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Arthur J. Gallagher & Co.

2 Pierce Place, Itasca, Ill. 60143; 630-773-3800; fax: 630-285-4000; Internet:

1996 1995

Gross revenues $456,679,000 $411,998,000

Brokerage: Retail 55% 55%

Reinsurance 1% 1%

Personal 1% 1%

Services 38% 39%

Investment income 5% 4%

Employees 3,939 3,739

Rev./Employee $115,938 $110,189

Offices 64 62

Openings created by recent megamergers among insurance brokers not only pulled Arthur J. Gallagher & Co. higher up the list of the world's largest brokers but also created new opportunities for growth.

Those opportunities include prospects for new retail brokerage accounts, the chance to bring additional talent into the Gallagher organization and access to new sorts of business and business relationships.

"There are tremendous opportunities for us right now. We are as turned on and as excited a company today as I think we ever have been," said J. Patrick Gallagher Jr., president and chief executive officer of the Itasca, Ill.-based broker.

"We have picked up accounts that have not been happy with the consolidation, that have said, 'I chose not to be with X broker or Y broker; I'm not going to let them just buy my business, " he said.

While cautioning that the megamergers haven't prompted "wholesale defections of clients," they have given Gallagher "an opportunity for us to get out and tell our story."

"The second thing they've given us is a great opportunity to hire people," Mr. Gallagher said. The company recently picked up a "substantial team of people" from Minet Group in London, he noted, and is "talking to a whole host of other people in the London market and in this country."

That access to talent facilitated Gallagher's creation this spring of its Risk Placement Services wholesale unit.

For that unit, "we hired four people in Chicago that were not available to us until the megamergers," Mr. Gallagher said. "We're talking to people in Atlanta, New York, Los Angeles, San Francisco."

The new wholesale operation will be built as a separate business within the company, and "there will be a 'Chinese wall,'*" he said. "We're not going to disrupt these people's relationships with outside brokers," he said. "And our property/casualty production force will not get access to other brokers' information."

Mr. Gallagher said he expects the new unit will be in the black after just its first three months in operation.

While the companies at the top of the broker heap-Marsh & McLennan Cos. Inc. and Aon Group Inc.-have been busy with acquisitions, Gallagher has proved no slouch in the M&A department itself.

"We have been part of the consolidation," Mr. Gallagher conceded. But, he said what distinguishes his company's approach to mergers and acquisitions through the years is that it isn't swinging for the fences with every deal.

"We want to hit singles and doubles, singles and doubles, pool interest, build our partnership," he said.

Over the years, the Gallagher family and the firm's original owners have taken their equity in the company down to about 20% from 100%, he noted, "And it's the old adage: We're much happier owning 20% of a watermelon than 100% of a pea."

In addition to last year's purchase of majority interest in Sydney, Australia-based National Risk Control Services Pty. Ltd. to create Gallagher Bassett Australia Ltd., in 1996 Gallagher used 1,115,000 of its common shares to acquire five brokerage firms and an investigation services firm.

Those companies included Levitt/ Kristan Co. of Los Angeles; Phoenix-based Alliance Insurance Group; Lamberson Koster & Co. of San Francisco; Morgan, Read & Coleman (Holdings) Ltd. and Morgan Insurance Services Ltd. of London; Pasadena, Calif.-based R.W. Stephens & Co. Inc.; and Maitland, Fla.-based Beymer & Bond Investigations Inc.

"By doing that, using our currency, the stock of our company, we've built a marvelous partnership," Mr. Gallagher said.

So far this year, Gallagher has acquired Englewood, Colo.-based Byerly & Co. Inc. and Troy, Mich.-based Arnold & Co. Inc., both employee benefit consulting businesses.

Also this year, Gallagher divested itself of an office in Atlanta, selling it to Willis Corroon Group P.L.C. Terms of the transaction were "immaterial," Mr. Gallagher said.

In approaching mergers, ultimately Gallagher is looking at the opportunities they bring for expanding the company's operations, rather than trying to capitalize on economies of scale.

"We're not a consolidator in the sense that we're eliminating expense in a merger," he said. "We're trying to create a growth dynamic."

But, Michael A. Smith, an analyst with Salomon Brothers Inc. in New York, said Gallagher has been successful at quickly squeezing down high-expense structures in many of the closely held companies it acquires. "I think they will have more opportunities to do that now, too, as the smaller independents become more and more discouraged with the direction of property/ casualty pricing," he said.

Mr. Gallagher also sees new partnering potential for his firm on the international front.

Numerous foreign brokers are contacting Gallagher about handling their U.S. business, he said.

And the international front is another area where Gallagher might be positioned to benefit from the megamergers fallout, particularly as members of the international UNISON broker network determine their response to M&M's acquisition of partner Johnson & Higgins.

"We are talking to UNISON partners," Mr. Gallagher said. "The UNISON partners have not decided what they're going to do."

"Let's face it: They'd prefer not to continue doing business with J&H," he said. "They may not be able to do that, but I'd like the opportunity to work with some of those guys on ac

counts here."

Another development at Gallagher this year didn't stem from the megamergers but from a "strategy of changing and shifting ourselves," said Mr. Gallagher. That is the formation of its ARTEX rent-a-captive operation in Bermuda.

Mr. Gallagher said ARTEX gives Gallagher a chance to penetrate anew market and better meet clients'

needs, "and it gives us an opportunity to better control our program business."

The alternative market always has been an important aspect of Gallagher's business, Mr. Gallagher noted, and with the growth possibilities it offers, that's true now more than ever.

