Brown & Brown Inc (BRO) 2010 Q4 法說會逐字稿

Good day everyone. 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 or events are otherwise forward-looking in nature and reflect our current views with respect to future events, including financial performance. Such statements are intended to fall within the Safe Harbor Provisions of the Securities laws.

Actual results or events in the future are subject to a number of risks and uncertainties and may differ materially from those currently anticipated or desired or referenced in any forward-looking statements made as a result of a number of factors, including those risks and uncertainties that have been or will be identified from time to time in the Company's reports filed with the Securities and Exchange Commission. Additional discussion 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. With that said, I'll now turn the call over to Mr. Powell Brown, our President and Chief Executive Officer.

Thank you, Felicia. Good morning, everyone. Rates continue to be under pressure. Several areas of our business seem to be hitting bottom on exposure units and we are very pleased with our acquisitions in Q4, closing $19.1 million in revenue. Now I would like to turn it over to Cory for the financial report.

Thanks, Powell. Our net income for the fourth quarter of 2010 of $32.1 million was a strong improvement over last year's fourth quarter net income of $23.7 million. That's a 35.9% increase. Our earnings per share for the fourth quarter was $0.22 and that was up 29.4% over the $0.17 from last year. From a revenue standpoint, commissions and fees for the quarter increased 7.4%, or $15.8 million, to $229.1 million. Included in our press release is our table that summarizes our total growth rate and the internal growth rate from our core commissions and fees. In the fourth quarter, we received $6.4 million of profit sharing contingent commissions, that's $5.9 million more than the $0.5 million we received in the fourth quarter last year.

Now, if you look at the internal growth schedule, we had a negative internal growth rate of 3.3% but when you exclude Proctor from that internal growth schedule, we ended up having a negative internal growth rate of only 2.7%, which if you look as a comparison on a sequential basis, the same comparable quarter in the third quarter was 3.5%. I think it's important to step back and realize that Proctor was one of the best acquisitions we've ever made, but because this past year has been a down swoop, specifically in the fourth quarter this year, they ended up having about $1.4 million, $1.5 million less revenues. But when you take our internal growth schedule from the end of '09 and you exclude Proctor, we ended up for all of '09 at a negative internal growth rate of 6.9% without Proctor.

If you exclude Proctor in all the other four quarters, the first quarter we were only negative 5.6% and then the second quarter, we were negative 3%, and then third quarter we tweaked up to the negative 3.5%. And now this fourth quarter, we're back down to negative 2.7%. So three of the four quarters have been a sequential improvement during the year of 2010.

So if you look again at the total core commissions for the quarter, it increased totally of 4.8%, and that's $10.2 million in total new commissions and fees that we received. However, within that net number was $17.2 million of acquired revenue. That means we had $7 million less commissions and fees on the same-store sales basis and that gave rise to the 3.3% negative internal growth rate. As the internal growth rate indicates, the negative growth rate primarily was the result of National Retail and Western Retail, but Powell will talk about each of our business segments in a minute.

Moving on to our investment income, we had a small increase of $88,000 over last year's prior quarter, and that was mainly because of increased levels of invested cash. Our other income decreased by approximately $100,000, and that's just due to various books of business sales differences. Our pre-tax margin for the fourth quarter 2010 was 22.6% compared with the prior year fourth quarter margin of 19.2%. That's an improvement of 3.4 percentage points.

Employee compensation and benefits as a percentage of total revenue was 53.2%. That's a slight decrease of 5 basis points from the 53.7% percentage in the fourth quarter of '09. The total dollar increase on a net basis in employee compensation benefits was approximately $7.2 million, of which $5.3 million was attributable to just the new stand-alone acquisitions since last year.

Therefore, if you exclude those stand-alone acquisitions, employee compensation and benefit costs on a semi-same-store sales basis, and I say that because some of our existing offices do have fold-ins in that and still include that portion, but that group increased employee benefits and compensation by $1.9 million. $1.1 million of that related to an increase in salary producers' expense, and that's primarily our new or unvalidated producers. $2.3 million related to an increase in profit center bonuses, because of the earnings increase. $900,000 of it related to an increase in our group health insurance, but then those increases were partially offset by $3.2 million reduction in management and staff salaries.

Our non-cash stock-based compensation costs of $1.6 million in the fourth quarter of 2010 that was down slightly, mainly due to forfeitures in some incentive stock options, and PSP shares.

As we mentioned in our third quarter conference call, we have introduced a new stock incentive plan. We refer to it as SIP, stock incentive plan, and that is going to be effective January 1 of 2011. This plan is focused primarily on our producers and our profit center leaders. The expected annual cost of this plan is a little less than $5 million per year and so that's going to be in addition to the current annual cost, which is primarily the performance stock plan of $6.8 million.

I want to stop and give you all a brief overview of how this plan works. Essentially our producers will be receiving a SIP grant, and let's say it's, for easy math, $50,000. It will be based on their book size. And the profit center leaders will also receive a grant and it's primarily based on their levels of responsibility. But if we take $50,000, we're going -- for everybody, there's going to be two buckets. 50% of SIP grant goes in one bucket. The other 50% goes in another bucket. The first bucket is always going to be based on personal performance criteria. For producers, it's going to be based on generally the fact that do they increase their net book by $150,000 over a five-year measurement period. And so the end of the five years would be the 12 months ended 2015.

