Good afternoon, and welcome to Arthur J. Gallagher & Company's Fourth Quarter 2022 Earnings Conference Call. [Operator Instructions].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 statement 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 Patrick Gallagher, Chairman, President and CEO, Arthur J.

Gallagher & Company. Mr. Gallagher, you may begin..

First, attachment points were raised broadly; second, reinsurers pushed to remove prepaid reinstatements from some contracts; third, reinsurers, in some cases, were able to reduce coverage to named perils only; and fourth, top layers of many programs saw the largest percentage increases as reinsurers sought to push up minimum premium rates.

On the casualty side, prices were up in the single to low double-digit range for most programs, while terms and conditions were more stable. Despite the tough market backdrop of higher prices, lower capacity and tightening terms, the reinsurance team was able to deliver favorable outcomes for our clients.

Looking forward, the challenging reinsurance market conditions will, no doubt, put pricing pressure on the primary market during '23, and that's on top of our primary carrier partners dealing with catastrophe losses in secondary perils, including convective storms, floods and wildfires, high replacement cost inflation from raw materials to shortages in labor, social inflation, combined with the easing of the judicial system law , escalating medical cost trends and ongoing geopolitical tensions.

So there's good reason to expect continued price increases and cautious underwriting for the foreseeable future. And as I mentioned before, we are not seeing any signs of exposure contraction. Rather, it seems our clients' business activity remains unchanged from the past few quarters.

Within our employee benefit brokerage and consulting business, the backdrop for '23 is also broadly favorable. Employers continue to add jobs and wages are growing. So demand for our services and offerings should remain robust. So as I sit here today, '23 could be another fantastic year with brokerage organic growth nicely in the 7% to 9% range.

Moving on to mergers and acquisitions. We had a really active fourth quarter completing 17 new tuck-in brokerage mergers representing more than $140 million of estimated annual 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.

For the year, we completed 36 mergers, representing annualized revenue of about $250 million. Additionally, we announced an agreement to acquire Buck, a very complementary business providing retirement, HR and employee benefits consulting and administrative services with estimated annualized revenues of $280 million.

We expect the transaction to close during the second quarter and look forward to welcoming our new colleagues. Moving to our merger and acquisition pipeline. We have nearly 45 term sheets signed or being prepared, representing more than $300 million of annualized revenue. We know not all of these will close.

However, we believe we will get our fair share. And before I conclude my M&A comments, let me give you a quick recap on our reinsurance acquisition now that we have a full year in our books.

We had a fantastic '22, thanks to strong client retention, the expansion of existing client relationships, some great new business wins and excellent growth in our pro rata business. The team is fully assimilated, is delivering for clients and there's a lot of momentum. I believe we're on track for an even better '23.

Needless to say, reinsurance continues to be an exciting story. Moving on to our Risk Management segment, Gallagher Bassett. Fourth quarter organic growth was 15.6% as a strong finish to the quarter pushed organic above our mid-December expectation.

Core new arising claims increased during the quarter, driven by recent new business wins and continued growth from existing clients. And fourth quarter adjusted EBITDAC margin was great at 19.3%.

So putting it all together, Gallagher Bassett finished the year with an adjusted EBITDAC margin of 18.5% and 13.3% organic benefiting from increased claim activity coming out of the pandemic and some really nice new business wins. Looking forward, full year '23 organic should be pushing 10% and adjusted EBITDAC margins should be around 19%.

That would be another fantastic year. And I'd like to conclude with some comments regarding our bedrock culture. It's a culture of teamwork, client service and excellence, captured and celebrated in the Gallagher way.

It is the culture that drove full year '22 results for our combined Brokerage and Risk Management segments of 24% growth in adjusted revenues, 10% all-in organic, 25% growth in adjusted EBITDAC, adjusted EBITDAC margin in excess of 32% and 20% growth in adjusted EPS. We have a culture that our people believe in, embrace and live every day.

It's a culture that will continue to drive us forward. That is the Gallagher way. Okay. I'll stop now and turn it over to Doug.

Doug?.

First, FX. With last year's midyear strengthening in the U.S. dollar, you'll see some volatility in how FX will impact our brokerage and risk management results in first half versus second half of '23. Please make sure to consider these impacts as you're planning your models. Second, our adjusted tax rate. With the U.K.

corporate tax rate increasing to 25% effective April 1, we're providing our current estimate for full year '23 tax rate. More of an impact to our Brokerage segment than it is to our Risk Management segment, given the size of our U.K. retail London specialty and reinsurance brokerage operation. And one other thing.

