Arthur J. Gallagher & Co.

Good afternoon, and welcome to Arthur J. Gallagher and Company's fourth quarter 2018 earnings conference call. Participants have been placed on a listen-only mode. Your lines will be open for questions following the presentation. Today's call is being recorded. If you have any objections, you may disconnect at this time. Some of the comments made during this conference call, including answers given in response to questions, may constitute forward-looking statements within the meeting of the security laws. These forward-looking statements are subject to risk and uncertainties discussed on this call or describing the company's reports filed with Securities and Exchange Commission. Actual results may differ materially from those discussed today, and the company undertakes no obligation to update these statements. In addition, for reconciliation of the non-GAAP measures discussed on this call, as well as other information regarding these measures, please refer to the most recent earnings release and the other materials in the investor relations section of the company's website. It is now my pleasure to introduce J. Patrick Gallagher, Chairman, President, and CEO of Arthur J. Gallagher & Company. Mr. Gallagher, you may begin.

Thank you, Devin. Good afternoon, and thank you for joining us for our fourth quarter and full year 2018 earnings call. With me today is Doug Hall, our Chief Financial Officer, as well as the heads of our operating divisions. As I do each quarter, today I'm going to touch on the four key components of our strategy to drive shareholder value. Number one is organic growth. Number two is growing through mergers and acquisitions. Number three is improving our productivity and quality. And number four is maintaining our unique culture. The team once again executed on all four, resulting in another great quarter and a fantastic year. Let me start with some financial highlights for the quarter. Our core brokerage and risk management segments combined to deliver 11% growth in revenue, 5.8% all-in organic growth, adjusted EBITDA margin expansion of 45 basis points, and we completed 19 tuck-in mergers during the quarter representing about $90 million of annualized revenue. And let's not forget about clean energy. $22 million of after-tax earnings in the quarter, bringing the full year total to almost $119 million. Just a great performance by the team. Now for some more detail on our results, starting with the brokerage segment, organic. Fourth quarter organic growth was 5.6% all in. reflecting strong base commission and fee growth of 5.9%. Combined, supplemental and contingent commission growth was 1.7%, light by about $2.5 million in the quarter, mostly related to catastrophe loss experience. This shortfall didn't move the organic needle much, but it did pull our brokerage margin expansion down from 65 to 70 basis points to 46 basis points. Regardless, a really strong result by the brokerage team in the face of a tough comparison from last year's fourth quarter. Let me break down our fourth quarter organic growth around the world. First, our domestic property casualty operations had a really great quarter with base organic of over 6%. Our domestic retail benefits operation was closer to 2%, which is good performance given that the unit was up against a tough comparable of nearly 8% in the fourth quarter of 2017. Outside the U.S., our U.K. operations posted 8% organic, Canada was up 6%, and Australia and New Zealand grew around 9%. Property casualty rates and exposure combined are trending higher across all major geographies and continue to be a modest tailwind to our organic growth. Similar to last quarter, these two factors added a little over a point to organic. Let me give you some rate sound bites during the quarter, focusing on a few noteworthy lines of business. In our retail PC business, commercial auto and property lines are up about 5%, and workers' compensation is down a little less than a point. In our domestic wholesale operations, property and commercial auto lines are up 4%, casualty lines up 3%, and workers' compensation down over 3%. U.K. retail is flat or modestly positive across almost all lines with the exception of professional liability, which we see up over 5%. In Canada, property is up more than 4%, while commercial, auto, and casualty lines are up less than 4%. And finally, Australia and New Zealand continue to show the strongest impact. Casualty and specialty lines are up over 5%, and property is up around 9%. Overall, the PC market remains stable, similar to past quarters, but we do see it trending just a little higher than, say, we saw in the fall of 2018. Regardless, it's a market that is good for brokers, it's good for carriers, and most importantly, it's good for our clients. Looking forward, 2019 brokerage organic growth feels like it will be around 5%. Next, let me talk about brokerage merger and acquisition growth. 