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Operator
Good morning, and welcome to Arthur J.
Gallagher & Company's fourth 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 the conference call include answers given in response to questions and may constitute forward-looking statements within the meanings of the securities laws.
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 is now my pleasure to introduce J.
Patrick Gallagher Jr., Chairman, President and CEO of Arthur J.
Gallagher & Company.
Mr.
Gallagher, you may begin.
- Chairman, President and CEO
Thank you, Claudia, and welcome, everybody, and thank you for being with us this morning.
We got a great snowy day in Chicago.
If any of you watch the news, you can see the Great Blizzard of 2011.
As is our custom, I'll make some comments this morning.
Doug Howell, our CFO, will add some color, and we'll go pretty quickly to questions and answers.
I'm joined today by Doug as well as the operating heads of our operating divisions.
We ended 2010 on a strong note, and I'm really proud of our team.
Our fourth quarter adjusted EBITDAC was up 17% in our Brokerage segment, and up over 18% in our Risk Management segment.
Both segments improved their fourth quarter adjusted EBITDAC margins; Brokerage by two points and Risk Management by 70 basis points.
We showed substantial margin improvement in 2009, and I'm pleased with the fact that in 2010, we held those margins in our Brokerage segment, and we even improved it in our Risk Management segment.
This is excellent work if you look at the environment that has now for seven years seen falling insurance pricing, and for three years, we've had the worst economic conditions since the Great Depression.
It's tough, tough work when your clients are not buying as much insurance because they have decreasing payrolls, their sales are down, and their businesses are down.
Our acquisition program also finished strong in 2010.
We have a tremendous pipeline coming in 2011.
In the fourth quarter, we closed seven transactions for nearly $90 million in revenue; nearly $40 million in the Brokerage segment and $50 million in the Risk Management segment.
I'm very happy with how the team handled the level of activity.
I'm also pleased that these fine firms joined us.
All of those people had choice, and I'm very pleased that they chose to join Gallagher.
A special note about Gallagher Bassett buying the TPA business from GAB Robins.
This really is a great deal.
Putting Gallagher Basset together with GAB Robins combines two of the great pioneers in this industry.
The employees of GAB Robins are excited to be part of Gallagher Bassett; they appreciate that we are viewed as being the best highest quality organization in the business.
They appreciate that we've had stable and committed ownership for over 50 years, and they appreciate an experienced, professional and dedicated management team.
Our integration is going better than we expected, and by the fourth quarter, we'll be one unified and rock-solid organization.
Let me go back to each of the businesses and give you some thoughts on our significant operations.
Our retail property and casualty continues to be very, very niche-focused.
In 2010, our ability to show clients and prospects that we truly understand their business and their risk management needs, really it led to strong new business and strong account retention.
Over the last three years, we've fought the headwinds of economic decline and soft P&C rates.
I think it's a testament to our sales culture that we're able to overcome this continued downward pressure.
Serving our clients and bringing new business in the door is what Gallagher is all about.
Our employee benefits team has been working very hard with existing clients and prospects, to come to grips with the changing landscape in the healthcare world.
The new law is complicated and sure to be modified frequently over the coming months and years.
We have the capabilities to help clients sort through this complex law.
We're benefiting from being one of the firms who have the resources to stay on top of these changes and to advise our clients on how to react, and this is going to continue and be an opportunity for us in 2011.
Our wholesale and MGA business improved nicely in 2010.
Risk placement services has been recognized as the largest MGA in the US.
We started this business from scratch 14 years ago, and our success comes largely from professional underwriting we've done on behalf of our markets.
It's still tough in this space because it serves new business startups and hard-to-place business.
With fewer startups and primary cares looking for growth from businesses that might be better placed in surplus lines carriers, growth is a struggle.
Internationally, great opportunities, great 2010; our growth over the last few years has been substantial.
We have been one of the fastest-growing Lloyd's brokers for over a half a decade.
We added to that in 2010 with the acquisition of First City.
We have also opened -- we've taken on additional equity in our Australian operation, we've opened in Brazil, and our opportunities internationally are going to be a big part of our success in 2011.
Gallagher Basset Services continues to see lesser claim counts domestically, due to lower employment and lesser economic activity.
When claim counts are falling, that puts pressure on our revenues.
The management team remained focus on expenses and did a good job of maintaining margins.
On the other hand, internationally, we're seeing some very nice growth, particularly in the UK and Australia.
Growth is coming from expanding from traditional public (inaudible) into the commercial marketplace, and we've had some very nice wins from our domestic customers using our services internationally.
Okay, now let me make some specific comments on how we are seeing rates and the economic conditions.
First, rates continued to soften in the fourth quarter.
The Council of Insurance Agents and Brokers, CIAB, quarterly report, reports rate declines on average of 5% in the quarter, and that's exactly what we're seeing.
New business is still extremely competitive, and we're seeing carriers quote new business considerably down from expiring terms.
Even renewal business remains soft.
Not as soft as new business, but we're still seeing rate cutting.
Second, there's talk of an economic recovery.
We share the view, and it seems that our clients' businesses appear to be stabilizing.
Hopefully, we'll see some job growth in 2011.
Any improvement in our clients' businesses help us grow our business.
Despite the rate and economic environment, financially, we ended 2010 well-positioned for 2011.
