Arthur J. Gallagher & Co.

Good afternoon, and welcome to Arthur J. Gallagher and Company's fourth quarter 2021 earnings conference call. Participants have been placed on a listen-only mode. Your lines will be open for questions following the presentation. Today's call is being recorded. If you have any objections, you may disconnect at this time. Some of the comments made during this conference call, including answers given in response to questions, may constitute forward-looking statements within the meaning of the securities laws. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the cautionary statements and risk factors contained in the company's 10-K, 10-Q, and 8-K filings for more details on its forward-looking statements. 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 J. 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 fourth quarter 2021 earnings call. On the call for you today is Doug Howell, our CFO, as well as the heads of our operating divisions. We had an outstanding fourth quarter. For our combined brokerage and risk management segments, we posted 18% growth in revenue, 11% organic growth, net earnings growth of 11%, adjusted EBITDA growth of 17%, and we completed 18 new tuck-in mergers in the quarter. That's on top of closing our Willis re-merger. All told, for the year, our merger strategy added more than $1 billion of annualized revenue. That's just fantastic. Needless to say, I'm extremely proud of how the team performed during the fourth quarter and the full year. So let me give you some more detail on our outstanding fourth quarter performance, starting with the brokerage segment. During the quarter, reported revenue growth was an excellent 19%. Of that, 10.6% was organic, another sequential step up from the third quarter and the fourth consecutive quarter of improvement. Net earnings growth was 8%. Adjusted EBITDA growth was 17%. And we expanded our adjusted EBITDA margin by 13 basis points in line with our December IRJ expectations. Remember, that's lower because of the natural seasonality of the reinsurance acquisition. Margins would have expanded nearly 90 basis points. So another great quarter for the brokerage team. Let me walk you around the world and break down the 10.6% organic, starting with our PC operations. First, our domestic retail business posted 13% organic, driven by excellent new business, higher exposures, and continued rate increases. Risk placement services, our domestic wholesale operations, posted organic of 15%. This includes more than 30% organic in open brokerage and 5% organic in our MGA programs and binding businesses. New business was better than 2020 levels. and near double-digit renewal premium increases helped too. Outside the US, our UK business posted organic of 12%. Specialty, including our existing Gallagher Rebusiness, was up in the high teens and retail was up 7%, both fueled by new business and retention in excess of 2020 levels. Australia and New Zealand combined, organic was more than 8%, also benefiting from good new business and improved retention. And finally, Canada was up more than 13% organically and continues to benefit from strong new business trends, stable retention, and renewal premium increases. Moving to our employee benefit brokerage and consulting business, fourth quarter organic was up about 7%, a couple of points better than our December IR day expectation. We saw some nice sequential improvement over the course of 2021, up from the 2% organic we delivered in the first quarter. thanks to a rebounding global economy, declining U.S. unemployment, and increased demand for our consulting services as businesses look to grow. Next, I'd like to make a few comments on the PC market. Overall, global fourth quarter renewal premium increases were above 8%, broadly consistent with the increases we saw during the first three quarters of 21. Moving around the world, renewal premium change, which includes both rate and exposure, up about 8.5% in U.S. retail, including a 13% increase in professional liability, 8% in property and casualty, and 4% in workers' comp. In Canada, Australia, New Zealand, and the U.K., retail renewal premiums up between 7% and 9%, mostly driven by increases in professional liability and property. Within RPS, Wholesale open brokerage premium increases were up 13%, and binding operations were up 6%. Shifting to reinsurance, January 1st renewals showed price increases that varied by geography and client loss experience. Loss-free programs saw rates flattish to up 10%, while loss-impacted accounts and CAD-exposed property business experienced rate increases that were in many cases double that. So rate tended to be based on client-specific attributes and loss history, and I consider that to be a healthy outcome. So whether retail, wholesale, or reinsurance, premiums are still increasing almost everywhere. Looking forward, I see a difficult PC market conditions continuing throughout 2022. That's because our risk-bearing partners remain cautious on rising loss costs. For property coverages, replacement cost inflation and the increased frequency and severity of catastrophe losses are causing underwriters to rethink rate adequacy. On the casualty side, social inflation, low investment returns, and the potential for increases in claim frequency as global economies further recover are all potential negative drivers of future underwriting profitability. And on top of higher loss costs and lower investor returns, reinsurance costs are also increasing. So I think carriers will continue to push for rate and don't see a dramatic change in the near term. We shine in this type of environment by helping our clients find appropriate coverage while mitigating price increases through our creativity, expertise, and market relationships. I'm equally as upbeat on our employee benefit consulting and brokerage business. As you know, the first quarter is seasonally our largest employee benefits quarter and is looking like the team had a strong annual enrollment season. Early indications are pointing to an increase in new client wins over prior year, consistent client retention, and a slight increase in covered lives. With improved business activity and increased demand for goods and services, businesses are trying to grow their workforce, but the labor market remains extremely tight with more than 10.5 million job openings domestically