Arthur J. Gallagher & Co.

Good afternoon and welcome to Arthur J. Gallagher and Company's third quarter 2020 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 any time. Some of the comments made during this conference call, including answers given in response to questions, may constitute forward-looking statements within the meaning of the security laws. These forward-looking statements are subject to risks and uncertainty. that could cause actual results to differ materially. Please refer to the cautionary statement and risk factors contained in the company's 10-K, 10-Q, and 8-K filing for more detail on its forward-looking statement. In addition, for reconciliations 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 and Company. Mr. Gallagher, you may begin.

Thank you. Good afternoon. Thank you for joining us for our third quarter 2020 earnings call. Also on the call today is Doug Howell, our Chief Financial Officer, as well as the heads of our operating divisions. We delivered a very strong third quarter. Despite the current global health crisis and the related economic slowdown resulting from COVID-19, our teams continue to execute at the highest levels. While we continue to place health and safety first, we are selling new business, we are servicing and retaining our clients, we continue to look at merger and acquisition opportunities, and our bedrock culture keeps us working together even while physically apart. These are times when our global capabilities, niche expertise, and product specialists support our local professionals as they help our customers navigate these challenging times. I'd like to thank our 30,000-plus Gallagher professionals for their efforts and relentless focus on delivering the very best insurance brokerage, consulting, and risk management services to our customers. That is the Gallagher way. Moving to our third quarter financial performance. We grew our combined brokerage and risk management revenues in the third quarter organically and through mergers and acquisitions, and together with our expense control efforts delivered excellent growth in EBITDA and net earnings. These results demonstrate our operating flexibility, which has enabled us to quickly adjust our expense base, optimize our workforce, improve our productivity, while also raising our quality. Let me break down our results further, starting with our brokerage segment. Reported revenue growth was a positive 8.3%. Of that, more than half, or 4.2%, was organic revenue growth. We did have some favorable timing. I'll discuss that more in a minute. Net earnings margin was up 334 basis points and adjusted EBITDA margin expanded 632 basis points to 33.4%. Net earnings up 37% and adjusted EBITDA up 32%. So another excellent quarter during a global pandemic. A fantastic job by the team. Let me walk you around the world and give you some sound bites about each of our brokerage units, and I'll start with our PC operations. In U.S. retail, another strong quarter with organic growth of about 4%. We saw solid new business and slightly better retention versus last year's third quarter. Rate increases are more than offsetting exposure unit declines. Midterm policy modifications, including full policy cancellations, are similar to prior year levels. And our U.S. wholesale operations, risk placement services, organic was 8%, and our open brokerage business even better than that, while our MGA program binding businesses returned a positive organic in the quarter. Here, too, rate increases are more than offsetting exposure unit declines. Moving to the U.K., around 2% base organic with stronger growth in our London specialty business due to firmer pricing. In Australia and New Zealand combined, also around 2% organic, with New Zealand slightly stronger than Australia. New business is down a touch in Australia and up in New Zealand. Rate increases there remain positive, but not enough to offset exposure decline. And finally, our Canadian retail operations posted organic of 8%, another terrific new business quarter and stable client retention. So overall, our global PC operations reported about 4% organic in the quarter, again, an excellent result in a difficult environment and on the higher end of our mid-September expectation. Moving to our employee benefit brokerage and consulting business, third quarter organic was positive 6%. This includes a large life insurance pension funding product sale that we expected to close in the fourth quarter. Otherwise, new consulting and special project work remains soft, while covered lives under employer-sponsored health plans continue to be more resilient than headline unemployment numbers. So when I bring PC and benefits together, organic of 4.2% and even allowing for the big benefits win, a great quarter. Looking forward to our fourth quarter. First, recall we had a terrific fourth quarter last year, 6% plus organics. So we're starting off with a tough compare. Second, I just discussed some favorable timing here in the third quarter. So I don't see us hitting 4% again. But thus far in October, PC retentions, new business, full policy cancellations, and other midterm policy adjustments are in line to slightly better than the third quarter. So perhaps we can be nicely in the 2% to 3% range. That would deliver a full year 2020 around 3% organic, which would be a great year in this environment. While there's still a lot of economic and governmental uncertainty, which makes forecasting organic a challenge, we can control what we spend. We've demonstrated over the last seven months that we can execute on our cost containment playbook. That makes us highly confident we can deliver another quarter and a full year of really strong EBITDA growth. Now let me give you an update on the PC rate environment. Rate again continued to move higher around the globe during the third quarter. Globally, it caught up nearly 7%, with tighter terms and conditions and increasingly restrained capacity. By geography, Canada is seeing the greatest rate increases, up more than 9%. The U.S. is up about 8%, followed by the U.K., including London's specialty, at about 6%, and Australia and New Zealand around 3%. By line of business, property remains the strongest, up 12%. Next is professional liability, up over 10%. Other casualty lines are up 5% to 10%, with umbrella rate increases at least twice that level. And workers' compensation is flat. So while PC rates are moving higher, the total amount of premium increases our clients are paying are more modest. This is the result of reduced exposure units, higher deductibles, lower limits, and clients opting out of coverages. Looking forward, October results are already indicating continued increases during the fourth quarter, and the carriers, in the face of catastrophe, the pandemic, rising casualty loss costs, low investment returns, are making a case for firm rates to persist. But remember, that's where we excel. Our job is to make sure our clients get a well-structured insurance program at a fair price. Regardless, it is It's certainly a more difficult market today than last quarter, and we are seeing some pockets of a hard market in certain lines and geographies. I see that continuing into 2021. Next year organic should be better than we are seeing this year play out. Moving on to mergers and acquisitions. We completed five brokerage mergers during the third 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. As I look at our M&A pipeline, we have more than 40 term sheets signed or being prepared, representing around $350 million of annualized revenues. And our pipeline continues to grow. 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. Right now, it feels like it will be a more active finish to the year as merger prospects have concerns over possible 2021 tax changes. Next, I'd like to move to our risk management segment, Gallagher-Bassett. Third quarter organic revenue at minus 5.3% was a bit better than what we said at our September IR day. This is a really nice sequential improvement from second quarter organic being down nearly 10%. And our risk management team also did a fantastic job managing its workforce and controlling costs, delivering third quarter adjusted EBITDA higher than last year by $1 million. Looking forward, we are seeing October claim counts trending similar to September. While we have experienced a steady climb out of the second quarter bottom, many clients are still operating at partial capacity and claim counts have not yet fully rebounded to last year's levels. So we're seeing fourth quarter organic revenues in our risk management segment similar or slightly better than third quarter. And just like our brokerage segment, we expect to grow our EBITDA again in the fourth quarter due to expense savings. That means we should deliver on our goal of full year 2020 adjusted EBITDA coming in better than 2019. That's just an amazing job by the team. Before I pass it to Doug, I'll finish with some comments on our bedrock culture. Despite the pandemic challenges, our global colleagues, together as a team, continue to deliver the very best service, expertise, and advice to our clients. I believe it's our unique Gallagher culture that is guiding our team through these challenging times. Specifically, I'm reminded of tenant number 20 of the Gallagher Way. We run to our clients' problems, not away from them. Since my grandfather started the company more than 90 years ago, our people have been solving problems and working hard for clients in both easier and more difficult times. And I can tell you this about our culture. It will guide us through the global pandemic. hurricanes, wildfires, and any other obstacle in front of us. Throughout Gallagher's history, we have emerged as a better, more cohesive company. I believe we will emerge from today's difficult environment stronger than ever. Okay, I'll stop now and turn it over to Doug. Doug?