Our balance sheet is strong, and last Thursday, our Board approved a 3% increase in our dividend.
We have free cash flow of over $100 million, and we are also putting another $125 million of long-term debt in February that will give us powerful merger and acquisition flexibility.
As I look to 2011 beyond, we continue to push ourselves for growth, regardless of the conditions.
We really believe we have the secret sauce; it's our culture.
For those of you that have followed us over the decades, you know our culture is the glue that keeps us together, in good times and in bad.
We work together, across the globe, keeping our clients' needs first, helping our existing clients, and aggressively seeking new business.
To conclude my comments, in our press release we listed a number of accomplishments achieved in 2010.
I'm proud of our team.
We continue to grow our business, our culture remains strong, our people are turned-on and selling, and I feel good coming into 2011.
Doug?
- CFO and VP
Thanks, Pat, and good morning, everyone.
You heard Pat comment on the industry and the operating environment, and in the earnings release, there's a lot of financial information that you can read for yourself.
So, let me spend some time pointing out significant financial items for to you consider when building your models.
For Brokerage, it was a very straight-forward quarter.
So, the biggest item for to you focus on is modeling future revenues.
I really encourage you to do it in three components, like we present on page two of the earnings release.
For commissions and fees, pick your organic percentage change.
Apply your pick to the first quarter 2010.
Remember, our first quarter is seasonally our smallest, so don't project off of our fourth quarter.
Then add to your first quarter estimate about $20 million of roll-over revenue from acquisitions.
Do the same approach for the second and third quarters and fourth quarters of 2011, but add about $15 million of roll-over acquisition revenue in each of those quarters.
For supplemental commissions, make an educated guess using the three years worth of information we provide in note 8 on page 11.
Look at the Adjusted Supplemental line, not the Reported line, and make your best guess.
Using the Adjusted line will help you avoid the noise you saw in our first quarter 2010, when we began [giving] supplemental information on a quarterly bases.
This is an extremely important point to get right in your models, otherwise you will be way off.
For contingent commissions, again, make an educated guess using the information in footnote 8 on page 11.
Using note 8 will help you see the lumpy quarterly revenue patterns inherent with contingent commissions.
Please also note that we do not anticipate total 2011 contingent commissions to be much more in aggregate than what we booked in 2010.
For Risk Management, some things to consider for your models also.
First, when modeling revenues, use the table on page three and model -- and build your model using those three separate components.
For fees, pick your percentage guess for organic change, then because we bought GAB Robins October 1, you need to add about $12 million of roll-over M&A revenue for the first three quarters of 2011.
For now, assume about 15 to 20 points of margin on that M&A roll-over revenue.
For performance revenues, assume about $3 million per quarter in 2011.
For adjusting fees from natural disasters, also assume about $3 million per quarter in 2011.
Last, you'll need to load in some additional expense of about $2 million to $3 million per quarter for GAB Robins integration costs.
Do that just for the first three quarters of 2011.
By the fourth quarter, we should have those costs behind us.
Moving to the corporate segment, build your models in the manner shown on page four of the earnings release.
But realize, and I realize, that there's a lot of noise in the fourth quarter relating to winding down our old legacy investments and closing some tax years, which won't repeat.
At December 31, 2010, our legacy investment portfolio is practically zero.
So, going forward, you don't need to model anything related to the Legacy Investment line.
For the other three lines, consider the following.
For the Interest and Banking line, Pat motioned that we're doing another $125 million private placement here in February, so you'll need to increase Interest and Banking Expense to about $11 million, or about $0.06 per share after tax, per quarter.
For the Corporate line in 2011, model about $2 million of pre-tax cost, or about $0.01 or so of loss, per quarter.
For the Clean Energy line, that's a bit more difficult to predict at this point.
Breaking it into two components may help organize your thoughts.
First, for the six plants we have in place, we have received our private letter rulings from the IRS, and we have received permanent emissions regulatory approval for one of the six sites.
We're extremely happy to have that first permanent permit in place, and we're back up and running in that plant.
Assuming we get the other five permanent permits in short-order, and we get the plants back running at historical levels, we should make about $0.04 to $0.05 per share, per quarter.
But given that it's already February 1, I wouldn't model too much here in the first quarter, as we wait for those permits to be issued.
For the other two plants, we're making great progress, and when we get them up and running, we should make about $0.03 to $0.05 a share, per quarter.
But because we don't anticipate having them up and running much before the fourth quarter, at this time, I wouldn't model too much of anything before then.
So, when you add up interest expense, corporate costs, and a guess for our clean energy plants, your models for the total Corporate segment should end up with about $0.05 to $0.07 of loss in the first quarter, and maybe about $0.03 to $0.04 of loss in the other quarters, assuming we get our six plants running.
Of course, with all of this being said, there are still a lot of uncertainties in this area; it takes time to get these things up and running.
We're pleased to have one in place; that's a great, great step for us.
So, those are the best guesses we can give you at this time.
Okay.
Those are my financial comments.
Back to you, Pat.
- Chairman, President and CEO
Thanks, Doug.
Claudia, we're ready for questions and, hopefully, some answers.
Operator
Thank you.
The call is now open for questions.
(Operator Instructions)
Our first question is coming from Bob Glasspiegel with Langen McAlenney.
Please state your question.
- Analyst
Good morning.
I can tell you the weather in the Northeast is not much better.
