Brown & Brown Inc (BRO) 2007 Q3 法說會逐字稿

Good morning and welcome to the Brown & Brown Inc. earnings conference call. Today's call is being recorded.

Please note that certain information discussed during this call, including answers given in response to your questions, may relate to future results and events or otherwise be forward-looking in nature and reflect our current views with respect to future events, including financial performance, and that such payments are intended to fall within the Safe Harbor provisions of security laws. Actual results or events in the future are subject to a number of risks and uncertainties that may differ materially from those currently anticipated or desired or referenced in any forward-looking statements made as a result of numbers or factors, including those of risks and uncertainties that have been or will identify from time to time in the Company's reports filed with the Securities and Exchange Commission. Additional discussions of these and other factors affecting the Company's business and prospects are contained in the Company's filings with the Securities and Exchange Commission. Listeners are cautioned that such forward-looking statements are not guarantees of future performance, and those actual results and events may differ from those indicated in this call. Such differences may be material.

With that said, Mr. Brown, I will now turn the call over to you.

Thank you, Chris, and good morning, everyone. We have Cory and Jim and Powell, and actually one of the things that we're going to add to this call this morning is that Jim is going to talk a little bit after acquisitions about Citizens and the Florida CAT Fund, and Jim is the current Vice Chairman of the Florida CAT Fund. So I think that you all will find that information interesting.

So without further ado, Cory, would you like to talk about the financials?

Thank you, Hyatt. Our third-quarter financial results reflect the continuation of one of the most difficult insurance market environments for insurance agents that we have seen in the last 15 years. Our net income for the third quarter of 2007 was $46.2 million and was up 14.8% over the last year number. Correspondingly our net income per share for the quarter was $0.33, and that is up 13.8% from the $0.29 we earned in the third quarter of 2006.

From the revenue standpoint, commissions and fees for the quarter increased 8.1% to $225.4 million. That is up from $208.6 million earned in last year's third quarter. Included in our press release is a table that summarizes our total growth rate and the internal growth rates from our core commissions and fees.

In the third quarter, outside the core commission fees, we received $8.9 million of profit-sharing contingent commission compared to $2.1 million we received in third quarter of last year. Now most of this increase in the profit-sharing contingent commissions came from our brokerage division, and specifically our Hull & Company subsidiary.

Now looking at the internal growth schedule, for the third quarter, we had a negative internal growth rate of 3%, and that was mainly due to the significant insurance rate declines in the state of Florida. Our total core commissions and fees for the quarter increased 5.6% or $12 million of total new commissions and fees. However, within that net number was $18.1 million of acquired revenues, and that means we had $6.1 million less commissions and fees on a same-store sales basis.

Hyatt, Jim and Powell will then talk about the activities in each of these business segments in a minute. But moving along to the other revenue line items, our investment income was just slightly higher than prior year, so no real change there. Our other income was $8.6 million this year or this quarter. And inside of that number, we had $7.2 million of gains from the sales of various books of business around the country.

As it relates to our expenses in our pretax margins, our pretax margin for the third quarter 2007 was 31.8%. However, if you exclude the gains on the sale of the books of businesses, our pretax margin was approximately 29.6%. That's 120 basis point reduction over the prior year pretax margin of

30.9%. Excluding these gains, employee compensation benefits increased 40 basis points to 48% of total revenues. That 40 basis points represents approximately $1 million of net additional costs, which was principally due to just various miscellaneous expenses ranging from group health insurance to employee education and just miscellaneous expense accounts.

Our non-cash stock-based compensation costs increased $700,000 in the third quarter, and that is primarily due to the increased number of employees participating in our employee stock purchase plan that has a new annual plan year that starts each August.

Other operating expenses as a percentage of total revenues, again excluding the gains on the sales of the books of business, was 14.3% of total revenue compared to 13.9% in the third quarter of '06. That is also a 40 basis points change, and it equates to approximately $1 million of actual net average cost. And that was again no specific line item makes up the majority of that. It's just various expense accounts like T&E, legal and insurance costs, but it probably had much more to do with the fact that in the quarter we had lower revenue growth and the general expenses just tweaked up a little bit.

Amortization and depreciation expense on a combined basis is consistent with last year's third quarter when considering the acquisitions that we have done over the last 12 months. Our interest expense is consistent with the expected quarterly expense of around $3.4 million.

Our effective tax rate for 2007 is currently expected to run in the 38.8% range, so the quarter was consistent with that. And then really if you look at the year-to-date basis, the trends that we talked about in the third quarter really are consistent with what happened year-to-date, and so I will bypass just this line by line discussion and just say that looking at year-to-date earnings per share for 2007, excluding the gains that we had on the books of business sales and the gains that we had in the first two quarters on Rock-Tenn, the year-to-date earnings per share was approximately $0.99, and that is about a 4.2% increase over the $0.95 that we earned for the first nine months of September 30 of '06.