2018 was an outstanding merger and acquisition year. We completed 44 mergers representing about $318 million of annualized revenues. I would like to thank all of our new partners for joining us, and I extend a very warm welcome to our growing Gallagher family of professionals. Looking toward 2019, our merger and acquisition momentum continues. So far this year, we have announced seven mergers representing about $130 million of annualized revenue. In addition, our internal M&A pipeline report shows around $350 million of revenues associated with about 50 term sheets either agreed upon or being prepared. While not all of these will close, the continued strength in our pipeline shows our ability to attract tuck-in merger partners at fair prices who are excited about our capabilities and believe in our unique culture and realize that we can be more successful together. Moving to productivity and quality. As I mentioned earlier, lower contingent commissions tempered brokerage margin expansion by about 20 basis points in the quarter. But even with the shortfall in contingents, adjusted EBITDA margin was up 46 basis points in the quarter, a really nice result. The brokerage team continues to work hard to find efficiencies across the organization and further leverage our scale, helping us become better, faster, and deliver higher quality service to our clients. Next, let me move to our risk management segment, which is primarily Gallagher Bassett. Fourth quarter organic growth was a really strong 6.7%, domestic organic was 6%, and international posted 11%. In the U.S., workers' compensation and general liability claim counts are moving higher and finished the year up around 3%. Our insurance carrier business once again grew nicely during the quarter as more and more insurance carriers realized that we can customize and handle claims more efficiently. Outside the U.S., growth was excellent in Australia and the U.K., which reflects our ability to deliver superior claim outcomes for our clients anywhere around the globe. As we look forward, 2019 risk management segment organic growth feels like it will be in the 6 to 7 percent range. Moving to mergers and acquisitions, Gallagher Bassett completed two mergers in the quarter, an Australian-based provider of worker risk management services and a UK-based provider of property repair services. These are two excellent examples of the type of specialized partners we are attracting to Gallagher Bassett. In terms of margin, The risk management segment fourth quarter adjusted EBITDAG margin was increased by 17 basis points. This brought our full year adjusted EBITDAG margin to 17.4% within our 17 to 17.5% expectation. Looking forward, we see margins in a similar range next year as the team leverages its scale through shared services, increases its utilization of our offshore and domestic service centers, and invests in technology and analytics. And finally, I'll touch on what truly distinguishes our franchise, and that's our culture. It is a culture that values teamwork, ethics, client service, and a dedication to the communities we operate in. The core tenets of our culture, which have been part of this company for generations, are memorialized in the Gallagher way penned by my uncle in 1984. Every day, our colleagues get up and work diligently to maintain our culture, to promote our culture, and to live our culture. It is a culture that has also been recognized externally. This past year, we were the only insurance broker to be recognized by Forbes magazine as a world's best employer, and for seven straight years, we have been named a world's most ethical company by the Ethisphere Institute. Awards and recognitions aren't everything, but I believe these continue to show that even as we grow and become more global, our unique Gallagher culture resonates with all of our offices. Okay, an excellent quarter and a tremendous year on all measures. I'll stop now and turn it over to Doug. Doug?

