Arthur J. Gallagher & Company (AJG) — Q4 2024 Earnings Call Transcript

Thank you very much. Good afternoon and thank you for joining us for our fourth quarter 2024 earnings call. On the call with me today is Doug Howell, our CFO, other members of the management team, and the heads of our operating divisions. Before I get to my comments about our financial results, I'd like to acknowledge the tragic wildfires in California. Our heartfelt thoughts are with all those impacted, including our own Gallagher colleagues. Our Company and industry have such an important role and responsibility, helping families, businesses, and communities rebuild and restore their lives. And like many times before, Gallagher and the industry will rise to the occasion. Okay, on to my comments regarding our financial performance. We had an excellent fourth quarter. For our combined brokerage and risk management segments, we posted 12% growth in revenue, our 16th consecutive quarter of double-digit revenue growth, 7% organic growth, reported net earnings margin of 13.5%, adjusted EBITDA growth of 17%, and adjusted EBITDAC margin of 31.4%, up 145 basis points year-over-year. GAAP earnings per share of $1.56, and adjusted earnings per share of $2.51, up 15% year-over-year. The December capital raise for the acquisition of AssuredPartners creates some noise in these headline numbers, so I will peel back the impact in my comments. Regardless, another fantastic quarter to close out another terrific year by our team. Moving to results on a segment basis, starting with the brokerage segment. Reported revenue growth was 12%. Organic growth was 7.1%. Base commission and fees were 7.8% in line with our expectations, which got offset a bit by slightly lower contingents. Adjusted EBITDAC margin expanded 168 basis points to 33.1%, which includes interest income related to funds raised for the acquisition of AssuredPartners. Excluding that interest income, margin expansion was 109 basis points. Let me give some insights behind our brokerage segment organic. With our P/C retail operations, we delivered 6% organic overall. The U.K., Australia, and New Zealand were all in the high single digits. U.S. retail organic was around 5%, and Canada was down a couple percent, impacted by lower contingents. Our global employee benefit brokerage and consulting business posted organic of about 10%, a really strong finish that includes the catch-up of the large life case sales that shifted from earlier in 2024. Shifting to our reinsurance wholesale and specialty businesses, in total organic growth of 9%, which overcame some expected market headwinds in our global aerospace business. So very strong growth, whether retail, wholesale, or reinsurance. Next, let me provide some thoughts on the P/C insurance pricing environment, starting with the primary insurance market. Overall, the global P/C insurance market continues to grow. With fourth quarter renewal premium increases, that's both rate and exposure combined, consistent with the past two quarters. Thus far in January, renewal premium increases are ticking slightly higher than fourth quarter and are above 5%, driven by increases in casualty lines like umbrella and commercial auto. Breaking down fourth quarter global renewal premium changes by product line, we saw the following: Property and professional lines were about flat. Workers' compensation rose 1%, general liability up 4%, commercial auto up 9%, umbrella up 10%, and personal lines up 9%. So we continue to see increases across most lines and geographies. Carriers are behaving rationally and pushing for increases where it's needed to generate an acceptable underwriting profit. It's a great market for us to operate in because we can further differentiate ourselves with our leading tools, data, and expertise. Remember, our job as brokers is to help clients find the best coverage that fits their budget while mitigating price increases. We're becoming more successful securing lower pricing for our property customers, especially for cat-exposed property, which enables them to buy more limit or reduce their deductibles, resulting in more coverage for the same spend. Shifting to the reinsurance market. Overall, January renewals were orderly and reflected an environment that generally favored reinsurance buyers. Growing demand for property cat cover was met with sufficient reinsurance capacity, despite 2024 being an elevated year with more than $150 billion of estimated insured natural catastrophe losses. This resulted in property price declines that were greater at the top end of reinsurance towers, and similar to January 2024 renewals, reinsurers continued to exercise discipline on terms and did not revert to attachment points that exposed them to greater frequency. Reinsurance