Arthur J. Gallagher & Co.

Good afternoon, and welcome to Arthur J. Gallagher and Company's second quarter earnings conference call. Participants have been placed in 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 meanings of the security laws. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to questionary statements and risk factors contained in the company's 10-K, 10-Q, and 8-K filings for more detail on its forward-looking 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 earnings release and other materials in the investor relations section of the company's website. It is now my pleasure to introduce Jay Patrick Gallagher, Chairman, President, and CEO of Arthur J. Gallagher & Company. Mr. Gallagher, you may begin.

Thank you. Good afternoon. Thank you for joining us for our second quarter 2020 earnings call. Also on the call today is Doug Hall, our CFO, as well as the heads of our operating divisions. We delivered an excellent second quarter. Despite the economic deterioration caused by COVID-19, our teams are executing at the highest levels while we continue to place health and safety first. We are servicing our clients, we're selling new business, we continue to look at merger and acquisition opportunities, and our bedrock culture keeps our teams working together even while physically apart. I would like to thank our 33,000 Gallagher professionals around the globe for their constant and tireless focus on delivering the very best insurance brokerage, consulting, and risk management services to our customers. More than ever, these are times when our global capabilities and resources support our local professionals as they help our customers navigate these challenging times and still generate strong new business. That really truly is the Gallagher way. Moving to our second quarter financial performance. We grew our combined brokerage and risk management revenues in the second quarter organically and through mergers and acquisitions, and together with our expense control actions, delivered excellent growth in EBITDA and net earnings. This demonstrates that our investments over the last decade have enabled us to quickly adjust our workforce and expense base, increase the utilization of our centers of excellence, efficiently work remotely, improve our productivity while always raising our quality. Let me break down our results further, starting with our brokerage segment. Reported revenue growth was a positive 6.2%, and even a bit better at 7.6 when leveling for foreign exchange. Of that, 2.1% was organic revenue growth. Net earnings margin was up 364 basis points and adjusted EBITDA margin expanded by 635 basis points to 32.6%. Doug will provide some additional details on our expense control efforts, which was primarily responsible as we drove net earnings up 38% and adjusted EBITDA up 34%. Clearly a very strong quarter and pointed the team execute in a difficult environment. Let me give you some sound bites about each of our brokerage units around the world. Starting in the U.S., our retail P&C business held up very well during the quarter, delivering organic growth of about 4%. Still strong new business generation, a small drop in retention in non-recurring business, rate increases offset exposure unit declines, cancellations were not up over first quarter levels, and midterm policy modifications were still a net positive. but a bit lower than first quarter levels. All in, we are seeing similar trends in our domestic wholesale operations, but a bit of a tale of two cities. Our open brokerage business had mid-teens organic growth benefiting from strong new business and rate. Our MGA program binding businesses were backwards, about 5%, resulting from a slowdown in programs like transportation, amateur sports, and construction. However, When we look at June alone, our MGA and program businesses were showing improvement over the lower activities seen in April and May. We had an excellent quarter in Canada at more than 5% organic, driven by strong new business and higher rates. The U.K. delivered 4% organic, and Australia and New Zealand were closer to flat, where we were not seeing as much tailwind from rate. So exposure declines are weighing just a little bit more on our organic. So overall, our global PC operations reported about 4% organic in a quarter, a really strong result in a difficult environment. Moving to our benefits business, as anticipated, we saw some second quarter weakness down about 3% on an organic basis. New consulting and special project work declined in addition to a decrease in covered lives on renewal business. But we are not seeing covered lives decreasing as much as the headline unemployment numbers When I bring our PC and benefits together, the 2.1% organic here in the second quarter came in pretty close to where we thought it would be at our June investor day. Looking forward, so far in July, nearly every metric we are monitoring is trending better than the second quarter. Accordingly, based on what we're seeing today, we think third quarter brokerage organic and expense saves will be similar to the second quarter. As we move into the fourth quarter, if the economy continues to recover, it