brown call.

We're seeing flat here, but I think it's pretty much flat in terms of exposure unit across the whole US.

And then secondly, just thinking about terms and conditions, I think with the competitive environment, I am hearing a lot of loosening by the underwriters on that end.

Are your brokers out there basically winning much better terms and conditions for the client basically at the same price, which I guess would be a price reduction if we talk about it that way?

Yes.

That is absolutely happening.

And I will tell you, it's difficult for our wholesale business because the primary markets are taking business back away from the wholesale -- from the excess surplus markets, and that's all terms and conditions, which a price cut by any other -- not that --

And then last question for Doug, just your commentary around the Liberty deal earnout.

I just want you -- help me understand why that is in an incremental negative if the earnout is changing.

What data points specifically led to a change in that earnout, just so I understand it correctly.

I think it's purely a timing of their ability to cross-sell into the market.

And if they put more business -- cross-sell more into their clients and that happens outside of the earnout period, so it takes them a little longer to get it, we don't pay as much for the business.

So in a way, it's a timing issue that's sliding it back more than it is a belief that there is any less capability of producing.

So, remember, this is a wide range from $0 to $125 million and we tweaked a couple estimates of the timing of when we think they will fully mature into the cross-selling ability or adding products to their client portfolio, and that is what caused the change.

Does that change your accretion on that deal in any way, shape or form?

No, and I want to make sure, I think I may have had marble mouth when I said we expect the acquisition earnout payable line to be $1.5 million per quarter next year.

I just want to make sure you are clear about that.

It doesn't change the accretion by hardly anything at all.

Okay, thanks a lot.

Thanks, Keith.

Thank you, our next question is coming from the line of Mark Hughes of SunTrust.

Please state your question.

Thank you very much, good morning.

Good morning, Mark.

How about the claims frequency in the risk management business, especially in workers comp, any change this quarter?

We continue to see a slight decrease in claims activity, and it really does -- I said in my comments, fewer employees, fewer claims.

Exposure units are flat out there, that means the employment situation has not improved.

How about the rate of decline in frequency?

Similar, a little less?

No it's very similar.

And then you talked about a good quarter in terms of new business.

Is that sustainable?

Was there anything unusual?

Any special prizes this quarter?

No, in fact, there is no single big win that I could sit here and say don't model that into the future.

I really think our team is focused on getting new business, they're doing a good job.

We pound the street very hard, by the way, guys.

This is not unusual for us.

But we are out there every day trying to get new business on the books, and we just had a good quarter.

And then the UK, Australia, I assume that is accelerating from prior periods?

What is causing that?

That is a good question.

I think the thing that's driving us in the UK are new teams, and, remember, we did the FirstCity acquisition in the second quarter, which is turning out to be a very good deal for us.

In Australia, we completed the acquisition of the other 60% of the partner that we had in Australia that we didn't own, and they have done very well organically.

Interesting, in Australia, they actually piggy-backed on the niches that we have here in the United States done quite well using our expertise in some of the areas that we have in the US to produce business in Australia.

So I think it's just a culmination of both organic activity as well as acquisition activity.

Thank you.

Thanks, Mark.

Thank you.

Our next question is coming from Dan Farrell of Sterne Agee.

Please state your question.

Hi, Mr.

Farrell, your line is open for questions.

Okay, we have lost Mr.

Farrell's line.

Our next question is coming from the line of Meyer Shields from Stifel Nicolaus.

Please state your question.

Thanks.

Good morning.

Let me start, Doug --

Good morning, Meyer.

How are you?

Good, how are you this morning?

I'm doing okay, it's raining here.

Good.

The $1.5 million in anticipated acquisition earnout payable increases, do I have that right?

Yes, third quarter.

Third quarter.

That starts in fourth quarter of this year?

Well, here's the thing.

It's been a consistent run rate at that since we did the Liberty deal.