For profit center leaders, they are going to have two components of that personal goal, and that is, have they grown their core organic -- their revenues on an organic basis a certain percentage. And then also, second part is, have they grown their total operating profit by a certain percentage on a compound annual basis. Now, if that measurement period carries over the next five years, if they make that goal, then the shares that are in the first bucket will then vest one-third in year six, one-third in year seven, and one-third in year eight. So that's basically the first performance bucket. The second performance bucket is going to be based on the earnings per share growth of the Company and the Company will have to grow their earnings per share on a compound annual basis of 7.5% over the same five-year measurement period. So this will be for the 12 months ended December 31, 2015.

And we either do that and they get the shares vested, or we don't do it and they don't get it vested. If they do get them awarded at the end of the fifth year, that bucket will not vest until the end of the tenth year. So just to summarize the costs, there's two aspects of why there's an increase in costs. First of all, we have shortened the period from this typical 15-year period down to basically six, seven, and eight, and a year ten vesting. And the second part is it is focused on the producers and profit center leaders who at the end of the day are driving the internal growth, and that's what the focus is, is to grow the Company.

So with that said, I'll move along and talk about other operating expenses. Other operating expenses as a decrease, as a percentage of total revenues, by 2 percentage points to a total of 15 percentage points of total revenues. The total dollar decrease this represents is $1.8 million, of which $1.4 million of this total is attributable just to the new stand-alone acquisition. Therefore, on again, on a semi same-store sales basis, those offices had aggregate reduction of other operating expenses of approximately $3.2 million. The single largest decrease in the fourth quarter was $1.3 million reduction in legal costs and related claims and settlement reserves. The other reductions were for travel and entertainment expenses, bad debt write-off, and office expenses.

Our amortization and depreciation expense on a combined basis was just up slightly $700,000. And that was really due to the increased acquisition activity.

Interest expense is consistent with our $3.6 million on a quarterly basis. We do want to point out that we do have the $100 million seven-year debt that carries an interest rate of 5.57%, is coming due on September 15 of 2011. So we have signed an agreement with Prudential Capital Markets Group to replace this debt when it comes due, with a new seven-year note, and that note will carry an all-in coupon rate of 4.5% . So then moving on to our effective tax rate for the year, 39.2%, which is slightly lower than what it was last year. And then just looking at the year end, the same trends hold true and we ended the year with $1.12 earnings per share, which is a 3.7% increase over the 2009 annual EPS number of $1.08. And so with that financial overview, let me turn it back to

Thank you, Cory. Great report. Before we begin, I would like to congratulate our 4 new Regional Vice Presidents; Eric Anderson, Tony Grippa, Tommy Huval and Rich Knudson, an indication in our system of 180 decentralized operations and leaders that people rise on their merit, and these individuals will be taking on additional responsibility in the future. But I would say that I am personally very excited for each and every one of them and look forward to working more closely with them in the future.

That said, now I would like to go into the reports. Florida Retail specifically, down 2.9% versus down 2.6% in Q3. Property rates are down typically 5% to 10% with exposure units flat. Interestingly enough, we're starting to see property appraisals on commercial properties and habitational properties, up 5% to 8%. Liability rates are down 5% to 10% with exposures flat to down 10%. Auto rates are down 5% with exposures typically flat. Work comp payrolls in Florida, non-construction down 5% to 10%. Construction accounts are down more. In National Retail, we're down 3.5% versus down 5.2% in Q3. In the Northeast, property rates are flat to down 5%. Liability rates are flat to down 5%, typically with exposures flat. Auto rates are up slightly to down 5%. Exposure units are flat. Work comp rates are also flat to up slightly with exposure units typically flat.

You'll find interesting around New York City area and surrounding areas in to Northern New Jersey are under more pressure now seemingly from a rate standpoint than they have in maybe the last year. Construction liability rates are typically flattish. Exposure units are down 5% to 10% and auto rates are down 5% plus.

In the Southeastern United States, property rates are flat to down 5%. Liability rates are down 5% to 10%. Auto rates and work comp rates are flat to down 5%, and typically the exposure units are flattish. We're seeing more pressure on rates in Texas, but some exposure increases on accounts, which is new. Construction liability rates are down 5% to 15%, with exposure units up slightly to down 10% and auto rates are flat to down 10%.

In Midwest, property rates are flat to down 10%. Liability rates are flat to down 10% with exposures up slightly to down 5%. Auto rates and exposures are generally flat and work comp rates are flat to down slightly. Construction, auto and GL rates are down 5% to 10%, more on good accounts, meaning accounts with superior loss experience. Exposures in construction, though, in the Midwest are way down, 5% to 30% plus.

Western Retail, down 10.4% versus 7.9%. Property rates are flat to down 5%. Liability rates are plus 5%, and with exposures flat to down 5%, auto rates are flat to up 5% in the West. Exposures are flat to down 5% Construction-related accounts in the West, still auto and GL rates have pressured typically down, but they could be flat, down at least 10% Exposure units are still under heavy pressure, down in most places, sometimes big, big down.

Employee benefits country-wide as a general statement, small group accounts. That's under 50 insured lives, rates are typically up 5% to 15% -- excuse me, with insured lives typically flat to down 10%. And on large groups, the rates are up 5% to 20%. The number of insured lives are typically flat to down slightly.

