Arthur J. Gallagher & Co. (AJG) 2013 Q3 法說會逐字稿

Good morning and welcome to Arthur J. Gallagher & Co.'s third-quarter 2013 earnings conference call.

Participants have been placed in a listen-only mode.

Your lines will be open for questions following the presentation.

Today's call is being recorded.

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

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

These forward-looking statements are subject to certain risks and uncertainties that will be discussed on this call and which are also 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 Mr. Patrick Gallagher, Chairman, President and Chief Executive Officer of Arthur J. Gallagher & Co.

Mr. Gallagher, you may begin.

Thank you.

Welcome, everyone, to our third-quarter conference call.

We appreciate you being with us this morning.

Today I am joined by Doug Howell, our Chief Financial Officer, as well as the heads of our operating divisions.

We had a very active quarter, and I'm very pleased with our accomplishments and financial performance.

First, our results were excellent.

Frankly, our operating teams hit the ball out of the park this quarter.

On a combined basis, brokerage and risk management were up 13% for the quarter on adjusted revenue, 6.2% of that was organic and adjusted EBITDAC is up 17% for the quarter.

Year-to-date, adjusted revenue is up 15%.

That equates to $256 million of additional revenue.

Adjusted EBITDAC is up 20% or over $74 million.

Let me talk a little bit about the Brokerage segment.

As I said, we had an outstanding quarter.

Adjusted revenue is up 15%.

Organic revenues grew 5.5%, a continuing testament to our sales and service culture.

Adjusted EBITDAC was up 20%, and our margin expanded 120 basis points, really, frankly, an incredible quarter.

Virtually all of our brokerage operations globally contributed to our growth in the third quarter.

This morning I would like to add some color in three specific areas of our Brokerage segment.

The first is the property/casualty rate environment, and I want to talk about our recent trip to the Council of Insurance Agents and Brokers meeting.

Secondly, mergers and acquisitions -- we had an incredible quarter.

And, thirdly, employee benefits, especially concentrating on private insurance exchanges.

First, on the rate environment, the CIAB quarterly survey shows rates rising again in the third quarter by an average of 3.4%.

Earlier this month, we spent five days meeting with more than 20 senior management teams of our insurance company partners at the CIAB meeting.

I came away very encouraged that the present environment of sensible underwriting will continue.

Every leadership team we spent time with were clear.

They knew exactly where they are or are not making money.

They have a very detailed understanding of their lost cost inflation numbers.

They want their people to account, underwrite and to insist on rate increases where warranted.

In this investment environment, they have to make money by successfully underwriting accounts.

Again, this quarter we saw rates across most lines moving up.

An exception to that is catastrophe-exposed property.

Clearly our customers should expect some relief on the cat side.

The wind hasn't blown.

But especially in worker's compensation, south central US property and most lines of casualty, rates continue to increase.

This is a fair environment for our clients.

We would rather see rates rise in single-digit increments rather than 50%, 60% or 100% jumps.

This is an orderly market, but one that our capabilities shine through and give us an advantage.

In our results, less than 1% of our organic growth is coming from rate and exposure growth.

So you can see the kind of growth we can produce if we can just maintain a flat market.

We are clearly in a great spot that looks like it will continue.

Secondly, let me move to mergers and acquisitions.

We had a record third quarter.

Most noteworthy in August, we closed on Bollinger and then in September we announced Giles, which we expect to close in the next few weeks after final regulatory approval.

Both represent very similar fantastic opportunities.

They are both well-run, high-margin companies that expand our footprint -- Bollinger in the Northeast, Giles in the UK.

We continue to be excited about our international opportunities.

We are truly a global enterprise.

But more importantly, both these acquisitions bring us excellent producers, high-quality support staff all embedded in a rich culture that matches ours.

With us, they have found permanent ownership and unsurpassed resources, which bodes well for our future growth.

And we are already seeing growth.

Our sales teams are working together to win new clients already.

We also closed seven other mergers in the third quarter.

Each of these new partners also expand our footprint and find value in our capabilities.

They add choice, and we appreciate that they recognize Gallagher as being the right family for them.

Welcome to all our new colleagues!

Thirdly, there is clearly a lot of discussion about private insurance exchanges, and I would like to focus on a few points today.

We think exchange adoptions should increase quickly in 2014 for three main reasons.

First, employers are looking for ways to cap the cost of their employee benefit plans.

Secondly, employees are asking for greater choice and control over their own benefits.

And thirdly, medical carriers are starting to promote their own private exchanges as an alternative to public exchanges.

We have discussed before how our team is ahead of the healthcare reform curve with respect to our capability, offerings and expertise, including our ability to deliver private insurance exchange solutions.

Gallagher will continue to be compensated for the services either with commissions, fees or a combination of both.

But keep in mind that no matter whether our clients decide to use an exchange or a more traditional model for their employee benefits, they will continue to need Gallagher's expertise and consulting services every single year.

Let me move to our Risk Management segment.

Our Risk Management business had a solid quarter with excellent organic growth, up 8.5% and an adjusted margin of 15.9%, which is right in line with what we forecasted in last quarter's call.

We have mentioned we are making significant investments in product and service enhancements.

Let me mention a few of those investments and some of the early impact that they are having.

First, the launch of Gallagher Bassett's Analysis Workbench, which is a tool for claim analysis and risk analytics, has been very well received in the marketplace and played a key role in selling several nice prospects in the US this past quarter.

Secondly, formation of a unit dedicated to serving carriers has contributed to a growing pipeline of claim outsourcing opportunities.

And thirdly, implementation of a new system to support GB's Homeowners business in the UK has enabled us to grow our business there.

Across all of our businesses, our results are a direct reflection of the hard efforts our team puts in every single day.