Thanks, Pat, and good afternoon, everyone. Today I'll highlight a couple things in the earnings release and then move to the CFO commentary document we post on our website. But first, as Pat said, a great quarter to wrap up a fantastic year deserves special mention. I'd like to thank all of our worldwide professionals for such a strong finish. Okay, to the earnings release. Pat hit the highlights of the brokerage and risk management segments, so let's turn to page 9 to the corporate segment shortcut table. That's a little noisy, so let me break that down. First, you'll see that we had a terrific quarter for clean energy. Due to favorable December weather conditions, our clean energy earnings came through to post an additional $3 million of after-tax net earnings than we had forecasted during our December 11th investor day. That completely offset the slight shortfall in contingents that Pat mentioned earlier. In effect, a nice weather hedge for our total corporate earnings. I know it isn't technically a hedge, but it certainly worked that way this quarter. Second, you'll see that we had two favorable items that we have adjusted out. So looking at the last line in the fourth quarter table that's at the top of page nine, that's the adjusted line, you'll see that our corporate segment came in about $5 million better than the midpoint average. we provided during our December IR day. The first adjustment is the favorable impact of reorganizing our legal entity structure. A $22 million benefit from releasing the tax valuation allowance. It's not really a cash item this quarter, but it does help reduce our ongoing administrative costs, and it will reduce cash taxes paid over the next 10 years. equates to a couple million dollars a year of cash savings going forward. The second adjustment is an $8.9 million favorable impact from clarifying guidance issued last month related to the Tax Reform Act passed in December of 2017. It clarifies how the U.S. taxes earnings of our foreign subsidiaries. I'll come back to the other corporate segment line items in a few minutes when we get to the CFO commentary. Next, flip to page 10 of the earnings release. The third item from the bottom called other. We did sell a small brokerage unit in January. We thought the product and customer service offering fit better with the buyer's underwriting business, so it ended up being a nice win-win for both of us. Let's go now to the CFO commentary document, to page 2. We've now provided our first look at items for 2019. Two modeling notes. First, amortization expenses. Please take a quick look at your brokerage segment amortization picks. We're forecasting $74 million in the first quarter, and as the footnote says, you'll need to tick that up a couple million a quarter for M&A that we could do for the rest of the year and now get you close. Second, the earnings from non-controlling interest line. Our first quarter is when our brokerage segment has the largest impact from earnings from non-controlling interest. Please double-check your models as this has caused some modeling noise in the past. Let's now turn to page three, to the corporate segment. Let me walk you through that page. First, the blue section is just a reprint of the corporate shortcut tables from our earnings release this year. Next, we've added the yellow adjusted section to remove the favorable tax items I discussed with you a minute or so ago. We believe the yellow adjusted numbers are more helpful when comparing to both the gray section, and that's just a reprint of our estimates given last month during our December IR day, and in comparison to the pinkish section, which is our first estimates for 2019. Let me take each line in that table. Interest in banking. Our fourth quarter came in better than our December estimates, call it a million dollars after tax. Stronger cash flows in the fourth quarter kept us out of our line of credit. Our borrowings are a little bit lower. As for 2019, again in the pink column, you'll see that our estimates for interest expense are going up to reflect our additional $600 million of borrowings, as noted in footnote one on that page, and also in the 8K we filed with our earnings release this afternoon. We'll use all of that for M&A, which I'll touch on later in my comments. Moving down to the M&A expense line, M&A expenses ran a little hot in the fourth quarter, coming in about $4 million more than our estimates. It's simply more external legal and due diligence costs related to two international deals that we've recently announced and one larger domestic deal that we pulled the plug on in December. Looking forward, we see 2019 more like the first three quarters of 2018 than we do the fourth quarter of 18. The corporate line, adjusted fourth quarter came in about $3 million better than our December IR day forecast. Looking forward, we again see 2019 being more consistent with adjusted 2018. So let's go next to the impact of tax reform line. While the guidance gave us a benefit in 2018, unfortunately other guidance takes away a different benefit in 2019. So you'll see that 2019 is more in line with the adjusted amounts in the yellow column. But again, it's very important to remind you that this line is mostly a book expense, not cash, because the additional taxes are nearly all offset by the use of our credits. In the end, tax reform has been a home run for Gallagher. Finally, to clean energy. As I mentioned earlier, fourth quarter came in about $3 million better than we forecasted due to a cold last half of December. When you look at our full year 2018, we estimate that ideal weather patterns contributed about $8 million to our full year net earnings of $119 million. So now, as we and our utility partners look out over 2019, we're not expecting increased production levels from another ideal weather year. Rather, something closer to production levels we saw back in 2017. It's fantastic that we're still forecasting another year over $100 million in net earnings, but we just don't see it as being amazing as it was in 2018. Okay, let's flip to page five of the CFO commentary. you'll see that we've updated our roll-in revenue estimates for mergers that we have announced thus far this year. Usually our first quarter is a little slow, but it's certainly not the case this year. For full year 2019, looks like we can do about $1.5 to $1.7 billion of M&A with free cash and debt. That consists of $300 million of cash on hand. We'll generate another $700 million after our dividend here in 2019, plus an Another $600 million borrowing that I mentioned earlier. Of that, we used, or will use, about $500 million for mergers we have already announced and have included in our roll-in revenues in the table, meaning that we still have about $1 billion to fund additional M&A in 2019. In 2018, our weighted average multiple was around 8.3 times. and it equates to much lower than eight times when you factor in our tax credits, showing that we can execute our tuck-in merger strategy at fair pricing, which gives us a nice arbitrage to our trading multiple. Okay, those are my comments. An excellent quarter to close out an outstanding year, and we're in a really terrific position to continue our success here in 2019. Back to you, Pat.

