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2 Pierce Place, Itasca, Ill., 60143;

630-773-3800; fax: 630-773-4000;

1997 1996*

Gross revenues $488,028,000 $462,022,000

Brokerage revenues $463,627,000 $448,161,000

Brokerage: Retail 63% 64%

Reinsurance 1% 1%

Personal 1% 1%

Services 30% 31%

Investment income 5% 3%

Employees 3,890 4,019

Rev/employee $119,184 $111,511

Offices 56 64

* Restated for 1996.

With consolidation remaining a prominent feature on the insurance industry landscape, it's no surprise it also continues to shape business at Arthur J. Gallagher & Co.

Consolidation at the top of the brokerage industry, combined with Gallagher's growth through increased business and its own acquisitions, has the Itasca, Ill.-based firm sitting comfortably in its position as the world's fifth-largest broker for the second year in a row.

The company posted more than $488.0 million in corporate gross revenues in 1997, up 5.6% from a restated 1996 revenue figure. Brokerage revenues for 1997 were more than $463.6 million, up 3.5% 1996.

Commercial retail brokerage revenues of more than $307.4 million were up nearly 4% in 1997.

"We happen to be a beneficiary of consolidation in two ways," said J. Patrick Gallagher Jr., Gallagher's president and chief executive officer. "One of them is that we are consolidators."

"We have done about five deals this year," Mr. Gallagher said. "We are continuing to seek out what we believe are the best partners in the marketplace and continue to do a pretty decent job of attracting those partners to our company."

Another way Gallagher has benefited from the consolidation trend is that its fifth-place status has put the company "on the map" in a smaller pool of competitors, the president and CEO said.

"We have a lot more attention from the buying community than we had when there were 10 real viable competitors," Mr. Gallagher said. "It's made us certainly important to our markets as well."

Consolidation has further benefited his company in terms of attracting talent, Mr. Gallagher said. "Nothing huge; we haven't wholesale recruited gazillions of people from any of our large competitors. But certainly there have been more opportunities we've been able to take advantage of in the last 18 months."

In the consolidation environment, Mr. Gallagher believes his firm has an advantage over some of its competition in the culture it has created and the sense of partnership and teamwork among its employees.

Mr. Gallagher sees how closely employees work companywide every time he looks at his computer and sees internal requests for information from Gallagher employees.

"Every day when I turn on that (computer) screen, there are literally dozens of requests for information, help, what have you on different accounts," Mr. Gallagher said.

"What that tells me is we're creating virtual account teams every minute," he said. "We're drawing the expertise from our organization no matter where it resides to the right spot at the right time, and that's a very, very powerful thing."

Using information technology to assemble those "virtual teams" is a key to Gallagher's ability to compete with larger brokers and to attract merger partners to facilitate its own growth.

"When I started, if I needed expertise, I might talk to the people around me," Mr. Gallagher said. "If I knew people down the hall or on a different floor I'd go see them. This thing has unleashed the power of our team."

By tapping into the resources of the rest of the company online, brokers in smaller offices can be more competitive in bidding on accounts. All Gallagher offices have access to the company's full resources.

"This is one of the benefits of people joining us," Mr. Gallagher said. "They tap into that team, and they can sense and feel that culture, and they see it working in real life."

Making maximum use of the abilities of the company's staff is critical to competing with "the Big Two," industry giants Marsh & McLennan Cos. Inc. and Aon Corp., Mr. Gallagher said.

"We pick the areas we compete in-that varies by branch and it varies by operation, but we're very good at picking our fights-and with the use of technology, we can put a team on any account that rivals any team out there," Mr. Gallagher said.

Gallagher continues its own emphasis on growth, both through organic growth and expansion of business niches, as well as through mergers and acquisitions, selecting potential partners it believes fit with its culture and business niches.

"We use our stock as a currency, and most of the people that have joined us maintain their position in our stock, which really is truly building a partnership," Mr. Gallagher said.

In 1997, for example, Gallagher used 263,000 shares of its common stock to acquire three companies: employee benefit consultants Byerly & Co. Inc. in Englewood, Colo., and Arnold & Co. Inc. in Troy, Mich., and White Plains, N.Y.-based broker Trinder & Norwood Inc.

Meanwhile, Gallagher also seeks to maximize growth by offering customers expanded service offerings, such as responding to an increased interest by middle-market companies in alternative risk transfer mechanisms.

"That's another area where we thrive. We've always been very, very good in the alternative market," Mr. Gallagher said. "This past year we helped form Artex Insurance Co., and we really think that's going to be a home run for us as well."

Bermuda-domiciled Artex, a rent-a-captive facility, came online last year as Gallagher's venture into this segment of the alternative market.

"Artex is up and running," Mr. Gallagher said. "It's getting good reception from our field force, and in a soft market, it's still providing us with a lift."

With the middle market increasingly embracing alternative risk transfer opportunities and sales people becoming more comfortable with the alternative vehicles as well, "I think rent-a-captives are going to be a very big part of things," he said.