feels like organic would equal or even be a bit better than the third quarter, and we should be able to continue to deliver cost containment as well. Still a lot of economic and governmental uncertainty, but that is where we are forecasting today. Before I leave the brokerage segment, let me go a bit deeper on the PC pricing environment. PC pricing continued to move higher around the globe, with most geographies reporting 5% or greater price increases, tighter terms and conditions, and somewhat restrained capacity. By line of business, property remains the strongest, up more than 10%. Next is professional liability, up over 7%. Other casualty lines are up 5% to 10%, with umbrella rate increases at least twice that level. and workers' comp is flat to down 2%. By geography, Canada is seeing the greatest price increases up more than 8%. The U.S. is up about 7%, followed by the U.K., including London's specialty, at about 6%, and Australia and New Zealand between 2% and 3%. So PC pricing is up across the board. but client premium changes are more modest due to lower exposure units, higher deductible, reduced limits, and clients opting out of coverages. Looking forward, I see rates continuing to increase within an already firm market, and early indications from July point to continued increases in the third quarter. Before the pandemic began, loss costs were outpacing rate, and I see just as strong a case for underwriters to push for even more rate in this environment. It is certainly a more difficult market today, but not yet a hard market because most risk to still find a home. Jumping to mergers and acquisitions, we completed four brokerage mergers during the second quarter at fair multiples. I'd 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. While second quarter mergers were lower than normal, the number of conversations with potential merger partners is picking up so far in the third quarter. Difficult market conditions and the pandemic are further highlighting the need for expertise and data-driven tools. Our platform is an excellent fit for entrepreneurs looking to support their current clients, use our tools and data to grow their businesses, and advance their employees' careers. As I look at our M&A pipeline, we have about 40 term sheets signed or being prepared, representing around $300 million or so of revenue. Based on the activity we are experiencing in July, we are optimistic we will return to more normal levels of merger activity later this year. Next, I'd like to move to our risk management segment. Second quarter revenue was in line with the guidance we provided at our June IR day. with reported revenues down about 8.8% and organic down about 9.6%. This reflects a dramatic pullback in new claims arising due to higher unemployment and a reduction in overall business activity, offset somewhat by an increase in COVID-related claims. We think April was the worst of it, and I'm encouraged that claim counts in the later half of the quarter and into July improved off the lows. However, New claims arising are still well below pre-COVID levels. Our risk management team also did a terrific job on cost containment. Adjusted EBITDA was only $2.7 million lower in the quarter relative to last year and margins held, which is also right in line with our expectations. It takes a little longer to turn this ship versus our brokerage segment, so we would expect to see third quarter EBITDA improve relative to second quarter, and then as our expense actions are fully realized, even greater improvement in the fourth quarter, leading to full-year adjusted EBITDA at least equal to 2019. Just a fantastic job by the team to adjust our expense base and rebalance claim loads across adjusters while maintaining our client service and quality levels. So when I combine our core brokerage and risk management segments together, despite the unprecedented economic challenges, we grew our adjusted revenues 5.3%. It grew our net earnings and adjusted EBITDA about 30%. That's truly an excellent quarter. But before I turn it over to Doug, let me finish with some comments on our bedrock culture. When times are tough, teams can either break apart or band together. Since my grandfather started the company in 1927, we have consistently expected every leader and associate at Gallagher to live our culture, talk about our culture, and promote our culture. Culture matters. Culture prevails. Culture is important in the best times, but even more important during challenging times. Our team is together. We respect and support one another. No one is an island. There are no second-class citizens. We learn from each other. Everyone is important. For those of you that have followed Gallagher since we came public more than 35 years ago, you'll recognize those statements as just a few of the 25 tenets of the Gallagher way. This document puts our core values into words, which shapes and then guides our culture, and we believe in it because it matters to us. We live it every day, and it's guiding us through these challenging times. I believe we will emerge on the other side even stronger than we were before. Okay, I'll stop now and turn it over to Doug. Doug?