Thanks, Doug. Devin, I think we can go to questions. Questions and answers now?

Alright, thank you. The call is now open for questions. If you have a question, please pick up your handset and press star 1 on your telephone at this time. If you are on a speakerphone, please disable that function prior to pressing star 1 to ensure optimal sound quality. You may remove yourself from the queue at any point by pressing star 2. Once again, it's star 1 for questions. Our first question comes from the line of Elise Greensman with Wells Fargo. Please proceed with your questions.

Hi, good evening. My first question, going back to some of your comments, Pat, when you kicked off the call, you described the market as stable, but you did say it's a little bit better than the fall of 18, which is good to hear, but that also you've You said organic growth probably around 5%. I know you guys have been talking about 19 being about the same as 18. So you came in at just, you know, 5.6% this year. So is there any reason, I know it's only half a point slowdown, but how you're kind of coming to that 5% that would cause next year to drop a little bit from where 2018 was?

Yeah, I think at least Pat and I are looking at it. I think it's just a little more conservative than we are seeing here in this year. We'll see how our contingents and supplementals come out next year. We'll see if there's any slowdown at all in the economy. We're not seeing it now, but I think a 5% pick feels more like 5% than it is 6%, that's for sure.

Plus, I think, Ilyas, when rates go up a little bit, What we really have a hard time tracking is the opt-out. So, for instance, someone may take a higher retention, bring that premium back down. Someone may drop limits. Instead of buying $100 million, drop it down to $50. It's really hard to track that stuff. So as rates go up, they don't just flow through, which is why when you see us talking about rates up here at 5 and somewhere there at 3 and in Australia and New Zealand, 9, but the impact to the company from rate and from exposure units is only about 1%.

And you would expect it to continue to be about 1% in 2019 as well?

Yes.

Okay. And then another question, you guys are going to be issuing some interest expense. It sounds like the M&A pipeline is very robust. So obviously, we update our models to factor in higher corporate expenses due to the interest expense here, but then the offset should really be that it sounds like there's going to be a lot more revenue flowing through this year. So can you just give us a sense? I mean, obviously, you know, decent uptick in corporate expenses, but is the offset that as you guys kind of model this through internally, you see earnings going up because it's the firepower gives you to finance future transactions?

Yeah, I think, Elise, I think it's important you look at page five of the CFO commentary. For just acquisitions that we've closed and we have announced thus far this year, the role and impact, you know, is $92 million in the first quarter, $80 million in the second, but then there will be new acquisitions that come on there, too. So, yes, if you push up your interest expense in your models, you need to make sure that you put in the role and impact of the acquisitions that we're using that debt for.

Okay, that makes sense. And then so you guys did $318 million of annualized revenue in 2018, already $130 million so far this year. So I guess based off of the strong start to the year and the pipeline that you alluded to earlier, both of you guys, you would expect, I guess, the acquired revenue on that metric on deals that you announced for all of 19 to be higher than 18, I would assume?

Yeah, probably 40% higher, 30% to 40% higher.

Okay, that's great. And then you guys didn't call out just one last margin question. I know there were some acquisitions that were dilutive to your margins in the third quarter, and the thinking was that for the full year on an annualized basis, they would be margin kind of neutral. Did you see a benefit in the fourth quarter, or is that something that we think about more benefiting the first half of 19 margins?

Yeah, it was about seven basis points in the fourth quarter of margin lift, so next to nothing on that. We had, you know, maybe I think for the whole, in the third quarter, it was 40 basis points of memory, so maybe it was 10 basis points of positive in the first seconds and a little bit here in the fourth. So year-to-date, not much.

Okay, that's helpful. Thank you very much. I appreciate the caller.

Thanks, Alicia. Have a good evening.

Our next question comes from the line of Kay Penn with Morgan Stanley. Please proceed with your question.

Thank you and good evening. So my first question is on margin. So if you look at past three years, mentally, I'm drawing two lines. You look at organic growth, 2016, 3%, 2017, 4%, and 2018 is almost 6%. So the organic growth is accelerating. Then the other line is margin expansion year-over-year, about 80 basis points in 2016, 50 basis point 17 and 40 basis point 2018. So why these two lines diverging and can you help us to see is that wage inflation investment you need to make or and we'll try to figure it out in 2019 while the pace of margin expansion better than the 40 basis point you've seen in 2018?

First, I see 19 very similar to 18, so that will help you on that one. In terms of why, I think it really comes down to the fundamental investment layer that's going on inside of the business. We're investing heavily in data, analytics, sales support tools, branding, sales support on the marketing side. So there's an investment layer there, Kai, that's happening underneath. As for actual wage inflation, as you know that we feel like we have a little bit of a safety valve on that with our offshore centers of excellence where we can continue to move work to lower cost labor locations. So the real cost, any additional costs that we're spending are primarily going to things that we believe should help us grow better in the future.