It's just masked in the last quarter or so because we had to make a change in the acquisition earnout payable adjustment also, so if you assume that we have no further adjustments to our estimate, which is a little bit unlikely, you would have a normal expenses running through 2011 of about $1.5 million a quarter.

Remember, Liberty was primarily on an earnout basis, so that puts a larger number on that line than we would get if we did smaller deals with only 25% on an earnout.

That's helpful, I just wanted to see if I got the modeling correct.

Two other questions, if I can.

One, Pat, you talked a lot about the need for expertise in healthcare consulting because of the uncertainty with the bill.

How common is the idea of employers just paying the penalty and dropping healthcare coverage from their benefits?

Actually, at this point, Meyer, it's pretty interesting.

Not very much.

There's not a lot of -- employers are looking at this as part of their comp costs and part of their recruiting efforts and holding their people.

There is not a lot of activity, and the bellwether in this is if you go to our Massachusetts clients, we have not had a single commercial client just opt out and go into the Massachusetts plan.

Employers are working their way through this.

Now I will tell you that the act itself is not making that easy.

And this is one complicated act , the compliance issues are huge, and I will also tell you that I don't think commercial America has really focused on it yet.

Because if you think about it, the only thing we have had to do is to add the 26-year-olds to our plans as of September.

Now, various compliance starts to come in, as we get into 2011, 2012, 2014, 2018, and I think you're going to see a huge kickback from commercial

Okay.

But you're not worried about it impacting your revenues either from that perspective or from the NAIC excluding it from the MLR calculations?

I think what we're seeing is an uptick in activity and that is really -- again, I'm not in favor of the bill.

Having said, it's going to be good for Gallagher.

Okay.

Fantastic.

And one more question, if I can.

Do you get a sense that insurers are being too sanguine about inflation in their pricing?

Yes, I do.

I think that right now, and let's face it, they have had terrific results for a number of years and, yes, I think that the idea that inflation could be around the corner is not in the pricing at all.

Okay, fantastic.

Thanks so much, guys.

Thanks, Meyer.

The next question is from the question of Brian DiRubbio of Y/CAP.

Please state your question.

Good morning, guys.

Morning, Brian.

I want to go back to the acquisition of GAB Robins.

Historically, as far as my notes and the history of the company goes back, you guys really have not done any M&A activity in that business?

I know you made a small divesture a bunch of years ago.

Can you talk about it?

Is that a change in strategy for risk management?

No, it's not a change in philosophy or strategy, and you're right, we have done a couple of small deals with Gallagher Bassett.

Gallagher Bassett and the risk management segment has been all organic growth.

We have grown the business over the last 25 years from literally $23 million to a $0.5 billion.

This was an opportunistic move, and, of course, we will look -- and we have over the years looked at every deal that has come out in the business, this is one that really fit nicely.

So this is something that you that may see more of or it's sort of as they come along?

As they come along.

Okay.

And, Doug, can you maybe give us details, or will this be in the Q on specialized brokering?

because didn't see anything because it was only a 40% minority stake when you made it in 2008.

Can you give us some numbers around what the size of that business is, on a consolidated basis?

Thanks, Brian.

What Brian's referring to is we bought 40% of a broker in Australia a few years ago, and in the last quarter, we moved our ownership from 40% to 100%.

It is a great broker in Australia.

The leadership there is outstanding.

This was as much about buying talent as it was about getting another footprint in Australia.

It's, size-wise, the revenues are about $6 million, but it's a highly profitable broker down there.

But this is more about the expertise in there, and when Pat talks to you about how all of a sudden now we're importing some of our niche expertise into Australia, it shows you how us having a footprint there, under -- with some good leadership and a nice existing platform can be a nice entrance into another market there.

We have been there for a long time, but this really is a nice deal for us, but it's not financially that big.

Okay.

And last question, you guys also have a minority interest in CGM Group Limited?

Yes.

I think it's 38.5% that was done in 2007.

Is that something you can foresee cleaning up and taking full control or is that dependent on the owners?