buyers of specialty coverages saw modest price declines across many lines of coverage, but again, no softening in terms and conditions. Looking forward, wildfire losses and casualty reserve increases seem to be the stories here in January, and time will tell how each of these ultimately impacts the market. Regardless, Gallagher Re had a fantastic January with some nice new business wins and should continue to excel in this environment. Moving to some comments on our customers' business activity. During the fourth quarter, our daily revenue indications from audits, endorsements, and cancellations remained in net positive territory. The same is true for full year 2024. While the activity is not quite as high as 2023, the upward revenue adjustments this past year are very close to full year 2022. So we continue to see solid client business activity and no signs of a meaningful global economic slowdown. Within the U.S., the labor market remains strong. Since April 2024, the number of open jobs has remained relatively steady and at a level that is still well above the number of unemployed people looking for work. Employers are looking for ways to grow their workforce and control their benefit costs. And at the same time, faced with wage increases and continued medical cost inflation, both are headwinds that our professionals are helping to navigate. Regardless of market conditions, I believe we are well positioned to take share across our brokerage business. Remember, 90% of the time we are competing against the smaller local broker that cannot match our niche expertise, outstanding service, or extensive data and analytics offerings. So with some nice momentum in net new business production across our brokerage business, a P/C market still seeing mid-single-digit premium growth, and a strong U.S. labor market, we continue to see full year 2025 brokerage segment organic growth in the 6% to 8% range. Moving on to our risk management segment, Gallagher Bassett. Revenue growth was 9%, including organic growth of 6%. Heading into 2025, we should continue to benefit from excellent client retention, increases in our customers' business activity, and rising claim counts. Adjusted EBITDAC margin was 20.6%, in line with our October expectations. Looking ahead, we still see full year 2025 organic growth in that 6% to 8% range and margins around 20.5%. Shifting to mergers and acquisitions, during the fourth quarter, we completed 20 new tuck-in mergers at fair prices, representing around $200 million of estimated annualized revenue, bringing the full year to $387 million. For those new partners joining us, I'd like to extend a very warm welcome to the Gallagher family of professionals. And of course, the big news in December was signing an agreement to acquire AssuredPartners with $2.9 billion of annual pro forma revenue. It's a compelling opportunity to build upon our commercial middle market focus, deepen our niche practice groups, and further leverage our data and analytics, allowing us to provide even more value to clients. It should also expand our tuck-in M&A reach and create more retail and specialty revenue opportunities across Gallagher. What is especially exciting is that the combination involves two highly innovative, entrepreneurial, and sales-based cultures. Although we will continue to operate as two independent companies until close, we have started discussions and are very impressed with the talent, professionalism, and excitement of the Assured colleagues. We anticipate we will receive necessary approvals and complete the acquisition sometime here in the first quarter. In addition to the pending AssuredPartners acquisition, we have about 45 term sheets signed or being prepared, representing around $650 million of annualized revenue. Good firms always have a choice, and it would be terrific if they chose to partner with Gallagher. With a strong close of the year, let me reflect on our full-year financial performance for brokerage and risk management combined. 15% growth in revenue, 7.6% organic growth, 18% growth in adjusted EBITDAC, 48 mergers completed with nearly $400 million in estimated annualized revenue, and we signed a definitive agreement to acquire AssuredPartners. These are terrific metrics. And as proud as I am of the excellent financial performance this year, I'm more proud of the way our culture has stayed true as we continue to expand. Our culture is about our colleagues, guided by the Gallagher way and a rock-solid foundation they form based on every interaction we have, whether it's clients, carriers, future merger partners, or with our Gallagher colleagues around the globe. Frankly, our culture is unstoppable, and that is the Gallagher way. Okay, I'll stop now and turn it over to Doug.