Including producer hires.

Yeah, that's right.

Okay, that's great. And then my second question on the acquisition. It looks like you have a very strong pipeline, and I saw a press release every day So in January, the seven deals seems particularly large, on average about $18 million each, much larger than your normal deal. You're talking about $3, $5, $7 million. Is there a trend that you're getting more larger deals? And also, what do you pay for them? Is that the larger deals tend to command a higher multiple?

Yeah, I think that one that's inflating the first quarter numbers in terms of the the revenue per acquisition as we announced Stackhouse Poland in the UK. We think that's a terrific addition to our growing retail operations there. The multiple on that was above 10 times, but I think our portfolio for the year this year was 8.3 times. And then again, for anything we do in the US, our tax credits bring that number down. As a matter of fact, it ends up being a multiple about 6.9 to 7 times on US acquisitions. The little bit larger one that we're doing here in the first quarter is what's influencing what you're seeing there.

Okay, that's very helpful. Last one, if I may, on your leverage level. With the $600 million additional debt, what's your leverage level? Are we going to see further leverage as you grow your business, doing more acquisitions? or is the leverage level you're going to just go up with the sort of EBITDA growth?

I would get – it's more the latter of what you're saying. This is not a levering up of our balance sheet. We think this is a safe level consistent with what we've done in the past. Our cash flows at the end of 2018 were particularly strong, so our debt ratio dropped down maybe 0.2 turns of – of EBITDA, and we'll reset that number at 0.2, but it's not going to be, you know, you're not going to see us running three times or something like that.

Perfect. Thank you so much, and good luck for 2019. All right.

Thanks, guys.

Our next question comes from the line of Yaron Kinnar with Goldman Sachs. Please proceed with your question.

Hi. Good morning. Good afternoon. Sorry. Good evening. I had a question on the risk management margins. I think you call out a non-recurring favorable settlement in business insurance there. Can you maybe quantify what margin impact that had?

In the quarter, maybe it's, I'm just doing the math in my head here, maybe it's 20 basis points, something like that, 10 basis points.

Okay, so now it's very significant. Yeah, right. And, you know, as we keep hearing these or seeing these headlines about potential recession at some point the end of this year or maybe next year, can you maybe remind us or talk through some of the expense structure, basically what component of that would be variable and what actions could you take to manage expenses should organics start slowing?

Yeah, I think that there's two things. First of all, we're not seeing a recession in anything in our clients at this point. We're seeing our clients continuing to grow. So we're not seeing that yet. But what would happen if they did? I'm going to talk about a slight recession, not a great recession. But usually what we do is we just tighten our hiring a little bit. We typically have not been One, to go to large layoffs. We don't cut benefits back. We don't really cut back on those things that are building our franchise going forward. But rather, what we'll do is we'll be just a little bit slower to hire. And when you're having 10% of your workforce turn over every year, you can tighten your belt a little bit and reallocate work. And that tends to be what you can do in a recession. So the model is highly flexible to respond in a recession. And usually it's just a little tightening of the belt that allows us to get through just a modest recession.

Two things I'd add to that. This is Pat. Number one, Doug started off saying we're not seeing that, and we've checked with our field people, and our clients' businesses are strong. So what's going on right now is clearly not a recession. The other thing I'd point out is I tell our people this all the time. We're in the luckiest spot in the world of commerce. I don't care what happens to the economy. You're going to buy your insurance.

Right. Look, I'm not in any way suggesting there is a recession. I'd say the fact that you're actually – it sounds like you've actually increased your organic growth estimates here because I think only a month ago you were talking about 5% organic for 19 off of a lower base. And so clearly the organic numbers are very strong.

Yeah, we're still seeing 5%. Our best guess for next year is 5%.

Okay, well, I thought you said 5% for brokerage and 6% to 7% for risk management.

Oh, fair enough. Yes, you're right. You're correct.

Okay. Okay. Those are great organic growth numbers. Thanks again.

Yeah, thanks, Ryan.

Our next question comes from Mike Zarmiski with Credit Suisse. Please proceed with the question.

Hey, good evening. On the risk management segment, I guess I'm just a little bit surprised about your guidance for no margin of improvement given the healthy revenue trend and outlook. Maybe you can just quickly, and I think in the past you've also talked about you can squeeze some margin of improvement out as long as organic's above, you can correct me if I'm wrong, above four or five-ish. So if you can kind of talk to the rationale on the guidance there.