Several things that we're seeing in that area, they are changing some accounts in certain areas of the country are changing from commissions to per head per month in certain places, and as you've probably read, there are certain national carriers who are switching their large group compensation plans from commissions to fees. That's going to be dictated on a state-by-state basis on what large group is defined as. That would be either 50 lives in certain states, and 100 lives in other states.

In the wholesale arena, I'd like to congratulate in a difficult operating environment, Tony Strianese and Mike Riordan. Their business overall in Q4 was flat versus down 2.5% in Q3, in a very challenging environment in terms of significant rate pressure.

Brokerage property rates are down 5% to 10%, but large accounts, particularly accounts over $1 million in premium, attract a lot of attention, thus rates could be down significantly more than 5% to 10%. In the GL area, rates are flattening out to down slightly. Exposure units continue to be down due to economics. The standard markets, as we've talked about in the past, continue to take accounts from the excess and surplus lines markets, but particularly in liability. In the Professional arena, rates are down 5% to 10%. Exposure units are typically flat, barring one group which we're going to talk about. Lawyers, we're seeing exposure units down at least 10%. Financial institutions, directors and officers' liability and E&O, is the only area we're seeing upward pressure in pricing and it's 5% plus on accounts, except those that have experienced losses and more for those.

In the Binding Authority arena, property accounts are typically flat to down slightly. In GL, rates are flat. Exposure seems to -- exposure units typically on many of those have seemed to bottom out and construction GL rates are stabilizing. We're still seeing lots (inaudible) of contractors going out of business.

In the Professional Programs arena, we are down 5.7% versus down 7.6%. The dental program, rates are flat to down 10%. Lawyers, rates are still under pressure, down 5% to 10%, but we have seen in certain areas competitors retrenching due to adverse loss experience. In CalSurance out West, we're continuing to see rate pressure on the book typically down 5% to 10%.

In the Special Programs arena, we're down 1% versus up 8.6%. Proctor, rates continue to be under pressure, down 5% to 10%. FIU, rates continue to be under pressure there, on the sand or beach front specifically, they have 3% wind deductibles, which is the best typically terms and conditions that you can buy. Off the sand, and thus with the 3% wind deductible, excess and surplus lines markets typically are not doing that. They are usually doing 5% wind deductible. But off the sand, meaning not beach front, the excess and surplus lines markets continue to be clipping right at their heels. Properties under $40 million of total insured value off the sand attracts a lot of attention.

Citizens will be coming out with revised A rates in April, we've been told, and we believe those would be implemented in June or July. Also, you may have read or heard about these new rating models, and there's lots of speculation out there on these new rating models about what it will do to the PML, probable maximum losses, of inland properties, not so much beach front properties, but inland properties.

In services, we were down 80 basis points versus 70 basis points down in Q3. On an acquisition front, I would like to say we're very pleased Scott Penny has taken over as our new Chief Acquisition Officer. In Q4, we did $19.1 million in the fourth quarter and year to date in the final and total year of '10, we did $70.4 million of acquisitions. In this year to date, in January of '11 and into February, we've announced $12.6 million in closed transactions.

I would like to point out that we feel like we have the best infrastructure in order to touch as many people and communicate with as many potential agency targets across the country, by telling the Brown & Brown story through our one senior leadership team, which is growing, as you know, and two, through all of our leaders of offices. But as I said, we're very pleased that Scott is our new Chief Acquisition Officer. The pipeline continues to be good.

As many of you may have asked me in the past or us, Cory and myself, there was some discussion about would the change in the Bush tax cuts significantly implement -- I mean, influence sales of agencies. And quite honestly, we would say at the end of the day, we did not see that. We saw a normal flow of agencies throughout the year, and if agencies were very much considering or significantly -- or seriously considering selling, then the pending Bush tax cuts was a potential motivator. If they weren't serious about selling, it did not have an impact one way or the other. So we continue to talk to people all over the country and think that there will be lots of opportunities to talk to additional people in the future. But until they are done, they are not done. But we are excited to continue with our goal of talking with as many people as we possibly can and getting lots of people with good cultural fit to join Brown & Brown in the future.

Finally, in conclusion, we're looking forward to 2011 being a good year and we know the world's not going to change dramatically in the next 12 months, but we at Brown & Brown are going to do well. With that said, Felicia, I would like to turn it back over to you so we can open up to questions.

Thank you.

(Operator Instructions)

We'll go first to Keith Walsh of Citi.

Good morning, everybody. How are you? Just quick question on the PSP plan. Just want to know how you calculated or how you came up with the 7.5% EPS growth in the second bucket.

Quite honestly, Keith, we just brought that number up because it was a threshold that we thought. That is not a stated goal to grow, meaning I don't want you to say that's what we're thinking we're going to grow. We're going to try to grow our business as much as we can, but we came up with that number that we thought would be a measurement, which would be a good hurdle over a five-year period. So that's how we came up with it.

And just regards to the PSP plan overall, the changes that came into it, were you seeing retention issues because of the excessive Cliff Vest that you had on the prior plan? Was this changed to kind of make people want to hang around, not have to wait so long to get paid, basically?

No. First of all, to answer your first part of the question, we didn't see a retention issue with the Cliff Vest. It worked really well for the number of years that the PSP plan was in place and it created -- and it's currently working really well still because we have a lot of it still in place for a number of teammates across the country.

So we didn't have an issue relative to that, but what we did do is we listened to -- we heard what people would say about it, and more specifically, there was individuals say I personally did not have as much influence over the stock price. And yet they had a significant -- whoever that person was, they had a significant influence on growing their individual book or their individual office.

