Arthur J. Gallagher & Company (AJG) — Q2 2025 Earnings Call Transcript

Thank you for joining us for our second quarter '25 earnings call. Joining me today is Doug Howell, our CFO, along with other members of the management team. We had a strong second quarter, with 16% revenue growth in our combined Brokerage and Risk Management segments and 5.4% organic growth. Our reported net earnings margin was 17.3%, and the adjusted EBITDAC margin increased to 34.5%, up 307 basis points year-over-year. We achieved a 26% growth in adjusted EBITDAC, marking our 21st consecutive quarter of double-digit growth. Our GAAP earnings per share stood at $2.11, with adjusted earnings per share at $2.95. For the Brokerage segment, we saw reported revenue growth of 17% and organic growth of 5.3%, meeting our expectations despite some challenges from CAT property renewal premium changes in June. The adjusted EBITDAC margin improved by 334 basis points to 36.4%, with an underlying margin increase of about 60 basis points. Doug will elaborate on this margin expansion later. Within our retail operations, we achieved 4% organic growth overall, largely due to a focus on property business this quarter. In the U.S., organic growth was 5%, differing slightly between P/C and Benefits lines. International operations in the U.K., Canada, Australia, and New Zealand had an organic growth rate of around 3%. Our specialty businesses contributed nearly 7% organic growth, with Gallagher Re contributing 5% and our wholesale and specialty businesses contributing over 7%. In terms of the P/C insurance pricing environment, the global market remains rational, and we anticipate that trend to persist. Insurers are gaining insights on product performance and areas that need re-evaluation to enhance profitability. Increased competition among carriers is evident in property lines, with caution remaining in casualty lines. In the second quarter, we observed a 7% decrease in property rates and an 8% overall increase in casualty lines, with general liability up 4% and commercial auto up 7%. There are differing trends for various client revenue sizes regarding renewal premiums and property coverages are having a more significant impact compared to previous quarters. The reinsurance market has shown stable renewal conditions similar to earlier in the year, with property covers favoring reinsurance buyers. The casualty reinsurance dynamics reflect ongoing concerns regarding past loss developments and rising loss trends. Thus, pricing has been steady to slightly higher. Gallagher Re will continue to succeed in a market ripe for showcasing our expertise. Regarding customer business activity, our revenue indicators for the second quarter and July suggest positive trends, with solid client activity and no signs of a significant global economic downturn. Job growth in the U.S. continues, although not as strong as in 2024. Rising medical treatment costs are a trend we are monitoring, where our benefit professionals can provide support to employers. With a strong first half, we expect Brokerage segment organic growth for the year to be in the range of 6.5% to 7.5%. Doug will discuss our quarterly outlook further. In our Risk Management segment, Gallagher Bassett, we recorded a 9% revenue growth with 6.2% organic growth. We gained solid new business revenue this quarter, and with excellent client retention, we anticipate full-year organic growth to fall between 6% and 8%. The second quarter's adjusted EBITDAC margin improved to 21%, surpassing our earlier expectations. We foresee a margin around 20.5% for the full year, indicating another successful year for Gallagher Bassett. Turning to mergers and acquisitions, we have made great progress with Assured Partners and are on track to complete this deal in the third quarter. During the second quarter, we finalized 9 new mergers, which contribute approximately $290 million in annualized revenue. We have around 40 signed term sheets in our pipeline, representing $500 million in annualized revenue. We look forward to welcoming new partners into the Gallagher family. Lastly, I had the opportunity to engage with many colleagues, including over 500 interns in our 60th internship class. This rigorous program is essential to our future, and I am confident in our sales culture's strength moving forward. Now, I will turn the call over to Doug.