I think that deal is panning out to be a very, very good deal for both parties, and, yes, if the opportunity -- when the opportunity presents itself, we can see ourselves going to 100% for sure.

Yes, and I think it's illustrative of international expansion opportunities there.

I think that we want to take -- put a tow in the water, find good, indigenous leadership that is committed to do business the Gallagher way in these countries, and I think it's -- both of these transactions are ways that I think you will see us growing internationally.

Great.

Thanks a lot, guys.

Thanks, Brian.

Our next question is coming from the line of Adam Klauber with Macquarie.

Please state your question.

First question on the GAB deal.

Doug, I think you mentioned it could be profitable in the back-half of the year.

Will you be able to get GAB up to your traditional Gallagher Basset models by the second half of the year?

Yes.

These are great claim adjusters and these are great clients.

I think everybody has received this transaction in favorable light, and people inside of Gallagher Basset, people inside of GAB Robins are working hand-in-glove in making sure that we continue to provide great service to our clients.

So I see this transition going similar to like the Liberty deal.

We had experience with bringing in 250 people in Liberty, we put them into 42 locations in the Gallagher, and the GAB transaction, there are 21 different locations and some are going to join forces with Gallagher Basset, some of them will be stand alone.

We have a model of doing this and I think the team will do a great job over the next six to nine months to get this thing in place.

Yes, Adam, this is Pat, I am very proud of what we have done in this regard, and we've talked to virtually every client.

And the feedback has been very, very positive.

The feedback has been one that, look, we knew this Company was owned by private equity and we knew that there was going to be a transaction that was going to occur, and we're very pleased that someone who is strategically interested in this business has picked up these clients.

So, right now, knock on wood, it looks really, really good.

Great.

Do you think you will have charges in the first half as you have -- as you try to improve profitability there?

I think that we should be able to absorb that in the profit stream of the Company.

So I wouldn't say -- you would have timing in it one quarter, but we're not talking about tens of millions of dollars of charges by any means.

We might be $1 million dollars or something like that here or there but nothing that I would say would cause to you have a different outlook in the first -- in the fourth quarter or the first couple of quarters.

Okay, and one follow-up on organic.

When you look at organic went from negative 6% a year ago to flat, and a quarter ago went from negative 3% to flat.

How much of that improvement is roughly due to exposure improvement?

I think the CAB is correct, Adam.

I think that our rate situation is down five points, and so I think that probably 4% is, in fact, exposure.

Okay.

2.5% to 4%.

Great.

Thank you very much.

Thanks.

Thanks, Adam.

Our next question is from the line of Jay Gelb with Barclays Capital.

Please state your question.

Thank you and good morning.

Good morning, Jay.

How are you?

Good.

First, a follow-up on the last question.

If organic growth is probably flat to higher from where it is at current levels, what does that imply for the potential for margin improvement?

I think our -- I want to make sure I give this as a balanced response and not predicting which way it's going here.

In a down organic market, the franchise will do very well to hold -- it will be great work to hold margins flat.

In a flat organic environment, you might see a slight margin expansion but probably not enough to change your models too much.

In an organic growth environment, in a little organic growth, there will be a little margin improvement, in a big organic growth margin, more will fall to the bottom line.

So there is a full spectrum of possibilities, all depending on which way our organic growth goes.

Okay, so far --

I'm not propagating one way or another.

Right, and so far this year, Gallagher's basically kept the margin flat to up modestly, so seems like there will be less of a headwind going forward.

The other thing I just wanted to touch on is the ability for Gallagher to capture increased core commissions from the markets on an ABC basis.

Can you talk a little about that?

I'm not clear on that question, Jay.

Will you redo it for me?

Sure.

In a soft market, typically we might see the carriers paying increased commission rates.

Okay.

In order to attract or retain the business and -- first, is that the case, and second, what kind of traction are you having there?

The good news for us, is that by and large, our production teams are paid based on what they bill.

So, at the underwriting desk to get a deal done, we empower our producers to do what they need to do.