Maybe your claims processing, or risk management, in Q1 will benefit from this crappy weather.
I'm looking for a silver lining, somewhere.
- Chairman, President and CEO
We don't do an awful lot of storm chasing, unfortunately, at Gallagher Bassett.
That will be some of our competitors, but --
- Analyst
So roof collapses don't do anything for you?
- Chairman, President and CEO
Not a lot.
But also, you guys have had it worse up northeast than we have.
This is a good dose, though.
If this storm comes your way, you are going to be digging out over the weekend.
- Analyst
Well, we had 71 inches in April and I had to laugh at Chicago griping about 15 to 20.
I think we have had a couple of those already.
- Chairman, President and CEO
You have already had what, three of those now?
- Analyst
Yes, yes.
- Chairman, President and CEO
[laughter] Well, you've got another one coming.
- Analyst
Yes.
Question on brokerage fees, which haven't been growing, and I assume that is a little bit the economy, but why is that segment of brokerage not benefiting from acquisitions even, to show some revenue growth?
- CFO and VP
Bob, first of all, we've always said in the brokerage segment, the distinction between the commissions and fees, some years our clients want to work on a fee, some years they want to work on a commission.
It just depends one what we're pricing.
I have always cautioned everybody to not read too terribly much into the difference between those two lines.
And so, you know, we picked up the Liberty acquisition last year, so that may have influenced the increase last year, and we just -- more of that is moving over to commission, at this point.
- Chairman, President and CEO
Also, Bob, to add to that, most of the acquisitions that we're doing with are firms that deal in the commercial middle market, and most of that business is commissionable.
- Analyst
Okay.
Traveler's and Chubb, obviously, you seem to be a little bit in conflict with Jay Fishman's commentary that Q4 was less bad than Q3, but both Travelers and Chubs seem to say that organic growth is picking up within their segment more than, I think, you were saying related to the economy.
I wonder if you could maybe just see what you're seeing differently than Jay on the pricing front, and maybe expand on whether the economy is less of a help for you guys than what they're saying.
- Chairman, President and CEO
Let me comment on both.
The question is around rates and the economy.
Let me start with the rates.
What the CIAB is reporting is what we're seeing in our business.
That is just what's coming from the street.
As it relates to our clients' businesses, we're kind of the mind that things have flattened out.
I think we're through the cycle of returned premiums, I think we're kind of bottomed out.
We're not seeing, depending on the industry, we're not seeing a lot of job growth out there.
Our clients are not adding employees, but I would say that by and large, they feel like they're at the bottom and, hopefully, there will be some upturn here.
- Analyst
Okay.
Appreciate it.
- Chairman, President and CEO
Thanks, Bob.
Operator
Our next question is coming from the line of Keith Walsh with Citigroup.
Please state your question.
- Analyst
Hello, good morning, everybody.
- Chairman, President and CEO
Morning, Keith.
- Analyst
I will just skip the first question I had, because Bob asked it, so I'll go right to the second, and this is for Doug.
And just really want to delve in a little bit more on contingents and supplementals, and when I look at what you guys, that schedule on page 11, you've really rebuilt the contingents from, sort of, the peak of $35 million back in 2005, before Spitzer, and then you're back to $37 million, right?
And then on top of that, you have $46 million of adjusted supplementals.
So I guess my question is, and recognizing it's a difficult economy in pricing, the last several years, you had over a 20 margin in 2005, and now you're doing about 500 bips below that.
Shouldn't the supplementals make up some of that pressure on the economy and pricing?
If you could maybe talk through that, a little bit.
- CFO and VP
Yes, two observations.
You're right.
The problem is, is that we have had three straight years of negative organic growth, if you just take, I think that is 5%, if you add it up on the years for our brokerage segment across, you know, $1.2 billion of revenues, right there, that is $60 million erosion just in negative organic growth, you know, if you look at it that way.
So picking up $70 million of supplementals and contingents probably replaces most of that negative organic growth, in that case.
So, that explains the top-line.
In terms of margin expansion, we have had nice margin expansion over the last two or three years, we have -- our operating expenses are much lower than before, our comp lines are in check.
Our workforce levels, other than acquisitions, are lower than they've been in three years.
So any, any -- holding, you know, improving margin over the last few years, going back to 2005, I would have to look at your map to do it.
I have a feeling, when I look in 2005, I don't know if we had investment gains in there also, we had investment income of $15 million that, I think, in the brokerage space we don't have anymore.
So, between loss in investment income, negative organic growth, the supplementals and contingents, it's been hard work by the team to replace that lost revenue.
Margin expansion from 2005 has been better.
It's kind of coming off the hard market.
I think you picked the year -- if you go back to 2001, I know that we're up 3 full points in margin since then.
But 2005, we were still getting a little bit of the tail winds of the hard market, too.
- Analyst
Fair enough.
Maybe a different way of asking it is that, considering that your workforce is probably leaner now than it was back then, and you're getting these $46 million of supplementals that you weren't getting back then.
If you get a little bit of an economic tail wind for a couple of years, should you have a higher margin than in 2005, the 20% that you were doing back then?
- CFO and VP
Yes, absolutely.
I think that if we can get into positive organic space, there could be an opportunity for margin expansion.
There's no question, in our platform today.
- Analyst
Okay.
And then the last piece to this.