Yeah, I think that, you know, we've been saying between 17% and 17.5% on the risk management segment for a number of years now. Would we like to see it at 17.6% or 17.7%? That might happen. But right now, we're pretty comfortable at that 17.5% margin range. In that business, it's not quite as levered as the brokerage businesses. It's still a heavy labor. So you really need, if you go back and listen to it, you really need margin expansion to above 3% in the brokerage space, and you really need organic growth of at least 3% or more to expand in the brokerage space, and you need at least 5% in the risk management space just because it's not heavily as leveraged or geared business. We'll see what happens when we come through the year this year. We'll see what – there's some pretty exciting things that we're doing with some of our domestic service center work, But 2020 might be a year to see more of a step up.

Mike, let me make a comment too. This is Pat. When you write claim business, you better put the people on because the bags of claims are coming. You better have them on, you better have them trained, and you better have them ready. You can't wait until the claims start flowing in to go recruit people.

Okay, understood. My other question is on Pat, you mentioned in the prepared remarks that workers' comp and general liability claim counts are up a few percent year over year. Does that figure include exposure growth, or is that a frequency statistic?

That's a frequency measure.

Okay. I ask because we sometimes use that as a read-through for the carriers.

And I also would say that it also gives you an idea of kind of what's going on in the economy a little bit. When claim counts start to rise, it's usually because there's more work being done by our clients.

Okay, got it. And I guess just a final one, and I don't know if this is a big deal or not, but does your 1Q guidance for clean coal take into account the lovely weather we're experiencing in January in the Midwest and parts of the Northeast?

I don't have those production levels today, but it's pretty darn cold here, and we have a lot of plants in Iowa. Actually, you know, it's interesting. It's electricity use in the south that drives it more than it is necessarily the cold weather in the Midwest because there's so much natural gas in homes. In the Midwest and the north, when you get in the south, it's much more baseboard heat, et cetera. So you really need the cold weather in South Carolina happening a little bit now. But, yeah, we'll see a little bit better on first quarter results as a result of this week's weather.

Okay. Stay warm and good luck in 2019. Thanks. Thanks, Blake.

Once again, if you would like to ask a question, please press star 1. Once again, if you would like to ask a question, please press star 1. Our next question comes from the line of Ryan Tunis with Autonomous Research. Please proceed with your question.

Hey, good evening. Follow up on Kai's question. I was thinking about the wage inflation aspect of things. Doug, if you had to, it's probably just a guess at this point, but what do you think inflation did in 2018? What impact did that have, do you think, on just the expense growth component? Was it 1%, 2%, 3%? Just the wage inflation aspect of things.

All right, there's two components in that. There's the actual raise increase, and that probably was about a 1% pool this year in just terms of wage inflation. And then when you take a look at the replacement cost, this year our average replacement was running about 8% more than what our termination rate was, level was. So that's also a little bit that we're hiring perhaps more technical folks in the data, the analytics area, but we're continuing to become more efficient in some of the middle paid layers as we implement technology and use our offshore centers of excellence. But by and large, as a percentage of revenue, we're seeing wage and replacement inflation somewhere around, as a percentage of revenue, 1.2%. Got it.

That's helpful. I'd like to ask you, what percentage of your workforce in the normal year is a new employee?

We typically replace about 12% of our workforce just through natural sources.

I mean, Doug, in 19, that 1.2, is there more heat on that?

No, I think that's a pretty good number right now. I feel like that 2019, we can operate it at that level.

Gotcha. Then the other thing I wanted to ask about was, again, I don't want to use the recession word, but back in 08, you guys were much smaller in employee benefits. And that's obviously been a pretty big growth area for you guys and competitors as well. But what's really been driving that? Has that been more health? Has that been talent? And how much of that revenue growth is tied to essentially payroll versus just project and hours and that type of thing?

This is Pat Ryan. You've got two things that are influencing that. As we've grown through acquisitions, we've brought on more product offerings for our clients. We're much bigger now in the retirement field. We're much bigger in HR consulting and all the other services that are folded in and around health and welfare. Health and welfare still remains our biggest, and that is, of course, that attaches based on headcount.

population but the rest is a mix of project work most of the HR stuff would be project work and ongoing which you might call annuity revenue from things like retirement and realize too that you know right now even if even if we have an uptick of a point in unemployment right now employers number one issue is the war for talent and that's exactly where our benefits are folks play in that is how do they create a better workforce to attract more talent? Because even if employment goes from three and a half back to four and a half or to five, there's still going to be a war for talent out there. We are not seeing a great recession before, so this isn't like payroll numbers are going to be dropping dramatically, 10%, 12%, something like that.