They can cut commissions and they can ask for more.

In a soft market environment, where there is decreasing pricing and there is plenty of market around to do a deal, our people will typically do better on their core commissions, and we are seeing that.

Alright, so seeing higher commission rates as premiums fall?

Let's put it this way, our producers are essentially getting the commission rates that our contracts call for.

I'm not -- you can clarify that?

Yes, the bottom line is we're not having to cut our commission rates to get deals done.

And, in fact, we're typically asking for more commission where available to produce business for the market.

Makes sense.

Thank you.

Thanks, Jay.

Our next question is coming from the line of Scott Heleniak with RBC.

Please state your question.

Hi, good morning.

Good morning, Scott.

Wondering on M&A, are you seeing more from competition for employee benefits, acquisitions?

I know everyone -- it's kind of a hot spot lately and just I wondered if you're seeing a difference, is that impacting your strategy or your ability to close deals there?

Well we are seeing more competition, but, no, it's not impacting our strategy.

One of the things that I think gives us a leg up in the acquisitions in particular in the employee benefits space is the fact that we have built tremendous expertise in that business.

We have diversified away -- we're not just a health and welfare broker.

We have all kinds of expertise in different areas that helps.

These new merger partners cross-sell more things to their clients.

If you think of the typical insured out there, they're not just buying health insurance.

There is all kinds of voluntary products, there's life insurance, 401k, retirement, et cetera, et cetera.

We bring expertise in all of those areas and so it gives us an opportunity to expand the relationship with the companies that join us through the merger and acquisition process.

Yes, there is competition.

But we're not seeing pricing tick-up.

It's not changing our strategy in the least.

We continue to build out that platform, that is a business that has grown extremely well for us over the last decade.

Okay.

Thanks, and just one more question, too.

You guys have done a nice job the past couple years at the expense controls, and just wondering if there is any expectation for changes in expenses in 2011.

Just wondering if there is any additional renegotiation of leases or anything left, or how are you viewing expenses heading into 2011?

Yes, Scott.

Good question.

I think that in terms of expenses, let's take it a couple of different places.

I think there is opportunity still in the real estate space, that is a slow creep that comes through.

We're not going to rush out and do a wholesale reset of our leases at this point, but we're having a lot that we'll renew and we'll look at them differently, and I think there are savings there that we can harvest there over -- in 2011 and 2012.

When it comes to consumable expenses, we buy our pens and pencils and phones and everything else pretty cheap at this point.

The furniture pretty cheap.

So I wouldn't expect much more savings there.

On our travel expenses, you're seeing natural inflation out there with the airlines so that is causing an uptick in expenses, and our people are travelling more to see their clients and more to do internal meetings in 2010 than they did in 2009, so that uptick is already in the numbers.

Would I think there is a big uptick coming in 2011 in those expenses?

Probably not.

So I think holding that steady to 2010 levels in 2011 is about where we're going be.

So, the place to look for opportunities is primarily in the real estate spot, and I don't think you that will see much slippage unless you get inflation and all consumables, then that is what you would see.

Okay.

That is all I have.

Thanks.

Thanks, Scott.

Thank you.

(Operator Instructions).

Our next question is from a Dean Evans with Keefe, Bruyette & Woods.

Please state your question.

Thanks.

I think most of my questions have been answered at this point.

I was just wondering if you could go into more detail, additionally when you were talking about the organic improvement, you did reference both new business and retention.

I was hoping you could give a little more color on those, and hopefully if you would be able to give us the numbers for the quarter and what they were last year, that would be great.

If not really, just a little bit of a discussion around what is happening there.

Well, Dean, let me give you the discussion, not the actual numbers.

I think -- and you've seen this from our results in the past, we tend to ebb and flow and sometimes we're better on new business than we were in previous quarters.

This just happened to be a good new business quarter for us.

I think that is probably saying something like 2% better than what we have done in previous quarters, so I'm not sitting here telling you that organic new businesses has jumped 10 points because we've done.

something magnificent.