So with that, I will turn it back over to Hyatt.

Thanks, Cory. First of all, the Florida retail, which is the biggest surprise that we have had in a long-time. As a matter-of-fact, I don't think -- well, I don't think, I know I don't remember any quarter where we have had a negative growth rate in Florida. Last quarter we were at positive 7.1, and this is a negative 12.3. And there were a number of reasons, some of which we were somewhat aware of, but we are not -- we did not expect them to be quite as voracious in terms of eating up topline.

First of all in '06, Q2 and Q3 were pricing peaks. There was a tremendous amount of anxiety among all the risk barriers in anticipation of the hurricane season. Now you know the hurricane season is really July 1 through I think the end of October, but it is really July through the first of October.

So last year the highest prices for property insurance in the history of the world in Florida were written, and that was fear of the hurricane season. In Q3 of this year starting in June and it really cascaded in July, August and September, the carriers all out the pedal to the metal, and pricing of property is down 25 to 40 on every account and a substantial more even higher than that. And a lot of that is non-admitted pricing reductions.

The largest single example that I know of personally was a premium that was in the quarter, third quarter of last year. The premium was $3,562,000, and the renewal price was $1.560 million. It was down 56%. There are a number of other examples that are in that neighborhood, and they are all the larger accounts, of course.

Now the second thing, which is a little more difficult to think through but it is pretty simple when you think about it for awhile, in quarter one and quarter two of this year, we did have a number of cancellation and rewrites because of the dropping -- the prices dropping so rapidly with Citizens. And so something that would be in Q3 and sometimes Q4 we were canceling and rewriting in Q1 and Q2, and of course, that revenue was absent from this quarter. Exactly how much that is we don't know, although we have a number of examples.

The third thing is that casualty all of a sudden started down as pressures by all the companies -- on all the companies to increase their topline in terms of writing for casualty revenues and casualty pricing, which had been kind of flattish, was down 10% to 20%, and a new account, if you're going to write a new one, you have to be at least 30% below expiring to get in the ballgame. Last and also not least is payroll in the housing-related businesses are down 5 to 30% around the system where we do have a lot of homebuilding kinds of exposures. And this would include artisans and etc.

So not only do the payrolls go down, but also the estimates for the revenues. So the coverages that are based on revenues are also down similarly for homebuilders and those people that surround building. And, of course, this is Florida. I mean this has happened before, not possibly not quite as severely as it is this time.

Additionally nonadmitted markets are continuing to reduce our prices and give better terms and conditions, and of course, I think Powell is going to talk a little bit about that in a moment. One national admitted carrier is now writing property on a limited basis but not on the standard property form. It is on an inland marine form. So they have got a certain amount of ability to move pricing around based on what they want to do.

Umbrellas on a vanilla basis are down 20 to 30%, and Citizens now has $3.5 billion in premiums. I think that is about 30 or maybe 35% of the market. Jim is going to talk about that. And we are due for another worker's comp rate decrease in January of I think it is 14 or 15%.

A general statement about employee benefits. If you go all around the country, employee benefit is up 7 to 10%. Looking at national retail, last quarter it was a positive 27. It is now a negative 8/10 of 1%. In all areas the national retail experience continued downward rate pressure. Looking at Georgia and South Carolina, property and casualty is minus 10 to 20%. Nonadmitted is sometimes as much off of as 40 to 45%.

Midmarket and worker's comp in Georgia is not quite as competitive as South Carolina, which is very competitive. Coastal Virginia is down 10 to 20%. Casualty only accounts can really be crazy, 30% or more. This is renewals and new business both. Marine is going south fast when the two titans go after the same account. And the two titans are two risk barriers who have a thing for each other, and when they get after an account and each knows the other's competition, then you can throw the prices out the window.

Regionals are most aggressive when you get away from Coastal Virginia. New Jersey and New York City area, casualty and property is very competitive. It is one of those things of 10 to 30% pending upon the kind of account.

However, one difference if you look at Manhattan contractors, and we have talked about that in the last two quarters, Manhattan contractors have been flat, and now the good ones are down 10, maybe 12%. That is different from Q2. But if you are a Manhattan contractor and you have a bad loss ratio, you're going to pay the price.

Some companies are limiting their coastal exposure on Long Island and New Jersey. A product is flat unless it is light exposure. Some umbrellas down 20 to 40%. Nonadmitted is very competitive more than Q2. Condos and co-ops are resting around $0.09, which I think is about as low as they can go, but who knows. Not much more to go.

Work comp rates may be down a little bit but not that much. Upstate New York renewal pricing is more competitive than three to six months ago. Now bear in mind upstate New York has been a haven for profitability for P&C companies since the beginning of time. Accounts, however, with losses the companies are doing some underwriting. Accounts with losses are going to pay up. The state fund is aggressive in worker's comp, and with the elimination of the second injury fund being pretty much abolished, that has an impact on pricing.