Thanks, Pat, and good afternoon, everyone. Like Pat said, solid top-line growth and truly remarkable bottom-line performance. Our combined brokerage and risk management at Dusted EBITDA is up nearly 30% over second quarter last year. Many thanks to all of our colleagues around the globe for digging deep on our cost control efforts, all the while continuing to deliver unique insights and high-quality service that our clients need even more in these times. Today I'll spend most of my time on our expense savings, give you some comments using the CFO commentary document, and then finish with thoughts on cash, M&A, and liquidity. All right, let's go to the earnings release, pages 4 and 7. You'll see both the brokerage and risk management segments expanded adjusted EBITDA margins this quarter. Our brokerage segment reduced compensation and operating costs by about $60 million versus prior year when you adjust that for role and impact of mergers closed after March 31st, 2019. In the risk management segment, the savings abounded to about $14 million. So in total, we were able to adjust our expense base by about $74 million during the second quarter. That's at the top end of our estimates that we provided in April and again at our June IR day. Let me give you a breakdown of these savings. We reduced travel, entertainment, and advertising by about $24 million. We reduced technology, consulting, and professional fees $14 million. Reduced outside labor and other workforce actions saved about $13 million. We saved on office supplies, consumables, and occupancy costs of about $12 million, and lower medical plan utilization by our employees saved about $11 million. When I look towards the third quarter, I think savings will be in the $65 to $70 million range relative to last year, again adjusting for roll-in mergers. This is a bit lower than second quarter simply because our production staff is beginning to travel to see clients and prospects. We are increasing our advertising costs again. And in June, we did see a reversion to pre-pandemic levels of our employees utilizing our medical plan. As for the fourth quarter, that all depends on what happens with organic. If we're at plus 2% or plus 3% organic, then our producers are likely traveling more, and we may restart some of our postponed investments. and thus we wouldn't see as much savings in areas like technology, consulting, and professional fees. But if organic is flattish, we'd expect to see a similar level of savings as the third quarter. Okay, let's go to the CFO commentary document that we post on our IR website. On page two, most of the items are fairly straightforward and consistent with what we provided to you in our June IR day. There's two items to highlight, which basically offset one another. First, foreign exchange in our brokerage segment was slightly unfavorable this quarter. Call it about a penny. And second, in the brokerage segment amortization, that came in about a penny favorable, again, offsetting the FX. Flipping to page three to the corporate segment table, relative to the midpoint of the guidance we provide at our June IR day, interest in banking came in about a penny or so favorable. The acquisition line came in just a little bit less than a penny, but still favorable. The corporate line is about a penny unfavorable, but you'll read in footnote three that that was simply due to foreign exchange rates bouncing around in the quarter. Finally, clean energy was a penny below the midpoint of the range due to mild temperatures, more use of natural gas, and weaker electricity consumption due to COVID. A hot July has started off a strong third quarter, but we are still seeing natural gas prices on the lower end and lower economic activity could likely dampen generation later in the second half of the year. So we have lower to bet our full year range to $60 to $70 million net after-tax earnings. But let's not forget the billion dollars of tax credit carry-forwards we have on our balance sheet. That's effectively a receivable from the government that should allow us to pay lower cash taxes for many years to come. All right, let me wrap up with some comments on cash, M&A, and liquidity. Our customer cash receipts were strong during the quarter, rebounding in May and June after a slight slowdown in early April. So far in July, we're tracking back to pre-pandemic levels, so we don't see any concerns at this time. As of today, we have more than $1.3 billion of liquidity consisting of available cash on hand of nearly $275 million, and we have access to over a billion dollars on a revolving credit facility. As for M&A, as Pat mentioned, we did complete four acquisitions during the quarter. A couple were tax-free exchanges, so we used a little of our stock, but even then, with an average multiple paid below eight times, there was a nice arbitrage to our own trading multiples. More importantly, our pipeline is really heating up. So we could have a strong finish to the year and a strong start early next year. Okay, those are my comments, a great quarter by the team for them to continue growing revenues and executing on cost containment. Let's keep the economy from another clinch, we should pull off an excellent full year. Back to you, Pat.

Thank you, Doug. Operator, let's go to questions and answers.