Gallagher also started a wholesale brokerage, Risk Placement Services Inc., last year. "It's small, but it's growing," Mr. Gallagher said.

"We're adding people throughout the United States," he said of the new subsidiary. "We're now in Atlanta and Chicago. We'll soon be in Atlanta, Chicago, Los Angeles and New York. And there are great consolidation opportunities there. We are very interested in MGA and wholesale operations joining us."

Despite the new ventures, the brokerage services division remains the heart of Gallagher's operation as well as the company's "cash cow," and Mr. Gallagher said the company will continue to grow as a broker.

"Clearly, that is an industry that is very, very difficult because the rates continue to come down," he said of retail brokerage business. "But we really love that business and will be able to continue to grow it."

Another key component of Gallagher's operation, and one Mr. Gallagher sees taking on even greater prominence in the years ahead, is the Gallagher Bassett Services Inc. risk management services subsidiary. "That's a huge, huge business component," Mr. Gallagher said.

Gallagher Bassett provides claims and information management, risk control consulting, appraisals and claims investigations.

"I believe that every single major account in America, all the way to the upper end of the middle-market, will be unbundled at the end of my career," Mr. Gallagher said.

Favoring Gallagher in a future in which unbundled claims handling becomes increasingly significant is that the claims handling business has "a huge cost of entry," Mr. Gallagher said. "How are you going to get in?" he said of potential competitors.

He noted that Gallagher Bassett has 105 offices in the United States, 14 more in Australia, four in the United Kingdom and another in Canada, all of which can communicate electronically.

"We grew it one branch at a time over a 30-year period," Mr. Gallagher said. "We started this business in 1962. It's been 36 years to get where we are today."

And Gallagher's own operation is not the only broker doing business with Gallagher Bassett.

"We work with all of our competitors, and we're really pleased to do so. We maintain an absolutely inviolate Chinese wall," Mr. Gallagher said. "No Arthur J. Gallagher salesperson can ever walk downstairs and figure out what's going on with one of those accounts. We know that would be death."

The company's Gallagher Benefits Services operation, representing nearly $63.8 million in 1997 revenue, about 13% of the year's total, is another growth area, Mr. Gallagher suggested, and should top $70 million in revenue this year.

"The government continues to make the laws complex. We continue to spread the things we do for clients, which is again more client-touch. And, quite honestly, it looks like rates are going to go up," he said of health insurance. "So all in all, I think the whole benefits arena is a solid one for us."

But the division that might make the most news this year, according to Mr. Gallagher, is the investment unit AJG Financial Services Inc. division the company started last year. "We've got so much going on there, it's absolutely mind-boggling," the CEO said.

Most recently, AJG Financial served as merchant bank and adviser and also took an ownership interest in Asset Alliance Corp., an investment management holding company that essentially acquires hedge fund managers.

AJG Financial also has taken positions in tax-advantaged investments such as alternative fuel operations Covol Technologies Inc. and Alternative Power Corp. and has taken a minority equity position in Peachtree Franchise Finance Co., an Atlanta-based operation that originates and then securitizes loans to regional and national franchisees.

"What we told (Wall) Street was that we would use our capital and our balance sheet to prudently invest limited amounts of money in what we thought were good financial services opportunities," Mr. Gallagher said, likening the operation to J&H/Marsh & McLennan's Putnam Investments Inc.

AJG Financial is serving another function as well, managing the investments of the Artex rent-a-captive operation.

Companywide, Gallagher's pretax earnings for 1997 stood at nearly $80.8 million on an as-reported basis, while the company posted net earnings of $53.3 million. In 1996, pretax earnings were about $65.7 million, with net earnings of slightly more than $43.1 million.

Mr. Gallagher expects 1998 to be another good year for his company.

"I think we'll do more mergers this year than we've done in a couple of years, which is real positive," he said.

And, as for the possibility that in a consolidation-driven industry his company itself might be a takeover target, Mr. Gallagher said: "We've been pretty publicly quoted as saying our preference is to remain independent.

"I'm not totally naive," Mr. Gallagher continued. "I mean, we're a public company, so we recognize that if someone out there says, 'I don't care what the market says, I'm paying Gallagher $150 a share,' then they own a company. But we are not actively seeking nor are we interested in being actively sought."

Gallagher's stock, which had a high of $46.56 and a low of $33.56 in the 52-week period through July 10, stood at $44.31 July 10.

Other company units include:

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

* Arthur J. Gallagher & Co. (Bermuda) Ltd., an offshore subsidi-ary providing access to the Bermuda market and acting as an intermediary 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 for Gallagher brokers.

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

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

As reported to the Securities and Exchange Commission, Gallagher's five highest-paid officers in 1997 and their cash compensation, including bonuses, were:

Michael J. Cloherty $846,000

J. Patrick Gallagher Jr. $656,000

Gary M. Van der Voort $428,100

James W. Durkin Jr. $378,000

Peter J. Durkalski $366,100