In Ohio, Indiana, Illinois, Wisconsin, those areas, excluding Chicago metro, those areas had the lowest rate to start with. So they are down by percentages, but again it is pretty brutal in terms if you compare prices for accounts, let's say, in Ohio and Indiana and Illinois rural areas, and you compare them with some of the more Metropolitan states there the base prices are much lower. Again, new business to get a new account has got to be 30% lower.

Occasionally there will be an account that will move based on terms and conditions. In the Gulf Coast, Louisiana, Texas and etc., the economy is very strong. It is oil related. Property and nonadmitted is going down 30% or more. Worker's comp is very competitive, particularly in Texas. Texas, the oil boom is going on. The market in Houston in that area other than coastal is as competitive and possibly more competitive as it was in 1998 which was the depth of the previous market. And one national company is in Texas buying business.

Chicago metro, that is a little different ballgame. I talked about Ohio, Indiana, Illinois, Wisconsin. You get into Chicago metro, those contractors were flat, and they are down now 5% to 10%. Regionals in the metro area are very competitive on contractors that are artisans and have moderate to low hazards. On the heavier contractors, they are not going to play the game.

In Western retail it was a negative 4.1%. It is now a negative 5.9. More of the same, except California work comp might be, might be starting to moderate, and that is not shown up in the pricing yet. But there's all kinds of discussion about the rating bureau recommended a 4 to 6% rate increase and the fact that loss costs are rising, so maybe.

In Arizona the state worker's comp fund is getting more aggressive, and that is making it more difficult to write new worker's comp accounts. Renewals are down 10 or 15%, not quite as bad as California. New got to be 25 to 30%.

New Mexico and Colorado, now here is something talking to our officers, price reductions may have moderated? And I'm not sure whether that is real or not. It might be just our book of business for this quarter. You know construction is off 5% to 10%. If it is nonresidential, it is minus -- these are pricing, pricing numbers -- minus 15 to 20. And the worker's comp may be steadying a little bit in Colorado, and it is a little softer. Worker's comp is a little softer in Mexico.

If you get outside in California, if you get outside of the Metro areas like Los Angeles and San Diego, it is a little different ballgame. Renewals may be down 5% to 10% in certain areas. Worker's comp though down 15 to 20 still, still hoping when one changed. And umbrellas are down about 15.

There is a little now change in Quake. Quake has been going up. Some renewals now are coming in 5% to 10% below expiring. In Washington we have sort of the same as it was last quarter. 5% to 15% down on renewals. If the account is heavy in GL, then the companies are very aggressive in that area. Marine is flat to down 5%, and our travel business is off 5% to 10% on renewals.

So, Powell, would you like to talk about the other sector?

Thank you. In special programs, FIU, we would say more of the same. Revenue Q3 in '07 over '06 is down about 50% as we anticipated. Citizens rates are about the same as they were around $0.50, but they are erratic on the interpretation of the rules. On a positive note, we can now write condotels. Those are condos that have occupancy like a hotel where they have nightly rentals, but it would have to be less than 50% of the time. The downdraft there this quarter was slightly offset by the performance of Proctor Financial, which as you know focuses on force placed property, and they have sold more new accounts than last year in Q3. We had lost an account, and we got a new account back.

Relative to brokerage, in the property arena, in coastal areas rates are going down very substantially, 20 to 50%. Terms, this is in Florida, from Jacksonville and down through the center part of the state are under significant pressure with Wind deductibles lowering to 2% and 3%, but they are typically holding at 5% Wind and coastal areas. Limits now are doubling even with the reduction of rates. So if you paid $100,000 last year for a $5 million primary limit, you may pay 80,000 or $70,000 for a $10 million limit now in Q3. A significant number of mid-term cancellations and rewrites.

Property Inland is cheap, cheap and getting cheaper. There is lots of standard market activity there.

In terms of casualty business in the East, Eastern United States and the Midwest, big automobile and residential contractors are typically down up to 15%. Commercial contractors are down 25% or more. Regional carriers are attacking the umbrella business around the country. In the West residential contractors not only are their rates down significantly, but payrolls are down significantly. And as we talked about in Q2, that has significantly impacted the revenues of international E&S.

Premiums though as a number, premiums under $100,000 in the West, casualty are typically down 10 to 20%. Premiums over 100 to $150,000 and up are down 30% or more. The admitted market continues to be very, very active in the West. Professional liability brokerage is down 15 to 30% depending on the class of business. Binding authority in Florida, rates are down 20 to 30%. We're seeing increased property capacity which is afforded in those binding authorities. We're seeing more admitted markets there, and Citizens continues to impact the personal lines segment of Hull as we talked about in Q2.