Thanks, Pat, and hello, everyone. Today I'll quickly recap some highlights from our quarter and replay our early thoughts on 2025, most of which Pat just touched on, then use the rest of my time to unpack the impact of the AssuredPartners financing activities on our results during the quarter. Then I'll wrap up my prepared remarks with my usual comments on cash, M&A, and capital management. Okay, highlights from our fourth quarter that you'll see in our earnings release. Terrific base commission and fee organic growth of 7.8%, solid supplemental growth of 4.7%, and while contingents went backwards a bit this quarter, we don't see that as a trend by any means. As I look to 2025 brokerage organic, Pat relayed that we're in a favorable environment with rates still needing to increase to cover higher loss costs, trillions of global premiums growing and inflating, and our sales and service offerings outpacing our competitors, which should increase both new business and our retentions. So as we sit here today, we still believe our full year 2025 brokerage segment organic growth should be in that 6% to 8% range. That's unchanged from what we said in October. As for brokerage margins, a little noise on page 5 of the earnings release. Please see the footnote. You'll read that the margin was aided by about $20 million of interest income earned on cash we're holding to close AssuredPartners. Adjusting for that, our margins would have been 32.5%, up 109 basis points over last year. That's nicely above our October expectation of margin expansion in the 90 to 100 basis point range. Looking ahead to 2025, we are still viewing margin expansion like we have, like we've said many times before. We see margin expansion starting around full year organic growth of 4%. At 6%, maybe we could see 50 basis points, and at 8%, perhaps 100 basis points of expansion. Of course, those ranges can then be impacted by changes to interest income on our fiduciary assets, and then the rolling impact of M&A. By our March IR date, maybe we'll have a better read on where interest rates might go, and also the impact of Assured rolling into our numbers. But at this time, we don't see either having a significant impact on those ranges. So, really no change to how we're thinking about margins in 2025. As for risk management, another solid quarter posting 6% organic growth. Admittedly, a couple million dollars below our October expectations, all stemming from a smaller quarter of construction consulting revenues in the Northeast that can be just a little bit lumpy. So, adjusted margin expansion of 20.6% in the quarter was also in line with our October expectations. And then looking forward, we're seeing full year 2025 organic growth also in that 6% to 8% range, with margins again around 20.5% for the year. So, a great quarter and full year by both our brokerage and risk management teams, and both have a strong outlook for 2025. Turning to page 6 of the earnings release and the corporate segment shortcut table. For the interest and banking line, we are a bit better than our October forecast because we just were not into our line as much as we thought at that time. For the adjusted acquisition lines for M&A and clean energy, both were close to our October expectations. Then, when you look at the corporate line of the corporate segment, that was better than our expectation due to unrealized non-cash foreign exchange remeasurement income, which was partially offset by a return to actual tax catch-up of about $4 million. So, let's move from our earnings release to the CFO commentary document that we post on our IR website. First, an overarching statement. Please take some time to read any headers or footnotes throughout this document to understand what information has or hasn't been updated for the AssuredPartners deal. So, let's move to page 3 for our modeling helpers. Across the board, fourth quarter 2024 actual numbers were fairly close to what we provided back in October. As for 2025, we provided a first look of what we forecast. Again, none of these numbers include any impact from AssuredPartners. Turning to page 4, a first look at our corporate segment outlook for full year 2025. The only impact of AssuredPartners is found in the interest and banking line. It includes additional interest expense from the $5 billion debt raise. Flipping to page 5 of the CFO commentary document to our tax credit carryforwards. As of year-end, about $770 million that will be used over the next few years. So, still a nice sweetener to fund future M&A. We would not expect those numbers to move much because of the Assured financing or the roll-in of Assured's taxable income. That's because of the interest shield and also the amortization of the $5 billion deferred tax asset that we'll get with AssuredPartners. That should save us about $1.4 billion of taxes over the coming years. Flipping over to page 6, the investment income table. This table includes an assumption of two 25 basis point rate cuts in 2025. It includes interest income from cash we're holding to pay for Assured, assuming a late March close. But it does not include interest income from Assured's fiduciary assets after closing. When you shift down on page 6 to the rollover revenue table, the pinkish columns to the right include estimated revenues for brokerage M&A that we closed through yesterday. And below that table, we've added a separate section for AssuredPartners' revenues. Again, assuming a late March close, which of course is highly dependent on regulatory approvals. Then, just a reminder, you also need to make a pick for other future M&A. And then further down on that page, you'll see the risk management segment rollover revenues for 2025 are expected to be approximately $5 million for each of the first two quarters. All right, moving to Page 7. This is a new page to help you see the impact of the AssuredPartners financing on our fourth quarter 2024 revenues, EBITDAC, net earnings, and EPS by segment. The three items just to keep in mind. There was additional incremental interest income on the cash that we were holding to fund the acquisition. There was additional interest expense we incurred on the newly issued $5 billion worth of debt. And then the additional shares outstanding from the December equity offering. You'll see that for fourth quarter, it all nets out to nearly nothing, but it does cause a little noise in our numbers. Also, the callout box on the right of that page provides some information on shares outstanding because of the AssuredPartners equity raise for our first quarter. This includes the full impact of the shares we issued in December and the exercise of the green shoe in early January. Finally, if you flip to Page 8, you'll see that this page is just a repeat of what we provided in the December Assured presentation for ease of reference. There's no new news on this page. Finally, let's move to cash, capital management, and M&A funding. Available cash on hand at December 31st was more than $14 billion, of which approximately $13.5 billion will be used to fund AssuredPartners. Since year-end, we received another $1.3 billion as the underwriters exercised the green shoe. So, considering this and our strong expected free cash flow, we are in an excellent position to fund our M&A pipeline of opportunities. Here in 2025, it's looking like we could have $3.5 billion to fund future M&A. Then it jumps up to nearly $5 billion in 2026, all while maintaining a solid investment-grade rating. So, an excellent quarter and an excellent year to have in the books. As I reflect on 2024, I have to say that we had a pretty terrific year. For the combined brokerage and risk management segments, we posted adjusted revenue growth of 14%, organic growth of 7.6%, overall margin expansion of 94 basis points, and most importantly, we grew our EBITDAC by 18%. Those are terrific numbers and reflect what Pat said. That's our unstoppable culture. So, those are my comments. Back to you, Pat.