Is there an inherent margin difference between the way you take supplementals in, versus the contingents that you're taking in?
How should we think about each of those revenue streams?
- CFO and VP
Well, other than the fact that contingents are lumpy, that distorts the margin on a quarterly basis, but when you look at them on a year-to-year basis, I wouldn't say that they impact -- if you're thinking about the contribution of each of those to margin, there are some cases where our supplemental commissions, we do share some of that with our field.
Not a huge portion of that.
Contingents are generally, all fall to the bottom line.
Management participates in some of that, field management does.
There are two possible answers to your question there.
On a year basis, whether it's a supplemental or commission, we're happy to have it either way.
- Analyst
Okay.
Thanks a lot, guys.
- Chairman, President and CEO
Thanks, Keith.
Operator
Our next question is coming from the line of Mark Hughes with Suntrust Banks.
Please state your question.
- Analyst
Thank you very much.
The expense base you've got now in the brokerage business, does that represent a full rate of spending, nothing that needs to be ramped up again, after being very lenient the last couple of years?
- CFO and VP
It's a little bit of a yes and a no answer, in the same one.
So let me explain.
We did allow our meeting and travel expenses to creep up about 10% this year over the prior year.
They're still down -- they're up slightly against 2009, but they're down still from 2008.
I think we've adjusted to this level of activity in our travel expenses.
So I wouldn't say there is substantial creep there, other than natural inflation.
Airlines are going up, hotels are going to have some reset, so there could be a little inflation creep in that line.
When you look at our technology costs, the actual base costs such as telecom and everything is moving lower still, but we are spending more on software applications that I would say are in our sales layer, our sales management software, new global phone system, new document management systems, work flow systems, so we're spending a little bit more there.
But a lot of that gets offset by just natural deflation in some of our communication costs.
When it comes to compensation, most of our people have been touched in the last three or four years, in terms of compensation adjustments.
We might have to do a little bit of that this year, in 2011, so you might see some raises being handed out.
But a lot -- most of our good performers have had raises in the last couple of years, so I think we're in good shape there.
So you might have some creep in those numbers, but I wouldn't say it's anything too terribly meaningful.
- Analyst
One other question.
The $125 million in the new borrowing, should we assume that most of that will be spent?
And then, also talk about consideration mix on acquisitions.
If you're going to spend $125 million in cash, what is your consideration mix?
What does that mean in terms of your outlook for M&A?
- CFO and VP
First and foremost, we have a great acquisition pipeline right now, and I think that we will have plenty of opportunities to use cash in acquisition.
The opportunity for us to pull another $125 million down, $75 million of that is on 10-year notes and $50 million of it is going to be on 12-year notes, and we got it in the low 5s.
We're happy to have that type of cash for a decade or more of use.
Frankly, though, our pipeline is big.
If we need to favor cash more this year, I am fine with that.
We have another $100 million of available cash sitting on our balance sheet right now.
This next year, we have $225 million of cash that we can use, plus the future earnings off of this year, to ramp up our investment -- excuse me, our acquisition activity.
The mix between stock and cash, I will look at it on an every single deal basis, to see where we are.
- Analyst
Thank you.
- Chairman, President and CEO
Any other questions, Claudia?
Operator
Yes.
Our next question is coming from Sarah DeWitt with Barclays Capital.
Please state your question.
- Analyst
Hello.
Good morning.
- Chairman, President and CEO
Good morning, Sarah.
- Analyst
My first question is, could you discuss how we should be thinking about the sensitivity of Gallagher's brokerage organic growth to an economic recovery?
And maybe you can just give us a point of reference in the past, when have had a soft market and a normalized economy, what average organic brokerage revenue has been.
- Chairman, President and CEO
I think -- this is Pat -- the brokerage business is very much of a lagging indicator on the economy.
When our clients' businesses go soft, it takes a good, full 18 to 24 months for those results -- and remember, all insurance premiums are predicated on payroll, sales, the value of buildings, the number of cars, et cetera, and so when that stuff is shrinking, the premiums that thee markets are charging those clients are going down, and we're primarily on commission income, so the commissions go down as well.
The flip side is also true.
When our clients start to recover, we will lag a bit behind that recovery, but we will benefit from increasing payrolls, from increasing sales, from the addition of new employees, in our benefits operation, et cetera.
So in a normalized economy, I think if you go back to our -- the quarterly spread that we put out, if we were just to get, say, a 2% to 3% normalized growth from the economy, and then if you coupled that with something like on the order of 2% to 5% decline in rates, we kind of start off the year every year with a little bit of headwinds, a little bit of pressure, against our organic renewals.
But that -- it would be a huge benefit for the Company to just get 2% or 3% organic growth off of economy, then of course we add new business to that, and lost business, and you come up with kind of what that organic growth figure is.
If the Company could return to something on the order of 3% to 5% organic growth, that would be very beneficial to earnings.
- Analyst
Great.
Thanks.
And then switching gears to the risk management segment, could you discuss what drove the sequential improvement in the organic growth there and what you're seeing in terms of claims counts trends?
- Chairman, President and CEO
Claims counts continue to go down.
I think the organic growth this past quarter was primarily new business.
As well as, our international operations have done very, very well over the last number of years.
The UK and Australia have had great growth years.
- Analyst
Great.
Thanks for the answers.
- Chairman, President and CEO
Sure.