And so what we try to do is truncate slightly the plan, knowing that culturally speaking, we do have rewards plans that are much longer than traditional companies, which keep us all in the boat together, which is part of our Company and the goal. We decided to switch it from a stock-based, stock price-based model to one, an EPS model, and a personal responsibility model, as Cory alluded to via growth in their book or growth in the responsibility, i.e., growing organically and/or operating profits.

Makes total sense. Last question for Cory. Just thinking about your expense base, maybe if you can give us a breakdown of what are your fixed versus variable costs? And I would imagine you're a little more weighted towards the variable, and if so, relative to your larger broker peers, that's protected you, let's say in the downturn, but going into the upturn, that would imply less leverage to raising -- to rising premiums and revenues, if you could just talk to that a little bit?

Yes. Well, and we talked a little about it in prior quarters. And I think that the breakdown on the specifics is obviously we have -- the main variable employee benefit costs we have is commission producers, and as a general rule, our commission producers get 40% of the new commissions on new business and 20% on renewal. Then the other large component of the variable is really the profit center bonus, which all-in varies between in total, is probably 8% of their operating profit of an office.

Probably the question you're trying to get to is that some people have asked is, from an incremental basis, if we get a new dollar of revenue simply because our clients' exposure unit increases, essentially we will end up paying 20% of that increase to our retail producers. Wholesale producers may be a little bit different. Our brokerage and services area is much higher fixed cost side of it, but I'm focused mainly on the retail side.

So that dollar of incremental new revenue, 20% will go to the producer. Let's say that all-in, between the whole Company bonus and the office bonus, it's somewhere between 8% to 12%, so let's say 12%, will go to the bonus pool. There may be additional various frictional costs of 4% or 5% because we don't have to buy a new sheet of paper or a new pencil when that incremental dollar comes in.

So, there is a fairly high leverage to that, and I think it's important to look at even though we've had such tremendous headwinds, and it has impacted our internal growth numbers. And I explained earlier how we did have an internal growth -- I mean, the negative internal growth last three out of four quarters have decreased, but I think it's important to look beyond that because -- to the margin side of it. Because internal growth is only valuable to shareholders and the Company as if you translate that into real operating profit dollars. And you look at -- even though we've had internal growth really for three years now, if you look at just the margins of 2009 on a quarterly basis compared to last year's quarterly margin -- for instance, this year we ended up with, if you take earnings before interest and taxes, amortization, and then that line change in acquisition earnout, exclude that, so it's really more of a true operating profit -- we finished the year at 34.6%. Now, that is up from last year's same percentage of 33.7%, okay?

So that's up almost a full point, even with internal growth being less negative each of the quarters. But if you look at each quarter, the first quarter we actually slid back about 60 basis points from the first quarter of '09. But the second quarter, our margins were up 70 basis points, and then our margin in the third quarter was up 180 basis points. And then in the fourth quarter, our margins were up 270 basis points.

So, I think you ought to -- that is an indication that even in a negative internal growth rate, the quality of our profits and our leaders and our producers and their [all] teams in each of the offices Powell alluded to, they are just high quality people that know how to run a business. So that's the leverage I think you were trying to hit at. And I probably expanded a little more than you wanted, but I think it's probably good, useful information to keep in mind.

Thank you very much. That's very helpful.

We'll go next to Mark Hughes of SunTrust.

Thank you very much. Those changes you described in the benefits area, how are those shaping up as you see them now to affect Brown & Brown?

Mark, it's yet to be determined, because we're hearing about them in certain areas and they are not occurring in certain areas yet. For example, though, in some of the areas they talk about going commissions to a per head, per month. The idea, at least in the areas that we've heard so far, is to keep the commission or the amount of compensation the same in many of those areas as it would have been on commission.

However, next year if the premiums go up with medical trend, then the amount would be fixed as opposed to float up as it may have in the past. As it relates to the going from a commissioned amount to a fee amount on the larger accounts, as you know, most of our business, as Cory has alluded to, is commissioned business in our retail segment.

However, we do have a number of fee accounts and in that space, the traditional person, meaning the employee benefits broker who is just procuring business on behalf of their client and possibly working out of their house or doing something like that, are changing dramatically.

And so it's for firms like ours, larger firms, that are able to bring certain services to their clients that they need and want, and in doing that, the carriers for the first time in the employee benefits area are starting to differentiate, based on volume, typically, written with carriers.

And what I mean by that is in the past, you could have a person, one man or woman person selling health insurance out of their garage apartment in Atlanta, and if they had the relationship with a carrier and a client, they would be able to get the same quote. That doesn't mean they could deliver the same value proposition or the services as a larger firm, but they could potentially get the same quote from a national health carrier.

That is allegedly changing. And what I mean by that is the health carriers are seeming to not appoint as many agents or starting to stratify their books in terms of their distributors, which isp an interesting thing, which has occurred for a long time with the property and casualty world.

So it is a changing environment, Mark. We view it as a positive thing ultimately for us. When there is change, there is opportunity, but it's still a little uncertain about how it's going to impact our employee benefits departments.

Thank you for that. And then, Cory, any thoughts on 1Q contingents?