The left side of this page might be a nice reference when making your picks for quarterly margins given our quarterly seasonality. And finally, when you do make your margin picks, recall we were still in the Omicron portion of the pandemic during the first quarter of '22.

So we're not expecting as much margin expansion in first quarter as we are in the second, third and fourth quarter of '23. Okay. Moving to Page 5. This page is here to highlight the incremental cash flows from our clean energy investments over the coming years. And remember, those come through the cash flow statement, not the P&L.

You'll also see that we have $773 million of available tax credits as of December 31, '22. And that we forecast using about $180 million to $200 million in '23 and that should step up a bit in '24 and each later year. That's a really nice cash flow boost to help fund our M&A.

The way I look at the math, it might say that an additional $773 million of free cash, combined maybe another $70 million of recurring EBITDAC at that 10 to 11x multiple, which would then have a nice arbitrage for our current trading multiple. Moving to Page 6 on the rollover revenue table.

For the fourth quarter, rollover revenues came in higher than our December IR day guidance. Most of all of that came from reinsurance. Over the last 3 weeks, cedents have been closing their books for '22, and we're getting updated ceded premium figures. That translated into additional commission revenue for '22.

For the sake of clarity, nearly all of that upside is excluded from our organic results because it likely relates to pre-December 1, '22, which marked the first year anniversary of the acquisition. And no -- also, please note that not all of that hits the bottom line because of production and incentive comp expense on that additional revenue.

That said, it's terrific to get the bump-up. Staying on Page 6, but moving down to the bottom table. That table shows our actual reinsurance acquisition results. In a transition year, the team overperformed our pro forma expectation. That's impressive and terrific work by the team.

So now let me move to some final comments on cash, capital management and future M&A. At December 31, available cash on hand was about $325 million. Our current cash position, combined with strong expected cash flows and incremental borrowing positions us well for our pipeline of M&A opportunities.

In total, we estimate towards $3 billion to fund potential M&A opportunities during '23, which would include paying for Buck. And also yesterday, our Board of Directors approved an increase in our quarterly dividend by $0.04 per share. That would imply an annual payout of $2.20 per share. That's a 7.8% increase over '22.

So with a strong organic outlook, margin expansion opportunities and an ever-growing M&A pipeline, from my vantage point as CFO, we are extremely well positioned for another fantastic year in '23. I'd like to thank the entire Gallagher team for another great quarter and outstanding year. Back to you, Pat..

Thank you, Doug. Operator, I think we're ready for questions..

[Operator Instructions]. Our first question comes from the line of Weston Bloomer with UBS..

So my first question is on the reinsurance market and the growth you saw there. It's obviously really strong end of the quarter. And I think you've talked about high single-digit growth there for 2023.

So did the end of the year kind of change how you think about that level of growth? Or how should we be thinking that going into next year?.

I think we are definitely going with some nice momentum. I wouldn't bank on some incremental big jump. But what I like about the momentum is when you come through a time like we did in this fourth quarter, it's interesting because you actually become much more valuable to your clients.

And it's not an easy time when you're tussling back and forth with the cedents and the reinsurers trying to get these things done, terms are changing. Attachment levels are changing.

But in the end, as I said in my prepared remarks, we got the placements made, and I think we are in a very strong position going forward, number one, with those clients, but also with the opportunity to pick up some new business..

Great. And then my second question within brokerage as well. I noticed the compensation ratio as a percentage of revenue dropped pretty materially. And I think you'd called out some back-office saves, lower benefit costs, offset by some hiring.

Is there a way you can call out how much each of those had an impact? Or where I'm trying to go with the question is how much additional leverage do you have to kind of bring that lower in 2023?.

All right. Let me see if I can break that out from memory here. I don't have it in front of me exactly, but when you're talking about being down was at 180 basis points, something like that. Yes. Is that right? I'm just going from memory, Sorry, I'll look it up here.

Probably 1/3 of that is due to the continued efficiency that we bring by being able to push work into our lower-cost centers of excellence. I think that we've had some technology wins in that area, too, to help us make our workforce more effective on that and didn't have to put on additional heads as a result of that -- those technology investments.

And then I think that when it came to -- the other 1/3 is kind of escaping you right here..