and 6.3 million people unemployed and looking for work. This lays the groundwork for robust demand for our consulting services in 2022 as employers look to attract, retain, and motivate their workforce. So we finished 21 with full-year organic of 8%. That's really nice improvement from the 3.2% organic we reported in 20. and above pre-pandemic 2019 organic of 5.8%. And as we sit here today, we think 22 organic will end up in a very similar range to 21, and there is a case that it ends up even better. Let me move on to mergers and acquisitions. It was great work by the team to close the reinsurance acquisition in early December. Integration is well underway and progressing at a good pace. Remember, we are a seasoned integrator. On the revenue side, much like our tuck-in acquisitions, we've mobilized our local teams from retail, wholesale, and even Gallagher Bassett to partner with our new colleagues and generate new revenue opportunities. I'm also very pleased that our combined Gallagher reteam hit the ground running and had a strong finish to the year. Financially, the acquisition added about $20 million of revenue in December and, as expected, generated a small EBITDA loss due to seasonality. More importantly, I'm already seeing examples of cross-division cooperation and collaboration, so our new reinsurance colleagues are quickly embracing our better together Gallagher culture. Outside of reinsurance, we completed 18 tuck-in brokerage mergers during the quarter, representing about $65 million of estimated annualized revenues. I'd like to thank all of our new partners for joining us and extend a very warm welcome to our growing Gallagher family of professionals. As I look at our tuck-in merger and acquisition pipeline, we have around 35 term sheets signed or being prepared, representing over $200 million of annualized revenues. We know all these will not close. However, we believe we'll get our fair share. Next, I'd like to move to our risk management segment, Gallagher Bassett. Fourth quarter organic was 13.1%, a bit better than our December IR day expectation. Margins approached 19% in the quarter, leading to full-year adjusted EBITDA margin of 19.1%, another great quarter, and full year, for that matter, from the team. We saw more new arising claims within general liability and property, and to a lesser extent, core workers' compensation during the quarter. New COVID-related workers' comp claims were similar to the third quarter, aided slightly by the late-year surge in cases from the Omicron variant. Regardless of the short-term variability of new rising claim activity, we feel really good about the business. Looking forward, continued strong retention combined with new client wins in the fourth quarter should drive 22 Organic into the high single-digit range. So it was another fantastic year for our franchise and I'm extremely proud of our team and our collective accomplishments. Together, We produced 8.6% organic growth in our combined brokerage and risk management segments. Completed 38 mergers with more than $1 billion of estimated annualized revenue. More than 110 basis points of adjusted EBITDAG margin expansion. And we were recognized as one of the world's most ethical companies for the 10th year in a row by the Ethisphere Institute. And all this in the face of a pandemic. What a fantastic year. More than ever, our success is due to our bedrock culture. Our culture helps us deliver better results, better results for all of our stakeholders, including our customers, our colleagues, our underwriting partners, and of course, our shareholders. Every day, all of our teammates get up and work diligently to maintain our culture, to promote our culture, and to live our culture. That truly is the Gallagher way. Okay, I'll stop now and turn it over to Doug.

Doug? Thanks, Pat, and hello, everyone. As Pat said, a terrific quarter to close out an outstanding year. Today I'll start with our earnings release and touch on organic margins and our corporate segment shortcut table. Then I'll move to our CFO commentary document where there I'll talk a little bit about how we're now providing our typical modeling helpers for 22. add some commentary on the Willis reacquisition, and our latest thinking on clean energy. I'll then finish up with my comments on cash, liquidity, and capital management. Okay, let's flip to page four of the earnings release to the brokerage segment organic table. All-in brokerage organic was 10.6%, a nice step up from the 9% we posted last quarter, and the 6-plus percent we posted in the first half of 21, leading to full-year organic of 8%. Looking forward, as Pat said, we see full year 22 similar to 21 or even better. Now turn to page six to the brokerage segment adjusted EBITDA margin table. Headline all-in adjusted margin expansion for fourth quarter was 13 basis points, right in line with our December IR day expectation. But recall, that expansion has the adverse seasonal impact of closing Willis-Ree on December 1st. Without that, adjusted margins would have expanded 88 basis points, also right in line with the forecast we provided in December. For a full year, adjusted margin expansion was 123 basis points. Excluding Willis-Rhee, it was up 142 basis points. And it's important not to forget, that's on top of 420 basis points of adjusted margin expansion and 20 and 75 basis points in 19. That's absolutely incredible execution before, during, and as we emerge from the pandemic. Moving on from 21, looking forward, as the pandemic limitations continue to ease in 22, we will naturally see some costs returning in areas such as travel, entertainment, and perhaps some other office consumables. Incremental full-year 22 costs from these three areas could be as much as $25 million. But even then, Our full year spend on these categories would be below pre-pandemic levels, showing that we're holding savings. Also, we are back to making targeted investments to drive long-term growth. In 22, we're planning for increases in marketing, advertising, consulting, professional fees, and certain IT investments. These costs, combined with higher insurance premiums, say for E&O, D&O, and work comp, would total around $35 million. So like we said at our December IR day, we should be able to absorb those costs and hold margins if we post around 7% organic. And if organic is over 7%, even show some margin