No. I mean, it's -- we won't really know until we get into the first quarter. I think as a general rule, you all probably have more industry standards in terms of what the loss ratios are of carriers in general, and whatever that relationship has to the '09 year is pretty much how our contingents will move in the direction from the aggregate '10 year. And so for all of '10, we ended up with about $54.7 million of contingencies. And that was in '09, we ended up at $47.6 million. You just have to look to the industry general loss ratios to get a better indication. So, your guess at this time is going to be as good as ours.

Thank you.

We'll go next to Mike Grasher of Piper Jaffray.

Good morning, everyone. I wanted to follow up on Mark's question, just in terms of the change here, particularly with regard to workers' comp plans and change in accounts from commissioned to fee-based or per head per month. Are you seeing this across all risk categories within comp, or is it stuck in a particular class?

No, Mike, it's just in employee benefits.

And, remember, we're not changing our model, meaning we are a middle market-driven, middle market-focused firm. So the vast majority -- I mean, the vast, vast majority of our clients are on commissions. And so to Mark's question and your follow-up, I would continue to direct you to employee benefits, and in the past, in '09, we wrote $158 million of employee benefits revenue. Cory, last year, was it $160 million?

$171 million.

I'm sorry. $171 million last year. Of that, two-thirds of that business is healthcare related, and the vast majority of that is large group. Or the majority of that, I should say, is large group, over 50 lives. And so the question I think, that Mark was driving at and you're driving at, is how does it impact our business now?

As I said, there's only certain national carriers that are saying right now large group business will be on a fee, not exclusively, just certain ones. And certain carriers, certain areas of the country, I should say, the national carriers are big players. And in certain areas of the country, they are not big players. So if you're in the Boston area or the Phoenix area or the Miami area, they all may be different. So you might be doing business with a national carrier in one, and you might be doing business with a local health provider in the others. So, employee benefits, think large group, defined on the state -- not Brown & Brown -- the state. Typically, it's either 50 or 100 insured lives.

Okay, understood. Thanks very much for that. And then, Cory, couple questions. I missed the number that you had thrown out in terms of Brown & Brown's expense related to the healthcare program.

I think what -- let me see, I have to look back. On a healthcare, I think it was basically when I was talking about we had a net increase in basically offices that were there in both periods. We had a net increase in employee compensation benefits, about $1.9 million, so breaking it down as to what were the major components of that. And there was roughly a $900,000 increase in our group held insurance for the quarter.

Okay.

I think that's what you're referring to. And you got to keep in mind, we have a self-funded insurance plan. So it does fluctuate based on what claims get paid that particular quarter and what the actuaries' estimates of the IBNR. So it's fairly a large number every quarter. That's why it does pop up.

Okay, and then, yes, another good year here in terms of squeezing more juice here from the standpoint of improving the margins. The $1.3 million legal costs that you highlighted in terms of the operating expense reduction, does that imply one-time in nature, so, I guess, bringing into question the sustainability going forward?

Well, the legal cost is always, is just dependent upon what cases we have going on, and in '09, as one of our previous conference calls, I pointed out that legal cost is not always just defending yourself against somebody else. And in '09, we actually were spending some money to protect our rights to people infringing on our non-piracy agreements. So, some of that was expended last year, and so there's two parts of why it dropped.

So is there -- our objective is always to lower our legal costs every year, and that's why we do have a very large and strong what we call our quality control -- it's a quality control team. And so we pay a lot of attention to that, because there is always a direct cost. And so I certainly hope it is an indication of what will be in the future. But with legal costs, you never know.

Okay. And then final question for Powell. Just in terms of the -- if you take a step back and look at your geography, what region of the country gives you the greatest level of optimism?

Well, that's an interesting question, Mike. I would tell you that there continue to be pockets around the country that perform really well, and I would say -- I don't think it's a region by region. I think it can be class of business. I think it can be areas. You've heard me before say things like the economy impacted San Antonio, Texas, as an example, differently than it did in Phoenix.

Right.

And some of that's pretty obvious. Some of it isn't.

Others, I've said that the slowdown in the economy was late to come in the Pacific Northwest, yet it's had a pretty dramatic impact on places like Portland, as an example, from an unemployment rate and standpoint.

And so I say that -- I'm not trying to not answer your question, but I would tell you that it is interesting as we look at our year-end numbers and you talk to our teammates, there are areas around the country where you can see that, or it seems like clients are getting towards the bottom, but in the middle market accounts, we haven't seen that big uptick yet.

And so all of us read the "Wall Street Journal" and you see some of these larger companies that are reporting significant earnings growth and expansion, many of those are international companies. However, I would tell you that we're just not seeing that translate directly yet to our customer base. That does not mean that they are not doing better or not doing as badly, but I would tell you that if you had a contractor for example, just as an example, in Orlando, Florida, and that contractor is down 60% off their high two years ago, if they are up 5%, that's good for them, but there's still a long way to getting back to where they need to be.

Right.

So, I don't want you to take the impression, taking my comments that it's negative. Quite the contrary. I think that there's lots of good opportunities this year for us. However, I am guardedly optimistic, because I would just tell you in the middle market, I'm not in offices hearing all these people saying, we just had all these renewals up 25%. That's exposure units up 25%. You heard that in my remarks. That's not what we're hearing. We're just hearing it not down as much in areas like in wholesale and things like I said in liability and areas like that where they are saying it kind of feels like it's getting to the bottom of some of those exposure units.