Thanks for the answers.

Thanks, Ray.

Our next question comes from the lineup, Adam. Cobbler with William Blair. Please see with your question.

Thanks. Good afternoon, guys. Hi, Adam. How did RPS do this year? Was it in line with overall organic or somewhat better or worse? And then on top of that, there's been some dislocation in the ENS markets. Lloyds and AIG are pulling back. Is that a help or is that going to be a challenge for RPS next year?

Well, RPS was basically in line with the brokerage segment in terms of growth and what have you. They are seeing a little bit stronger tailwind in terms of some of the placements they're making in the E&S market. But to your point, you do have some pullback at Lloyds and AIG, but I will tell you, we're finding no problem in particular with the U.S. domestic market gobbling those disruptions up. Business will move from London back into the United States. A D&O policy quoted by Chubb here versus Lloyds there, that will move. So I think there's good growth at RPS, and there's a lot of great cross-sell into the Gallagher organization by our brokers to RPS, and I see that continuing.

Okay, thanks. And then, sorry if you said this, your U.K. business, what's the general outlook in 19 versus 18 for the U.K.? ? for your business?

I'm really pleased with our UK business. I mean, that organic number that we mentioned earlier today is a real, really good improvement. And, you know, the franchise, the retail franchise throughout the UK, up into Scotland as well, is really strong and has just gone great opportunities to continue growing. And our specialty operation in London is second to none in that market and is growing in spite of what Lloyd's is doing.

Okay, thanks. And then as far as sort of same store produce, I don't think you give out that number, but in general, did that grow last year and do you expect it to grow this year?

Yeah, we're up this year, Rob, considerably better than we were in 2017. We typically don't talk about specific numbers, but if 17 were flat up 2%, we'd probably triple that this year.

Well, Adam, you know us pretty well. This is a sales machine. You're not going to be here if you're not growing your book.

Right, right. Okay. Well, thank you for the answers, guys. Thanks, Adam. Thanks, Adam.

Our next question comes from the line of Mark Hughes with SunTrust. Please proceed with your questions.

Yeah, thank you. Good afternoon.

Hi, Mark.

Hey, Pat. You had mentioned maybe a little more tailwind in early 2019. I think you're talking about P&C pricing compared to the fall. Care to expand on that a little bit? What might the magnitude of it be? What's driving it?

Well, I think part of it is you've got good economic activity. I'm trying to get to what my actual prepared comments were, but we're seeing... Rates in the U.S., commercial auto and property up about five, and that's being driven a lot, Mark, by auto. The transportation market is actually tough right now. And property lines, of course, you had the storms, and that's got to be spread out across the book. But at the same time, workers' compensation is down about a point. So I think what you've got is some recovery from the storms in the property market, and the transportation market is driving a bunch of the others.

But you feel like it's a little better in Q1 as opposed to back half of 2018?

Yes. But, Mark, don't adjust your model. It's up slightly. And remember, I talked about the fact that clients opt out. So I might take a bigger retention depending, you know, if I'm a small account, I don't have that opportunity. But any commercial middle market account has levers they can pull to reduce the rate impact.

Understood. On the domestic benefits, I think you were up two. Last quarter you were up five. Anything going on there?

Just a tough comparable to last year. They had a dynamite fourth quarter last year.

And then finally on contingents, I don't know whether you said what drove that. Was it just a timing issue or some sort of shift in the mix on payments? What's behind that?

Catastrophes took our loss ratios up.

Okay.

drove our payments down.

Understood. Thank you.

Thanks, Mark.

Once again, if you would like to ask a question, please press star 1. Once again, if you would like to ask a question, please press star 1. Our next question comes from the line of Mayor Shields with KBW. Please share with your question.

Thanks. If I can just spring off of that last question. I guess I'm surprised that the the travel time between catastrophe losses and the impact on contingents is as quick as it is. Does that mean that there won't be a continued impact from, let's say, California wildfires or Michael in 2019?