Thank you, Pat, and hello, everyone. Today, I will take you through our earnings release and share insights on organic growth and margins by segment, as well as our expectations for the rest of the year. I will then review the CFO commentary document available on our IR website and discuss our typical modeling aids. I will finish my prepared remarks with my usual updates on cash, M&A, and capital management. Let’s begin with Page 3 of the earnings release. The brokerage segment's organic growth of 5.3% aligns with our guidance from June. With the first quarter organic growth at 9.5%, we are currently at 7.6% year-to-date. Looking ahead to the second half of '25, we anticipate third and fourth quarter organic growth to each be around 5%, resulting in a full-year organic growth range of 6.5% to 7.5%. I would like to highlight four points. First, from our first quarter earnings call and June IR Day, the 9.5% first quarter organic growth benefitted from positive timing that is now turning into a headwind for the second half. Second, as we've mentioned before, organic growth can be affected by large and unpredictable live cases. Due to current uncertainty in interest rates, clients may choose to expedite or postpone purchasing policies. Third, fluctuations in property rates, whether decreasing or a sudden uptick due to a large CAT during wind season, may also impact our organic growth. Lastly, regarding casualty rates, some lines appear to be stabilizing while others continue to rise steadily. Moving to Page 5 of the earnings release regarding the brokerage segment's adjusted EBITDAC, the second quarter margin was 36.4%, which is an increase of 334 basis points year-over-year and exceeds our June expectations. Let me outline the typical contributions from last year. If you refer to last year's second quarter earnings release, you would see an adjusted EBITDAC margin of 33.1%. Adjusting for current FX rates, which are negligible, we can assume that the adjusted margin would still be 33.1%. The organic growth of 5.3% contributed roughly 60 basis points of margin expansion this quarter. The impact of M&A contributed about 40 basis points, while lower rates on fiduciary interest income subtracted around 30 basis points. However, the interest income from cash held for Assured Partners added about 340 basis points this quarter. Following this logic, we arrive at the second quarter 2025 margin of 36.4%. This reflects great discipline from the team. For the second half of the year, we maintain our outlook for underlying margin expansion potential. With organic growth above 4%, we anticipate underlying margin expansion, potentially around 70 basis points at 6.5% organic growth and around 90 basis points at 7.5% organic growth. I expect this trend to continue into '26 as well. We have numerous factors that will enhance our productivity and quality, including a more stable labor environment, better returns from our technology investments in client-facing tools, successful early AI implementations, further centralization of back-office services, all supported by a strong operating system capable of significantly higher revenue with minimal added costs. In summary, in any organic environment, we still see substantial opportunities for improvement, increased efficiency, and a better quality of offerings to our clients at lower costs. Continuing on Page 5, the Risk Management segment showed organic growth of 6.2%. As Pat mentioned, this exceeded our expectations due to robust new business revenues from contracts initiated in Q2. For the year, we expect organic growth to remain in the 6% to 8% range. The adjusted EBITDAC margin of 21% surpassed our June expectations, and we continue to foresee full-year margins closer to 20.5%. Now, turning to Page 7 of the earnings release regarding the corporate segment. Compared to our guidance from June, both the adjusted interest in banking and clean energy lines were very close to expectations. The adjusted acquisition cost related to typical tuck-in acquisitions was slightly better by one cent, while the adjusted corporate line was $0.04 lower due to a larger noncash unrealized FX loss from the dollar's decline in June, which has mostly reversed in July. This also highlights the volatility this can introduce into our corporate segment results. Moving on to the CFO commentary document on our website, please pay careful attention to the headers and footers regarding how numbers include or exclude the impact of Assured Partners. Turning to Page 3 and our standard modeling aids, most of the actual numbers for the second quarter '25 were close to what we predicted in June. One notable change is a slight shift from amortization to depreciation, costing us about a penny in adjusted EPS, due to updates in the opening balance sheet from our recent acquisition. Finally, please review the FX disclosures for the Brokerage and Risk Management segments as you refine your models. On Page 4, the outlook for the corporate segment in the second half of '25 shows little change from our previous guidance. You can find the tax credit carryovers on Page 5, which are about $685 million as of June 30, expected to benefit us over the next few years. This benefit impacts our cash flow statement, not the P&L. There's been no change in the value of these credits following the recent U.S. OB3 tax bill, which is positive news. Additionally, there are no concerns regarding other provisions in the new bill. On Page 6, the investment income table has been updated to reflect the current FX rates and changes in fiduciary cash balances, assuming two future interest rate cuts of 25 basis points each in September and December. The interest income related to Assured Partners financing is also shown in this table and will adjust based on the timing of our closure. The rollover revenue table shows only minor changes from our June CFO commentary, resulting from a refinement in revenue seasonality from our second quarter '25 acquisitions, which have a heavier weighting towards the first quarter compared to the others. Looking ahead, you can find estimated revenues for brokerage M&A completed up to yesterday in the pinkish columns on the right. It’s essential to make a decision about future M&A and when Assured Partners might close, and the purple section on that page is intended to assist with that. Now, regarding cash, capital management, and M&A financing, our available cash as of June 30 was approximately $14 billion, with no outstanding borrowings. With robust cash flows in the latter half of the year, we are well-positioned to fund an additional $2 billion of M&A in '25, and we anticipate having around $5 billion in '26 without utilizing any stock, all while maintaining a strong investment-grade debt rating. This represents an opportunity for $7 billion in total over the next 17 months, allowing us to add approximately $600 million to $700 million to EBITDAC at an attractive arbitrage. I am optimistic about this, as we have spent 20 years developing the foundation to support substantial revenue growth, provide excellent service, and empower numerous talented producers to succeed. Therefore, our M&A strategy has a promising outlook. We have had a strong quarter and first half, and an exciting future lies ahead with Assured Partners, organic growth, margin expansion, and M&A opportunities, all driven by a talented team and a solid culture. Those are my comments. Back to you, Pat.