Thanks, Pat, and hello, everyone. Like Pat said, another excellent quarter. I, too, would like to extend my appreciation to all of our Gallagher colleagues around the globe. What a remarkable job you are doing in these challenging times, servicing our clients, generating new business, all the while executing our cost control playbook. Today I'll begin with some comments on organic and the interplay with our cost saving. That seemed to get a lot of questions during our July earnings call and again during our September investor day call. So I'll spend a little more time on that today. Then provide a few observations from our CFO commentary document and finish with some thoughts on M&A cash and liquidity. So all right, let's go to the earnings release page four to the brokerage organic table. As Pat said, a great quarter with 4.2% all in organic, which equates to about $50 million of organic growth. Then when you turn to page six to the brokerage EBITDA table, You'll see that we grew adjusted EBITDA by $105 million this quarter. So how do we deliver that $105 million on $50 million of organic? First, about $13 million of EBITDA came from M&A net of divestitures. Next, a bid over $30 million came from that $50 million of organic. So that means we saved about $60 million from our cost control playbook. From a margin perspective, All in, we grew adjusted EBITDAG margin about 630 basis points. And then when you do the math, you'll see that even without the additional expense savings, we expanded margin about 150 basis points, which is impressive in and by itself. In the risk management segment, a little easier to compute. Revenues were backwards about 10 million, but EBITDAG grew about a million. So cost savings were about $11 million. Combine both segments, you get about $70 million of cost savings, which is at the top end of our estimates provided during our September IR day, and close to what we saved in the second quarter. Let me give you a breakdown of these savings. Reduced travel, entertainment, and advertising, down about $26 million. Reduced consulting and professional fees, down $15 million. Reduced outside labor and other workforce actions, $14 million. reduced office supplies, consumables, and occupancy costs about $11 million, and reduced employee benefit and medical plan costs about $4 million. Now, when I look towards the fourth quarter, we're starting to see a slight increase in our producers traveling more to see clients and prospects. We are executing on some targeted marketing and advertising programs, and our medical plan utilization continues to return to pre-pandemic levels. But even with that, we're still seeing savings in that $65 to $70 million range relative to last year, again, given pro forma effect for roll-in mergers. Now, moving to the CFO commentary document we post on our investor website. On page two, most of the items are consistent with what we provided to you during our September investor day. Then on page three, in total, the corporate segment came in about two pennies better than the midpoint of our September estimate. The interest and banking line, about a penny favorable. The acquisition cost line, also slightly favorable. The corporate adjusted line, that's in line with our September midpoint, and you'll also see we have a small adjustment for a one-time tax expense related to Brexit. We described that a little bit more in footnote six on that same page. Then in terms of clean energy, third quarter came in a bit better. And you'll also see our fourth quarter estimate is also a bit better. Then on page four, you'll see that we provided our first look at our 2021 estimates based on the preliminary forecasting from our utility partners. It looks like 2021 could be a lot like we're seeing here this year. And then when you get back to page 14 of the earnings release, You'll see that we have about a billion dollars of credit carry-forwards on our balance sheet at September 30. Remember, those credits are fully earned, and while we are using some currently, the big return comes between 2022 and, say, 2028, when we will use those credits and thereby harvest about $150 to $200 million of annual cash. Sure, book or gap earnings of 60 to 65 million will go away in 2022, but instead we'll have that $150 to $200 million of cash earnings in those years. As for M&A, you heard Pat say, we have a really strong pipeline. I think there could be a flurry of activity between now and year end, given what could happen with taxes. So we're really well positioned for that. We have more than $1.6 billion of liquidity consisting of available cash on hand of nearly $550 million and more than a billion dollars of borrowing power on our revolving credit facility. Okay, those are my comments. Thanks to the team for another great quarter. I think we're well positioned to pull off a terrific 2020. Back to you, Pat.