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 the star 1 to ensure optimum sound quality. You may remove yourself from the queue at any point by pressing star 2. Again, that is star 1 for questions. Our first question is coming in from Elise Greenspan with Wells Fargo. Please proceed.

Hi, good evening. My first, hi, how are you? My first question, Pat, or maybe this is, I guess, for Doug, is on the expense phase. So I guess I have a few questions here, but the first one is, you guys expanded your brokerage margin by 6.2%. So what I think maybe gets a little bit lost in the numbers is if we adjust out the phase and 2% organic revenue growth, if my math is right, you saw around 120 basis points of margin improvement. So am I thinking about that correctly? And then I guess there's just some pretty good just margin improvement in your business away from just the phase, or am I missing something there?

No, you have it about right. I think that's right. We didn't get raises this quarter, so that would have dampened the 1.2% a little bit, but you're looking at it the right way.

Okay. Okay. And then I think you guys, you just provided some good color in terms of the staves that we could see in the third and potentially the fourth quarter. If I remember from your June investor day, you had said that kind of post-COVID that about half of the staves, I believe, could persist on an ongoing basis. I just, given you provided some updated figures, I wanted to make sure that guidance still exists today.

Yeah, I think probably when we looked at it six weeks ago, that probably would have been about right. I think right now we are learning a lot as a result of this crisis, and we are finding ways to deliver service and advice clearly more cost-effectively than pre-pandemic. But I think what matters in the end is what we spend will be highly correlated, at least, to how our clients, prospects, and underwriting partners expect us to do business. that will determine really how much we travel, you know, how much we communicate virtually. Do they want to be entertained anymore? How much do we advertise and how do we advertise in the market? And then also it will drive what investments in technology and technical resources that we need in order to service and compete in the market. It also goes further when you look at – what it takes to attract and retain talent. That will dictate a lot on how we leverage our work-from-home capabilities, maybe where we locate our offices, how we configure them. And it also will impact how we train, develop, and mentor our folks. So that will influence the ultimate cost savings. And then also, you know, one thing I have to say, as being experts in employee benefits, we truly hope that our employees get back to utilizing our medical health and welfare plans. We need everybody to be doing their preventative exams and getting the services they need. Nothing good comes from delays in getting your medical treatment. And that saved us several million dollars this quarter. So when I bring it all back together, over the long term, could we be saving $30 million to $40 million a quarter after we adjust the real estate footprint, as we adjust postage, express, office payments? occupancy costs, maybe higher some of the external resources that we were using externally, yeah, maybe we could get to that number. So it wasn't far off as a guess, but it will really depend a little bit on how our clients, prospects, and underwriting partners want us to do business.

Okay, that's helpful. And then on the organic side, Pat, I think you said that the third quarter brokerage organic, you know, seems to be trending in line with the Q2, which is a little bit better than your June investor day. And then, you know, we've been hearing from some, you know, peers that there's some lags in some of the businesses, right? So the third quarter could be worse than the second quarter. Is that business mix that's helping the Q3? Is it incremental pricing? Just a little bit more color on how you see the third quarter transpiring.

Well, first of all, Lisa, as you know, July is a very big month for us. So it's a good bellwether. And we had a very, very strong July. And so I think as we sit here today, if things don't completely fall off the table in August and September, we feel just exactly the way we phrased it today.

Okay. That's helpful. I appreciate all the color.

Thanks, Lisa.

And now our next question is from Mike Darzynski with Credit Suisse.

Please proceed.

Hey, good afternoon. Hi, Mike. Hey, first question, in terms of leverage levels, where could you go to temporarily with the rating agencies if there was kind of something chunkier or larger? Could you go to kind of a materially higher level for a year or two and then then kind of work its way down if something became available?

Yeah, I think they'd be receptive to that. I think we've seen that with other brokers, so that would seem reasonable that they would, you know, be willing to accommodate that. Do we have the appetite to do that? We probably won't push our debt ratios very much at all, but I think they could be willing to listen to that.