Thanks, Doug. Dale, do you want to open up for questions, please?

My first question is about the date you provided the HSR information to the DOJ and how you responded to that request. Did you establish a timing agreement, or does the 30-day clock begin once you submitted all the information? For my second question, regarding the 5% brokerage outlook for the second half, are you anticipating that the pricing trends from Q2 will continue along with the slowdown in property that occurred in June? Additionally, during the June IR Day, you mentioned some benefits business being deferred to the second half. Is that still the plan, and in which quarter do you expect that to materialize?

Well, Elyse, we aren't going to give out dates that we did this or did that. We are done responding to their second request, and we do continue to engage with them and respond to certain inquiries. And so the review is ongoing. So I'm not going to get into any more real details about timing. But our evaluation of where we stand, given the give and take back and forth and given the relationship is that we'll be in a position to close the transaction during the third quarter. We're very, very excited about it.

Let me reiterate that we expect the next two quarters to be in the 5-plus range, without focusing too heavily on a single number. There is some risk and opportunity in the life business, and we'll have to see how that unfolds. The policies sometimes depend on interest rates, and with the Fed maintaining its current stance, it's uncertain whether these policies will be initiated sooner or later, possibly into next year. Our projections also consider the current property and casualty environments. The timing from a strong first quarter has provided a bit of a headwind for the third and fourth quarters. Overall, we are optimistic about our business and believe we can achieve a range of 6.5% to 7.5% for the year.

And we are heavier in the second quarter on property than we are the next two.

On the property, I just heard an E&S writer say that we made the same point as you about June seeing a big drop-off, maybe 20% to 30%. Is that baked into your guidance for the balance of the year, something along the magnitude of 20% to 30% property lines? Or is that just...

That's a bad number. That's a bad number. Whoever gave you that number, it's not what we're seeing. Absolutely not close. So no, we didn't take any 20% or 30% decrease.

Property is in the 7% range, a bit higher or lower in June. June is a significant quarter for property. It's important to remember that our revenues can include changes in exposure as well. While property rates might decline, our customers tend to purchase more coverage when rates drop. Therefore, when we report a 7% decrease in property, it reflects lower rates but also an increase in exposures or the uptake of those risks.

Got it. And the number I gave you might have been off because it might have been weighted more towards E&S and large risk.

That's a bad number. It's a bad number on large accounts, it's a bad number on middle accounts, it's a bad number on small accounts.

Good to hear. And then maybe just shifting to your pipeline. I mean it sounds really exciting. You've done 9 mergers already. No disruption from Assured Partners. You can just kind of keep going at your regular pace.