I could not be prouder of our team and our results.

Our sales culture drives new business to record levels quarter in and quarter out.

Our service capabilities and determination to help our clients keeps our retention of clients nicely above 90%, again, each and every quarter.

We are client focused, team oriented, bring the best of Gallagher to the point of sale on virtually any opportunity.

So all-in-all, it was a great quarter for Gallagher.

We feel like we are hitting on all cylinders.

We are well prepared for the healthcare changes and preparing already for a strong 2014.

Doug?

Thanks, Pat, and good morning, everyone.

Let's start on the first page with the Brokerage segment.

What a terrific quarter!

The Brokerage segment was up nicely on all measures.

A couple things to know.

First, the integration costs.

About $0.03 was wrapping up Heath Lambert and a $0.01 was from Bollinger, and both of those right in line with what we discussed before.

Looking forward, we are done with Heath, and now we have about $0.02 to $0.03 a quarter related to Bollinger and Giles running through the first quarter of 2015.

Second, you'll see a couple pennies of acquisition earnout-related adjustments.

There's are always a bit volatile, and you see them from time to time.

Now as for the Risk Management segment, another solid quarter with no adjustments of significance, so let me foreshadow the fourth quarter.

Recall in the fourth quarter of 2012, we had $0.01 of costs related to ramping up a new large Australian client that went live effective January 1, 2013.

As for this year, you heard Pat say that Gallagher Bassett has been making investments in capabilities to better service our carrier outsource space.

We are pleased to say that we are on track to take over a portion of our carriers claim operations effective January 1, 2014.

If we do, we would again incur a $0.01 of ramp-up costs in the fourth quarter of 2013, and that would set us up nicely going into 2014.

Let's flip to the Brokerage segment organic growth tables at the lower half of page 2, another strong quarter with base commissions and fees being up 5.5%.

And just so you know, we saw about 5% in each of our domestic retail and wholesaling units and a bit more than 10% internationally.

And as Pat said, less than 1% came from rate and economy.

So it was another nice quarter of new business and retention.

Let's slide down a little bit to contingent commissions.

You will see we are backwards about $2 million in the third quarter.

Most of that is timing, and we should pick up much of the difference in the fourth quarter.

Flip to page 3. You will see we continue to make good progress on our Brokerage segment comp and operating ratios that led to EBITDAC margin expanding another 120 basis points.

One footnote -- about 20 basis points of that came from Bollinger, which is seasonally the strongest in the third quarter.

However, Bollinger is seasonally the smallest in the fourth quarter.

So don't expect that level of contribution and margin contribution coming into this fourth quarter.

Speaking of seasonality, please use the investor supplement to see our quarterly seasonality.

Gallagher, too, has seasonality.

Our first quarter is always by far our smallest, our fourth quarter is the next smallest and the second and third quarters are about the same.

Next, given the significant M&A activity of Bollinger and Giles, let me give you some thoughts related to modeling the Brokerage segment's non-cash items for the fourth quarter.

For depreciation, assume about $9 million of expense.

For amortization, assume about $34 million of expense, and that includes both Bollinger and Giles.

And for acquisition earnout amortization, assume about $3 million of expense.

As for 2014, use the fourth quarter as your baseline.

Then for M&A amortization, increase it about 4% per year or 1% per quarter for every dollar we pay for an acquisition.

And that will get you reasonably close.

That's 1% of the purchase price, not 1% of the revenue.

Leaving the Brokerage segment and moving to page 4 of the risk management tables, excellent organic and margins right at the 15.9%, as we forecasted in our July earnings call.

As for the fourth quarter, model margins, similar to the third quarter and you will be close.

That would then result in our full-year 2003 margins coming in at a bit over 16%, which is a little bit better than we forecasted at the outset of 2013.

It's great that Gallagher Bassett can spend on enhancements and still hit their margin targets.

Let's turn to page 5, the shortcut table for our Corporate segment, and also you might want to refer to page 14 of the investors supplement.

First, related to the interest expense line, we intend on closing Giles using our new line of credit, which will cost us about 1.3% per annum.

And then over the next three to six months, we will refinance that with longer term notes.

Next, move down to the clean energy investments line.

Our investments performed very well, but not quite to the level forecasted.

So we have learned that we need to be more conservative as we interpret the production estimates we get from our utility partners going forward.

But even then, earnings from these investments will always be unpredictable and volatile, especially on a quarterly basis and, frankly, will always produce some modeling headaches.

That said, please keep this in context.

In 2011 these investments posted about $3 million of after-tax earnings, in 2012 nearly $33 million, and this year they are on track to earn over $60 million after-tax.

This is really excellent progress and becoming a nice funding vehicle for our M&A program.

Looking towards 2014, our best guess is that the investments could earn 10% to 20% more for full-year 2014 than they did in 2013.

I will try to give you some quarterly spreads in our January call, but then again, please expect volatility, especially on a quarterly basis.

Finally, let's move to the M&A line.

In that line, you will read that we recognized $3 million after-tax gain related to hedging pounds in anticipation of funding the Giles transaction.

Looking to the fourth quarter, we expect about $3 million to $4 million of after-tax costs principally related to the Giles transaction.

But as for 2014, we would anticipate that line returning to about $1 million to $2 million per quarter of after-tax costs.

So to wrap it up, our core operation is up double-digits year-to-date on most measures, margin expansion across the board, a good rate and economic environment, investment earnings on track to about double last year and excellent M&A revenues coming into the fourth quarter.

All of this should contribute to continued success well into 2014.

All right.

Those are my comments.

Back to you, Pat.

Manny, do you want to open this line up now for questions, please?

(Operator Instructions) Arash Soleimani, KBW.