One Citizens note that we have referred to in the past is in June of this year Citizens ruled out a Wind only product for $1 million of coverage, part of I think it is $10 million of total insured value. On 9/1 of this year Citizens was allegedly or supposed to rollout a $2.5 million all perils policy. That has not occurred yet. Apparently that will now happen on 1/1 of '08, but we don't know anything about it. But we know that it did not occur on 9/1, and we had alluded to that in the past.

Binding authority outside of Florida rates are typically down 15 to 20%, and the standard market continues to be active there as they are in Florida. Public entity business countrywide, depending on the loss ratio, typically rates are down 0 to 20%. In the services area, we continue to be very pleased with USIS and NewQuest; however, we would point out that one of the clients of United Self Insured Services has taken part of their business in-house, and the impact to us is roughly a shortfall of about $400,000 of revenue a month in USIS.

In the professional national programs, dental professional rates countrywide seem to be relatively flat, but the corresponding package is typically down 0 to 10%. Lawyers, larger firms are down 20 to 30%, and smaller firms are down typically 0 to 15%. CalSurance professional rates are down 10 to 20%.

And with that, I will turn it over to Jim Henderson.

Thank you, Powell, and good morning. As reported in our earnings release, we're pleased to report the increase in acquisition activity in 2007. The run-rate for acquisitions, $81.8 million year-to-date. We believe that we based upon current activity that number could exceed $100 million for the year.

Of greater significance is the quality of the agencies and the people that are joining Brown & Brown. 18 of the transactions announced were retail agencies and two were wholesale brokerage.

The total national deal flow activity for insurance agency acquisitions continues to increase for 2007 compared to the previous two years. For 2005 there was 172 announced transactions, 184 for 2006 and the pace for 2007 could exceed 220. The increased activity has come primarily from public brokers and from the three former public brokers now acquired by public equity capital. There is no significant change in activity for banks or for private agency deals.

There is some indication in the agency acquisition market that the tighter credit terms will restrict or have an impact upon the growth of the acquisitions by the private equity firms. We're pleased that our cash flow and the access to credit will provide an advantage to Brown & Brown for acquisitions. Agencies with revenues of less than $5 million comprises a significant share of the intermediary market. This size agency continues to be a target-rich environment for Brown & Brown. We have a long-term success story of acquiring and integrating the small and medium-sized agencies and will continue to focus on this group and larger agencies.

To handle an increased number of transactions, we continue to expand our agency prospecting teams and transaction capabilities. Acquisitions are an ordinary part of our leadership's responsibilities. As Hyatt mentioned to you, we wanted to give you an update on some of the activities of the Florida Hurricane CAT Fund and also Citizens Insurance Company to give you another angle and view of the property pricing in the state of Florida.

First, the Hurricane CAT Fund. This entity is the phenomenon of the 1994 legislature. It was enacted to provide lower cost reinsurance to the carriers for the state of Florida. Over the period of time the following 10 years post-2000 -- 1994 to 2004 -- the CAT Fund accumulated approximately $7.5 billion in cash. The '04 and '05 seasons will result in a payout of claims from the CAT Fund to various carriers in the state of Florida of approximately $10 billion, leaving a $2 billion shortfall which has resulted in assessments now adding on -- tacked onto policyholders throughout the state.

In recent activity the CAT Fund has borrowed approximately $5 billion in preevent cash funding to assist for any hurricanes in '07 and '08. The legislature increased the payout capacity of the CAT Fund to a new level of $27.5 billion with options below and above that amount. Those options have not been picked up by the carriers.

The lower cost of reinsurance has been a factor in reducing property pricing for carriers in Florida and principally for Citizens. The largest reinsurer reinsured by Citizens or by the CAT Fund is Citizens Insurance Company. I wanted to give you a few stats that has been released on Citizens to share with you. The current policies enforced for Citizens is $1.38 million. The forecast for 2007 is to reach approximately $1.58 million, and for 2008 they are forecasting a growth to two rating policies.

There has been a decrease in the rate of growth, although Citizens continues to grow at a fast clip. The premiums enforced for Citizens currently is reported as $3.55 billion in annualized premium. The market share have announced for the property as of June 30 of '07 is that Citizens now represents 30% of the property market for the state.

On the financial side for Citizens, the current surplus level for Citizens based upon their reserving program represents a $1.2 billion surplus within Citizens. The amount's PML, the probable maximum loss for Citizens, and this announcement was associated with a 100 years' forecast, not the 250 of which most carriers are allowed or required to reserve. The PML amount was $24.5 billion.

Citizens retention before recovery from the Florida CAT Fund, so now it is at $1.8 billion, and their recovery from the CAT Fund is approximately $8 billion. Citizens rates remained frozen through '07 into '08 to be reviewed and adjusted to market conditions on January 1 of '09.

The assessment accumulations in Citizens under a 2004/2005 storm scenario could result in assessments to Citizens policyholders representing anywhere from 80 to 90% of their current premium levels.