Thanks, Sarah.
Operator
Our next question is coming from Dan Farrell with Stern Agee.
Please state your question.
- Analyst
Thank you, and good morning.
- Chairman, President and CEO
Good morning, Dan.
- Analyst
I was wondering if you could give a little more detail on brokerage organic, maybe talk about some of the trends that you're seeing in retail versus employee benefits, and also some of the trends that you're seeing in the wholesale and program operations.
And then secondly, maybe a little bit more of an update of your efforts on your international operations, and potential for further expansion there.
- Chairman, President and CEO
Why don't I start -- why don't I go in reverse order.
I'll start with international.
Very excited about our opportunities, internationally.
We go slowly.
We have no interest in running around the globe, putting pins in cities and saying we're there.
We typically trade with people that we get to know quite well, and if there is an interest in allowing us to take some equity in those people, we'll do that.
We have a little bit north of 40% what we think is the best brokerage operation in the Caribbean.
We opened up with a small shop in Brazil this year.
We took 100% position in the Australian broker that we had a minority position just a year ago.
And primarily, these are opportunities for us to expand with people that we're actually already trading with.
I think internationally, you will see -- and, of course, internationally, in the UK and primarily the London market, great opportunities for expansion and we have done quite well there over the last decade.
So, I think our international opportunities are great.
As it relates to -- I'm sorry, give me the other couple questions you asked?
- Analyst
A little more detail on sort of the domestic brokerage, maybe talk a little bit about retail versus -- .
- Chairman, President and CEO
Wholesale?
- Analyst
-- employee benefits and then also the wholesale trends.
- Chairman, President and CEO
Retail is going to flow with the economy, and we do a good job on risk management accounts, but by and large, our business -- the bulk of our business is the commercial middle market.
You are going to see us as a PC retailer, doing business with clients that are going to generate anywhere from $15,000 to $25,000 in total commission income.
And those people -- basically, I believe, that is the bulk of our economy, anyway -- and those are the folks that, as their businesses start to recover, we're going to do quite well.
As it relates to employee benefits, if we get some job growth -- the big thing with employee benefits, it's all predicated on full-time and equivalent employees.
And if payrolls are down and head count is down, the employee benefits business is down.
If we get some job growth in the economy, that business is going to do well based on the growth there.
Wholesale, our most sensitive business to the cycle.
As the primary markets want more premium, they tend to dip down into the stuff that would typically be in the wholesale market, in the excess and surplus market, and we're seeing a lot of that.
Also, from an MGA perspective, it's all about new business start-ups.
When new businesses start, they typically don't go into the primary market, they typically come into MGA programs.
So if we get new business start-ups, we get some economic growth, we get some additional employment, all three of those businesses will do well.
- Analyst
Thank you.
That color was helpful.
- Chairman, President and CEO
Thanks, Dan.
Operator
Our next question is coming from Meyer Shields with Stifel Nicolaus.
Please state your question.
- Analyst
Okay.
Thanks.
Good morning, everyone.
- Chairman, President and CEO
Hello, Meyer.
- Analyst
Sorry.
One big picture question for Pat, and then some numbers for Doug.
I guess, Pat, when you look at the rate activity that we have seen over the past seven years, do you have a sense in terms of whether there is much less conservatism in the lost picks that we're seeing on an industry-wide basis for 2009-2010.
- Chairman, President and CEO
Meyer, restate that question for me.
I didn't quite hear you.
- Analyst
I'm starting with the premise that the brokers have good insight, not just in terms of rate trends but the implicit underwriting profitability of that business, and I am wondering whether it's your sense that, because of the compounding rate decreases we have seen since 2004, that implies that loss picks across the industry are much less conservative than they were, let's say three, four years ago.
- Chairman, President and CEO
Yes, yes, I get the question now.
Yes.
I think definitely, we're at a point in time right now where the industry is very well-capitalized.
The carriers have done extremely well, but if you take a look at their accident years and the amount of reserve releases that they have, I think we're coming to the end of those opportunities to release reserves and to create earnings, and definitely loss picks are less conservative than they were three, four, five years ago.
- CFO and VP
The other thing too, Meyer, this is Doug.
I think that -- it doesn't necessarily mean that the loss picks are wrong right now, the loss picks might be okay, because there is so much less frequency than previously anticipated.
Now, this is our guess from our view.
If you have a rebound in frequency, I think some of those loss picks might need to change.
I think that the carriers have been -- and, again, I don't have the data that they do, but I would guess they have had some nice frequency decreases that's helped their loss picks look pretty reasonable, at this point.
- Analyst
Okay, that is very helpful.
And just two nit picky questions, I guess.
The tax rates in the individual segments --
- CFO and VP
Yes.
- Analyst
-- were sort of below the 40% line.
Is there anything recurring in that?
- CFO and VP
Here is the thing.
In the two -- in the brokerage and the risk management segments, when we settled our 2008 and 2007 exams, there were some reserves released related to those tax years.
So that did push down the tax rates, and we break that out on the face of it.
We didn't take credit for it, we broke it out in the face of the press release there.
It probably fueled us about a penny in the fourth quarter of 2010.
- Analyst
Okay.
And is there any rough metric that we can use for the inflation of compensation costs?
- CFO and VP
I think the question that you have, you have got to look at -- it's two questions there.