Thanks for taking my questions.

Just a couple quick ones here.

First, I wanted to ask about the margins on the exchange business, the partnership with Liaison.

I guess there, I know you said they are both as both a commission and a fee component.

Would that business have higher margins than the traditional benefits brokerage business, or would it be about the same?

I just wanted to --

It's going to be the same.

We are brokers.

We are going to place people where they are best suited, and we will get paid a fee or a commission based on how our client wants to pay us.

And the margins will be the same.

Okay, that's fair.

And then the second quick question I just wanted to ask, just a numbers question -- that line you have, I think it was about $2.5 million disposed of operations.

What is going in there, exactly?

I just wanted to get more clarity into that.

From time to time, we will divest ourselves of an office location or a unit that doesn't fit in, let's say, one of our niches.

It doesn't fit with our culture.

It doesn't fit with how we think that it should be operated.

So that's really what happens, and you'll see those pop up every other quarter or a little bit every quarter.

It just happens from time to time when we get a book of business that would be better operating someplace else.

Gregory Locraft, Morgan Stanley.

I just wanted to ask on coal, it looks like in one of the notes or in the release that you guys acquired another five plants or something from a third-party on September 1. Can you give us some color what happened there?

We are really stepping into five plants where we are acting as the monetizer from those credits, so we bought a significant portion of each of those plants.

They are very small plants.

These are mostly in industrial locations, so it was an opportunistic investment.

The advantage of owning more 2011 plants is they actually generate tax credits that move the AMT rate down from 20% to 8.75%.

So the nature of those credits are actually better credits right now than the 2009 era plant.

So it was a partner that was a licensee of Chem-Mod that was looking for a partner to own a piece of the plant.

So I think that our cash out for them was like $4 million, something like that.

Okay.

But these are new plants.

This isn't an existing investor that just wanted to walk from the investment that you had to bail out?

No, not at all.

These were plants that were built in 2011, were placed in service probably prior to the end of 2011.

And they don't have -- very common, the developers don't necessarily have an appetite for all the credits that they can generate, so they look for partners that can use the credits.

And we can use the credits.

So it wasn't a struggling situation or anything like that.

It's just they are looking for a partner to own a piece of the plant.

Got it.

And do you anticipate more of these kinds of deals?

In other words, are there developers out there that are basically doing what you all used to do and then bringing it forward to you because you guys have an appetite and can use the tax credits more efficiently than they can?

I would think generally no.

I think that these are -- I think this opportunity is there.

We are getting to the point, if we are successful throughout 2014, that we will be saturated with credits that we need.

Remember, we don't want to generate credits that we warehouse to use in 2023 or 2024 or 2025.

We want to create credits that create tax savings for us today so those cash flows can be used for M&A.

So I think that we are about done.

I think our appetite is full at this point.

And then again, I know this is a very, very hard business to predict.

But obviously the miss was largely in that line in this quarter relative to what you thought it was going to be a few months ago.

I assume it's all just production schedules, right?

You are trying to guess utilization at the utilities?

Is that the entire reason?

Yes, that's exactly right.

What we are learning is, as a plant operator, we will look for opportunities to take the plant down, to do maintenance.

Where we would prefer that they always just run the machine full out, they actually look for opportunities to take it down in kind of low peak loads so that they can do maintenance on it so that they don't have the plant go down during peak loads.

So we are learning on this.

Going back to my actuarial days, if I had great triangles on this, I think I would be better at predicting it.

But we are learning that the behaviors of these utility partners are not exactly predictable.

And unfortunately -- but then again, if you look at it on a yearly basis, to make $60 million or more, I will take the volatility, I guess.

Yes.

No, I know it's a good thing for cash over time.

It's just trying to predict it, which sounds like you are wrestling with as well, and it sounds like we just have a more conservative plan on the table going forward.

I think so.

Okay, great.

Other entirely different question is just on the integration costs, and this is just something I'm wrestling with, Doug, which is you guys have done some excellent deals, especially in the third quarter.

We've got Giles coming in the fourth.

There is a difference between your adjusted numbers and your reported numbers due to integration expense.

It's now running all through 2014 and 2015.

At what point, does this become a cost of doing business for A.J. Gallagher because you are acquiring businesses constantly?

I mean should we really be stripping it out for our purposes and for compensation?

I think you guys pay yourselves on EBITDAC adjusted on an adjusted basis.

We actually paying ourselves on reported.

So I think --

Oh, you do.

Okay.

(multiple speakers) So the Board sees it as -- okay, great.

But the fact is, on these larger deals, the acquisition amounts -- interesting, both Bollinger and Giles are extremely well-run organizations.

So, if you look at the amount of money that it really will take to integrate into our operations, it's not like Heath Lambert.

If you recall, Heath Lambert was really struggling to make margins.

It was transformative for our UK operations.

So the amount of -- and we didn't pay the multiple that we did for Bollinger and to Giles.

It was probably 2 turns less.

So we knew that there would be more investment.

If you go back and listen to that back then, we knew there would be more investment.

But we feel good about Giles and Bollinger because they are well-run operations, and I just don't think a few million dollars, $3 million a quarter, is that much money to bring in, basically $250 million of additional revenue.

But I do understand what you are saying, but on the smaller deals, we just pay for those as we go.

And again, it's perfectly disclosed, so we know what it is reported and adjusted.

So that's good, and the deals are good.

Last is just on Giles.

Again, you guys are picking these up at good prices, but it sounds like you are very clear that you are going to use the credit facility, pay 1.3% to pull it in, it's an all-cash deal and then you are going to term it out.

The terming out -- how do we think about the cost of debt or the cost of funding as we model our interest expense going forward?

I think it will be somewhere between -- it just depends.