Well, the flip side of that is some of those accounts, (inaudible) contractors, are either not going to make it or they are going to go up from where they are. And conversely, there are other accounts that are manufacturing and nursing home administrators and things like that, that they will continue to do well and some of them will buy new businesses and do things like that and hire new people. It's just we haven't seen it translate as quickly into the middle market exposure units as what I like to say we read in the "Wall Street Journal" and the "New York Times" and "USA Today."

And I'll add my little two cents, that I think that if this global warming continues and it snows as much as it does up in the North and around the country like it has, I got a feeling that more people when they dig out will say, I'm moving down to Florida where Cory and these guys are playing golf on Saturdays in shorts in the middle of February.

Understood.

(Operator Instructions)

We'll go next to Matthew Heimermanan of JPMorgan.

Good morning, everybody. Couple questions. First, I was hoping just on the healthcare issue, if you could just maybe remind us how much employee benefits is of the total, and then of the employee benefits maybe what's actually the health plans versus maybe other discretionary employee purchases? And then of the healthcare piece, maybe what's fee versus commission, just to give a sense of really what might be impacted?

Good morning, Matt. I would say number one, remember, about $172 million of our total is what we would call employee benefits. In the employee benefits bucket, two-thirds of that is healthcare. One-third would be ancillary. Ancillary would be dental, life and group life insurance, vision, all those type of things. Many of those are provided by the employer. Some of those are voluntary benefits, meaning where the employee decides to buy it themselves.

So, back on the two-thirds. On the two-thirds of the $171 million, $172 million, the majority of it is large group, over 50 lives. The other piece would be under 50 lives. And so in there right now, I can't tell you exactly how much of our business is fee, but some of our larger health accounts are fees. But the majority of the business is on a commission currently.

Now, you might say, well, how do you think that impacts you? Well, remember, we have been very transparent with our customers and our prospects about how we get paid, and in the event that they want even more information, if they want to get into it, we are very forthcoming about what we make. And so the reason I say that, which is important, is if somebody's afraid to tell somebody how much they are making, maybe they are making too much.

And so what I would tell you is we view this as not a negative. We view this as an opportunity. So with change will create more opportunity. We are writing more employee benefits business in our system new today than we ever have.

Now, this is slightly off the subject, but you would find it interesting. I have said in the last four years -- we have said, that our average new business account written is about $12,500 in commission.

I would also tell you interestingly enough in the last year, which you've been looking at it more closely, because of exposure decreases, the value or the average on the property and casualty accounts in the last year is about $10,000 in commission, and the average commission on the employee benefits account would be about $15,000 in commission.

So, just trying to give you a sense of what's going on, but to close the loop relative to the healthcare comment, we view it not as a negative. And, quite honestly, the thing that hasn't been asked, which is interesting, is we don't know what the ultimate outcome of healthcare reform will be, but we do believe internally that there will be more changes to healthcare, be it in the current law that has been passed. That does not mean repeal. That means modification and we don't know what that means.

So, therefore, what we try to do is we try to be agile and able to react and do what is in the best interest of our clients; and, therefore, if we're going to be compensated a little differently, which we thought we might, we just didn't know how that would turn out, we'll roll with that, too.

That's helpful. I guess just to make sure I'm on the same page, it doesn't sound like you -- you would be entirely willing and it sounds like -- well, you're obviously willing to disclose, but in your mind, it's not inconceivable that you could have a conversation with a client and say we used to get this paid in commission, the insurance -- that's what we think the value we deliver is, the insurance Company is changing around. Would you be fine paying a fee, and net-net it's -- you're no worse off than before.

And then, meanwhile, the opportunity to your point is you potentially have a big section of the distribution channel that doesn't have scale, doesn't necessarily have all the relationships that probably will feel this and doesn't deliver the same service and will feel this more?

I think that's a very, very clear and consistent statement of what we've been saying, yes, I would agree with that.

All right. And then the other question -- two other questions, if I may. I'll just throw them out quickly.

Yes, sure.

In the last question you talked about exposure, but I'm still trying -- what I'm trying to foot is some of the comments we're hearing from some of the middle market commercial companies on exposure and aggregate being flat or slightly positive. With your summary, which still I would say is negative, not even flat if I was to average it across the board. So just some insights there would be great. Then also would be curious with respect to -- I can't remember how much public entity business you do, but I would be curious in terms of what the trends are looking like there given everything we read on budgets, et cetera.

Let's talk about the carriers. Remember, I don't know -- Cory and I don't know how carriers calculate rate increases and more specifically, how they track exposure increases. I think one of the things that you look for when you're listening to carrier calls is you're looking for premium growth or shrinkage. And so in our world, we only talk from this standpoint, we think about compensation, meaning commissions or fees, growing or shrinking as evidenced by the internal growth schedule.

So, I would tell you that we work with, I would say, all of the carriers that you may be referencing in one way, shape or form, and what we see in very competitive markets is continued downward pressure. They may see things slightly differently, and they are looking at their small business books and maybe talk about their under $25,000 in premium versus their key accounts or middle market accounts as defined as $25,000 to several hundred thousand in premium, and then their national accounts and things like that.

But if I understood your question correctly, I would just say that we have always focused on middle market accounts. So those would be small middle market to medium middle market to upper middle market accounts, but primarily small to medium and some upper middle market. And we have a couple of Fortune 1000 type accounts.

