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2006 was a mixed bag for world's big brokers

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While 2006 may have been a more stable year for the world's largest insurance brokerages from a regulatory standpoint, restructuring initiatives and a soft pricing environment made for another challenging year.

The world's four largest brokerages, which gave up millions in contingent commission revenues in 2005 as part of regulatory settlements, all reported increases in their 2006 brokerage revenues, albeit in the single digits.

And, with the exception of Chicago-based Aon Corp., which reported a 2.2% decline in profits, the largest brokers reported improved profits last year.

Analysts say that after the regulatory upheaval in late 2004 and 2005, various restructuring initiatives and the soft pricing environment were the main themes for the world's largest brokers in 2006.

Overall, "it was a year of normalization...where you started to see some stabilization and refocus within the brokerage market," said David Small, an analyst with Bear Stearns & Co. Inc. in New York.

"It was a mixed bag," said Cliff Gallant, an analyst with Keefe, Bruyette & Woods Inc. in New York. "On one hand, you had a more stable environment, but on the other, internally there was a lot of restructuring and a more difficult operating environment."

London-based Willis Group Holdings Ltd. reported the largest brokerage revenue increase among the four, a 6.7% rise to $2.34 billion. New York-based Marsh & McLennan Cos. Inc. reported the smallest growth in its brokerage revenues--a 4% increase.

Itasca, Ill.-based Arthur J. Gallagher & Co. Inc. reported the biggest profit improvement, a more than 300% surge to $128.5 million vs. 2005, which was impacted by more than $200 million in litigation and contingent commission-related expenses.

"I generally think the results this year were uninspiring for Marsh and Aon specifically," said Mark Lane, an analyst with William Blair & Co. in Chicago. "Organic revenue growth was pretty sluggish and we didn't see the margin lift that we were expecting."

"What's funny to us is that underwriters describe the market as relatively stable and with modest pricing pressure, but it's clearly had a lot of impact on the organic growth of the large brokers," Mr. Lane said. It does appear, he continued, that Willis "is doing a better job in finding growth opportunities globally and maybe is seeing some of the benefits from the investments they've made in people over the last few years."

Organic growth

Compared with Marsh and Aon, which reported zero and 2% organic growth in their risk and insurance brokerage units, respectively, in 2006, Willis reported 8% organic growth and Gallagher reported 6%.

The disparity may not be as great as it would seem. MMC and Aon include the impact of lost contingent commissions in their reported organic growth numbers, while Willis and Gallagher exclude contingent commission revenue from organic growth rates.

At this point in the insurance cycle, Mr. Small of Bear Stearns said he is looking for "a broker that has some potential to expand margins and also some potential to grow organically." Willis is in a good position to do that as it expands in specialty niche areas, builds out its geographic platform and focuses on expense reduction through its previously announced "Shaping Our Future" initiatives, he said.

Willis incurred $101 million in expenses in the second half in connection with launching its cost-reduction effort, which is expected to save $65 million by 2009 and result in 500 job eliminations.

Jay Cohen, a research analyst with Merrill Lynch & Co. Inc., noted in a report, however, that Willis will be challenged to maintain its growth rate going forward due to softening market conditions. At the same time, he noted, "Marsh, in particular, looks as if it is no longer playing defense and will likely be a tougher competitor in the future."

In a separate report on MMC, Mr. Cohen said third- and fourth-quarter 2006 results "suggest a definite change in momentum at MMC" and that his confidence in MMC's earnings has "improved."

Although Marsh reported a 1% drop in revenues in the fourth quarter of 2006, Michael G. Cherkasky, MMC's president and chief executive officer, said in a statement that new business revenues at Marsh "were the highest they have been since the first half of 2004."

"A number of nagging concerns" remain about MMC, though, Mr. Small said in a report. Among other things, "retentions are unlikely to return to pre-2004 levels" at Marsh given the trend of buyers putting their business to bid more frequently and seeking multiple brokers to handle their accounts, he said.

Marsh's biggest competitor, Aon, had "a rocky year" in 2006, but it did "end well," noted Keefe, Bruyette & Woods' Mr. Gallant.

There were "lots of changes" at the brokerage in 2006, the first full year with President and CEO Greg Case at the helm, Mr. Gallant said. Aside from selling much of its underwriting business, Aon put $167 million toward its three-year restructuring plan that is expected to result in a net reduction of about 3,600 employees and annualized savings of about $280 million by 2008.

"But the fourth quarter shows signs to be optimistic, I'd say," Mr. Gallant said, noting that while 2% organic growth is "weak" it is OK "considering the soft market." He also noted that Aon's operating margins "are starting to improve."

As for Gallagher, the world's fourth-largest broker reported "disappointing" fourth-quarter earnings, Mr. Small said in a written report. The "major reason for the miss was that expenses were $21.7 million higher than anticipated, while top-line growth was only marginally better than expected." He noted that higher expenses appear to be driven by acquisitions and staffing levels in the risk management segment.

Gallagher noted in its earnings release that pretax margins decreased in the quarter within its risk management segment "because we maintained our staffing levels in anticipation of higher reported claims--which did not occur."

On a positive note, Gallagher seems to have a very "robust pipeline" of acquisition candidates in the $3 million to $15 million in revenue range, Mr. Small said.