Thanks, Doug. Rob, you want to open it up for questions?

First question is surrounding the cadence of organic growth next year. Loud and clear, 6-8, no change. I guess, yes, for both segments. I guess I'm more specifically focused on the brokerage segment. But in terms of the cadence or seasonality, anything you'd like to call out? Two of your peers called out kind of weaker seasonality in 1Q. We do know that reinsurance is overweight in the beginning of the year too, and maybe downwards pricing there could cause some year-over-year tougher comps.

Let me go back to that. Let me start with the end of that. There have been some price changes on the reinsurance, but our customers are buying more reinsurance. So when you look at the total spend for us that our customers are spending, we're really not seeing a decrease, and like Pat said in his comments, we had a terrific new business quarter also. Going back to the first part of your question, yes, reinsurance is typically stronger in the first quarter, and so you could see some seasonality of better organic growth in the first quarter than what develops out for the rest of the year. I'll study in a little bit about that, as we do have a substantial amount of our health and medical benefits that renew in the first quarter that mitigate maybe a higher reinsurance on it. And then throughout the year, our retail is performing well. Our wholesale seems to be getting stronger and stronger. Our programs are doing well. But, yes, you would see a little seasonality because of reinsurance in the first quarter and our organic growth.

Okay, got it. So you're saying actually it could be higher, not lower, even if reinsurance pricing is down? Okay.

I'll have a chance to talk to you again on our March IR day, and we should have a better feel of the seasonality for that too.

Okay, awesome. The last question is on, do we share investment income? I'm thinking through post the deal close, if you're able to comment. So my understanding is that the company you're purchasing kind of didn't fully leverage its fiduciary income in that it was direct pay relationships between the businesses paying directly to the insurance carriers, and you guys might be able to optimize that working capital to gain more fiduciary assets. If that's what I'm describing is correct, can you offer kind of a timeline on how that works in terms of getting those asset balances onto your balance sheet?

Yes, your recollection is correct, and I think that if you go back, I don't know, 10 years ago when we went through our exercise in consolidating bank accounts from around the world, this would be obviously mostly in the U.S. We did have some good success of picking up more fiduciary cash into our accounts, and I think that would be invested. So we do see that as an opportunity that we'll be better together on that metric. So, yes, there should be versus their run rate, I'm guessing together we'll be better on that going forward.

Doug, is there just any, is that kind of a one-year process, or does that kind of take many years?

Listen, in 18 months we shouldn't be talking about it anymore, so I think we'd get it done. Hopefully faster.

I guess I'd like to start with California. Given the substantial potential loss to the insured market, I'm curious if you could give us some perspective of how it might touch your operations. I'm interested in, you know, the business going inside RPS, if there's any impact on the wholesale market that you're seeing. If you can just talk about your perspectives of that as we watch this disaster unfold, that'd be great.

Well, first of all, Greg, it's Pat, we reached out to thousands of clients already to make sure that they had the knowledge of how to file claims and what have you, how to get ahold of us if they're having difficulty in filing those claims. We are presently tracking, I forget the exact number today, but we have hundreds of claims that we're helping our clients with already. I think that you've got a situation that is going to continue to unfold for us. We're a big player in California. We're a big player in Los Angeles. Not huge in personal lines there, but it's going to keep us incredibly busy for a number of months. And then in terms of the impact of that, luckily, again, we've been able to stay in touch with our people. We have had our folks in some instances evacuated. We did not lose anybody and don't have many of our folks that have lost any of their homes. So I think we'll be well in a strong place to help our clients, but I can't give you much more than that right now in terms of how it's going to impact our day-to-day activities out there.