Thanks, Doug. And, Operator, I think we're ready for questions.

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 optimum sound quality. You may remove yourself from the queue at any point by pressing star 2. Again, that's star 1 for question. And our first question is from Joe Stefano with Deutsche Bank. Please proceed with your question.

Yeah, thanks. I'll start with a quick numbers question. The timing impact of the large life pension fund product, did that have any margin bump to it in the quarter or any one-time impact there?

No more or less than any of other our business. That was in that $30 million. We had $50 million of organic growth that included the one-time or the sale that we had there. And if you assume about 60 points of margin on that business, you get about $30 million. So no more or less than what their other business has.

Okay. Got it. And so, Pat, I think it was in your initial comments that you made the remark that next year organic should be better than we're seeing this year play out. And I was hoping you could talk a little bit about the extent to which stimulus plays a role in that. and how government support might be a moving mechanism, or at least how you felt it impacted you through 2020 to use for us to contemplate in 2021.

Well, I think for sure in 2020, in terms of a pressure release for our clients, as we got into the summer, it was huge. I mean, it just made a huge difference in terms of giving businesses an ability to keep their employees and to keep their businesses going. and quite honestly, to pay their insurance bills. So I do hope and do believe that stimulus will be brought about in the new year, and I think that, again, will be viewed as a very strong positive for the economy and for our individual businesses. I can't put a specific number on that, Bill, but anything that keeps the economy chugging along, as you well know, our entire business is predicated on exposure units. Yeah.

Okay. And the last one I got for you, and it's an unfair question, so I apologize, but we are getting a lot of questions from our end about the concept of brokerage margin expansion and the extent to which expectations should be up, flat, or down for next year. And it's something of a crystal ball question depending on how the economy unfolds and such. But I know that this question is something that's important to investors' minds. So if you have any thoughts about how we should contemplate this that would be appreciated.

All right. I don't know if it's an unfair question or not, but I don't know if it's an easy answer. So let me see if I can help you with that. Let's take a couple things that we know. First, as I said in my prepared remarks, we should be able to hold most of the expense savings that we're seeing here in the third quarter when we hit our fourth quarter and our fourth quarter right now. Then the next question is, let's go out one more quarter. Let's say to first quarter 2021. You know, absent a miracle, I just don't see that quarter much different than what we're seeing here in the fourth quarter. So let's say that we can hold 60 to 70 million of that, the savings that we're seeing now. The finesse is this. Now, you've got to jump way out to 2022. So let's just go to 2022. I think that we're turning the pandemic adversity into a real advantage for Gallagher. We've learned a lot in this short period about our business and how our clients are operating. So over the next 15 months, we believe a good portion of those savings that we're seeing now could become permanent. So let's call that half or 30 million bucks. So that leaves really what happens in the second, third, and fourth quarters of 2021 to fill in. The answer to that, I believe, kind of lies somewhere in between. I should have a better answer when we get to our December IR day, but what will stick of the $60 to $70 million or $65 to $70 million, we'll figure that out here over the next six weeks and have a better answer for you in December. Regardless, if you... get out to 2022, we believe there could be over $100 million of savings, annualized savings, that we might not have realized by 2022 had there not been a pandemic. So it has pulled together our efforts to re-look at our business and change some of the ways that we operate. So there will be permanent savings there relative to where we would have gotten on our own, let's say, without a pandemic by 2022. How that actually emerges in 2021, I'll have a better idea as we go through our budget and planning process over the next six weeks. So I hope that helps get you partway. I don't know if it's a complete answer, but that's what we know right now.