The growing concern about the accumulation of values given the below market pricing conditions for Citizens, that concern has not been affected and a growth of values of a PML now that makes the assessment capability for Citizens and for the CAT Fund. And this has been certainly talked about by CFO Sink in terms of ways to restrict Citizens growth and restrict the growth of the Florida CAT Fund. So that is kind of an update of those two entities and its impact upon the Florida property market.

At this time I turn it back over to Hyatt for closing comments and then open for questions.

Okay. Thanks, Jim. Good report. Relative to the forecast for the next quarter, 0 to 5% growth excluding Florida. 0 to 5% growth excluding Florida.

So now, Chris, we will open up the phone for any questions.

(OPERATOR INSTRUCTIONS). Keith Walsh, Citigroup.

Just a couple of questions. First, I appreciate the explanation about Florida. But I guess I was surprised like everyone else it deteriorated so quickly. Besides pricing what are the levers that you can pull to fix this, and do we enter a period of easier growth comps as we get into 2008? And then I have a follow-up.

Well, I think your easier growth comps is probably correct. We're going through a maelstrom this year that has never occurred before in Florida. And so we -- to get into what I would call a steady-state, we're probably going to be the second quarter of next year. So from now through the end of the fourth quarter and into the first quarter, we are still going to be having a very difficult kind of marketplace.

Now there are lots of opportunities to write new business. Don't ever realize that Florida is not a growth state; Florida is a growth state. And, of course, what happens is that we do have some great programs that are using -- that we are using to expand in Florida. But the bottom line is that probably casualty is going to continue to go South in Florida because it has not gone South as much as it had in other parts of the country, and everyone is thinking well no hurricanes this year. And so next year it is 12 months off. Don't worry about it until then.

So does that answer the question?

Yes, that is helpful. And then I guess the second question I have, just looking at the $13.1 million year-to-date, I guess it was $8.6 million in the quarter of books of business that you have sold, I mean that is by far and away the largest number I have seen in my models here going back several years. What exactly is driving that? Are these underperforming blocks of business?

Well, what happens when you have a market that is -- the pricing is declining where you have people who have sold books of business or agencies to them -- to us, sometimes they get a little enamored with not having to work too hard. And, therefore, things start to deteriorate a little bit, and it becomes apparent that it might be better for us to part.

The other thing that we are always doing is we are always looking for slices of business that are underperforming. Now an example of that would be the trucking business. Trucking business, unless it is high hazard trucking for which we have none of at the moment, that is going to be a max 15 to 20% margin and we are not going to do 15 to 20% margin business. So all of those kinds of things are constantly going on within our organization.

You see each of our profit centers because it is the income of the leader of that profit center is dependent upon growing the profits and the margins. They are constantly looking for ways to a) write more business and b) make a higher margin on those lines that they are already writing. And, of course, as we become more sophisticated across the Company and country about lines that are the most profitable, our people are responding. And so in this kind of market, it is a good time to take a look at all of those areas, and in a softer market if you have any kind of slice of business that has been kind of overlooked because you say, well, it is not doing quite so well but we're doing well, that all of a sudden the focus is upon those slices, and we're making those decisions as we go forward.

Chuck Hamilton, FTN Midwest.

Two questions for you this morning. The first question I guess deals with supplemental commissions. I see that in second quarter '07 that you recorded a little bit more than $3.2 million in that quarter. Of the net commissions and fees this quarter, do you know how much was related to supplementals?

Yes, it was $1.5 million.

1.5. And, of course, that is included then in your growth calculations for organic revenue?

That is correct.

Okay. And I know you folks don't look at this, but maybe you've got a sense of it is when we take a look year-over-year to the quarter, we are showing a 12% increase in other operating expenses. Do you have a sense what percentage of that is organic expense growth that is stripping out the effect of bringing in the acquisitions and also the sales of these books of business as well?

Well, talk about on the first part, there is -- most of the expenses are coming in from the acquisition. Most of them are not normally at our same margins. But there is no one particular line item that is really out of whack. And, as I kind of described, if you take out the book of business sales, it is about $1 million worth of costs that are in there, but really it is just all over the board, various costs. And it is really they went up a little bit, but it is mainly the softer revenues that kind of showed the margins up. I am not sure if I understood the second part of your question.

Right. I guess it is just adjusting the expense growth to also include the fact that you have taken out expenses with the sale of books of business, say the producer's expenses.

Yes but that does not show up quite as quickly because you're only talking about the one month of revenue. And so that would be marginal.

And I guess just the last part of that would be with the gain on books of -- excuse me, gain on the sale of books of business of $8.6 million, do you have a sense how much that translates into revenues that will not appear in future periods, the annualized revenues that have been foregone with that sale?

Yes, it is about 4, $4.5 million worth of annualized revenues. And the total gain of that was only about $7.2 million a quarter.