Got it. Is there any change to the compensation structure that you make in this market, too? I know there's some changes just, I guess, higher organic accounts, things like that..

No. We're pleased to pay our people for what they do. And we haven't messed with that compensation arrangement with our production force, in particular, in well over a decade..

Our next questions come from the line of with Autonomous Research..

I want to follow up on the almost 10% 2022 brokerage organic results. Would you mind giving us some more color as to how pricing and exposure and net new business drove that year-over-year acceleration in organic.

And then from where you sit today, how do you see those drivers changing in 2023?.

So are you asking for the quarter? Are you asking for the full year? Sorry, just so I've got the baseline..

Yes, yes, for the full year..

For the full year, right? So when I look at rate and exposure, as I did, our new business, we had a terrific new business here. So I'll say that our net new business spread was about 4 points and the rest of that is probably rate and exposure, remember between that.

So maybe, again, you think about it, 1/3, 1/3, 1/3 net new business over loss business is 1/3, rate was 1/3 and exposure unit growth was 1/3..

Got it. Okay.

And then as a quick follow-up, do you have any comments on the degree to which fiduciary investment income will impact margins next year, kind of thinking about that 50 bps of expansion on 6% organic, how much that move from fiduciary investment income?.

I think the -- when we give the guidance of 6 points, if we grow organically, 6%, we think we can show about 50 basis points of margin expansion on that. Investment income would be a sweetener to that. to a certain extent. But I don't have a clear line of sight yet on the size of our raise pool and our hiring needs going into next year.

We understand our budget. So I can't give you a specific number on it, but you give me a pick on what you think wage inflation is going to be next year to take care of our folks, and I can probably give you that number, but I don't think we're ready yet. I might be able to give you some more of that in March..

Our next questions come from the line of Greg Peters with Raymond James..

I'm going to stick on the margin commentary. In your press releases on Page 4, you talked about the operating expense ratio and some of the pressures on that.

So when you -- in your guide the 50 basis points or so of margin expansion provided 6% organic, how do we think about those factors affecting your ability to expand margins? And then just on the margin expansion, can you break it out based on business unit like is it going to come in international that you're going to get margin expansion or is it going to come into the employee benefits business, you get margin expansion? Or can you source where you think that's going to -- where that -- where the improvement is going to come from?.

Right. A couple of things. On the operating expense ratio, it was up in fourth quarter versus '21 fourth quarter, was up about 30 to 40 basis points, let's call it, 40 basis points on that. I think the footnote on that is explaining where it's coming from, mostly travel and entertainment, some consulting use and investments in technology.

So I'd say it's probably half of that increase is investments and half of it is just the inflation that we're seeing in travel and consulting costs on that. When you're -- I think the next question was how am I seeing that vis-a-vis next year. Remember, we were still in the omicron portion of the pandemic in the first quarter.

So we are going to see a little more travel and entertainment expense return in our first quarter, but we don't see it being up significantly in the second, third and fourth quarters. So we're looking at 50 basis points of expansion next year. Most of that will come in the later 3 quarters than the first quarter.

And what was there was another piece of your question, Greg?.

It was just when I think about within the Brokerage business, the different business units, the employee benefits, the international the retail RPS, when you look at it that way, where do you think the opportunity is for margin expansion in the context of that 50 basis points or so guidance?.

Yes, it's pretty much so across all of them, Greg -- there is no standout in there anywhere that's a laggard in there..

Makes sense. Okay. And the other -- just the other sort of cleanup question on Buck consulting. Can you give us -- is there any sort of cadence in terms of how the revenue flows and how the margins are.

I mean is it heavier in the first quarter, either revenue or margins? Or any sort of color you can add as we -- and just as a follow-up, I assume that's also going to get folded into the Brokerage segment, correct?.

Yes. So it will be part of our Brokerage segment and our Employee Benefit operation. Greg, we don't think we're going to close that in the first quarter. We think it's more of a second quarter close at this point.

I don't really have a good quarterly spread that I would feel comfortable giving on the call today for that because we have to apply our study on conforming the accounting principles to theirs, apply our 606 assumptions to it. So I need a little more time to work through that.

And we just signed the deal 30 days ago, and I just need to until March to give you that quarterly spread..

Our next questions come from the line of Michael Ward with Citi..