That's better than I hoped for. Thank you. That's perfect.

Thanks, Bill.

Our next question is from Elise Greenstein with Wells Fargo. Please proceed with your question.

Hi, thanks. Good evening. My first question, I guess, kind of picking up on that margin question. So, Doug, that kind of helps us think through the expenses, but then the second portion, right, is that, you know, Pat alluded to, right, organic revenue growth in 2021, it feels like should be better than 2020, right, which you guys have said should end up at around 3%. And so this quarter, right, you saw about 150 basis points of margin improvement, right, off of your organic revenue growth. So how do we think of that component of the margin, right? So you're growing organically over 3% next year. What's the component of underlying margin improvement that we should think about adding on to whatever expenses can be realized?

I think that you'll see, if we hit 3% organic growth next year, absent all these savings, there's a half a point to three-quarters a point of margin expansion in that 3% number next year. If it's 4%, maybe we get back closer to a full point, which isn't all that dissimilar to what we were running pre-pandemic. If you draw a line between 2017, we were marching up in margin every year, and you draw that line out to 2022, whatever you would have gotten in 2022, add another $100 to $120 million of savings to that, and you'll get pretty close to where we think the margin would be in 2022. So our march forward hasn't changed on the base organic piece.

Was there anything, though, then, that was one-off that you saw 150 basis points this quarter? I mean, obviously, there could be quarterly seasonality on, I guess, 4% organic or 3% at the one-time item?

Well, I think when we're at 4.2% organic this quarter, I think we would see over a point of margin expansion. That's probably not out of whack for other quarters in the past where it's 4.2%, but nothing that really pops out at me. We did have some headcount savings in there. Our hiring hasn't been as robust as it has in the past. raises have been deferred a little bit. That might influence a little bit, but there's nothing one time in there that I would point to.

Okay, that's helpful. Then a couple questions on M&A. The first one, I believe at your last IR day, you alluded to some modestly larger deals, I want to say in the $25 million range that you thought could come to fruition. Am I looking at the activity this quarter that hasn't happened. So are those some of the deals, I guess, that you guys alluded to that maybe could come to fruition in the fourth quarter as deals get done in advance of potential tax changes?

That's right. There are two nice $25 million revenue acquisitions that we're nearly done with due diligence on. We've had board approval on it, and we hope to get them wrapped up between now and the end of the year.

Okay. And then my last question... So as we think about larger M&A, it's been a few years, right? Gallagher expanded internationally, Australia, New Zealand, Canada, and the UK. And so if you guys were going to consider another larger transaction, Doug, you alluded to the debt capacity as well as cash that you have. Is there a sizable deal in the market that perhaps you chose to use more of your equity than you have in the recent times, would there be certain metrics, be it revenue, earnings appreciation, or something that you guys would be looking to if it was a more sizable transaction that potentially required the use of your own equity?

Yeah, we'd do the traditional review of that to make sure that it wasn't dilutive and that there were synergies that we could take out of it. But really, to be honest, Elise, we like our tuck-in merger strategy. This is our opportunity to pick every single one that wants to join the family. We have fair multiples on those that we're paying for them. We integrate much better into one another. We like our small tuck-in strategy at this point, and there's lots and lots of opportunity for that.

I think that's a key point. This is Pat. When you look at the top 100 in business insurance in the United States alone, that doesn't recognize the rest of the world. you still have another 19 to 25, maybe even 30,000 firms out there that are not in that top 100. And a good portion of those are still owned by baby boomers. So the opportunity to do these tuck-ins is just way, way greater than the large play.

Okay, thank you. I appreciate all the color. Thanks, guys.

Thanks, Liz. Thanks, Liz.

Our next question is from Greg Peters with Raymond James. Please proceed with your question.

Good afternoon. Just a couple of follow-on questions. If you were pointing to, I think, page five or six of your press release, six, where you go through the adjusted EBITDA margin, and I think through the nine months, Doug, you reported a 33.6%. EBITDA margin on an adjusted basis. And I know you're doing a good job of chronicling how much of the savings should extend themselves beyond just the opportunity you've had this year. At what point do you hit that threshold where you can't grow margins because you have to invest in the business? Or put it another way, at some point, you can't turn this into a 50% margin business, or maybe you can, you just haven't mapped it out for us yet.