Okay. And along the same lines, then, like, so if in terms of kind of making inroads into maybe the mid to large account space as a result of the merger that's taking place, is it more of kind of winning RFPs as the clients look for a new potentially to find another broker because they've consolidated to one, or is it more hiring or both? And if it's the RFP process, is that taking place more kind of next year when – the account comes up for renewal after the merger?

Well, Mike, this Pat, I think you touched on a very good subject. But let me go back to our genesis. I mean, Gallagher Bassett was started in 1962, basically to take care of the claims for Beatrice Foods, a Fortune 100 company at the time. So we've been in the large account risk management business since the 60s. Now, over the past number of years, we've gotten much, much stronger in that business as well, both on the claim service side as well as on the brokerage side. And, yes, I think that the fact that the four top players are going to consolidate to three is clearly giving us more opportunities. And as I said, our capabilities have gotten stronger and stronger, and we feel really good about our chances to expand that business.

Okay, great. And just lastly, back to Elise's question, given just a phenomenal quarter, in terms of margins. So, again, it sounds like, Doug, to your answer about kind of there was margin improvement beyond just the expense savings. And, Doug, it sounded like you were saying, you know, that there was over 100 base points of margin improvement beyond it. And it sounded like that could recur unless, you know, business kind of gets back to usual in terms of entertainment and and more people feel uncomfortable, employees feel uncomfortable going back to the doctor's offices. And so it sounds like that kind of underlying net of expensive positive trend could continue. I guess it's just, you know, I think, you know, sell-side estimates, as we know, haven't come up enough because it's just such great margin improvement during what is, you know, fairly muted organic growth times. So I want to make sure we're understanding.

All right. So first of all, let's go back. What do we think in the future? In the third quarter, we think they're going to be $65 to $70 million of things. We will give some of that back up because there are some costs coming back into the structure. In the fourth quarter, it might be closer to $60 to $70 million. We might have to give back another $5 million there somewhere. But that's the way we sit today. The margin expansion that Elise talked about is two things, is We did have some strength in our supplementals and contingents this quarter, which probably drove a little bit of that margin expansion. Longer term, we think we're learning a lot about our business. I think there could be opportunities here for us to do things differently because our clients' expectations have changed in this four-month period. And the question is, will they stay that way or will they expect to see five people showing up for a meeting for an hour? Or are they okay with our industry experts not getting on a plane, traveling the day for a half-hour presentation? We're finding some really good success in that, that we can put our – niche experts at the point of sale, and our customers are much more willing to accept a virtual face-to-face versus a real face-to-face. So there is going to be some savings on that that survives. So, you know, margin expansion, you know, we've always said it's hard to expand margins if it's below 3%. And we're okay at 2% with a little strength in supplements and contingents. We got a point of margin expansion out of it in the near term. I think it would be pretty hard to post 2% organic growth for the next 3% and expand margins a percentage point a year. I think that would be difficult. Give us over 3%, we can hold in there. Give us over 4 or 5, we'll expand them. So I don't see that changing much from what we provided in the past, but yeah. You know, there's opportunity there, but, yeah, I think that this in the near term, 1% organic, or excuse me, margin expansion on 2% organic is a pretty darn good quarter.

I agree. Be well. Thank you.

All right. Thanks, Mike.

Our next question is from Phil Stefano with Deutsche Bank. Please proceed.

Yeah, thanks. I was hoping you could give a little thought on contingents and supplementals to the extent that you have any forward view into them. I guess were there any catch-ups in first quarter or second quarter that we should kind of try to normalize out? In my mind, in this 606 world, the contingents and supplementals would be a bit more flat than maybe what we've seen or at least actual versus what I've expected.

Yeah, I think there's probably a little bit, a small little bit of catch up in the second quarter. A lot of these things get paid in the first quarter. We have like, you know, hundreds and hundreds of contingent commission contracts, and even, you know, several hundred supplemental contracts. So we probably will have some positive development in our second quarter a little bit, but might be talking a couple million bucks. you know, on an estimate. So the team does a really good job of making estimates. I think what happens in the future because of the pandemic, uh, you know, loss ratios are, are, are hanging in there pretty well. So, and it's, you know, our, our, our cost and value that we deliver right now, I think that we're earning our contingents and earning our supplementals. And I think, I think we've got a pretty fair, uh, series of contracts. I think the carriers, uh, um, that will hold up well with the carriers. So I don't see anything out of the ordinary in this.