We heard, I guess, one of your peers about -- talk about programs participants pushing back on capacity or trying to restructure commissions. I was wondering if you're seeing something similar..

No..

Not really..

Not really..

Okay. Second one, I guess I was wondering, your deal spend has kind of accelerated over the last few months. It seems hoping you could maybe discuss the drivers behind that.

And maybe talk about how you see 2023 playing out in this regard?.

We have definitely seen a change in the competitive environment vis-a-vis mergers and acquisitions in the last 60 days. I'm not going to sit here and say it's not still competitive, it is.

But I would say that the number of bidders is reduced, and we are seeing maybe, what I would call, a more attentive seller to exactly who the buyer is, what the culture is, the strategic value of that buyer that maybe existed 12 months ago..

Yes, we usually see a little bit of an uptick in the fourth quarter as people push to get things done by the end of the year, sometimes that's driven by tax or other financial planning that the sellers want to get done. But if there is a noticeable change in the market. I would say that we feel very good about our pipeline right now.

There are some names on there that are really nice to have looking at us. So a little bit of an uptick in the fourth quarter, naturally, change in market competitiveness a little bit. But I also think it's going to be pretty strong in the first couple of quarters of the year relative to what we saw this year, in particular..

Our next questions come from the line of Elyse Greenspan with Wells Fargo..

Maybe sticking on the M&A point. You guys seem pretty optimistic with the pipeline, and you have announced a good number of deals of late.

But if I look on the CFO commentary sheet, you also write the multiples you're seeing on deals went up 1x, right, 10 to 11x from 9 to 10, what are you seeing, I guess, in the market that's driving up multiples a little bit?.

I think it's mix right now is what we're seeing is -- I think that you're seeing some pretty high performing names on the list where the growth factors are a little bit bigger than maybe they were in the past. But one turn on that, it wouldn't overly react to it one way or another..

And then with your margin guide for kind of the 50 to 60 basis points of expansion, are you assuming any wage inflation embedded within that guide?.

Yes. We're assuming that we're paying raises this year about similar to what we have for the last 2 years. So that's in the numbers. Also in that, I did a little -- I did a small vignette during the December IR Day.

If you really look underneath that, there's probably 10 or 15 basis points as we toggle to Software as a Service that might be against that 50 basis points, too. So maybe it's more like 60 basis points, but in the accounting of where that expense gets charged does influence that a little bit. You and I talked about that in December, I think, too..

And then on the reinsurance side, strong into the year, great rate increases we saw at January 1, but also we've seen higher retentions by primary companies. And I don't think we've really been in a similar environment, right, where you have 40% price increases with perhaps less premium to the market.

So when you put that all together, does '23 feel like an environment where you could show double-digit organic growth within your reinsurance business?.

Yes, I think we could..

Our next questions come from the line of Rob Cox with Goldman Sachs..

My first question is on the U.K. retail and specialty organic of 17%. Obviously, very strong. And I was just wondering if you could talk a little bit about what's driving that growth..

Yes. As we said, a very, very strong new business in specialty with tenant rate increases. And as we've talked earlier, there were some term changes and the like. But also our aviation specialty team just crushed it this quarter in the U.K. And our retail operation across the United Kingdom did extremely well also.

But I just think the whole London-based specialty team, reinsurance aviation just is set phenomenal close to the year..

That's great. And just a question on the labor market. A number of companies are instituting layoffs. I'm just curious what type of unemployment rate is embedded in your organic guide of 7% to 9%.

And if we did start to see some erosion there, at what point in the year do you think we would start to see that impact potentially in your organic growth?.

Well, let me just back up to our prepared comments again. It's very, very interesting. First of all, we don't play that much in the high-tech Employee Benefit business, and it's not that big a segment for us in terms of the layoffs you're seeing that are making the newspaper.

And as I've said in previous quarters, we're already in the same papers, right? And we all see the same news reports.

However, our middle market, core business is doing -- our clients are doing extremely well, and we keep reporting our -- what we're seeing in our midterm endorsements and changes to policies and as we see both our renewals and the audits going forward, our middle market, retail, property casualty benefits business, these people are doing very, very well.

Truck counts are up. Our trucking business is very strong. Our work comp renewals in terms of payrolls are not being diminished. Now that doesn't mean that if there is, in fact, a global recession that it won't impact us, of course, it will. But at this point in time, we're not seeing that.