Listen, trees don't grow to the moon. I think that there are plateaus when you reach them. I think when you get into that 30% to 32% type range as an annual margin in a brokerage segment across the globe, that's a pretty fair margin to have. But scale does bring advantages, and this is a, you know, the brokerage business is showing that size can be helpful, especially with size in the same fairway that you're playing. If you can get more acquisitions that are right down the middle of the fairway using the technologies that we've developed, using our offshore centers of excellence, our centralization that we've worked on for 15 years, We think that there's still terrific opportunity for us to roll in and have nice, steady margin improvement. If we're growing over 3% or 4%, I think you can eke out a little margin just because of scale. And some of that depends on wage inflation, too. I mean, we are a people company. And we are lucky that after the Great Recession that wage inflation remained in check. Perhaps here the pandemic will keep wage inflation in check a little bit. But we are a people company, so raises are something that we want to give. But if we can keep wage inflation in check, I think that you can eke out some margins.

Just as a follow-up to that comment, when do wage or salary increases typically happen for staff? Is that a beginning-of-the-year event, a mid-year event? When does that generally hit?

Kind of late second quarter, early third quarter. It's a little bit later this year. We'll do that here in December.

Got it. In the balance sheet, I noticed that the premiums and fees receivable jumped up from year end. And I'm just curious if there's anything in that increase that is troublesome or if that's expected on plan or just some color behind that? The numbers I'm looking at are in the balance sheet, the 6702.5 versus the 5419.2. Yeah, okay, good question.

First of all, we look at our cash receipts every day. We're not having any slowdown at all from the premium payments coming in. So we don't have a liquidity issue there. And again, I just looked at the report at two o'clock this afternoon and our October is equal. Since the pandemic, our cash flows have been equally, if not better than what they were in pre-pandemic times. So that isn't it. We do have some, as we have a reinsurance operation now, you can get some significant reinsurance premiums that flow through that can cause some of that to be a little more volatile. But there is nothing there that is at all indicative of any type of slowdown in payments by our customers in that.

So, in other words, DSOs have remained fairly stable this year relative to previous years?

Yes, that's right.

Got it. I guess the final question, and I know you've already provided a lot of commentary around M&A, but I can't help myself but go back to that. First of all, Pat, when you're talking culture, I know it's very important to you. When you're looking at M&A opportunities, are you willing to consider M&A that has a slower organic growth profile? Or put it another way, is the deals that you've done in the last couple of years, have they boosted your, you know, have they been a net gain to organic revenue on a consolidated basis, or has it been neutral or been a headwind? Does that make sense?

Oh, it certainly hasn't been a headwind. And the nice thing about tuck-ins, Greg, is that, you know, if you get the right folks on, sometimes they can be terrifically accretive. But by and large, I think when you add all this, it's probably right in line with the rest of our organization. And, you know, we're seeing lots of opportunities. But again, you've You followed us for years. It's not brain surgery. Culture is absolutely critical. And I'd like to sound more sophisticated. We try to find people who care about their people, love this business, and run a good business. If they can't make money for themselves, they're not going to make money for us and our shareholders. But once they cross that hurdle, it's really got to be about are they going to fit culturally and are they going to really be able to take advantage of of the things that we bring to the table. And I think you've heard me talk about this before. I tell them that when we bring them here to Rolling Meadows or they join one of our offices out there, we open the curtain and show them the candy store. And they're like, whoa, I've got all this to work with now? And when that happens, it opens up, in many instances, accounts that are local to them. And we're very strong in our local communities. We want to help them build that strength. And accounts that they never had a chance to touch because of their size are now open to them because really there's nothing that we can't help them tackle. And frankly, that gets them excited. So for us, are they going to stay? Do they love selling insurance, which I know sounds crazy, but there are some of us that were born to do that. And the fact is, those people end up being with us a long time, building great businesses, having a great time doing it. And it really does come down to cultural fit.

Right. Well, I know you've described it before. I don't think you've used the phrase candy store with me, but it doesn't mean you haven't used it before.

But you understood what I meant, right, Greg?

Oh, absolutely. There you go. So the final piece on M&A, obviously there's a lot of stuff going around the election, anticipation of maybe a change in tax rates in the U.S., et cetera, that may happen. lead to accelerating deal flow. Are you seeing any activity in Europe? Are you seeing any change in the flow of potential deals outside the U.S.?