Okay. Just to go back to the expense days, and I don't want to beat this too much, but I guess in my mind, thinking about the $60 to $70 million we can expect third quarter, fourth quarter, and then the idea that bringing this all together, maybe we could be $30 or $40 a quarter, who knows what the normal looks like moving forward. Can you give us a sense for how quickly that gap closes? And is 2020 a pivotal year where things come back relatively quickly, or does it really depend on the economy and shelter in place and, you know, the fallout of COVID and all those ways?

Probably more of the second. It is highly dependent on that. I wish I had a crystal ball, and I think all of us would kind of hope that they come back a little bit faster because that means the economy gets back to zooming, people are back to work. I don't mean zooming face-to-face. I mean the economy moving fast and forward. Guys, I think you want to have some expenses coming back in to our number.

Phil, let me hit that too. This is Pat. We haven't gone to see a client in three months. That ain't going to hold up. So don't be pumping your models full of no travel, no face-to-face, no entertainment, no new people. We're writing a lot of new business, and we're going to service that business. And there is pressure in the field to take a trip to see a client. We do have clients that are back at work now saying, just come see us. And we've got very stringent restrictions for health and safety reasons about whether or not we're even letting our people do that. Believe me, we get a vaccine... And our people are going back to O'Hare, myself included. I haven't been on the ground this long since I was 11 years old.

Well, I think the outlook looks great, and I look forward to you guys zooming in anyway. Thanks, Phil.

Thanks, Phil.

Our next question is from Ryan Tennis with Autonomous Research. Please proceed.

Hey, thanks. I guess just thinking about the third quarter organic, thinking it's going to be somewhat similar to this. Behind that, what are you assuming organic revenue growth is going to be for employee benefits to get about 2% again?

I think it would be much the same as what we've got now. I don't see a lot of difference between the third quarter and the second quarter for our P&C business or our benefits business. It was back about 3% this quarter.

And at this point, workers' comp revenues were down, what, you said 10% through mid-June, correct?

Rates are down two, two-ish, maybe 3%, something like that. But if you talk about exposure units being down, I can probably dig that out here for you in a second. But let me work on that.

What I'm getting at, I think, is trying to understand why ultimately – you're not going to have some convergence of the employee benefits, which is only down three, and, you know, obviously you're still collecting on furloughed workers, COBRA, that type of thing, and the workers' comp that's just based on level of payroll. So if we're down like 10 on exposures and workers' comp, I'm trying to understand why we wouldn't think that health and benefits would be down a bit more in the third quarter.

I think that it might have to do with the mix of our business too. As you know, we look at this in high, medium, and low impact industries. When we look at that and stack it up, we have a lot of business that's in very low impact industries. Right now, you're not seeing the decreases in workers' comp and benefits in those industries at this point. Even the medium categories, we're not seeing it. There could be a convergence on it.

A big part of the drop in benefits is also related to project work and one-time stuff that we do when the economy is robust. Then people are willing to spend on, come in and help me communicate with my people. Right now, they're more willing to not necessarily communicate as well. They'll take that burden on themselves. It's projects and things like that that also diminished in the quarter that we'll have to see a return to prior growth to get that kind of project work back. But the underlying health and welfare business does probably look more like work comp.

Got it. And then, Pat, I guess my follow-up is, is it still safe to say that pricing increases are offsetting exposure declines?

Yes.

So is it fair to say then that essentially, on average, accounts are renewing at basically a flat premium?

or down because one of our key jobs is to help those clients in a difficult environment navigate what they spend. So people will take limits down. You had a $100 million umbrella this renewal or this expiration. Do you need 100 next year? Maybe it should be 50. Your retention was 150. Should we take it to 250? There's a lot of work that we do around that that helps our clients mitigate the cost of their insurance while at the same time protecting their future.