If we do 10-year notes, it would be somewhere around 4.5%, something like that, maybe a little bit less than that.

We will watch the rate.

If we decide to put some longer-term debt in, 15 or 20 years, that would probably go up a point on that.

I think we are in a really interesting position that if we could put some long-term debt out, maybe 15 to 20 years, because we are generating so many earnings from our clean energy investments, the additional point of interest on that probably wouldn't hurt us too much at all.

And I'm guessing that we will try to do something here before the end of the fourth quarter, and then we may do a delayed draw on it and not pull it down to April or even later.

Okay, good.

That's helpful.

Nice job in the quarter again, and I will let others to ask more about that.

Thanks again.

Thank you, Greg.

Good questions.

Sarah DeWitt, Barclays.

Looking at the two big acquisitions you did with Giles and Bollinger, has there been a change in the acquisition strategy where you are going after bigger deals now, and then also what do you see as the overall accretion from those deals?

Are there any risks to achieving that?

This is Pat.

I'll take the strategy side of that question, and Doug can answer the other.

No, this is no change in our strategy whatsoever.

First of all, if you take a look at business insurance July issue, they show the top 100 agents and brokers in the United States.

To be number 100, you had to do -- they did $22 million in total revenue.

We think there's probably 18,000 agents and brokers in America.

So there's an awful lot of them that are smaller than $22 million, and that's what makes up most of our pipeline.

But when the ones in the top 100 come available, if we can strike a deal that makes financial sense and if the culture fits, we are very happy to have an opportunity to play on those as well.

It's just there aren't that many of them.

So it was kind of an interesting quarter in the sense that we had two larger opportunities than we typically have seen.

But the other seven transactions we did were right in our normal sweet spot.

In terms of the accretion, it depends on how you want to calculate.

First of all, we did both of these deals with almost all cash and debt other than about 3 million shares we put out for Bollinger.

So if you really look at it, we put out 3 million shares to maybe make $80 million to $90 million of EBITDA per share, so it's a staggering number in terms of what it's going to contribute.

We used 100% stock.

If you do the math that way, it is still accretive.

If you use 2 times debt in it, it's accretive on that measure.

So it's accretive on all measures.

But because we did must all of this without stock, it's nicely accretive to our earnings.

And then looking at your private exchange with Liaison, how many enrollees do you have there, and how big of a revenue opportunity do you see this over time?

It is more just shifting your existing benefits clients from broker to an exchange, or is there an incremental revenue opportunity?

I'll let Jim Durkin take that.

Jim heads our benefits operation.

Currently we have about 2000 employees that have actually enrolled in the plan, a handful of different employers.

We do a very active pipeline.

There are a significant number of customers that are looking at this and considering it for 2014.

As Pat said in the comments, we expect there will be more uptake as we go through 2014 and beyond.

And I guess the second part of your question, could you expand on that?

I'm not sure I understood what you were asking.

Should we view this as revenue neutral because you are just shifting existing benefits customers onto the exchange, or is there an incremental revenue opportunity there?

I think for the existing customers.

It most likely will be revenue neutral.

There is an opportunity through the exchange platform to offer a variety of additional products, voluntary products, retirement products.

Those will generate additional revenues.

Certainly that will take time to get there.

But I also think the bigger opportunity for us going forward is, there's a lot of customers that are looking to us for what we can do or, excuse me, prospects that are looking for us.

So those are new opportunities, and this kind of technology will attract them to the services we offer.

So existing clients most likely neutral, but there is opportunity to bring additional products to that platform, and there's opportunity for new business.

Let me make a comment on that too.

The smaller brokers and agents out there that we compete with, and 85% of the time when we compete on an account, we are competing with somebody that's smaller than we are.

We actually know that.

And guess what?

They don't have a clue.

These smaller guys do not have a clue.

They don't know which way the exchanges are going, and clients are beginning to ask those questions.

It has taken longer for clients to wake up to this than I thought it would.

I thought they would be really all over the Affordable Health Act probably earlier in the year.

The fact that the mandate was moved back a year gives them even another your to breathe.

But ultimately, to Jim's point, we are going to have tremendous new business opportunities.

Michael Nannizzi, Goldman Sachs.

Just to follow up on that, do you expect then that benefit companies will provide a bigger part or become a bigger piece of your M&A program, just given that you are competing with folks that just don't have the expertise that you do, and do you see opportunities in this part of the market?

Yes, very much so.

You will recall last year we did 60 transactions.

30 of those were in the benefit space.

We are big believers that clients are going to need our help more today than they ever have.

Because this Affordable Health Act is complicated.

The compliance provisions alone are just draconian, and employers have got to -- then add the fact that what exchanges really are is additional choice.

And so the sorting through all the opportunities -- and let's also remember the costs of health and benefits to employers is huge.

This is a cost -- this gets the CEOs' attention, and they are going to need a lot of help.

And then another comment you made on the rational rate setting, I don't know if you addressed this in front of -- I missed the first couple minutes.

But where is that most relevant?

Is that standard lines, specialty lines, large risks, small risks?

I think if you look at the CIAB survey, you'll see that probably larger risks have the least amount of actual increase because larger risks take more of the risk themselves in their retentions.

So if you look smaller to middle-market, that's where you are seeing pretty consistent increases in pricing from a myriad of carriers.

This is not driven by one carrier.

It's not one line.

As I said in my prepared remarks, coming out of the CIAB meeting earlier in the month, it's very clear to me that there's a change in the marketplace in terms of what information these CEOs have.

They just really have a handle on where they are succeeding and where they are not.

And they are all over those and they know they have to make money underwriting.

So it really is pretty much across the board.

But listen, it's account driven.