That said, I don't know where there's the disconnect with the carriers, because I have -- and Cory and I have often remarked that when we hear, and in the last year, we've been hearing with rate increases in carriers -- and we don't see that, Matthew, in our business, meaning we have seen them try to do it. Don't get me wrong, but ultimately what bears itself out is flattish to downward pressure. From an exposure standpoint, once again, our mix of business might be slightly different overall than the carrier's mix of business, which would, therefore, impact our business differently.

To your second question about public entity business, you're right. Interestingly enough, public entities have not up to this point been that quick to modify, cut budgets, reduce increases in salaries of employees and the like. It's a little early. We hear a lot about it.But we have not seen it yet start to flow through our numbers. But we are keenly aware of the proposed impacts in public entities, all sizes, shapes, all across the country, and would expect there to be some potential hit, but we just don't know to what extent.

Got it. Very helpful. Thanks much.

We'll go next to Meyer Shields of Stifel Nicolaus.

Thanks. Sorry to keep on hounding on employee benefits issues, but I guess, Powell, my question is that I assume you'll be successful in -- if revenue neutral will shift from commissions to fees. Should we -- is there any concern that in year two, the normal inflation-driven increase to your revenues is not going to show up if you were on a fee-based model?

Well, that would assume, Meyer, that everything would go to a fee on large account business. And I don't think that's a fair assumption. So I don't know the answer today on what portion of that large account business is in with the affected or changing companies. I just don't know that. If we did, we would tell you. But what I would say, and this is not intended to be vague, but it's intended to be as clear as we have it today.

Number one, we like the employee benefits business.

Number two, we have grown substantially in the employee benefits business and have a lot of very high quality people on our teams in employee benefits and want to continue to invest in the employee benefits business.

So, with that in mind, we believe that the switch -- I'm not going to say it's a non-issue, because that would be unfair. I think it is an opportunity and issue all wrapped up into one, and how does that impact our business going forward exactly with the trends, meaning medical trends, up. I don't know yet because I can't tell you.

I would be better equipped to tell you a year from now that this percent of our business has gone on to fees with this change. I know that's frustrating for you and everybody else on the call, but I would tell you that healthcare reform in general has not been the clearest thing to everybody on the brokerage side and how will it impact, particularly with medical loss ratios and carriers sorting out how they are going to pay us.

So, I don't know if that answered your question or created another one, but it's our view so far, because we don't know exactly, but it's something that we think will continue to create a great opportunity for us to work with our clients and do what's in their best interest, and I think that we'll be rewarded appropriately.

That's very helpful. Obviously, I appreciate the uncertainty that everyone's [slogging] through with this. In the world of regional carriers that you do a lot of business with, is there any trend towards increased consolidation there that's beneath the radar screen of the companies?

Could you repeat the question, one -- just so I want to make sure about the regional consolidation, what you're asking?

Yes. I know that you do a lot of business with regional underwriters. And I'm wondering whether we're starting to see any of those companies start to consolidate amongst themselves?

Yes, meaning not being consolidated into national carriers?

Right, just the regionals joining up?

Yes. I think -- Meyer, I think that that would exist, yes, potentially. And I think there are some regional carriers that are stronger financially than others, obviously, as you can see, those that you can get their financial information. I would tell you one thing, though, that I would preface my statements or buffer my statements with. I would tell you, we do a lot of business with regional carriers, and they are fine insurance companies. And they have -- many of them have very fine leadership groups, and there is a common thread in those leadership groups, and that common thread is a very strong independent streak.

And so we've always thought that those carriers would combine, if they combine, for a number of reasons. But I can tell you that when you have leadership teams that have very strong independent streaks, that does not bode well to a combination, meaning it doesn't lend itself for them to sell the company. So I think that regional companies, just like any company, they are looking today at their distribution partners.

Those are larger agents, like a Brown & Brown, and they look at some of their smaller agents who might write $200,000 or $300,000 or $400,000 worth of premium with them, and they are looking at those distribution outlets as how are we going to grow our business in the future? And some of those people don't have internal perpetuation plans with their business. Some of them would be potentials for Brown & Brown to acquire, but some of them are not.

And so they look at how do we get our premium today, and how are we going to get our premium the next five and ten years? And I think all of that plays into as an undertone of what those leadership teams think and what do they want to do going forward and how independent is that streak?

Okay. That's very thorough and very helpful. Cory, one question for you. When we talk about that roughly $5 million increase from the stock incentive plan, in -- let's say, we look for one year. Is that another $5 million, or does it go to $10 million because we've got two years that are amortizing?

No. This is the estimated annual cost of that. Now, in the length of time, we'll be -- it averages nine years, but basically half the cost will amortize over ten years, half the cost will amortize over an eight-year period, okay?So this one set of grants that we have will basically have a roughly $45 million total cost, close to $5 million times nine years. Okay.So that will be just that one grant. Okay.

Now, we don't intend to have another big grant until the end of the measurement period. There will be other grants coming up in year two and three where we have producers who have less than $0.5 million book, and they, and they get over $0.5 million and they will be granted a performance grant which will have a five-year measurement period. So, it will be some coming in, but this will be the main slug over this next five-year period.

Okay, great. That's what I was looking for. Thank you very much.

We'll go next to Sarah DeWitt of Barclays Capital.

Hi, good morning.

Good morning.

Good morning, Sarah.

As we look into 2011, if exposure units are flattish to slightly higher, and you still have a headwind from falling PNC prices, how should we think about your ability to grow organically in that environment?