Our workers' comp business was down 2% in the quarter. If our benefits business is down 3%, we're seeing it there.

Pat, do you think it's sustainable that pricing can continue to offset exposure declines? Does that feel like something that can happen if we really are in a recession?

Yeah, I do. I mean, for now. If you'd asked me that maybe March 30th, I might not have been as bullish.

Okay. Thanks, guys, for sharing.

Thanks, man.

Our next question is from Yaron Kinnar with Goldman Sachs. Please proceed.

Hi. Good evening, everybody. My first question is, Hi. First question is with regards to the cost phase. I just want to understand, you know, when you're looking at $60 to $70 million in the third quarter, I think, Doug, you highlighted a few bad guys there. Are there other kind of positives that you haven't yet achieved in the second quarter that you think you can still dial up? Or is that $60 to $70 million simply a decline in the positives that you had in the second quarter without any offsets?

Just a couple of clarifications. We can't wait for our employees to get back to using their medical plans. I wouldn't call that necessarily a bad guy. We want our folks to access our medical plans. Fair.

I apologize for using them.

We all know we don't want a severity problem coming out at the end of the year because people aren't getting their annual exams. If that costs us $5 million to $10 million a quarter, we're happy to spend it. I think that Other bad guys, I wouldn't call travel bad guys, so I won't quibble on that. Do we have some other good guys that could come through? I think that we've done a pretty good job in the near term of getting down to a number that's going to be harder to keep than it is harder to create more of them. I think that we're about where we are in this environment, so I wouldn't expect too many good guys to offset the bad guys, using your terminology, coming through in the third and the fourth quarter. So I think our odds are pretty close. And, you know, if you think about it, we gave you an estimate between 50 and 75 million when we came out of the gates here in April, 30 days into it, and we hit 74. So I think we've got a pretty good insight about where we're spending money and what's going to stick and what's going to come back in.

Right. Okay. And I apologize for freezing. Yeah. And then my second question just goes back to the the buckets, kind of high impact, medium impact, low impact, you know, six months into this situation, as you look back, you think, how much of those buckets shifted? Like how much of the what you initially thought was a high impact bucket ended up being in a low impact bucket or vice versa.

All right. So if you look at it, let's say there were 25 SIC codes in there, what we picked in the second quarter. Of the high impact 25, we got 20 of them right. Excuse me, 21 of them right. And then we had three of them in the medium category that probably moved up to high. When you get to the low, kind of the same thing, and the medium, not much. So our pick on low, medium, and high coming out of the gate three weeks into this thing, I would say is pretty damn good. And so I feel fairly comfortable that those are the impact businesses that we forecasted in the near term. we'll see what happens over the next longer term and whether our picks are going to be right again. But we did a pretty good job of it, so I think that we've got a good insight into the nature of our business.

Okay, thank you.

Our next question is from Mark Hughes with SunTrust. Please proceed.

Yeah, just another good afternoon. A crack at the expense. When we think about 2Q next year, is this the kind of run rate on a go-forward basis, kind of a step function on 2Q? And so next year we go back to your usual template of the 3% or better. We get some margin expansion. Is that the right way to think about it?

Yeah, I think you've got to go back and reset and take us basically, if you think about it, we were expanding margins about a point a year, and we've been doing that, you know, 70 basis points a year for the last five or six years. If we get into a 5% organic growth environment, you're going to see us give back some of these savings, and then you're going to also see us just our natural continued, you know, margin improvement programs. You would be back into kind of that 50 to 70 basis point margin expansion on 5% organic growth. So you're looking at it the right way. But would there be a reset compared to second quarter next year? Probably, you know, because if we're back to, if you put in, you know, $30 million or $40 million of expenses and you're taking 70 basis points on $6 billion, you're getting 40 million. It's about a push, maybe a little expansion.

Okay. And then on the benefits business, it sounds like most measures are improving. Pat, you talked about July being very, very strong. I'm not sure if that was completely focused on P&C, but it sounds like 3Q organic in benefits has prospects of being better. Is that a fair read?