Yes, and I'll tell you why. It's exactly what we told you in 2014 when we did our transactions in the U.K., Australia, and Canada in particular, and now in Europe and Latin America. Once we've got a platform that gives people confidence that we're really there to stay, then the smaller broker has something to look at that is not just getting a new name or changing where they send their reports. They get the benefit of the fact that we've got scale, we've got brand recognition, and we have capabilities. So, yes, our pipeline in the U.K., our pipeline in Australia, Latin America – New Zealand and continental Europe are stronger than they've ever been.

Got it. Thank you for the answers.

Thanks, Greg.

Our next question is from Mike Zeromski with Credit Suisse. Please proceed with your question.

Okay, great. Maybe we could talk about risk management a little bit. I think from the prepared remarks, it sounded like claims counts were continuing to improve but still down. Maybe you can put some numbers around. Work comp and GL, are those still down double digits year over year? What do you guys, any update on the outlook for the risk management segment? I mean, margins improved more than We thought probably maybe you can talk why margins improve more than expected as well.

Yeah, I think the question is what type of claims. I think the more difficult claims that are arising that, you know, they're kind of the churn business is still down, maybe 20 to 30 percent on the small, but we don't make a lot of money off of those anyway, so they're kind of low margins, so that doesn't hurt us so much. I think we have had a little bit of boost in settling claims that have risen because of COVID. And so there are complicated claims. They're still there. And so that has helped this business be more resilient. If you think about it, it might be more of a lost revenue story than it is a lost profit story, as you can see by the margins. So the advantage we have is that we've held on pretty well, being only down 5% this quarter on a revenue basis. As we get a vaccine, as things start to improve, you will have that business come back in and hopefully be nicely in the positive organic space next year.

Okay. Maybe stepping back and thinking about brokerage again, one of your competitors today I think kind of hinted at, you know, maybe pricing had reached a point that, you know, you know, had reached its limit. At least, you know, there's definitely some businesses that are experiencing some fairly, you know, high double-digit rate increases. And I think that your competitor alluded to maybe the carriers, some are getting enough freight and maybe we're at peak freight. Any thoughts about kind of what you're hearing and seeing from the carriers? And, you know, it feels like there's some new capital coming coming into the spaces as well?

Well, there's clearly new capital coming in. And I will tell you that there is zero interest from the people that work, the partners we're talking to at modifying rate increases at all. I mean, they're not getting any rate of return on new invested dollars. Social inflation is killing them. Lines of coverage that have been under attack for years while the market stayed soft continue to raise their head. I see nothing in the way of softening or stopping the momentum. Now, remember, again, we tried to give you some detail in our prepared remarks. Workers' compensation is about flat. They make good money on workers' comp. Workers' comp is competitive in the United States. And our clients benefit from that. And remember, our job is to make sure we do everything we can for our clients to make sure the hard market doesn't cripple them. So it's not like I'm sitting here saying, yay, this is, you know, it's getting harder by the minute. But I can tell you, when you talk to the people that are the actual providers of capital, they're not seeing light at the end of the tunnel being Yahoo or back to softening, that's for sure.

Okay, great. And just lastly, just making sure, Doug, nothing supplementals and contingents that was unusual this quarter?

No, not this quarter. Not this year at all, as a matter of fact.

Thank you very much.

Thanks, Rick. And as a reminder, if anyone has any questions, you may press star 1 on your telephone keypad. Our next question is with Josh Shanker with Deutsche Bank. Please proceed with your question.

Yeah, good evening, everyone. Thank you for taking my call.

Thanks, Josh.

So I was curious, you know, historically, I guess for a number of years, we've been in a middling market, and I think that benefits brokers who have a lot of visibility on pricing, and maybe it disadvantages carriers in the negotiation with the client. As things are perhaps changing, is there anything benefit being given to the carriers in that negotiation where the client demands or would encourage some more competitive fee structure from the broker? Is there any renegotiation going on at that level?

One of the things that always happens, and this is since 2006 in the United States in particular, we've been completely transparent with our clients on what we make. And We are not feeling huge pressure on the income that we make for the extra work that we're doing today. And that's another reason when you look at fees and what have you, that even if rates were up 25%, you're not going to see our revenue jump 25%. That wouldn't be a fair transaction. But at the same time, there's a lot more work, and it's our expertise now that we're selling that sells a lot better in a hard market than it does a soft market. In a soft market, the person down the street that hangs a shingle off can get you five quotes. Well, you're not getting five quotes today. And you better work hard with somebody who's got some real, dedicated, inside, clear understanding of your business that can differentiate your risk from and you're approached a risk to that underwriting community, or you're going to get whacked. And so our services are more valuable than ever. And you're right. We went for about 10 years, and you'll recall in my conversations on these conference calls, I always alluded to the fact that I don't like hard markets. And everybody would say, and when the rates were up one, down two, up three, sideways, flat, that was perfect for clients. It gave them a chance to choose. It gave us a chance to be able to say this market or that one, put them together this way, build the tower this way, and it was really another way to show our expertise. Now this is a time where we've got to give good counsel, and they've got to understand that in many respects it's a seller's market, and we'll get them through it. No, it won't last forever, but now is the time to make sure you're partnering with someone that knows what they're doing. And we're getting paid.