I just think we had a good quarter of blocking and tackling and getting the job done.

Same is true when it comes to retention.

Some quarters, I think we mentioned in the second quarter, that we'd had one or two lost accounts that were -- kind of hurt us, this quarter we had better retention than we had in previous quarters.

And it all added up -- add to that our organic as well as M&A growth internationally and we come out flat, and we're happy with that.

That is an improvement over where we were the last six months, actually.

So I'm sorry not to give you the specifics, here it is.

That is what the numbers are, but that's the anecdotal thing, what is happening.

And what is my feel as we go forward?

My feel is that exposure units are flattening.

We're not seeing the decrease of people coming to us saying my payroll is $100 million, take this thing down to $50 million for my renewal, and we've live through that.

That is exactly what was happening a year ago.

People are saying look, my business is gone.

We had contractors doing $100 million of revenue going to $15, and we're putting out just as many bid bonds, they're bidding jobs they never would have bid and we're issuing certificates of insurance and working our tail off to keep that client who used to pay us x and is now paying us x minus a lot.

So it was a better quarter in that regard.

Okay, that is helpful commentary.

Trying to think about it, I guess, from the more positive side, is there was a chance that that x minus whatever gets back to x in the near-term and improves from flattening?

Yes.

Yes, I think there is.

Again, having a chance to -- and these are all anecdotal stories, but having a chance to interact with our people that are on the street dealing with individual accounts.

If you're in the home building business, if you're in the artisan contractor business, you're still going down, it's going down big times.

But if you're infrastructure, if you're transportation, some of these other businesses, retail, we're seeing a little bit of growth there.

Okay.

Thank you.

Thank you.

I guess last thing and a quick one, but definitely we have seen a handful of things like the litigation charge over the last few years.

Is there anything going pending that you can think of that is a one-off-type item that is going to be coming through the next few quarters or --?

Dean, that is a great question.

Yes, we have had a couple the last couple quarters and I think that's great work to the legal team.

We have cleaned up some stuff that is been hanging out there for a number of years.

I don't see anything on the horizon right now that is brewing, so I think we have a clear slate in what we're seeing.

Naturally, litigation is a part of every business's issue that they've got to face, but I think we're in really good shape and it is great work to the team.

Okay.

Perfect.

Thank you.

Thanks.

Our next question is from the line of Alison Jacobowitz of Bank of America.

Please state your question.

Hi, thanks.

Most everything's been hit on, but I was just wondering maybe if you could talk a bit about what you're seeing in the captives?

Yes, good morning, Allison.

I will.

Good morning.

We are -- it's interesting because I had a chance to chat last evening with some of our people that are actively involved in captives.

The captive clients by and large continue to be very happy with the fact that they're in a captive.

I am speaking now about our group captives, singe-parent captives are very, very stable.

Group captives are hard to sell new business into right now because you have to make a capital contribution, but we're seeing a very stable renewal book, they typically come into a captive and don't leave.

And the renewals on these captives have been very successful for the captive clients and, frankly, prices are down substantially.

So many of them have been good to us in the sense that when we have taken their costs down substantially, we have been able to get them to keep our remuneration pretty flat.

Thanks.

Thanks, Alison.

Thanks, Alison.

Our next question is from the line of Dan Farrell from Sterne Agee.

Please state your question.

Hi, guys.

Sorry about earlier.

I accidentally hung up instead of unmuting.

That's okay, Dan.

Welcome to the call.

Welcome back.

Good to get back.

So I apologize if this was addressed, but just on your free cash that is available for acquisitions, can you tell us where that stands post-GAB, and also I think some of your unrestricted have carrier revenue so if you could do a deck for carrier revenue, what you could actually put to deal?

Dan, good question.

We have about $80 million that we could do a deal with right now in free available cash.

Okay.

And then is your view still to use, on a go-forward basis, about 75% stock, 25% cash?

Or is that changing in any way?