I'd say that I think I was referring more to PC and my comments on July, Mark. It's only fair to say. I think what you're seeing in benefits now is systemic, and I think that will continue. Now, I will tell you from getting into the Salesforce data, et cetera, what have you, we did have a good July in new business. So people are still looking at needing help around benefits. both their health and welfare and retirement and all the other aspects. So I think new business will be good. But I do think you have an underlying softness in what's going forward with employment, et cetera. So I would not be predicting a stronger third quarter.

One thing we are seeing, Mark, we're seeing a lot of people on our webinars. We're doing a lot of joint webinars between the benefits and our P&C business. So there is interest in learning more. We did a back to work safety in the workplace webinar. So we are getting customers that are interested in thinking about how their 2021 medical plans and health and welfare plans should look in this environment. So that could lead to some better growth in the fourth quarter or first quarter next year as people are trying to redesign their plans. Third quarter, I don't know if you'll see it quite yet.

Mark, you know that you've heard us say this a thousand times. Ninety percent of the time when we compete, we're competing with smaller local brokers. And believe me, they're wondering now what else is out there. And those relationships are strong for sure. I mean, or our new business would even be higher. We don't win all the time. But just to put this in perspective, in the second quarter, our webinars, as Doug said, we combined property, casualty, and benefits in many of them around things like return to work. unprecedented attendance. We had 60,000 people attend webinars in the second quarter on content and material that we're putting out. We haven't had 60,000 people attend in 10 years.

Interesting. One final question. This question about furloughs, you know, once maybe some of these stimulus packages, the furloughs expire, maybe businesses just won't. and they'll cut to lose the number of employees at that point, and that'll impact your employee benefits business. Do you have any perspective on that?

Yeah, one of the things, Mark, we don't have that many people that actually have been technically furloughed. You know, maybe there's 100 and a half, something like that, that we've furloughed. So I think that, you know, what will happen after the furlough? We're hoping we're bringing them back.

No, I think, Mark, were you talking about our clients? Yes.

Correct.

I think, yes, I think that that is a possibility. I think that when the furlough support and the unemployment support erodes, yes, I do think you could see those people actually have their jobs disappear.

Any sense on the magnitude of the risk there?

No. Thank you. Thanks, Mark. Thanks, Mark.

And our next question is from Meyer Shields with KBW. Please proceed.

Pardon me. Thank you. I have two questions on reinsurance. One is a big-picture question. Pat, you talked to, I don't know, a gazillion insurance company CEOs, and I'm wondering whether you could give us their sense on concerns over reinsurance brokerage consolidation. And then second, I was hoping you could update us on how caps can be performed over the course of the second quarter.

Well, let me take number two first. I think I've said this publicly a number of times. Capscom is the single best startup I've been involved with in my career. And we were very pleased to get the final acquisition of the remaining equity over the line. That team is an excellent team. They've had an excellent first half. and continue to do just a terrific job of expanding that business. And so what we started with five, seven years ago, literally from dead scratch, today is really remarkable. So that team is doing a great job. And they'll continue to. The opportunities, I guess in my career I've seen an awful lot of consolidation. I've gone through If you look at who was out there competing with us, you know, 30 years ago, 20 years ago, and how many of those have consolidated down, consolidation offers us opportunity. And I think Capsicum is very well positioned to take advantage of that. And I'll be blunt with you, the big buyers of reinsurance don't like it.

Mark, we are well over 10% year-to-date organic growth in Capsicum.

Okay, that's all I have. Thank you so much.

All right. Thanks, Byron.

Okay, Operator, I think that's it. And let me just make a quick comment, and we'll say good evening. Thank you again for joining us this afternoon. As we said over and over, we delivered an excellent quarter. It's a difficult economic environment. but I remain confident that we have the right platform and strategy in place to successfully navigate these challenging times for the rest of this year and hopefully in better times next year. Thank you all for being with us this afternoon. We really appreciate it.

This does conclude today's conference call. You may disconnect your lines at this time, and thank you for your participation.