That's very clear. And on Gallagher-Basic, can you talk about the throughput of workers' comp claims and what the marketplace is shaping up to be with lower employment or with work at home and how that changes the services you provide there?

Well, the services we provide there, Josh, they're not different in the sense that if you have a workers' comp claim, we're going to handle it. There's all kinds of protocols, state-by-state rules, regulations, et cetera. There are fewer claims when you're not in the office, you're not in the factory, you're working from home. There are clearly fewer claims and fewer accidents. And when economic activity regains itself and people come back to the places of work, we expect that those claims will reflect that. But in terms of how you deal with someone that gets hurt, we still have to follow those state rules, and we still have to adjust and adjudicate the claim, which we think, if you use Gallagher-Bassett, will give you a better outcome.

And in terms of flow of claims incidences?

I'm sorry, you broke up, Josh. What was that?

Claims incidents during the pandemic, how is that shaping up?

Incidents are down. Significantly down. That's the whole reason. When we talk about claim counts, that's incidents.

Yep, yep. And does that change the service or the fees? They say, well, look, you know, we don't – in terms of your interaction with the clients for Gallagher Baptist, does that change what you can charge or does it change the negotiation at all or is it basically a fee for service?

No, no. It doesn't at all. Okay, great. Thanks, Josh. Thank you.

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

Hi, good afternoon. Thanks for taking my questions. A few timing questions, if I could. One, you're talking about M&A maybe being a little bit, the pipeline being robust here as we head into 2021 because of the potential tax impact there. Do you think that could mean that there's a bit of a lull in M&A as we enter 21?

I don't think so. I mean, you know, when I look at it, it really is a very interesting market, which is why you see, you know, it was not that long ago that there were very few billion-dollar brokers. Today there's about 11 or 12 of us. By that I mean revenue. That's why private equity has been so prevalent in the business, which is good for us because private equity is smart money telling the investment community we're a great bet. But the fact is there are thousands and thousands of independent agents and brokers that ultimately have a chance to capitalize their life's work, and I think that's not going to stop.

Okay. And then can you remind us, when in 2021 do the 2011 clean coal plants sunset, do the tax credits sunset?

Okay, there's two answers to that. Our plants that we operate will sunset mostly in late November, early December, absent an extension. For those plants that we don't operate, that our KibMod affiliate that we own a substantial piece of that gets a royalty off, those could stop production sometime more in the late third quarter. early fourth quarter just depends on it's ten years from the date that they were placed in service so if they were placed in service before December of 2000 then they would be they would sunset a little bit earlier so that's why on page five of the CFO commentary you'll see that our royalty income is just we're forecasting that just to be down a little bit relative to 2000 because some of those will sunset just a little bit earlier.

Okay. Okay. And those last couple of months of the year don't tend to be very large months from the clean coal perspective, right?

You know, it can be. You get a cold December and you can, you know, the southern plants that are dependent on baseboard heat, electric heat, would be. And, again, you know, I can't miss the opportunity to reinforce just because, again, 60 to $70 million of gap earnings go away. That's, you know, right away we'll flip in 2022 and to, to harvesting all the credits that we've been generating over the last 10 years. So that's, you might almost double the amount of earnings on a cash basis versus then on a gap basis at that time.

Right. And then final timing question, the contract that you pulled forward into the third quarter in brokerage, does that get renewed in the third quarter of next year?

Well, first of all, I wouldn't say we pulled it forward. They just got it closed sooner. So that was great work by the guys that have been working on that product for a while. That's going to be an occasional sale. I don't think that it's something that would repeat year in and year out. It would be another customer that would happen to see the real smarts in this product and decide to close it in third quarter next year. But that would be hit and miss. It's a little bit more elephant hunting on that. So call it that. If you close one every 18 months, that would be great. But who knows? It's a terrific product that's getting some momentum. So we might see it a little bit more frequently, but I'd be happy with one of those every 18 months.

Okay. Thank you.

Thanks, Sean. And our next question is from Ryan Tunis with Artemis. Please proceed with your question.

Hey, thanks. Good evening. I just had one question. So employee benefits, I might have missed this, Pat, but I thought you said it was plus six, but that included the one-off transaction. That's right. What was the organic excluding that within the employee benefits unit? Hold on.

Flat to 2%. I mean, let's call it 1.3% if I look at my notes.

Got it. And then just looking for an update, obviously that is a business that economically impacted it at a lot of the other brokers. We've had three quarters in the recession. Are you learning anything new that would change your organic outlook for employee benefits, or is it still kind of the same story you've been talking about in previous quarters and the mid-quarter updates?