I'll tell you what, I have to agree, if I was an outsider, I'd be pretty impressed. Our machine, and we're in just a great position is driven by literally hundreds of people in the field around the world, talking to folks that they admire and working with people who have been hired by folks to sell their business. And we're on that short list of virtually anybody that wants to take a look at possibly selling their enterprise, large or small. Our tuck-in acquisition business purchases are not all $50 million, $100 million. There's lots of 2s, 5s, 10s. These are family businesses, and they're not PE roll-ups and they're looking for a home for their people. And I couldn't be proud of the fact that there were still at the high end of that checklist. They want to know is Gallagher still the kind of company I'd like to join. And you're exactly right to pick up on the fact that 9 closures at the very time that they know we're doing the biggest transaction in our history. So it is a testament to...

On the RPC numbers that you provided, Pat, could you give an all-in RPC number? Also, how would that look with the mix for the third and fourth quarters instead of the second quarter?

Well, it'd be about 4%.

Yes, I believe you're noticing an important point, Charles. There is a significant emphasis on property. For us, property accounts for approximately 35% of our business casualty over the course of a year, and we are observing a consistent increase in casualty rates moving forward. From what I recall, casualty has risen by about 8%, affecting the mix and weight of the business. Overall, the market continues to show a mid-single-digit increase in rates. You're correct to identify the distinction between the two, but combining them, the mid-single-digit figure still represents a key area. In response to the latter part of your question, we anticipate this trend will continue throughout the rest of the year. We are just at the start of the wind season, so it will be interesting to see how this unfolds. In the next three months, this could influence the market. We are looking at $80 billion in catastrophic losses, marking the largest first half of any year in our history. It hasn't been long since the devastating California fires occurred, and I believe carriers still need to assess the impact on their reserves. There will be ongoing development from that situation. As casualty rates continue to rise, property is an area we are actively addressing. We'll see how the remainder of the year plays out.

Got it. And I guess, the 4.7% in base organic, are you expecting acceleration off of that in the back half of the year? Or I guess, are you expecting supplemental and contingents to kind of drive organic a little, yes.

I kind of look at base and supplementals together, and not pushing like 4.9% or 5%. So right in there, what we're seeing going forward, the contingents. I think the carriers are doing well. We do well in the environments where carriers do well. So I think that it's nice to see that base and supplemental together is still around 5%. Supplementals, maybe topping that up a little bit. So I think you're reading through that right. But we're holding in there. Our fee accounts are doing well, too. So it wouldn't surprise me that's the same number in the next 3 quarters or next 2 quarters also.

So I think, Doug, as you're going through in rapid fire formation, your comments, you alluded to the opportunities that you have to expand margins in all type of organic revenue environments. And I think it's particularly interesting as we think about next year. So could you go back and sort of unpack some of those comments and talk about the drivers, not for this year, but what you're seeing for '26 and beyond?

Here's the situation. I will elaborate more on this in detail during our IR Day in September. In summary, there's a culture of change at Gallagher, with everyone focused on continuous improvement daily. We understand the need for increased productivity. We're currently running some impressive AI projects that have begun to show early victories. We now have 15,000 associates in our centers of excellence who provide significant value. They are the pioneers of standardization and centralization, enabling us to integrate AI effectively. The technologies we are developing have shifted from merely securing our environment and ensuring uptime to truly empowering the business. The presentation layers we are creating help show customers the value they receive and the numerous opportunities for further enhancements. Each time we think the list of improvement opportunities might shrink, it instead expands. Thus, we have years of potential for betterment ahead, supported by our acquisition pipeline, as we continue to generate more revenue without dramatically altering our cost structure.

I'll wait until September for more details. I want to revisit the Assured Partners transaction. Last time we spoke, you mentioned that you had to suspend 11 out of the 13 work streams in the integration process. With a clearer timeline, have you restarted those integration work streams? Ultimately, I'm trying to understand whether this delay will affect the revenue and margin assumptions we laid out for the acquisition, and if it will postpone the recognition of benefits as we start to integrate that operation at the end of this year and into next year.