expansion. Then by 2023, we could be back to that pre-pandemic view that margin expansion might occur at a 4% or so organic level. And to be clear, all of these comments are before the impact of the acquisition of Willis-Rigg. On a pro forma basis, those margins can run a bit higher. So math would say it would naturally provide some lift to our consolidated brokerage segment margins in 22. A couple things to keep in mind as you build your quarterly models for our brokerage segment in 2022. First, consider seasonality. Due to our benefits business and now our larger reinsurance business, first quarter is our largest revenue in EBITDA quarter of the year. And second, perhaps slightly more nuanced, since we're not seeing price and or exposure increases in benefits and workers comp to the extent we are in other areas of P&C insurance, first quarter organic might be a point or so below your full year pick simply due to the mix. So the math would then suggest second, third, and fourth quarters could post over your full year organic pick. Again, that's just a nuance to help you with your quarterly models. Moving on to the risk management segment and the organic table at the bottom of page six. You'll see 13.1% organic in the fourth quarter and full year organic in excess of 12%. What a great rebound from the depths of the pandemic. And as Pat said, it's looking like revenue momentum continues into 22 with full year organic revenue growth in the high single digits, which is really terrific given 22 will naturally have more difficult compares than 21. Moving to the risk management segment EBITDA table on page seven. Adjusted EBITDA margin of 18.6% in the quarter and more than 19% for the full year. A fantastic result. And just like our brokerage segment, a nice step up from pre-pandemic levels of 17.5%. Again, that demonstrates our ability to maintain a portion of our pandemic period savings, even as we make some further investments in technology investments. Looking forward, as you heard at our December IR Day, we will continue to make investments in analytics and tools to enhance the client experience and drive better claim outcomes. But even with those, holding margins close to that 19% is achievable for full year 22. All right, let's turn to page 8, to the corporate segment table. In total, adjusted results, two pennies better than the midpoint of our December IR Day forecasts. Rob Leibowitz, Mostly as a result of strong clean energy earnings we did have a couple notable adjustments this quarter. Rob Leibowitz, First willis read transaction related costs as a discussed in footnote to or 22 million after tax. Rob Leibowitz, And second as discussed in footnote three and similar to third quarter we had non cash deferred tax adjustments related to international eminent earnouts. which is the most of it, as well as some other small tax and legal settlement items, together about 19 million after tax. Now let's shift to our CFO commentary document we post on our website, starting with page three. As for fourth quarter, you'll see most of the brokerage and risk management items are close to our December IR day estimates. Also on that page, we are now providing our first look at items related to the brokerage and risk management segment. A couple lines worth highlighting. First, FX. The late 21 and early 22 weakening of the US dollar against our major currencies is creating about a four penny headwind to EPS next year. Second, integration costs. You'll read in footnote one, the integration estimates provided here only reflect expense associated with Willis-Ree. As Pat mentioned, integration is well underway and we are still comfortable with our ultimate pick of about $250 million of total costs for integration. All right, let's turn to page five of the CFO commentary, the page addressing clean energy. The purpose of this page is to highlight we are transitioning from over a decade of showing gap earnings to a six to eight period where we harvest cash flows. You'll see in the blue column that we reported 21 gap earnings of $97.4 million, a really nice step up, up 39% over 20. And we generated $40 million of net after-tax cash flow, so also a nice step up from $20. But the real headline story here is in the pinkish column. Cash flows take a significant step up in $22. Looks like we'll be harvesting $125 to $150 million a year of cash flows, and perhaps even more in $23 and beyond. Now, there is still a possibility of an extension in the law, and we're well-positioned to restart production if that happens. But if not, we have over a billion dollars of credit carryovers. If we use, say, $150 million a year, that's a seven-year cash flow sweetener. Flipping to page six on the rollover revenue table, the reinsurance acquisition is off to a solid start, and we are encouraged with both its December results and early indications from the 1-1 renewal season. So it's looking like our pro-former revenue in EBITDAC of $745 million and $265 million, respectively, are holding up nicely. So the reinsurance acquisition is off to a terrific start. All right. As for the cash and capital management and future M&A, at December 31, available cash on hand was about $300 million. With strong operating cash flows expected in 22 and potentially a nice bump in cash flow from our clean energy investments, We are extremely well positioned to fund future tuck-in M&A using cash and debt. Over the next two years, we could do over $4 billion of M&A without using any stock. You'll also see that our board of directors announced a $0.03 per share increase to our quarterly dividend. That would imply an annual payout of $2.04 per share. That's a 6.3% increase over 2021. Finally, one calendar item. We are planning on our regular mid-quarter IR day from 8 AM to 10 AM Central Time on March 16. Again, that will most likely be virtual. During that, we will allocate some time to socialize our planned migration to reporting adjusted GAAP EPS results, excluding the impact of non-cash intangible asset amortization. We'll discuss the detail of all the adjustments, including representing historical results on the new basis. Okay, that's it. From my vantage point as CFO, we are extremely well positioned for another great year here in 22. Before I turn it back over to you, Pat, I'd like to thank the entire Gallagher team for a terrific quarter and fantastic year. Pat?