I think the thing that's probably... most beneficial to our business that we learned and first of all thanks for the question around when we when we look at the business in general and say what have we learned over the last seven eight months about what can happen how this business can be run where people can do it how expertise can be exported around the world I mean we've got experts in in in verticals that are world-class and you want to try to get them to a prospect or a client, you can use up a whole day or two days of travel. Today they can drop in by video call, and bam, they're there, and people accept that. So we've learned a lot, and there's lots of opportunities for our business because of that. But I think probably the thing that reemphasizes why we're so high on the benefits business is even in this pandemic and even with the recession that hit, The amount of employees that stay employed, the employers holding on to their people, it's incredible. I mean, we thought in March and April, get ready. The floor is going to drop out. Everybody's going to let everybody go. And, of course, I'm being facetious. But the fact is this war for talent, ongoing, long-term, what's your product? I don't care if you're making big steel drums. You're a people business. And people are holding on to their folks, and our censuses, by account, have not dropped through the floor. And people are saying, and as we come out of this, to me, it just makes that business even better. which demands incredible expertise to balance all the costs and all the covers and to make sure that you are, in fact, providing what the employees need, but that you also make sure through communication that they understand that they're better off with you. So basically it's really put us in a spot to want to double down on that business.

Got it. Understood. Thanks.

Thanks, Ryan.

And our last question is from Mayor Shields with KBW.

Please proceed with your question. Great, thanks. Just a small question. I feel like I missed the amount of the employee benefits contract that was signed earlier than expected. Have you given quantification of the actual revenue?

No, we really haven't. I think you could probably do the math, but it was about $12 to $15 million. Okay.

Okay. I can do the math now.

Thanks for making it easy, teacher.

The second question, I know there's been sort of a long-term strategy at Gallagher of moving clients along to self-insurance over time. Has the pandemic interrupted that at all?

No. I mean, in fact, if anything, it's made it more of a crucial conversation because it's crunching businesses. And, you know, when the economy is good and employees are being hired and there's There's fight over employees because of a full employment. Those times are heady times for many, many people. And, yes, financially we can always point out to those businesses why considering a large self-insured retention, bringing Gallagher Bassett in, getting better outcomes on your claims makes for better control of not only your insurance purchase but your entire risk management program, and we do a good job of selling that. You put a buyer against the wall, they're all ears. And we're really good at moving people from first-dollar cover into a form of risk management, risk retention, group captives, et cetera. That's our heritage.

Typically, when you have increasing pricing, an account that a customer that has really good loss experience is more willing to look to a component of their program being through self-insurance, and as prices go up, that gets their attention. And we do a lot of workers' comp in this, and workers' comp has had rate cuts recently. It's flat right now. I think that if workers' comp goes down, goes hard, I think you'll see considerably more folks with good experience or companies wanting to look at alternative risk transfer.

Well, Doug hit on something. I think this has been the dilemma that really wasn't talked about during that 8 to 10-year period where the market was relatively soft or was flat. When the market starts to firm, one of the dilemmas for the insurance carriers is they need the entire base to give them more rate. The better units of risk... look to move out of that buying community. And so now you're taking from the insuring community their better units of risk, leaving them to fight over what is maybe not the best units and even needing more rate. And that is when the competition thins, because there just aren't thousands of people that can do what we do.

Okay, no, that makes perfect sense, and that was very helpful. Final question, and I may have just been modeling this incorrectly, but the investment income in the brokerage, the investment income and net gains on divestiture has ticked up something like $3 million from the second quarter to the third quarter. Should we expect that sort of seasonality, or is that just randomness?

All right, so there's two questions there. What happened with investment income, right? What you're saying, well, listen, first, some of the numbers running through there have to do with our premium finance business down in Australia and New Zealand. But let me give you the punchline on it, is we are down somewhat in investment income, just in true investment income that we earn on the premium trust accounts, et cetera. We are down Probably in the third quarter, somewhere around $4 million, $3.5 million from where we were last year. So you would be seeing that right.

Okay. That is very helpful. Thank you.

Thanks, Mark.

And we have reached the end of the question and answer session. I will now return. I'll call back over to Pat for closing remarks.

Thank you very much. Let me give you just a quick comment. Again, thanks everybody for joining us this afternoon. We delivered an excellent quarter in the first nine months of the year in the face of a difficult economic environment. And again, I'd like to thank our 32,000 plus Gallagher professionals for their relentless efforts and dedication. I remain confident that we can deliver another outstanding year of financial performance and successfully navigate these challenging times Thank you again for being with us. We really appreciate it.

And this does conclude today's conference call. We may disconnect your line at this time. Thank you and have a good day.