I think also to give you a little more light around the issue of acquisitions, in many cases, maybe not most but in many, we do have moving expenses. For instance, we acquired recently the JPMorgan personal lines operation, which is in a suburb of Wilmington, Delaware. It is in their I guess datacenter. So we had to move immediately 60 days and move to a new location, etc., etc. That all is a -- those are the kind of expenses that are onetime expenses, but we have to absorb them anyway. That happens in almost every -- some of those kinds of expenses happen in almost every acquisition.

Okay. I was just trying to get the sense since you are showing organic revenue growth, would it not be great to be able to see organic expense growth so that we could then monitor the ongoing expenses compared to the ongoing revenue strain?

Right.

Mike Grasher, Piper Jaffray.

Hyatt and I guess Cory had in his national remarks mentioned the 15 years toughest environment. As you look at today's marketplace, is this the most difficult environment that you can remember, or do you see any difference in today's market compared to say '98, '99 time period?

Well, if you look at just the market -- forget, the Florida situation -- then it is about like '98, '99 and we have also seen back in really '82, '83 -- that is before most of you all were born, so we will not go into that -- but yes, we have seen this before.

Now the Florida situation is really an outgrowth of the fact in two years we had very abnormal hurricane activity which forced the prices up very substantially, and then no hurricane activity one year and hopefully none this year. And so all of a sudden you have a big up and a big down. And the big down, instead of being a more sort of like a pyramid where you're going down the side of the pyramid, a level sort of reduction. It was a 50% reduction or 60% reduction overnight because of Citizens. So that is an issue that we just never had faced before.

Understood. But then in terms of the carriers themselves, the underwriters, are they behaving any differently across the country than what you would have expected?

I think generally speaking I think that underwriters are probably in a little better position today than in '98 and '99 to make underwriting decisions on pricing. And one of the reasons is that I think the systems are a little more effective and efficient. The other thing, though, that makes this a difficult call is, if you look at a large group of the risk-bearers as reported in business insurance, you will see a combined loss and expense ratio of about 90 to 92%. That has never happened before, but it is because of Sarbanes-Oxley.

And there are not redundant reserves, even though some of those reserves are being released into the income stream now, which creates this very, very good combined loss and expense ratio. However, at a recent meeting at the Greenbrier, I was very surprised to hear a couple of companies that are well-known companies and well-run companies and regional in nature indicating that they thought that this year they would have reasonably close to 100% combined. I was very surprised at that. Now the risk-bearers are saying that because of Sarbanes-Oxley the turn is going to be a lot faster than in the past. And I'm not convinced of that, frankly.

Interesting. And then if you look at government intervention and obviously this applies the Florida a great deal but across the country with California and I think you mentioned Arizona and New York being involved in worker's comp as well, aside from worker's comp, has there been so much government intervention historically?

No, there is really not.

Relative to today.

Yes, the market is working quite well. Really what happened is there is really less governmental intervention. As an example, a monopolistic state was Nevada up until about four or five years ago. They then took the state fund and made it into a nonprofit and now it is a profit-making organization I believe, and they are writing worker's comp like crazy, and of course, they are using agents.

Another monopolistic state, West Virginia, that had been monopolistic forever was losing their ears and hat and teacup in the fund. And so they walled off the fund, created a new company, I think the name of which is Brickyard, and it is now a not-for-profit in West Virginia, and agents and brokers are accessing that market. And next year anybody can come in.

So there is a movement towards having a competitive marketplace. When you have a crisis situation and you get people in political positions where they think they have to respond because of the screaming and yelling of the populace like we have in Florida, then all of a sudden you're going to have a short-term Neanderthal approach.

Now has this happened before? It did. In the '60s and '70s, the same thing happened on automobile liability insurance, and there was a huge fight over whether or not we would have no-fault liability. And what was then called the assigned risk plan for auto liability grew by leaps and bounds, and everybody was gripping and complaining.

Well, over a period of time, the marketplace smoothed it out, and now profit and liability for private passenger is very, very competitive and has been for 10 years. So you have these peaks and valleys. Where you have a catastrophe exposure and the catastrophe exposure is in the United States as I see it is Quake in California and it is Wind along the coastal areas from Brownsville all the way to probably New York City. And, of course, the most difficult and the scariest catastrophe exposure is a CAT four, level four hurricane coming into the bottom end of Manhattan.

So but that is part of why they are -- the insurance companies are in the risk bearing business. They are in business to transfer risk and to take risk.

Sure. And I wanted to transfer to Jim and just ask a question on the acquisitions given the market. Has there been a surge in the pipeline due to the market, or has the pipeline remained stable in terms of opportunity? I mean it seems like this quarter and even your comments potentially reaching $100 million do reflect an increasing opportunity. Can you speak a little bit more about this?

Yes, there does seem to be an increased surge in the activity. If you -- the private conversations with those that are selling, you can -- you have got demographics involved. You have got markets involved. Demographics, the baby boomers that are looking at what do I do now? The family does not want to take the business over. The people inside really cannot buy it.