So if you ask me where do we see an impact on that type of growth as we go forward this year. I'll tell you, our plans at present don't count on any recessionary pressure. And that could be wrong..

Our next questions come from the line of Yaron Kinar with Jefferies..

This is Andrew on for Yaron. Just looking at head count in Brokerage, it looks like there's been a pretty good pickup year-to-date and in the quarter specifically.

Can we kind of talk about what's going on there? And roles you're hiring and the degree to which those hires have been reflected in organic yet?.

Yes. Well, a lot of that -- remember those numbers are impacted considerably by our M&A program. So as we close the year out strong on M&A, those numbers would be in the December numbers and not in last year's December numbers, and that would impact the quarter 2..

And I would want to comment on that as well. We are not undergoing an organic surge in new hiring. We have a very strong internship. We bring on a very strong number of young people every year.

Of course, we're always looking for good solid production hires, but you are not seeing our organic head count surge beyond the M&A activity that Doug just mentioned..

Great. And as we think about supplemental and contingent commissions, I suppose a part of that is based on underwriting profitability of those programs.

So when you think about '23, is there kind of a loss trend that you bake into forward guidance there? Or maybe more broadly, what is your view on loss trends over the course of the next year?.

Are you're talking about the carriers loss trends?.

Yes, our contingents..

Right, that relates to the contingents..

Supplementals are not subject typically to profit-sharing arrangements, our contingents are. And to date, I'd say we probably factored nothing in, in terms of having significant increases in our operating loss ratios..

Our next questions come from the line of Mark Hughes with Truist..

Another P&C CEO suggested he didn't see as much increase in property rates in the fourth quarter as you might have expected in light of the reinsurance market dynamics, but maybe that's something that builds up as the time goes by is the higher reinsurance rates do directly impact the carriers.

Would you share that observation? Do you think property could get firmer on the primary level?.

I think property could get a lot firmer. I would say in the fourth quarter, it was very firm, in particular, in anything that had to do with Coastal, any area that was exposed to wind and fire. This market in terms of property is very difficult as it exists.

And, yes, the changes to reinsurance at 1/1 will filter additional pressure onto the retail buyer. And we are out early telling our retail buyers about this. And it is going to get more difficult in what is already a very extremely difficult situation..

Yes. If you think about -- remember, our fourth quarter, Ian hit right at the beginning of the fourth quarter, there were replacements that were done in October and November that hadn't had the full impact of the $70 billion loss..

Yes. Yes. And then, Pat, last quarter, you mentioned a potential spillover effect on casualty.

I don't know whether you updated your commentary on that this quarter, but do you think the reinsurance market, how much of an impact, I think, it's having on casualty, ?.

Mark, I don't have a number on that yet. I just think that it's possible that in order to pay for some of these property increases, other lines are going to have to be tagged. And I think I'll be able to feel that since it maybe have a better number around that at the end of the first quarter. And I may be wrong on that.

At this point, I'm not being told by our carriers that that's happening..

Our final question will come from the line of Michael Ward with Citi..

I just had a quick follow-up maybe on Elyse's question and the potential for double-digit growth in reinsurance.

Just wondering if that's kind of -- if we should think about that as being achievable with current capacity or if incremental capacity might need to come to the market in order to get there?.

I think that it will be achievable with existing capacity. I was very pleased -- our reinsurance people were telling us in late November and December, early December that they were very fearful some of these placements just weren't going to get done. And that is a nightmare on all sides of the equation.

And in fact, really, really pleased and proud of the team that did the work to bring the programs together for our clients as January got going here. So I think on existing capacity, of course, the largest renewal season is now winding down. It's not over, but it's winding down.

And so I do think the increases going forward could come off existing capacity. However, having said that, any additional capacity would be very welcome and will be utilized quickly and would add to that. All right. Then let me just add a few comments as I wrap up. I want to thank you again for joining us this evening.

Obviously, I'm very pleased with our '22 financial performance. I am still very excited about our future. I want to thank our clients for their continued trust, our 43,000-plus colleagues for their passion, hard work and dedication. And finally, I need to mention our carrier partners.

They do play an integral role in meeting our clients' insurance and risk management needs. And we look forward to speaking with you all again at our March IR Day. So thank you for being with us, and we'll talk to you then..

Thank you. This does conclude today's conference call. You may disconnect your lines at this time. Thank you for your participation, and enjoy the rest of your day..