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After steering its way through fallout from the contingent commissions controversy for much of 2005, 2006 "was a back to business year," for Arthur J. Gallagher & Co., said J. Patrick Gallagher Jr., the Itasca, Ill.-based brokerage's chairman, president and chief executive officer.
"I think the hallmark of 2006 was going into a year with a complete change in business practices on the broker side," Mr. Gallagher said. "It was also a relief to have most of the controversy (about contingent commissions) start to fade as we paid out the funds we promised to pay. It seems our settlement with Illinois is seen as adequate with the other states."
He said moving to a fully transparent model in the brokerage business "was no small feat."
"This is not how the business has been done for 80 years or 100 years," Mr. Gallagher said. What's more, Gallagher does much of its business in the commercial middle market, "and our competition there quite often is the local or regional broker, and they were going to operate in the old-fashioned model," he said.
"What was probably one of the most rewarding things about our move to describing to our clients exactly how we get paid was the fact that there was no push back," Mr. Gallagher said. "That told me a couple of things. The first thing it told me, and I couldn't be prouder of this, our clients recognize the value we're providing to their company.
"By the same token, I thought it was a tremendous reflection on our culture. You could have easily had production talent, even management talent, recruited away to local competitors, basically on the premise of 'We don't have to change anything,"' Mr. Gallagher said.
He admitted his company missed some acquisition opportunities last year because of the move to full transparency. "We lost acquisitions that in some instances were afraid to move into the new environment," he said.
Looking back, Mr. Gallagher said the transparency his firm embraced in 2006 is truly a benefit that emerged from the contingent commissions issue.
"I think it's moved our relationship with our clients to a higher plane, and I think it is a good thing, which the industry never would have done if we hadn't been brought to scrutiny by regulators," Mr. Gallagher said. "The rest of it was whatever it was, but there actually was a benefit here."
And, he noted, 2006 was a "good growth year" for the company.
Gallagher's acquisitions slowed to 10 in 2005 from a record 19 in 2004. Last year, the company completed 11--all within its brokerage segment. And, said Mr. Gallagher, "It looks like 2007 will be one of our best acquisition years of all time."
So far this year, Gallagher has completed 11 acquisitions.
"I think they've done a good job of getting the acquisitions moving in the past 12 months," said Adam Klauber, managing director at Cochran Caronia Waller, an investment banking firm in Chicago.
"The company has been a very good acquirer, and I think they have done a very good job over the years of bootstrapping some acquisitions and using them to penetrate some geographies, penetrate some product lines," said Mark A. Dwelle, senior vp-equity research at investment banking firm Ferris, Baker Watts Inc. in Richmond, Va.
Last year also saw a rebound in organic growth in Gallagher's brokerage segment, Mr. Gallagher said.
Gallagher, the world's fourth-largest insurance brokerage, posted nearly $1.44 billion in brokerage revenue in 2006, an increase of nearly 6.5% from its $1.35 billion in brokerage revenue in 2005.
The company posted $128.5 million in earnings in 2006, up from $30.8 million in 2005.
"It was in many ways a great year," Mr. Gallagher said. "Of course, the most difficult thing in the year was that we lost my uncle."
Company Chairman Robert E. Gallagher died last August after a brief illness. "He was just a wonderful influence on our company. And it's been nine months now and people still miss him quite a bit," Mr. Gallagher said.
"That was the one thing that really put a damper on 2006," he said. "Here we are, fighting our way through some tough stuff, succeeding, writing some new business and then we lose our chief culture officer. And that's really what Bob was."
Thus far this year, Gallagher, like other insurance brokerages, is confronting the impact of a still-softening market.
The company had $246.0 million in brokerage revenue in the first quarter of 2007, up 9.2% from the same period last year. Net earnings for the quarter were $9.2 million, down 12.4% from $10.5 million in the first quarter of 2006.
"The market is extremely soft and getting softer every minute," Mr. Gallagher said. "It's a significant head wind."
"The biggest thing in the whole broker sector is just the state of the whole insurance market," said Ferris, Baker Watts' Mr. Dwelle. "That affects (Gallagher) equally as much as any of their competitors."
On the positive side, "they're a strong sales organization," Mr. Dwelle said. "They've always been good at creating new business volumes." But, the analyst noted, improving margins is more difficult in the current market.
"Organic growth in the first quarter dropped 1%," Mr. Gallagher said. "Overall growth was still good--our acquisition activity has been very strong this year, I'm very pleased with the acquisition activity--but I would like to see us do better when it comes to organic growth. We're a sales and marketing company. We're used to hard markets and soft markets."
Cochran Caronia Waller's Mr. Klauber said he'd like to see the brokerage making more progress on the expense side of the ledger. "On the negative (side), we're not seeing the expense improvements we'd hoped for," Mr. Klauber said. "We'd hoped that would turn around, but so far it hasn't."
On the subject of supplemental commissions that Gallagher receives from some insurers, Mr. Gallagher stressed that they are fully disclosed to clients.
"Over 80% of our brokerage segment revenue comes to us in commissions. Our clients choose the commission route to pay us," Mr. Gallagher said. "Those commissions are disclosed. If I can get Hartford to agree, or CNA to agree or Chubb, or St. Paul Travelers, that because I don't get contingents they ought to pay me more up front, and I show that to a client who says that's appropriate compensation, then I feel zero conflict in accepting it."
"It cannot, by my agreement with regulators, be contingent on anything," Mr. Gallagher continued. "It cannot be an incentive. It has to be agreed up front. It has to be locked in and it has to be disclosed."
"By the way, I'm happy to work on a fee," Mr. Gallagher said, "as long as we're remunerated properly and profitably. And our production staff is empowered to have that discussion. They don't have to come to me."
Gallagher's stock closed at $28.30 per share on July 6, with a 52-week high of $30.42 and a 52-week low of $24.42.