What I was interested in hearing is not one of these CEOs goes out to their team and says, get out in the market and get me 5%.

What they say is, if the account deserves a 10% decrease, give it to them.

But if the account demands a 15% increase, you better demand it.

And they are watching their underwriting team every single day, and their retention rates are not dropping.

So it is a very different market than we've seen in the past.

And then just one on kind of still on that theme.

If that's the case, do you expect that you could see more interest from insurance companies looking to build out areas in areas where they don't have infrastructure to see more interest in the services Gallagher Bassett provides?

Definitely.

I think one of our greatest opportunities in the next decade will be outsourcing from insurance companies.

That's a big part of what we do right now.

And to your point, new capital in particular has no interest in infrastructure.

New capital wants infrastructure when they need it, business process outsourcing is something that they are very comfortable with, and I believe that Gallagher Bassett is the best claim opportunity for that new capital and, frankly, for some of the old capital to take advantage of our expertise to reduce losses to get return for their shareholders.

And have you seen new customers of size come in or approach Gallagher Bassett recently?

Yes.

And as Doug mentioned in his prepared remarks, we have a substantial opportunity we are working on in the fourth quarter right now.

Sean Dargan, Macquarie.

Just following up on the Risk Management business, I'm wondering if your 16% EBITDAC margin target still holds here.

I now you called out several initiatives with Gallagher Bassett.

But could you quantify the level of additional investment made this year and in the quarter from a dollar perspective?

I think for the year we probably spent 1.5 points of margin, maybe 2 points.

Okay.

And so the guidance still holds?

Yes, we should be able to gather in that 16% a little above that for the year, and the team is doing a really good job.

I mean the majority of the Gallagher Bassett team, to be able to plan out enhancements actually queued against them yet still hit their margin targets is really a nice evolution for the folks there.

Adam Klauber, William Blair.

A couple different questions -- great acquisitions on Bollinger and Giles.

Right now, are those businesses growing organically as much as the other businesses, or is that an opportunity to get them growing faster?

Yes, Adam.

Actually, the trend is interesting, especially on Bollinger, which we have a better line of sight into Giles at this point is that their organic, really, in the third quarter is not all that different than what our retail operations were North America.

So they really have responded well to the new ownership.

There's a lot of team selling going on with Gallagher, and their return to organic maybe lagged ours a little bit, but it certainly got up to speed pretty quick.

And Giles, my understanding is they had a pretty good third quarter also, and they are already talking about how there's opportunities together with us to go out and serve new clients in the UK.

So both of them -- I don't see much difference at all.

Actually, Adam, part of the fun has been that we have written a number of new accounts.

And particularly with the Bollinger folks, right in our specialty areas, right in the niches that we operate in, there were opportunities that Bollinger was working on right before the transaction was announced, and literally the week after it was announced, we picked up a number of really nice accounts because the clients go, okay, I know Gallagher in this space, and I like the people I was working with at Bollinger, two or three really nice orders in the first three weeks.

They actually outperformed their EBITDA in the two months that we owned them versus the budget.

So they had the pro forma, so they have done really well.

That's great.

Another question.

Talking about wholesale a little, has that growth been better than your average over the last couple quarters?

Yes, it has been.

This quarter was right in-line.

There were a couple ins and outs this quarter that levelized it more with the broader group, but typically that has been running in the upper single digits this quarter, somewhere around 5%.

And how much of that business is property, and do you think that will be more impacted next year as property potentially is under more pressure than some of the other markets?

A quarter of it is property, so there could be some there.

But really that business is hard to place, new business startup business, but only about 25% is property.

And not all of that 25% is catastrophe property, so probably half of that.

So you have got about 12.5% of their business is directly impacted by catastrophe property.

Okay.

That's helpful.

And then finally, any view on supplemental and contingents or at least what factors we should be thinking about as we go into next year?

We said last year that we hope to bring it in at flat for the year.

If we catch up for the timing that we had in the third quarter and get it in the fourth quarter, we still hope to finish the year flat on an organic basis.

And I would say that in this environment right now, that's probably pretty good work for next year, too.

So if we can hold those flat, the carriers are showing some nice profitability, so maybe there could be an uptick on it.

There may be some geography between supplementals and contingents also, but I think we think that 2014 flat organically would be a good year.

Okay.

Shouldn't you with new deals, Bollinger be included in a bunch of new deals, shouldn't that push it up somewhat?

Oh, yes.

My comment was on organic, but yes.

Acquisitions should fuel that also.

Josh Shanker, Deutsche Bank.

So obviously you are not the only one in healthcare exchanges; we are learning on the fly here.

You talked about this revenue neutral opportunity for current clients.

Can we talk a little bit about how you are paying your partner, Liaison, in that situation, what they are making out of it versus --?

So is it more revenue than you would make ordinarily, but you are splitting that revenue with someone, or how should we think about that?

Liaison has, like most exchange platforms, has a per employee per month transaction charge.

Part of that includes benefit administration.

So there's an enrollment process.

There's an administrative function that takes place, which is included typically in the exchange platform.

So there's a cost associated with that.

Liaison has that charge.

We are passing that charge directly on to the customer as an expense to manage not only their benefit administration but to manage the exchange platform.

And one thing I'm always very unclear about is, what service are you providing the clients in advising them, and what service is the actual exchange backbone providing them in that relationship?

I will start with the exchange for the moment since it's probably easier.

As I said, essentially there's two things.

This is a technology play.

It's an electronic portal where employees can go and get access to the different choices that they might have.

So think of it as just an electronic chassis.

They go see what those options are, and they enroll in those plans.

That enrollment process is what I referred to when I said benefit administration.

So there's essentially two things that we are talking about, the actual technology platform and then the administrative process of managing enrolling and getting the premium allocation correct to the different insurance companies.