What is the productivity improvement pick, and then versus what is the natural wage inflation.
If you have an inflating economy, your pick is going to be higher when it comes to raise picks than it is in this environment.
We don't see inflation in the economy right now, so compensation changes, you know, don't need to follow -- are following the lower trend.
So, you know, by and large, if you picked over a five-year period, employees probably get two raises, you know, from a couple percentage points to 3%, during that time.
Bu it's not every year, so that might help you.
- Analyst
It does.
Thank you very much.
- Chairman, President and CEO
Thanks, Meyer.
Operator
Our next question is coming from Mark Dwelle with RBC Capital Markets.
Please state your question.
- Analyst
Yes, good morning.
- Chairman, President and CEO
Hello, Mark.
- Analyst
A couple of questions.
The first one is kind of a numbers question.
Doug, I'm trying -- the $8 million non-cash impairment charge related to the pipeline, is that booked against operating expenses or is that booked against other net revenues?
- CFO and VP
It will go through as investment losses in the P&L.
If you go back to the corporate segment, it is in the other revenues net, I believe.
- Analyst
Okay.
- CFO and VP
-- is where that number is.
Let me look here.
- Analyst
I see it.
Those were the two choices, I guess I meant.
In that event, if that's recorded to there, if you could break down a little bit, just some of the components of the $13 millionofn the operating costs in the corporate segment.
I had figured that since the plants weren't running, that that number would have been a lot lower.
- CFO and VP
Right.
First and foremost, I -- to follow you this through the P&L at the bottom of page eight, when it comes to corporate, will be a highly frustrating exercise (inaudible).
I am happy to answer all your questions.
I really believe that the table we provide on page four gives you insights into the categories of the activities we're doing in corporate.
One of the issues that we have is that we -- our income statement consolidates our 40% ownership in [Kimmod], which is our mercury control solution that we use in our section 45 plans and others license.
So we consolidate that, because we are the managing member of that.
So that is going to distort some of the operating items.
Also going through that is just operation expenses of the corporate segment, so rent expense and that.
The big pieces of that, that are going to be flowing through there, is that we donated about $7 million to our foundation, which is really the investment moving over -- so we could take a loss on that --
- Analyst
Okay.
That is probably the main item I was trying to pick up, is where the donation flowed through.
It basically seemed like there were three unusual items in the quarter, the $8 million, the $7 million, and the award meeting.
- CFO and VP
Two and a half, right?
- Analyst
And I was trying to track basically where those three pieces wound up.
- CFO and VP
Most of them end up in that category.
- Analyst
Okay.
The same question I had related to contingent commissions, and I know that these have evolved over the years.
Is there still a significant element of a combined ratio component in those, just to say, to the extent that combined ratios get worse, that would, in the future, diminish the level of contingent commissions you would expect to receive?
- CFO and VP
Absolutely.
One of the reasons why we think it's so important to show these three different categories in earnings releases, each of them has a different dynamic when it comes to what's happening in the marketplace, and you have to be very contemplative about that.
Contingent commissions, we can get them from -- through revenue growth, or -- so a volume based or profit based.
Most of our contingents right now, especially in the wholesale market, are profit-based contingent commissions.
When profits deteriorate, that line can feel some pressure.
On the other hand, if profits deteriorate the carriers raise rates at the same time, then you're going to get more commission income up above.
So the problem is that sometimes profits deteriorate before carriers raise rates, so you could have softness in that line before you see the increasing in the base commission and fees as they rate raises.
- Analyst
Okay.
That is exactly what I was looking for.
And the last question, really more for Pat.
Has there been any changes, any improvement in your own hiring environment?
Which is to say, people, once again, seeking to leave competitors and so forth.
I know you're not naming names, or any such thing.
For a long time here, we have seen people happy to sort of stay where they are, and whether there is any loosening in that environment.
- Chairman, President and CEO
I think, Mark, over the last five years, we have done extremely well in terms of recruiting.
You're right, A, I wouldn't mention any names and, B, I wouldn't ever even mention a location.
But, we are constantly looking for good people to join our organization and we have had no shortage of opportunities over the last five years, and we have done quite well with the recruits we've brought on, and we see that as an ongoing, serious part of our strategy.
- Analyst
Okay.
That is all of my questions.
Thank you.
- Chairman, President and CEO
That is on a global basis.
Thanks, Mark.
Operator
Our next question is coming from John Grimstad with Piper Jaffray.
Please state your question.
- Analyst
Thanks.
Good morning.
- Chairman, President and CEO
Good morning, John.
- Analyst
Just a quick question here, going back to an earlier comment surrounding the decline in claim frequency in the risk management sector, is that rate of decline the same as it's been the last few quarters, or how would you characterize the rate of decline this quarter?
- Chairman, President and CEO
I would say that the rate of decline has actually slowed.
We have had a month or two, we don't report by the months, but we've had a month or two in the last six where we have actually seen a little bit of claim activity pick up.
But by and large for the year 2010, the claim counts by our clients are down.
But, one of the things that's giving us a feel that the economy is kind of flattening out, is we sort of feel like the claim count situation is flattening as well.
- Analyst
Great, thank you.
And shifting gears a bit to deal activity, and looking into 2011, how would you view the deal pipeline relative to your expectations this time last year?