I think it's fair to say we had to pause some actual work streams, such as which producers would collaborate on accounts and which branches would share resources. However, we have had ample time and have been given the opportunity at the senior levels to continue discussions and refine our plan. We've adhered closely to the rules, and this extended period has allowed us to engage in more integration planning, even if we haven't delved into the specifics of some of these work streams. I believe we're well-prepared to move forward. When we announced this acquisition, we expressed pride in our expectation that it would be accretive in its first year, and we still hold to that view. We anticipate an increase in opportunities to sell in new regions where we previously had no presence. Keep in mind that we previously missed out on 94% of the acquisitions made by AP. Now, we're welcoming new team members who seem very eager, and we are excited to get started.

Yes. And Greg, just to clarify, I think you had your numbers backwards. I mean there are 12 or 13 work streams, and we really had to suspend 2 of them or 3 of them or something like that. So I think if you spoke backwards on that. But I got to say, like Pat said, is that we've used this time to get ready when things happen. If we're delayed 7 months in closing, 8 months in closing, maybe we lost 2 or 3 months in that journey, to be honest, so we didn't lose the entire time. So we're still bullish on the opportunity to put 2 great companies together and get a lot of benefit out of it.

My first question is on pricing. You mentioned that casualty, some lines bottoming out and some lines getting higher. Just curious, any specific lines that you want to call out? Just kind of want to know the mix that drives it. And casualty line pricing is like 8% in 2Q, which is in line with 1Q, look pretty steady. Do you expect casualty rates going to be flat or bumpy when it increases from here?

Let me address that right from my notes, Jing. We're observing a 7% decline in property rates, while casualty rates have increased overall by 8%. Breaking it down further, general liability is up approximately 4%, commercial auto has risen by 7%, and umbrella coverage has increased by 11%, which indicates positive trends in the underwriting business. Package policies, which include various property coverages, are up 5%. However, Directors and Officers insurance is down by 3%. Workers' compensation has seen a modest increase of about 1%, and personal lines overall have increased by 7%. This detailed breakdown should provide you with a comprehensive view by line. In the casualty market, I'm noticing ongoing caution, as discussed in our reinsurance report. Carriers are still worried about past performance, and as they look ahead, they are hesitant to offer more credits that could exacerbate earlier issues. Additionally, to echo Doug’s remarks, we are just one significant storm away from a shift in the property market. We are currently in a very intriguing phase of the market. These carriers are adept at understanding their profitability and are keen on ensuring their revenue stays above loss costs. It's a crucial time for us to engage with clients about these matters, as they are understandably confused.

Got it. My second question is on the E&S market. One of your competitors kind of mentioned, seeing some early signs of business coming back from E&S to the mid market? Are you seeing any similar trend? Or what are you expecting for here?

Yes, I can tell you that every retail broker globally has a key strategy in a market like this, which is to reestablish a direct approach to eliminate the wholesale commission. This is a significant statement. While there are wholesalers who have assisted you in writing accounts and you'll be collaborating with them, it's important to note that this strategy may not apply to every single account. However, it's clearly a tactic retailers will employ to avoid splitting commissions.

And we're actually seeing in our submissions. Our submission count is actually up. So when it comes to opportunities, we're still having a lot of opportunities to grow. That's obviously in our wholesale and E&S market.

Now also, there's a differentiation between programs and MGA-type lines of coverage where you've got something that's in an underwriting environment that's excess and surplus. Those are growing nicely right now. They're continuing to grow. So it is a mixed bag. But as you saw in our results, our excess surplus and specialty business was up 7% at a very strong quarter. So this is not like all the business is returning to the primaries. It's a logical balance.

I just wanted to confirm that in the outlook for a 5% plus organic growth in brokerage in the back half of the year that you guys are assuming a continued 7% decline in property RPC? And then maybe if you could help us think through some of the sensitivity around that if pricing came in maybe a little bit better or if it came in maybe a little bit worse, what sort of impact that might have to organic in the second half?