Okay. And then I guess my follow-up question is switch gears. You mentioned in your comments about the lower contingents. Just curious, given the profitability we're seeing in the industry, I would have imagined that supplementals and contingents would be up. And I think your guidance for 2025 suggests that they should go back up again. But maybe you could spend a minute and give us some color on what happened with contingents in Europe, and then color on your outlook.

Yes, great question, Greg. Thanks for asking. Like I said, I ended in my comments that this isn't a trend, and what you said there is right. We would expect it to bounce back up again. Frankly, it's simply because as we get the final year and loss ratio estimates in from the carriers, they're coming in just a little bit higher than what maybe we had been anticipating throughout the year. And to put this in context, we see this as about maybe a $7 million shortfall to what we were thinking back in October. Two-thirds of it is spread across hundreds of contracts. And so if the loss ratios are ticking up just a little bit, that probably costs us $4 million of it. And then another third is we had about three contracts and programs in Canada that just really kind of came in here in January with really not very great results. But if you look at it on an annual basis, when you combine supplements and contingents, I think if I do the math here mentally I think it's about 8%, even with the small blip in the fourth quarter. So it's still a terrific year. But I wouldn't over-read that there's some systemic shift in what contingents and supplements are going to be going forward. So I would expect those numbers to grow over the blip this year considerably.

Just a clarification on that answer, Doug, is there a specific line of business? Is there across a broader business set?

It's across the line, Greg. I wouldn't say there's anything there. We have hundreds of these contracts, and we get a lot of this information coming in here right around the first week or two of January.

I like how everyone is claiming they're Canadian. Doug, you mentioned.

I'll tell you personally, Meyer.

I had a question for Doug, just trying to unpack the brokerage organic this quarter. And I don't want to nitpick too much, but you guys were looking for 8%. And I'm just wondering, so what was the entire differential? Just the contingent and the life sales came back as expected, and it was just totally offset by the contingent. I'm hoping you can unpack that a little bit.

Yes, you're right. The base commission and fees at 7.8% percent. That business contingents and supplementals have been running kind of consistent with that together. So the difference of the $7 million, I'd put it up in the upper 7% range, somewhere pretty close to the base contingency. So you're right. You're spot on in your observation there.

Okay, great. Thanks for confirming. And then I wanted to follow up just on I guess I was surprised the RPC stayed at 5%. Just given the property price was flat versus up for last quarter. So I'm wondering if maybe it's mixed, but I'm wondering if there's anything else from sort of like an increased purchasing or buy up dynamic that you guys are observing as the property rates moderate here.

Well, we see that across that. Yes, I mean, we've always said it's been a long time. We've talked about this as rates are going up. Customers opt out of certain coverages. And that might be by raising deductibles or reducing limits on it. Sometimes they'll drop some coverages. So remember, rates are still increasing. I think it's important for everybody to realize that kind of across the board, we're still in a rate increasing environment. They're buying more insurance. And reinsurance you're seeing that from the carriers that they're buying more. And then the customers, they are buying more coverage on it. So they'll opt in.

Insurance to value is a big deal. Much more pressure on insuring to value.

I guess my first question is, thinking about the last call, I think, Doug, you'd mentioned that you expect brokerage organic growth in 2025, split between the components to come from about half new business and then perhaps a quarter each to rate and exposure. Has your perspective on the components of that brokerage organic growth guide changed in the context of the AssuredPartners acquisition?

No. Pat summarized it pretty quickly. That's what we're still seeing happening right now.

I guess I'd like to start with California. Given the substantial potential loss to the insured market, I'm curious if you could give us some perspective of how it might touch your operations.

Well, I mean, clearly claim activity helps this far. I mean, there's no question about it. But when it comes to severity, we don't participate in our clients up or down in terms of severity. We do everything we can to manage the final outcome, and we contend, and we believe we have the data and analytics to prove this, that if you hire Gallagher Bassett, your outcomes, meaning your final settlements, will be superior.