- Chairman, President and CEO
We knew last year, coming into the year, that the activity would be slow in the first half, and frankly, activity was slow through three quarters and we had kind of a rush to the gate in the fourth quarter, which we mentioned to all of you on the third quarter call, we thought was going to happen.
I believe that what's happened now is that sellers, or potential sellers, are looking at a two-year window and they're not going to miss the two-year window.
Their values are still down, so there is some hesitancy there, but there are a lot of people that looked at the tax rate increase coming into 2011 and have taken a deep breath and said, "I'm not going to miss the window this time." So I believe that our activity will be very,very solid.
The pipeline hs literally never been better.
If you took a look at our pipeline, it's dozens and dozens of people that we're talking to, some very, very nice firms.
Whether they will close or not, each -- every acquisition is like a marriage, it takes a long time to get together, and then when we close, we hope we're happy together.
- Analyst
I understand.
Thanks a lot for the color.
- CFO and VP
The other thing, too, just so everybody knows, is that the value proposition of coming to Gallagher still exists, regardless of the tax situations personally.
In our employee benefit space, to go out and interpret Obama care, many of these firms have great relationships with the clients, but they need our capabilities to go out and help the clients navigate through Obama care.
That's a tremendous value proposition.
On the P&C side, when you look at what our niches do, the experts that they can bring to bear on a client, those smart owner-operated brokers, understand that teaming up with their relationship with a client, with our expertise, is a great combination to win in the marketplace.
So we saw a lot of people really appreciating what we can do, in that respect.
So I think that is going help us continue with our deal flow throughout 2011 and 2012 as these people also try to rush before the tax increase.
- Chairman, President and CEO
I agree with Doug.
I wouldn't make it all just about taxes and money.
The other thing, too, that I believe differentiates us in the market is, we have a very unique culture and a lot of these sellers will tell us, after the deal is done, that the reason they chose Gallagher is they felt culturally there was a good fit.
- Analyst
Great.
Thank you.
Operator
Our next question is coming from Mark Hughes with SunTrust.
Please state your question.
- Analyst
Hello.
Just a follow-up on the question of benefits performance versus retail.
Any body language you can provide in terms of how the benefits segment did in terms of organic this quarter versus the broader business?
- CFO and VP
I think that one of the things that the benefit space has going for it is declining -- despite declining headcounts, there is natural inflation that you don't see over in the P&C space.
We're happy with our organic growth in benefits.
Obviously, we'd take more, but it was in positive territory and so I think that that's a space where -- that is a business right now that we're doing really well in.
Our clients appreciate it, our margin's good, our team's energized on it, and so I have nothing but positive things to say about the benefits business, at this point.
- Chairman, President and CEO
Also, I think if you look at just all the businesses we're in, there is no pain in the PC market right now.
If you're out talking to clients, they're buying insurance for less than they paid six years ago.
And while their businesses are hurting, and so there is even more pressure on us to either sell less insurance or to get the rates down further, there is not a lot of pain.
You talk to any employer and the pain is in the benefits space.
They're trying to figure out a way to keep their employees -- it's all a battle about how much you're going to shift to the employees, how much you're going to keep yourself, how broad your benefit plans are going to be, what voluntary benefits you're going to add or not add.
It is an incredibly sophisticated purchase.
You take a look at our own business, and I probably spend four hours a year, with my team on the PC insurance we buy.
I probably spend four hours a quarter on benefits.
It's a substantially bigger spend, and how are we going to define our plan?
What are we going to offer our people, et cetera?
It's huge, and it is getting more and more sophisticated.
We're incredibly proud of the fact that the business insurance readers, think about us.
In terms of our competitors, we're the small player in the mix, and our team got picked as the winner of the best benefits consultant by business insurance readers.
That is fantastic.
And to Doug's point, we 've got positive organic growth there.
- Analyst
What is your risk of pressure there related to custom commissions from healthcare providers?
- Chairman, President and CEO
The nice thing is, if you go all the way back to ERISA, 20 -- what, 28, 30 years ago, we have been pretty transparent in that business all of those years.
So while we have been paid on a commission, our clients have known exactly what they have been paying us every single year for the last 30 years, and we earn our money.
So, you know, if they carriers cut commissions or have to have a legislated loss ratio, I think we'll do just fine.
- Analyst
Okay.
Thank you.
- Chairman, President and CEO
By the way, our smaller competitors won't.
Operator
Our next question is a follow-up from Bob Glasspiegel from Langen McAlenney.
Please state your question.
- Analyst
Good morning again.
Doug, I was wondering if you could give us cash flow sources and uses in the quarter.
And also, you didn't give any sort of look out we got more expenses on this, you know, to think about for 2011, you know, pension or healthcare, and didn't know whether there was anything that we should be thinking about in modeling margins.
- CFO and VP
Let's tackle the margin.
Our pension plan is in great shape.
We froze that back in 2005, we took a little bit of it on the chin, a little bit with the investments, you know, contraction in the last few years.
But that is back up.
So, our pension expense, we don't have an unfunded pension plan there and we don't have a lot of pension expense coming through the book.
So that is something I wouldn't worry about too much there.
In terms of, I talk about the operating expenses, the natural inflation in that.
Real estate, I still think we have tremendous opportunity to adjust our real estate footprint.
We've had some nice wins over the last few -- over the last couple of quarters that didn't cost us anything in order to move out.