Right. So yes, on the first part of the question, we're assuming property pricing that happened in June continuing through the year. But again, we're not as heavily weighted to property in the second half of the year. Second thing, I think the sensitivity is, I think that we lose 40 basis points of organic every time there's a 2% drop in rates without any changes, including increases in exposure that would come along with that. So maybe down a little bit more because of the changes in rates, but then because of increased consumption and people opting back in. I think the net impact is about 40 basis points or 2% of drop on net-net property.

Got it. That's helpful. Following up on that, is what you mentioned in June different from the 7% decline or is it worse than the 7%? I recall you said there was a 5% decrease in April and May, but it seems that June was definitely worse, ultimately leading to a 7% decline for the quarter.

Yes, June may have been around 8% or 9% by the time it averaged out. However, we are not seeing that trend continue in July.

Got it. Okay. But you're assuming like the 8%, 9% in the outlook going forward?

I believe there is some moderation as we approach the midpoint of the storm season. The property business might not experience the same cuts that it did earlier on. Let's see how things unfold during the storm season. I think the carriers have set a target for writing business, and they are likely to focus on achieving that target more aggressively in May and June since they have seven months of unearned premium to consider.

Pat, if I heard you correctly, you mentioned that workers' comp was up one, and if I am interpreting this accurately, it increased by 5% last quarter. I understand you indicated that job growth might not be as strong and there could be less wage inflation, but is there anything else affecting that figure?

I'm not seeing it, Mark. I find the comparison surprising. Over the last decade, it's been relatively stable. So I wouldn't place too much emphasis on that. We could analyze it every quarter, but it's within a narrow range with minimal fluctuations. This does not suggest a significant drop, and the previous quarter's performance is not an indication of a subsequent increase.

The benefits organic, I think you said it was maybe a little bit faster than the overall U.S. retail. Is that right? Do you have a specific number on that?

We didn't provide that, but it might be 2 points better, maybe 1 point, 1.5 points better.

I think I heard you say 5% organic in reinsurance, and that's relative to some really strong quarters in recent history. Can you maybe break down just any impact on pricing on that organic number? And would also be interested in hearing maybe any benefit you saw from ILS activity.

In the second quarter, there wasn't much benefit from ILS. Overall, it was not a significant quarter for reinsurance. Can you please repeat your question about the reinsurance 5%? I might not have understood you correctly.

Just any impact from pricing that was a headwind to that 5%?

We're seeing that carriers are recognizing opportunities to increase their reinsurance purchases, which more than offsets any impact on pricing.

Great. And then I think in the script, you mentioned some early AI successes. Could you maybe elaborate a bit on those?

I mentioned to Greg that I wouldn't discuss it until September, so it's not fair for me to share details now. However, Gallagher Bassett is experiencing excellent results in their claim submissions. We're also making good progress with policy review. On the back office front, we're starting to gain momentum with near AI solutions for bank reconciliations, among other tasks, though we still have many of those processes ongoing. The key highlights at the moment are claims summarization and policy review.

I think I heard you guys mention 7% growth on E&S business in the quarter. Would you be able to break that down a little bit further, thinking about the difference between open brokerage and MGA's?

I think the faster grower of the 2 MGA's programs and open market is clearly the MGA business. I don't have a stat ready off the top of my head. Let me just look down the table here.

Yes. Listen, I can tell you, this is that the binding and is up towards double digit. And the issue you've got to look at an open brokerage is the submissions are up, but because some of the renewable premiums are flat, it's primarily a property quarter. For me to say that it was flat, that might be a little unfair without context that we're still getting tons of submissions going into the open brokerage spot.

I appreciate the additional context. And then just on thinking about the closure of the Assured Partners acquisition. I can appreciate that you don't have a whole lot of additional detail for us. But is there any changing in your thinking about the need to potentially divest some parts of that business or offer other remedies in order to get the deal over the finish line?

Absolutely not. Okay. I think that's our last question. I've got just a quick thank you for everybody for joining us. I know it's late this afternoon. I appreciate it. We feel we had a great first half of 2025. Most importantly, I want to thank the 59,000 colleagues that we have for all their hard work. Thank you. And to all our clients around the globe, we're proud to be your trusted advisers. Thank you, and thank all of you for joining us. Have a great evening.