That's what an exchange platform essentially is doing.

What we do is help the customer think about a strategy that gets them to where they want to be in terms of how they compensate their employees, as well as what benefit levels they are going to provide.

And exchange strategy is just one of those things that we have to help the customer think through.

In addition to that, if you look at the Liaison platform, it's our job to go out in the marketplace and bring the best insurance partners to that platform.

So we have designed what we call Gallagher marketplace, and these are the markets that we are bringing to the platform.

We are managing that side of the transaction.

Liaison simply brings the technology.

I don't know if that helps.

And those partners are paying you a commission?

May or may not.

It's up to the customer.

At the and of the day -- we have talked about this before -- I disclose my compensation to the customer every year.

The conversation goes something like this.

Here is what I am going to do for you.

These are the services that I'm going to provide as your advisor, as your consultant, as your broker.

Here's what I need in terms of compensation.

How do you want to pay me?

You can pay me a commission, you can pay me a fee, or you can pay me a combination.

It's that simple.

And we have been completely 100% transparent in our dealings on both the property/casualty, as well as the benefits side, since 2006.

Well, I think that it's very clear, and I appreciate the learning curve is still, for many of us, being climbed.

So thank you and good luck.

Charles Sebaski, BMO.

I wanted to talk, one, about strategy, the Giles acquisition in the UK.

Most of the ramp-up on the P&C business has been domestic.

What are your thoughts about further growth in continental Europe or other international expansion?

Giles, let me be clear.

We have not been focused on just domestic acquisitions for the last decade.

We have been building out our international platform literally since 1974 at about 25% to coming on soon 30% of our revenues will come from outside the US.

We have a very sizable business Australia, we are strong in Canada.

We are strong in the Caribbean.

We did a 21% trading partnership with our partners in Mexico last year, and we have been building out the UK platform, as I said, since 1974.

So this is not a new approach for us.

Giles fits perfectly as a platform play for us in the UK.

We had historically been a very strong specialty player as a wholesaler in the London market.

That was probably 90% of our business five years ago.

The Heath Lambert acquisition gave us a platform.

As we said at that time, that gave us a domestic retail platform to then be able to do acquisitions in the UK as we have in the US, which is essentially bolting them on, smaller transactions around the UK, and that led to probably 9 or 10 transactions over the last two years that did exactly that.

Giles comes in as really a nice fit in the commercial middle-market.

So we had specialty covered in London, and our specialty business there really is almost completely built out.

We had a good small accounts platform with Heath, as well as a risk management platform, and we were missing that solid middle-market, and that's really what Giles brings us -- 35-40 offices around the UK, GBP100 million plus in revenue, no single office that really drives the book.

Just a really, really nice retail fit for us.

I maybe misstated the question.

I think the Giles transaction is great.

I'm talking about additional breadth of middle-market size business like Giles in continental Europe, for instance, like that kind of thought process, not questioning the Giles or how that fits in.

I think definitely we have global aspirations.

We trade in over 100 countries.

We are not going to run around the globe sticking pins in the map.

What we do is we work with people.

Opportunities like Giles come along.

If we had an opportunity like that in Central Europe or in mainland Europe, yes, we would take a look at that.

But we prefer to know the folks very well, understand their culture, trade with them.

So what we did in Perth, Australia, what we did in the Caribbean and what we have done in Mexico is take positions with partners and then ultimately go to 100% ownership.

And that seems to have worked out very well with us, people that we trade with.

To pile on to that, when we have an opportunity on a certain niche -- for instance, we went into Calgary because of our energy platform niche.

When you see that pulling you into a country where we are adding a team in country X, really rounds out the global ability to service, let's say, an energy partner around the world, that's opportunistic for us.

So it would be the niche pulling us into the country, and then if they are trading significantly with us in the US or in the UK, we may want to deepen our relationship with them.

But we like putting the toe in first and then increasing ownership.

I think that at the end of the day, we want local management to continue to run the operations.

So many of these we might only own 80% of them ultimately long-term.

One numbers question -- did you say earlier that the amortization expense is going to run around $34 million?

It would be $34 million in the fourth quarter, and then you will have to make a guess of how it increases per quarter next year in 2014.

And generally the rule of thumb is take 1% of any purchase price and add that to the amortization per quarter, and you will get close.

Mark Hughes, SunTrust.

On the exchanges, when you shift from a group plan to the individuals shopping for insurance on the exchanges, what are you seeing on rates?

What do you mean?

Can you expand on that a little bit?

Yes, sure can.

Whatever the per person per month fee might have been under the group plan, once those individuals get shifted over to the exchange, and presumably it's an individual product where there is more selection, can you talk about how many carriers are actually active in those exchanges, and what is your assessment of their pricing?

What is the experience for the individual?

Are they finding that pricing is better or worse when they go to the exchanges?

I think it's all the above.

I think that an employer is going to make a choice to go to exchange for a couple of reasons.

One, they want to look at lowering their overall costs.

Ultimately, the long-term goal, the long-term, I think, interest will be employers looking at a defined contribution strategy.

So I'm going to give my employees a set dollar amount each month, and that's all I'm going to pay.

It's up to them to decide what they want to choose, what they want to pay above that.

In terms of the carriers that are on the exchange platform, while there's individual choice, individual employees are making selections, it's really still underwritten based on the overall group experience.

So I think that, are you going to see big swings for the exact same plan and costs?

Probably not, initially.

It's probably going to take a little time for that to sort its way through.

There is a belief -- and I know I'm giving you a lot of information here, but there is a belief that in today's selection process, because the employer makes the decision, essentially, here's the level of benefits all employees are going to have, that when you give employees choices, there will be a segment of the population that doesn't want to buy that much insurance.