There are a couple of spots I think that we need to consolidate down, reduce our footprints, look for lower cost locations, so we're going to work hard on that this year.
So there is a little bit of opportunity there, but nothing that I consider to be, you know, all that impactful on your models.
In terms of cash flow, Bob, we put out our K at the end of the week and we'll have it in there.
I don't have the numbers here in front of me, but we had a nice cash flow quarter, and we haven't spent any more than normal on CapEx, so it will be very consistent with what you have seen in the past.
- Analyst
Thank you.
- Chairman, President and CEO
Thanks, Bob.
Operator
(Operator Instructions)
Our next question is a follow-up from Keith Walsh with Citigroup.
Please state your question.
- Analyst
Hello.
Thanks, guys.
Pat, just for you, thinking about the leverage you guys have built in to the model, with the expenses, the way you have paired them back in a very tough environment, and holding the margin, and growing the margin the way you have.
Just thinking back, though, to earlier in the decade, and it's not just your company, I think the whole industry, you had some very strong years of organic that the leverage really didn't come through as you would think it would have.
So what is different this time around?
How do we know, if things start to get better in the economy and we eventually, at some point, hit a hard market.
That could be several years out.
How do we know where the economics are going to the shareholders versus the employees?
How do we think about what is different this time around?
Thanks.
- Chairman, President and CEO
First of all, if you go back to 2000, 2001, and I actually appreciate that there is people on the call that can go back ten years, that's pretty good.
You'll recall, we hired, at that time probably more people in two years than we had hired in a previous decade.
And we still believe that we called that -- we made that call pretty well.
We brought on about 250 new employees in about an 18-month period, right over the top of the hard market.
That was a little different than what we'll see today.
Today, we will not have those hires the next time around.
Since 2010, we're now up over 1,000 employees in India.
So we have taken a real opportunity to take margin increases, expenses out, and have offloaded a significant amount of work to lower cost labor, who are, by the way, great teammates and very much part of our company now.
If you go to our Indian locations, you look exactly like you're walking into a Gallagher office, whether it's New York, Chicago, Los Angeles, what have you.
In addition, we have done an awful lot of centralizing of controls.
We do all of our payables now on a central basis.
We've got all of our expense account reporting, all of our purchasing.
Before 2005, we didn't have any real central sourcing at all, and I give Doug a lot of credit for bringing that discipline to our company.
A, I think we're more disciplined than we were in 2010, B, we don't see the opportunity to recruit as heavily as we did in 2000, and C, we're doing an awful lot of work offshore, as well.
So I think that this time around, you can in fact model the fact that there will be significant -- if we got a 2001 contraction in the market, our margin would expand nicely.
- Analyst
Great.
Thank you very much.
Operator
And our last question is coming from Sarah DeWitt with Barclays Capital.
Please state your question.
- Analyst
Hello.
I just wanted to follow up on the insurance brokerage margin.
If organic growth is flat to modestly higher in 2011, but given there is unlikely to be much of a lift from higher contingent commissions and supplementals like you had in 2010, and there is some expense creep, to what extent do you think you can expand the brokerage margin in that environment?
- CFO and VP
I think in order to answer that question, make sure you focus on the table at the bottom of page two and the table in mid part of page 3.
Here is what you're seeing.
In an environment where we had 1.9% negative organic growth, we held our margin at 22 points on an adjusted basis.
All right?
And so question is, if we get a flat market, and so we don't go backwards 2%, how much will that 22% change?
If it just goes flat, it's not going to change that much, all right?
If it goes up two points, you might see it move up some.
But at this point, I think that where we are in our expense control, where we are in our salary and head count control, if we had a flat year next year and it produced $20 million more of revenue, I could see most of that going out the door in expense creep between natural inflation, some raises here or there, and some, you know, new investments and new talent.
So you wouldn't see much margin expansion for the extra $20 million.
- Analyst
Great.
Thank you.
- Chairman, President and CEO
Thanks, Sarah.
Claudia, any other questions?
Operator
No, sir, we have no further questions at this time.
- Chairman, President and CEO
Then I'd like to just make some closing remarks.
Again, thank you, everybody, for being with us today.
We appreciate you being on the call.
Despite what I think are really tough market and economic conditions, I'm pleased with our performance, especially over the last two quarters.
Over the last several years, our Company has been, in large part, re-inventing itself by implementing new systems and processes to improve efficiency and productivity.
You see that in our margin.
We have been cutting expenses and improving our margins, and you're starting to see the benefits of all of those efforts.
Despite all that hard work, our team remains united in providing what I think is premier service to our clients.
We get some affirmation of that.
We were pleased to receive awards from Business Insurance Reader's Choice.
Three of our operations were recognized in 2010.
Gallagher Benefits Services, I mentioned this earlier, was voted the industry's best employee benefit consultant.
Our retail PC brokerage operations received a Silver Circle award in the larger broker category, and Gallagher Basset received the award as the best PC third party administrators.
So we're proud of all that.
2010 was an extremely challenging year, but as my uncle, Bob Gallagher, used to say, "We push for professional excellence" and that is what this team has done.
I am proud of what we've accomplished and I'm very, very proud of our team.
So, thank you for being with us this morning, and that concludes the call.
Operator
Ladies and gentlemen, this does conclude today's teleconference.
You may disconnect your lines at this time, and we thank you for your participation.