That is our go-in.

Obviously, we'll always use the cash up first before we use the stock.

But right now, I think that this gives us -- we have some pretty good flexibility in our M&A pipeline with $80 million in the bank right now, plus we have a $500 million line of credit, too, so.

Okay, great, thanks.

And then could you just talk a little bit about the trends that you're observing in the wholesale and MGA environment versus traditional retail?

Sure, on the MGA side, one of the things that drives that business is start-up businesses, and we're seeing a little uptick in start-ups.

A year ago or so we would have told you, and I think we did, that start-ups just weren't occurring, and so on the MGA side, we're seeing a little bit of uptick from new start-up businesses that come into our various MGAs for coverage needs.

The wholesale business is very tough.

The open-market broking business is tough.

The primary carriers are, in fact -- they do have appetite.

Retail brokers would prefer to push their business with primary carriers because they get more commission, and so that business has been tough and prices continue to come down.

And so, that is a business that is our more cyclical business.

We understand that it's cyclical and I think we've built a real powerhouse.

We traded that business in the United States as risk placement services and Business Insurance has got us right now as the number one MGA open broker wholesaler in the business.

So I think that we have -- there is very, very good future growth there, but it's tough slogging right now.

Okay, thank you very much.

Thanks, Dan.

Thank you, our last question is coming from Meyer Shields from Stifel Nicolaus.

Please state your question.

Thanks, just a couple of quick follow-ups, if I can.

One, we found uptick on the gains in book sales.

What annualized revenue is associated with that that has been sold?

Actually, you will notice we call it book gains and other.

Most of that in this quarter came from when we bought the remaining amount of the Australia broker.

We went from 40% to 60%.

It produces an accounting gain on that purchase of about $2.5 million to $3 million.

And so there was not really much book sales in the quarter.

It's just we have this unusual accounting situation when you move from a minority position to a wholly-owned subsidiary, and it creates an accounting gain and we put it in that line item.

There was not that much in this quarter, Meyer.

Okay.

Good.

With regard to GAB Robins, the -- if I understand what you were saying before correctly, Doug, then we should expect really not much incremental earnings over the next three quarters and then ultimately margins should get back to legacy Gallagher?

No, I think -- I gave no opinions or comments on margin of the blended two organizations.

What I said is that if you model in the $45 million to $50 million of revenue that will come from the Gallagher -- from the GAB Robins, eventually that will throw off $9 million to $10 million of earnings.

Okay.

Would you care to comment on the margins?

Put it this way, it's pretty easy to do the math if you take Gallagher Basset at $450 million at 15%, or 15.4% where they are right now, and the GAB Robins and put them together.

You will get some margin expansion on that.

I don't have it here in front of me.

Okay.

Fair enough.

Last question.

When you were talking about the acquisition pipeline, is that basically still primarily domestic?

No.

And, in fact, I would say over the last five years that has not been domestic.

As you know, we did the FirstCity deal earlier this year in the UK, added a significant thin-pro practice to our organization in the UK and that has been a very successful acquisition.

We completed the deal at SBA in Australia.

We did a small acquisition in Brazil.

We're presently looking at a small deal in Singapore, so our aspirations are global.

Okay, great.

Thank you so much, guys.

Thanks.

There are no further questions at this time, gentlemen.

Great, Operator.

I will make a few just closing comments, if I could.

Thank you, everybody, for being with us this morning, I really appreciate it.

As I said, I think one of the reasons we have been able to keep growing, even in these difficult times, is because we have kept very strong focus on our strategies.

We're sales-focused working every single day on organic growth.

We're recruiting great talent, we're attracting merger partners that we're pleased to have join us.

We are expanding globally and, at the same time, we continue to feet tough headwinds.

But the Gallagher team is focused, selling, winning and growing, and I'm proud of that and I'm proud to be associated with these performers.

Thank you for being with us this morning, everybody.

This does conclude today's conference call.

You may disconnect your lines at this time.