So they will be buying less.

And that translates into lower costs not only for the employees, but could translate into lower cost for the employer.

So it's all over the board at the moment.

I don't think anybody has a real clear handle.

But ultimately I think this could help lower the cost for the employees and lower the cost for the employer.

Per the broader experience, when the individuals get their own in the individual market and pre-existing conditions have to be taken, it seems like the rate is more likely to go up.

This isn't the same.

These employees are already covered.

In terms of the employer marketplace, pre-existing conditions really haven't been an issue, except for the very, very small employers, for many, many years.

So I guess you are describing sort of a hybrid where the group plan is still in effect, and the individual is protected from the market, so to speak.

Initially when that goes to here's your subsidy, have at it, what is the risk of their sticker shock at that point?

I think you raise a good point.

There was a great article in the Chicago Tribune three Saturdays ago, and the sticker shock that they were talking about as they started to look at the exchanges here in Illinois wasn't necessarily the premium.

The deductibles were unbelievable.

They were saying you are starting off with deductibles at $9,000 and $10,000 for families of four making $65,000.

That is really sticker shock.

Just to expand on that, that's really in the individual market place.

And part of what's driving that is the fact that you are going to have an awful lot of employees that couldn't get coverage in the past, and that's what they are worried about.

So the pricing is going to go up.

In the group marketplace, the place -- and I use that term broadly.

The carriers that we are working with are already, in effect, dealing with this risk exposure.

These employees are covered under these plans today.

Now you are just giving them more choice, different options.

And in some instances, there will be multiple carriers where the employees can choose from.

So I think it's less about the phenomenon you are seeing in the individual marketplace, and it's more about what has occurred in what I will call loosely the group marketplace.

And my final point is that worked because everyone knew in the group that both sick and healthy were going to be in the group.

And so the carriers could underwrite based on that assumption.

If you then throw it open and the sick people buy the coverage and the healthier people buy less coverage or no coverage and put the subsidy in their pocket, then they become --

You are absolutely right.

I think the penalty for not having health insurance, I think, is like $97.

So you are going to have your entire young population pocket the money and say -- and, by the way, they get to go to an exchange anytime they want and buy.

So when they get sick, they will buy it.

In the individual marketplace, I think that the state-run, the federally run exchanges, those are going to be concerns.

Those are going to be challenges.

I think it's less of a concern in the employer exchange environment because -- again, think about it.

Most employers are going to offer a core set.

Here's the core you get.

Completely separate question -- the international market, 10% growth as I understand it organic on the brokerage side.

Is there some reason that was elevated this quarter, or is there some reason that should be sustained at a higher level going forward?

Our UK operation has been running at upper single digits, lower double digits for several quarters for the last year or so.

We are actually seeing a nice start of an economic recovery in the UK.

So that's helping, and I think that we feel good about our international growth rates in that number.

Brian DiRubbio, Yield Capital.

I just have one question, and it was regarding the two big acquisitions.

What was the motivation for both these guys to sell to you at this point in time?

You've done now a couple of very large acquisitions.

What's the change in motivation at Gallagher to do the larger acquisitions now where historically you have shied away from that?

I don't think that's -- there really was no change in motivation.

Both of these were opportunistic.

Both of them had different reasons for being for sale.

Both of them had large private equity holdings that were owners, and I think it was literally an opportunistic situation that came together, and strategically we thought they both fit.

These were not overnight, simple transactions.

Both of them were difficult and stringent negotiations, and we did incredible due diligence on both of these.

You literally would not believe the amount of due diligence we did.

And the more we looked at both of them, the more we thought there was a good cultural fit and a good business fit.

This is no signal in a change in our strategy.

Opportunistically, if some of the other top 100 brokers were to become available, we would be interested.

It's just more of the same.

We are building out our platform.

I think they are also seeing, Brian, they are seeing even at $100 million, the resources and capabilities that we bring to them at $3 billion is -- they are realizing that they need those in order to compete in the marketplace.

So the motivations about, especially when you look at aggregators like Giles and Bollinger, were that their needs for capabilities are very similar to what individual one-off locations would need.

They need the resources, and frankly, we just didn't see the level of investment being made into those franchises by their former owners.

So in this case, they needed our resources and our capabilities just like the $5 million shop down the road.

Good salespeople, great culture, hard-working folks that, when you take our resources and lay it open, they can be much more successful.

I think both deals are great.

It was just to see two large deals done so close to each other was a little bit of a change.

Remember, too, in the case of Bollinger, what you really had was three acquisitions there.

About $20 million of that business will fall nicely into our benefits operation.

About $15 million or $12 million will fall very nicely as program business into risk placement services, our wholesaler.

And that leaves about $65 million or $70 million that falls into our property/casualty retail branches in the US.

So it's really not all that big when you look at the three different groups that are taking aboard the revenue.

Great job, guys.

Thank you.

Dan Farrell, Sterne Agee.

Just another question for you on the clean energy.

The ultimate annual after-tax earnings that you put in as the ultimate target is a good deal higher than where your guidance would be for 2014.

Can you talk about some of the differences there in that?

Those ultimate targets also don't include some of the ones that are in negotiations as well.

So I'm just wondering -- explain the gap a little bit?

Can you talk about overtime do you see the gap and what you are earning in those ultimate targets closing?

A good question.

Think about it, there's lots of different reasons why those estimates move every quarter.

But basically the primary reason is the one utility that, if you recall, that purchased an incompatible coal with our solution, we hear they are going to ramp up back into better coal during 2014, so that's a difference between ultimate.

So if you look at what they will make in 2014 versus 2015, that would be a big difference between what they produce and then ultimately what they could earn in 2015.