Yes, what we've said, Sarah, in the past is if exposure units are flat -- now, and there's a big if there -- but if you could fix exposure units and you could look at rates on average -- and this is as of several industry surveys -- rates going down somewhere between 4% to 9%, but let's say more like 4% to 7%, we think that, that period that, that would make this period more similar to the late '90s, where we as an organization faced another time where exposure units were not expanding rapidly. There was slight exposure increase, but the market was down in a similar fashion and we grew 1.6% and 2.1% organically. That was in '98 and '99. So we have said at Investor Conferences before that we think that, that may be similar, assuming that exposure units are flattish to up slightly, and the rates do not spike downward.

So that leads to the next question probably, which is what do you think is going to happen to rates? And the answer is there's a lot, as we all know, a lot of excess capital out there, and many of you have heard me say that I believe the industry is probably $100 billion at least, $100 billion to $130 billion overcapitalized. And so you could take -- I haven't seen the year-end numbers, but the surplus in the industry domestically at the end of June of '10 was $530 billion. So I believe that the industry is adequately capitalized at $400 billion.

So what does that mean? I don't know. If you look at the information that's been published and information we're seeing as it relates to the reinsurance renewals, effective January 1 of '11, there's continued pressure on the reinsurance rates down somewhere between 5% and 10% depending on the line.

So, remember, I'm guardedly optimistic to the extent that we understand that we need to grow our business organically. We understand that we've been facing a headwind and nobody likes to talk about the headwind because we're over that. But having said that, we would like to think that as the exposure unit picture improves, if the rate picture stayed the same, that we would have a much better chance of growing organically.

Great, thanks.

Sarah, one other thing I want to add to that, too, though, is when we talk about future internal growth rates when we calculate, there is one thing that I would think out of a previous question when we talk about contingencies. There -- couple years ago, some of the carriers went to GSCs, guaranteed supplemental commissions, which they just said you're going to get 1% of all the business you write, and we'll pay you after the end of the year, but we had to accrue for that. It just occurred to me that there are certain carriers now that are rethinking that and are giving some of our offices the options of going back to a true profit sharing contingencies and doing away with the GSCs.

Now, from internal growth standpoint the way those numbers fall in is because the GSCs are known percentages based on business you wrote, we had to accrue -- we accrued for those GSCs during the whole year and then after the year end, then they will pay basically in January, February, March for those GSCs, but the numbers are in the '10 numbers.

We ended up accruing this year about $13.5 million of GSCs, so there are a certain amount of those that will now flip over to being contingencies, and so those -- that $13 million may shrink to, I'm not sure, $8 million, $9 million for '11, but hopefully that in the '12 first quarter, they will come in as profit sharing contingencies. So, I just want to point that out, because I think there may be a little bit of a difference on our internal growth rate just because of that, so just wanted to let you know that.

Okay. That's helpful. And then Proctor Financial has been lumpy through 2010. How should we be thinking about that in 2011? Should there be any more noise there?

Well, we don't know, Sarah. As there continues to be changes in that space with some of the large carriers, as I like to think the large three being Assurance, Balboa, and ZC Sterling, and all of that. I don't know the answer to that. My gut instinct would be that we're working really hard to maintain the client base that we have. Some of our clients have been impacted, as you know, by the FDIC or merger, i.e., meaning going out of business or forced mergers. And then we lost one or two or three clients to competition. And so we're going to always have competition on our book of business.

But I think this year will be an interesting year because of changes in that big three dynamic and what's going on out there as that market starts to settle out. So we look at it as a good year. We think they can have a good year, but that's --

Let me just say again, I kind of alluded to it up front, the people that operate Proctor are just tremendous people. They do a great job for their clients. AndI when we bought them, they were about $18 million of revenue, and this year they will finish with core revenues of in excess of $42 million, and they have gotten up to almost $60 million of core revenues.

Next year, there is some kind of a down swoop. They will probably settle in somewhere, I would say, around the $37 million, $38 million mark. So there's still going to be a little bit of down swoop, but it's a great business and great folks that run that operation.

Great, thanks very much.

(Operator Instructions)

Mark Hughes with SunTrust.

Yes, thank you. Correct me if I'm wrong, but it did sound like the Western business wasn't too bad in terms of rates or exposures when you went down through that discussion. Any particular challenges there that are keeping the organic low?

I said just to make sure property rates are flat to down 5%. Liability rates are down to plus 5% and exposure is flat to down 5%, auto rates are flat to up 5%, exposure is down. GL and auto and construction are flat to down 10%. Exposure units are under heavy pressure, down most places, down in most places, some places big, and so the West continues to have pressure on the book.

We have a lot of good people out there. And as you know, last year in March, I asked Roy Bridges, one of our senior leaders to take on the West, which is not an overnight deal, and some of the things that he is implementing in the West, which we're very pleased with what he's doing. But we still face strong headwinds there from either one, clients that are shrinking to lost business in a very competitive environment.

But we're very pleased to be there and we're very pleased with the people we have on the team and to that end, I would tell you that we continue to actively look for acquisition partners in the West.

Thank you.

At this time, there are no further questions in the queue. Gentlemen, I'll turn the conference back to you for any additional remarks.

Okay. Thank you very much, Felicia, for the call. And we look forward to talking to everybody next quarter. Thank you, and have a nice day. See you all later.

That concludes today's conference. Thank you for your participation.