Well, remember, Mayor, that with new GAAP accounting, we must estimate our contingent commissions and rather than booking them when we receive them like we have done in the past. So it shows up faster because we have to estimate those today. And so that's the reason why that happens. And I've warned about that volatility since we started talking about new GAAP a year and a half ago that you're going to see a little bit earlier recognition of those things than you would have in the past. And it also is, you know, admittedly a little harder to estimate. But... We take our best shot at it with the information that we have at hand, and it costs us a couple million bucks to score.

Okay, no, fair enough. I feel like I'm missing something here, but there's a footnote with regard to the commentary for brokerage segment amortization excluding Stackhouse Poland.

Yeah, the number, the $74 million excludes Stackhouse Poland, and then my comments would say that you need to tick it up a little bit I don't know where we're going to close that for sure, whether it will be here in this quarter or next quarter. So we just said that we would footnote that it's not in there, but you'll have to increase the amortization in the second and third and fourth quarters. You know, tick it up a couple million dollars and you'll get close.

Okay, that's perfect. And then final question, with regard to risk management, are the economics on carrier business any different from when clients are just retaining a layer of risk?

No, not really.

Okay, great.

Thanks so much.

Thanks, man.

Once again, if you would like to ask a question, please press star 1. Our next question comes from the line of Allison Jacobowitz with Bank of America, Merrill Lynch. Pleased to see you with your question.

Hi. Thanks. Hi. I was wondering if you could talk a little bit more big picture about the acquisition environment. Maybe give some color on... Maybe the nature of the deals you're looking for has changed. I'm curious if you're seeing a change in the landscape of agents or targets approaching you to sell, and also the competition that you're seeing for the companies you're looking at. Has there been any change there, private equity versus other avenues?

Yeah, I would say... The change is that over the last four or five years, there are significantly more competitors for deals, especially deals of size. And that's the private equity world that is very aggressive right now. So what I'm really proud of is that the people that have chosen us have chosen us to win that battle. And that's really what it comes down to. Every one of these, you're fighting to win just like it was an account. And you're going to fight that battle on a bunch of themes. And one of those themes is culture. And if, in fact, what you want to do is sell to someone that says, I'm not going to change anything about you. I'm not going to change your name. I'm not going to change your marketing. I'm not going to change your systems. I just want you to send me the check every quarter and make sure you make as much of a margin as you can. That's not going to be somebody that's going to fit Gallagher. And so that's what we're doing every day is trying to figure out who is going to fit. And then the second thing that I think we're pretty good at that is really important is the entrepreneur going to stay because they are the connection to their people. And the people that are excited about joining us because they are going to get capabilities and they are at a place that is stable and is not for sale are the ones that fit. So, yep, there's plenty of product out there. This is an incredible business. There's, you know, the baby boomers are looking at monetizing their life's work. And we're not just out buying baby boomers. And there are literally thousands of these agents and brokers that aren't even over $20 million in revenue. There's thousands of them. And so we offer, I think, a very, very stable home. I'm proud to be able to say to these people as they come through my office, any account of any size located anywhere in the world, we can do it. Isn't that cool if you're a little broker from, let's say, Cincinnati?

Thanks. You're welcome. Thanks, Allison.

Our next question comes to the line of Yaron Kinnock with Goldman Sachs. Please proceed with your question.

Hi, just one quick follow-up. Doug, I think you said that you were thinking of margin expansion brokerage in 19 roughly in similar veins as the margin expansion we saw in 18. Why wouldn't a rebound in contingent commissions actually drive margins, margin expansion a little higher?

Well, first of all, let's take it a rebound for the full year. If we pick up an extra $3 million of contingent commissions next year versus this year, you know, it's going to move at eight basis points, something like that. So it's not a big number on a $3 to $4 billion basis. It had a little impact in this quarter, but we still posted 46 basis points of margin expansion. So, yeah, a rebound would certainly help in that. But, you know, like I said, if we post 5% organic growth next year, we should be showing that margin expansion similar to what we have this year.

Okay. Thanks.

Thank you.

Ladies and gentlemen, this concludes our question and answer session, and I would like to turn the floor back over to management for closing remarks.

Thank you, Devin. Thank you again for being with us this afternoon. In closing, I'm extremely pleased with our 2018 performance, and I want to personally thank all of our 30,000 colleagues for their hard work and dedication. I believe our long-term strategy will continue to serve this company, our colleagues, our clients, and our shareholders well. 2019 should be another great year for Gallagher. We look forward to speaking with you again at our March 12th IR Day in Rolling Meadows.