There's also a couple smaller plants that we are going to be moving to higher production locations.

But by the time we take them off the line where they are now, move them, put the new footings in, we might not get the production 2014, but we would by 2015.

So that's illustrative of two reasons why there is a gap between being 10% to 20% next year versus the ultimate number.

For the remaining plans that will go into locations, remember what our objective is there.

Get those up and running, and then we will probably ratchet down our percentage ownership of all of the plants so we end up with a portfolio of about 30 plans that I'm just going to say maybe we own 30% to 40% of.

So it's really much more of a portfolio of investments than it is individual one-off ones that are causing some of these swings.

So I hope that we should be well through that by the end of 2014.

And then what we will do is we will be able to say, listen, we've got 30 of them that are producing.

If one goes off-line for a week, it doesn't hurt us that much in the overall smoothness of the earnings.

And then just another question on the two large deals that you've done.

On a full-year basis, how do you think about the impact to overall margins to the segment?

I think in some of the disclosures, it seemed like these were higher-margin businesses that might need a little investment, but still I'm just trying to think about how you think of the impact to the total margin?

If you just do the pure math, based on taking a guess for next year on what our Company will look like and add them in, it could be as much as 80 points of margin expansion for next year.

Okay.

All right.

Thank you very much.

(Operator Instructions) Brett Huff, Stephens Inc.

It's John Campbell in for Brett Huff.

Just trying to get a better sense for M&A just heading into 2014.

I know it's tough to tell at this point, but it's been, I would say, a blistering pace over the you can call it three years.

So just on a very high level view, do you guys anticipate running at that type of pace, or should we may be expect I would just say a meaningful slowdown, maybe back to that $100 million or so level we've seen in the past?

I think, first of all, the pace last year was -- in 2012 was helped a lot by the tax law changes that were coming in 2013.

So we saw a rush for the door in the third and fourth quarter of 2012.

We mentioned that in the first- and second-quarter calls.

This year I think we have been aided in terms of the dollar amount of revenue by having two larger transactions that are not typical of what we see month in and month out.

So I think you will see a consistent clicking off of acquisitions continually through 2014, 2015 and on.

I learned something recently that I found to be pretty interesting.

According to the Independent Agents Association coming out of the NAPSLO meeting just a month ago, I thought the business was consolidating down to fewer and fewer players.

According to the Independent Agents of America, for every player that gets taken out through an acquisition, at least one if not more than one new firms are started.

So the business continues to regenerate itself.

Now you've heard me say before that the people that we are talking to, most of the time, the independent owners are baby boomers.

This is their largest asset.

So our pipeline remains incredibly full, and I think we will continue to see as we continue to add people to our Company, there are literally dozens and dozens of us involved every single day in looking for, cajoling, talking to, selling people on joining our Company.

So I don't think you're going to see a big falloff and all of a sudden it slows way down again.

But I also think that the pace we have had the last two years will probably be looked at as a little bit stronger than the norm.

Okay.

Thanks for that color, Pat.

And just one housekeeping item.

I mean the brokerage tax rate -- it came in a little bit lower than we were expecting.

But just given Heath and Giles and, Pat, I believe you said that the rate outside the US now is about 30%, but maybe just what your expectations are for the brokerage tax rate in 2014?

I think that somewhere 37%, 38%, 39% would be a good pick, in that range.

We are getting some benefit by our Internet as Heath comes into more profitability, and we are through the integration phase on that and we are done with that.

Remember, the UK tax rate is less than the US tax rate, so that does have an impact on that.

We are seeing that in Australia a little bit also with our earnings on Gallagher Bassett.

So we think that you have got to make a pick between 37% and 39%, but you will see that drop compared to where it was in the past.

Arash Soleimani, KBW.

I had a follow-up on the exchanges.

Specifically, I wanted to ask about the small business health options program.

I know right now that's only available to smaller employers.

But once that does open up, to what extent do you anticipate that that would pose at least some level of a competitive threat, or is that something that would be rather meaningless to your clients?

Certainly, I can't sit here today and tell you how that would shake out.

I think that the platforms we are building, the options we are putting into these platforms are going to be very attractive.

They are going to be very competitive.

And I think what we do will be certainly viewed as a better alternative than for an employer of size to consider just pushing their employees off to a public or a federal exchange.

But I think your question was around small accounts, and that's not going to have much impact on us.

We just don't do that much.

But I think taking a step further and saying that it will be at some point in the future the option for employers to also -- larger employers to participate in that.

I don't see that as something that's going to be a groundswell.

Okay.

That's fair.

And then just another follow-up.

I know you had mentioned before that I think 85% of the competition was smaller brokers where it's basically an easy win for Gallagher.

Let's not say easy win.

I'm sorry, I guess easier win.

I've got a lot of colleagues listening to this call.

I apologize.

My question is, with the remaining 15%, I guess my question there is, what is the value proposition that Gallagher offers that would allow new business wins in that market?

What's the differentiating factor there?

100% of the time, 100% of the time it's our people.

All we have got is the matter between our ears, the gray matter.

That's what we are selling.

We have got the best people in the business on this team.

Okay.

That's fair.

Thank you for the answers.

We have no further questions in queue.

I would like to make just a quick comment as we wrap up here again.

Thanks, everybody, for being on the call with us this morning.

We appreciate your questions, good thoughtful questions.

We really appreciate you taking the time to understand our business.

Our team is turned on.

We are focused on selling new business and taking great care of our existing accounts.

We believe we are blessed to be working in the best business on earth, and the fact is we believe we are just getting started.

So thanks again for being with us, and have a great day.

Thank you.

Ladies and gentlemen, this does conclude today's teleconference.

You may disconnect your lines at this time.

Thank you for your participation.