Clients with more risk awareness "want to be treated separately. They want and are willing to take their own risk to have control over the processes and their investment and their underwriting income," he said. "We started ARTEX to be able to facilitate that."

Gallagher will provide all of ARTEX's initial capital, though the facility's initial capitalization and other details are still being set.

Meanwhile, Gallagher continues to assist clients looking to establish captives through its Gallagher Captive Services unit. "It's not growing by 100% leaps and bounds because the market is very, very soft, and it gets difficult to just fight that on price."

But, he noted, while some alternative market participants are returning to a soft traditional market and obtaining first-dollar cover, Gallagher Captive Services clients are holding fast with their captives.

While emphasizing his company's opportunities and its "share of success," Mr. Gallagher said "none of that changes the underlying difficulty of the P/C business. This is a tough business. We are slugging it out."

Gallagher's 1996 commercial retail brokerage revenue of nearly $251.2 million was up about 2% from 1995, while overall revenue of nearly $456.7 million was up more than 10% from the about $412 million for 1995 that Gallagher reported last year. Overall revenue in 1996 rose 3.9% from a restated $439.5 million in 1995.

Those numbers rank Gallagher as the world's fifth-largest broker.

For 1996, Gallagher posted pretax earnings of nearly $69.4 million and net earnings of $45.8 million.

Just the same, "last year was tough" to achieve growth, Mr. Gallagher said.

"We did have a record year in earnings, but it was not the kind of growth we're used to, and that's very indicative of what's going on in the market," Mr. Gallagher continued. "The market is very tough on our property/casualty broking operation, very tough on our third-party administrative operation, Gallagher Bassett."

Gallagher Bassett Services Inc., the risk management services subsidiary, saw the workers compensation TPA market "really drop through the floor," he said. He is convinced the competitive workers comp market won't last forever, and an expected turnaround there, coupled with new niches, makes him optimistic about Gallagher Bassett Services. "This is a business we've taken from $30 million in 1988 to probably $125 million, $130 million this year," he said. "We see new market niches all over the place. We started out working with self-insureds. We moved from working with just self-insureds to being very good at fronted programs. And now we see a great opportunity with insurance company outsourcing because we pay claims for less."

Offsetting a difficult market for retail brokerage and workers comp TPA efforts is the performance of Gallagher Benefit Services, Mr. Gallagher said. The unit posted $55.1 million in 1996 revenue, an 11% jump from 1995, and has been Gallagher's fastest-growing operation over the past five years, he said.

The unit's services include benefit consulting and brokering, and pension consulting and record-keeping.

Mr. Gallagher also is excited about the company's new AJG Financial Services Inc. investment unit.

"In the second quarter we announced that our financial services group was able to restructure both a lease arrangement in London as well as a pension" to Gallagher, Mr. Gallagher said. "We put $7 million on the bottom line, $7 million in pretax in one quarter just from being able to get in and work our magic."

"And we're taking advantage in that business of the core competencies that we've developed over the last 10 years of managing our money and our balance sheet," he said.

That ability has seen Gallagher becoming "a real cash machine," the CEO said. Since 1990, Gallagher has retired a $20 million note, repurchased more than $100 million of its stock, paid more than $70 million in dividends and accumulated an additional $50 million to its tangible net worth, bringing it to more than $120 million, or about $7.50 per share.

"That's a lot of cash. And that's doing it in a real, real difficult environment," Mr. Gallagher said. "So we're proud of those results."

Underlying all of Gallagher's numbers last year is a statistic the CEO said makes him particularly proud: the improved productivity reflected in the company's per capita revenue.

"We're up 27% in revenue per employee since 1990," he said. Last year, the company's 3,939 employees generated $115,938 in per capita revenue, a 5% increase from 1995's $110,189 per capita posted by 3,739 employees. Based on restated figures for 1995 revenues and 3,926 employees, the revenue per employee last year increased nearly 3.6%.

The company's target of $1 billion in revenue by 2002 remains a very real goal, Mr. Gallagher said. "We will be a billion dollars on our 75th birthday is what I like to say."

"We double the company every three to five years and have for the last 35 years, and that's our goal," he said. "And it's not just about the revenue line. This is about career path growth, earnings per share growth for our shareholders and opportunity for our people.

"We could be a billion dollars tomorrow by just going out and buying every dog that exists," he said. "That's not the goal."

Gallagher stock, which hit a high of $37.75 a share and a low of $29.13 in the past year, closed July 11 at $36.

Other Arthur J. Gallagher & Co. units include:

Gallagher Bassett International Ltd., the London-based Gallagher Bassett unit providing unbundled risk management services overseas.

Arthur J. Gallagher & Co. (Bermuda) Ltd., an offshore subsidiary providing access to the Bermuda market to place excess coverage for pools, captives, risk retention groups and other self-insurance arrangements.

Lloyd's of London broker Arthur J. Gallagher (U.K.) Ltd.

International Special Risk Services Inc., the company's in-house wholesale facility.

Reinsurance intermediary and surplus lines broker Arthur J. Gallagher Intermediaries Inc.

Risk Management Partners Ltd., a venture owned jointly with Am-Re Managers Inc. that markets insurance and risk management services to public entities in the United Kingdom.

As reported to the Securities and Exchange Commission, Gallagher's six highest-paid officers in 1996 and their cash compensation, including bonuses, were:

J. Patrick Gallagher Jr. $381,000

Michael J. Cloherty $371,000

Gary M. Van der Voort $320,760

Peter J. Durkalski $281,500

Robert E. Gallagher $275,000

Walter F. McClure $275,000