So this is one of those conditions that we feel like that is creating a lot more activity. So we are pleased with the -- we always have a certain amount of flow. There seems to be more than last year. We also are, in fact, we're looking at more of deals and building our infrastructure to go visit and talk with more people. Because I think one of the safest plays we have for our shareholders is to continue to look at the small deals. They are very accretive. They really fit well. They blend well with our culture. So we will continue to focus on that, not exclusively away from margins. So yes, I think we are encouraged by the activity flow.

The history, our 30-year history, is about one-third organic and two-third by acquisition. And we don't really see that long-term changing. Near-term when organic is certainly a challenge by the market and by the government, we are, frankly, very pleased that we have another option to go create growth.

Then just a final question or follow-up on that. How much of the smaller activity acquisition-wise is being driven by the potential for change in the capital gains?

Well, it definitely comes up in discussions with the sellers. When they are looking at the 15% rate and a lot of the national press in Canada indicates that they feel that that rate is unfair. So there is a -- it is coming up in conversation and timing matters that is it a component by itself? No, but it certainly is a factor that is encouraging now versus later.

Meyer Shields, Stifel Nicolaus.

If we look at I guess recent acquisition by you folks, by Hilb and by Hub, there have been a fair number of banks that have been divesting their insurance operations. Is that a trend, or are those just a number of one-off issues?

Well, I think it is a trend. What is happening is banks are starting to vomit up their insurance agency operations, and there are a couple of banks who are doing a very good job. But, for the most part, there is a substantial difference in culture.

There is always the Board of Directors being concerned about the specter of tide house evil. And if a bank ever gets nailed on tying credit to the selling of insurance, the class-action impact of that would be devastating. It would be more money than they make from an insurance agency operation in 1000 years.

So all of that does have an impact. Of course, what is happening right now is there are a number of banks that are divesting that are in the marketplace as we speak. And we have actually acquired the JPMorgan one as you know. We have acquired a small amount in Kentucky about a year ago or so, and we made an offer on another one in the Southeast, and it was sold internally. And then, of course, you know HRH bought Bank of America, and then there is a whole bunch of things going on.

So, as time goes along, I think we're going to continue to see more of that. I think there's another situation that is occurring where a bank has just bought another bank in the Southeast, and apparently there's some kind of divestiture concern. And so those are opportunities for us, and they are opportunities for other people too.

That is very helpful. Switching gears a little bit, has there been an issue with employee turnover? Is that getting worse over the past couple of years for you folks?

No, the one thing about having a market like this it does separate the good people sometimes from the people that are not quite as good because you have to be on your toes. Every account has to be very, very carefully handled. And so that's not just at the producer level. It has to do with the marketing level. It has to do with the customer service representative. It is the whole team.

So what we're constantly doing is one of the reasons that we have the kind of margins that we have is that we try to have the very best people and try to give them additional training.

Now we have something called Brown & Brown University, which has been going now for about three years? (multiple speakers) Four years. And it has been very beneficial in helping to upgrade our people in the retail P&C area, and we are now getting ready to look to see how we can do this in the brokerage or wholesale area.

As we go forward, the ability to run our model is very similar to the ability of a very well coached athletic team, taking -- let's take a football team -- where they have a fairly sophisticated game plan, offensive game plan. Ours is really kind of like that. And very good people can score lots of touchdowns in our model, but they have got to be willing to follow the model itself and to follow the leadership that has gone before them that has shown the way. In the case of turnover, I don't think we have any greater turnover today than we normally have.

And I guess one last question. In terms of the office leadership, are you comfortable with the people you have in force now?

Well, we always have turnover in leadership, and that has to do with several reasons. We have 163 or 164 offices. And so of the 163, 164, how many people are considering retiring, let's say, in one or two years or three years. Well, there are several, and so we have to then go forward and find someone. They have to start bringing on someone who will take over their position, and we have to help them grow that individual.

And then there are just people who all of a sudden one day, say, gosh I think I'm just going to walk out and go to to the beach.

So we do have some turnover. But generally speaking, our people, our leadership capital is the strongest today that it has ever been.

Doug Mewhirter, Ferris, Baker Watts.

I have two questions. The first is I noticed obviously your Florida retail is very disappointing, and also you mentioned that FIU was also still very soft for obvious reasons. But given the FIUs within special programs, and correct me if I'm wrong, but special programs showed very positive overall organic growth. What seemed to be picking up the slack?

It was a combination of one, Proctor Financial that we talked about, and we had some might nice growth in public entity.

Okay. And the second question, because the commissions seem to be I guess restructuring and the nature of them are restructuring, do you think, Cory, that contingents may be less frontloaded as they have in the past, and we see more quarters with unusually large amounts in the second, third and fourth quarter as opposed to just getting it all in the first quarter?

The short answer is no. And, first of all, there is really only three, maybe four carriers with Hartford are the only ones that I'm aware of that are restructuring, and it is all tied to their previous settlements. I do not see or have heard of any other insurance carriers of the other 900 that we deal with that they would go to a guaranteed supplemental commission. So that takes care of that. The rest of the contingents should fall in the normal period of time.

Now the reason why we had such a larger number of contingents in the third quarter relates primarily to the wholesale marketplace where a lot of those carriers have June 30 type year-ends. And so it was just -- they had good years this past year, and so the contingents were up. So there really overall will not be much of a change in the normal flow of those contingent commissions.

Doug, I think to piggyback on that, there's another issue here, and that is that when insurance carriers are making lots of money, our contingent commissions go up as a percentage of our revenue. When prices start to rise as they do when losses mount for risk-bearers, generally our contingents are flat or down, but we grow the other end of the spectrum, which is the organic growth. So it is kind of a balancing act.

Matthew Heimermann, JPMorgan Securities.

This is actually Keith Alexander calling on Matt's behalf. I just have one follow-up question. I was wondering if you guys could discuss how changes in price and exposure have possibly lead to any changes in compensation or commission ratios or how these three factors are moving on a relative basis?

Well, first of all, relative to commissions from companies, the commissions are the same. However, we're getting some additional commissions from some companies, and it is kind of sporadic and it is not across the country. But that is probably going to become a little more prevalent as they continue to cut the prices. So that is the top end. In terms of the way we are paying people, there is no difference.

(OPERATOR INSTRUCTIONS). John Fox, Fenimore Asset Management.

I just had a question for Powell. If you have the dollar amounts for FIU this quarter and last year?

John, last year FIU had about (multiple speakers) 4.2, and this year it was a just a little over $2 million. So there was roughly a $2.1 million downdraft in the third quarter.

Great. And then for Jim, I cannot ever remember any type of projection or anything about acquisitions before. But are you telling us to expect $100 million or just the pipeline looks good, or what is the message there?

That is just a run-rate, John, and we never have forecasts nor --

So that is annualizing the current run-rate.

Yes, the kind of run-rate, that is right. They are never done until they are done.

Nik Fisken, Stephens Inc.

How much of Florida is casualty?

I don't know. You have got --

Just kind of goalpost it if you can.

Well, it would be a scientific wild ass guess. (multiple speakers). Don't forget you have got employee benefits. You have got personal lines. You have got marine. So let's say, employee benefit, it was about $200 million. Casualty, you're talking about Florida only? Is that right?

Correct.

Maybe 40%. But that is kind of a guess. We would have to look at it.

Okay. Cory, what is our outlook for contingents for fourth quarter?

Right now it should be well less than $1 million, maybe $0.5 million from what we know right now.

And then if you look at the four underwriters that are paying you these guaranteed contingents, do you know how much they paid you last year in the form of the regular way contingents?

It was about the same amount. It was around $6 million in total contingents. And so right now, on the run-rate right now, we're running 6, 6.5. So it is almost a wash.

And then the last question for Hyatt, if you look at '08, you guys are pretty confident you guys can hit that part of B-40 goal? I'm wondering more on the 40%.

Well, I will tell you right now we have never normalized earnings. So, for instance, whenever we had the numbers last year where we had a $5.8 million payment to the folks in Tallahassee, we did not normalize those in our own thinking. So this year, including the Rock-Tenn sales, we're probably going to be 40% in terms of the margins. And I think Wall Street has us falling a little below the B. And so is it going to be $15 million below B? I don't know, but that is what some of the Wall Street estimates are as I understand that.

And what we are in the process of doing, as a matter of fact, is our leadership meetings start Wednesday, and we're going to talk about the next intermediate goal. And because on a rolling 12 sometime in the not too far distant future, we're going to be at the B. So we will declare a victory and then go to the next intermediate goal, and we don't know exactly what that is going to be. But I think you can probably figure it out by just thinking about it.

So if I look at margins year on year, you are down about 80 bips just on the comp and other op expense? Is there any reason that should not continue?

Well, it depends. It might continue; it might not. So if you look back at our history and, of course, you cannot look at one quarter or maybe any six months and say, it is up or down. We continuously accept for the cases -- I am talking about pretax now and you are thinking about EBITDA -- except for the cases where there was a change in the amortization from 20 to 15 years, our pretax has gone up fairly evenly. So we think that there is still upward mobility, and we're going to see if we cannot get there.

This is Jim. If you look at the acquisition activity and as that comes in, unless it matches obviously the current rate, there is some impact on margins from the acquisitions. And although they come in at a very high rate, some of them are not going to come in at the long established Brown & Brown rate.

It appears there are no further questions at this time. I would like to turn the conference back over to you for additional or closing remarks.

Okay. That is all we have, and so good luck, everyone, and we will see you in January.

This concludes today's conference. We do appreciate your participation. You may now disconnect.