Good afternoon, and welcome to Arthur J. Gallagher & Co.’s First Quarter 2021 Earnings Conference Call. Participants have been placed on a listen-only mode. [Operator Instructions] 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 security 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 J. Patrick Gallagher, Chairman, President and CEO of Arthur J. Gallagher & Co. Mr. Gallagher, you may begin.

Thank you, Laura. Good afternoon, and thank you for joining us for our first quarter 2021 earnings call. On the call with me today is Doug Howell, our CFO, as well as the heads of our operating divisions. What a fantastic quarter. We executed against our four long-term operating priorities to drive shareholder value: first, we grew organically; second, we grew through acquisitions; third, we improved our productivity while raising our quality; and fourth, we continue to reap the benefits of our unique Gallagher culture. I’m extremely proud of how our team continues to execute and deliver world-class expertise and service day-in and day-out. We’re off to a great start in 2021. So, let me give you some more detail on the quarter, starting with our Brokerage segment. Reported revenue growth of 12.2%, of that, 6% was organic revenue growth, better than our recent IR Day expectations, thanks to an excellent March. Our cost containment efforts saved about $60 million in the quarter, helping drive our net earnings margin higher by 94 basis points and expand our adjusted EBITDAC margin by 480 basis points and net earnings were up 17% and adjusted EBITDAC was up 24%, an excellent quarter from the Brokerage team. Let me walk you around the world and give you some soundbites about each of our Brokerage units, starting with our P/C operations. In the U.S., retail organic growth was strong at about 5%. New business was excellent and retention remains strong. In our U.S. wholesale operations, Risk Placement Services organic was about 6%. Open brokerage organic was 15% due to rate increases, higher levels of new business and improved retention. Our MGA program’s binding businesses were up about 4%. Retention in new business were similar to the first quarter of 2020. However, we did see a…

Thanks, Pat, and good afternoon, everyone. I’ll echo Pat’s comments, an excellent quarter and a terrific start to the year. Today, I’ll spend most of my time on both our cost savings initiatives and our clean energy cash flows, then highlight a few items in our CFO commentary document, and I’ll close with some comments on M&A, cash and liquidity. Before I plunge in on cost, one quick comment on Page 3 in the Brokerage segment organic table. You’ll see that we had a great quarter for contingent commissions. There is a little bit of favorable timing in there, call it about 50 basis points on total organic. That will flip the other way next quarter but regardless, a really solid quarter. Okay, let’s go to Page 5, the Brokerage segment adjusted EBITDAC table. You’ll see that we grew adjusted EBITDAC by $122 million over last year’s first quarter, resulting in about 480 basis points of adjusted margin expansion. That would have been closer to 550 basis points, but as we discussed in our March IR Day, M&A roll-in isn’t as seasonally large, and we did strengthen bonus a bit, given our outlook for 2021 as considerably more optimistic today than it was last year at this time standing at the gates of a global pandemic. Within that $122 million of EBITDAC growth is about $60 million that is directly related to our cost savings initiatives, call that about 370 basis points of margin expansion. So when controlling for these three items, we see underlying margin expansion of about 180 basis points on that 6% all-in organic, once again, absolutely terrific execution by the team. Moving on to the Risk Management segment on Page 6. We grew adjusted EBITDAC by $4.3 million, resulting in about 180 basis points of adjusted…

Thanks, Doug. Laura, I think we can go to some questions and answers.

[Operator Instructions] Our first question comes from the line of Elyse Greenspan with Wells Fargo. You may proceed with your question.

Hi, thanks. Good evening.

Hi, Elyse.

Hi. My first question is on organic. You guys printed 6% in the quarter. As I look to your comments, you said perhaps you get back to where we were in 2019, which is also 6%. But if you think about what’s going on today, you pointed to still strong P&C pricing and the economy is getting better. So what would cause the forward three quarters of this year to not be stronger? Like do you see anything decelerating or is it just there’s some conservatism in that outlook for things to kind of stay stable over the rest of the year?

I think it depends on the recovery pattern. I think there’s still a lot of unemployment in there, and we’re running somewhere in that 5.5% to 6% range right now. We’re going to hold that for the rest of the year. It looks like it could be a pretty good year. So there’s nothing inherently different today in that thinking other than it feels kind of like 2019.

Our clients are doing much better, Elyse. I think they are coming back to 2019, not surging beyond it.

Okay and then in terms of the margin, right, you guys had alluded to 400 basis points of margin expansion at your IR event, and that came 80 basis points above but we still had the headwind you were alluding to. So what was better, I guess, relative to the IR Day within the margin? Was it the contingence on supplemental? Or was it just kind of the core margin expansion away from the save which is better than you were thinking?

It was a contingent commission that came in better, primarily fueled that.

Okay and then on the M&A side of things, you pointed to an active pipeline in terms of tuck-ins. There’s obviously a pretty big merger between Aon and Willis that – where they’re working toward their regulatory approvals and I’m not sure if you can comment on it. Obviously a lot of speculation in the press in terms of what may or may not be divested. But as you guys think about larger deals, could you just give us a sense of how you’re thinking about, I guess, potentially on the M&A side, if there are properties that could become available there to the divestment process and things that could potentially be attractive to Gallagher.

Right. So there’s a lot to unpack in that. I’ll hit the capacity. We have up to $2.5 billion worth of M&A capacity this year and we’ve got a full pipeline of nice tuck-in acquisitions that are out there. In terms of what comes out of the Aon and Willis opportunity, we read the same things that you’re reading and we just typically don’t comment on acquisitions that we hear about in the papers, but we’ve got $2.5 billion and we like our tuck-in merger strategy.

Okay, that’s helpful. Thanks for the color.

Our next question comes from the line of Greg Peters with Raymond James. You may proceed with your question.

Good afternoon.

Hey Greg.

So I just want to turn around the discussion on M&A. Can you go back and revisit sort of the process that evolved and emerged when you guys were doing the JLT global aerospace deal in 2019? Was it a 3-month process? Was it a one-month process? And I guess, ultimately, what we’re getting at is or I’m going with is there’s some pretty strong time line issues with Aon and Willis Towers Watson. And I guess some of your investors might be concerned that you, in an effort to meet their time lines, not that you’re doing anything, but you might sacrifice your due diligence, if that makes sense.

Greg, I’ll take a shot at that. We did the Arrow deal in London in pretty short order. We’re really happy with that acquisition. It turned out to be terrific. We didn’t seem to sacrifice anything.

Okay and so one of the other areas that you referenced is culture. Maybe you can go back to the acquisitions, the large acquisitions you did in New Zealand and Australia and talk to us a little bit how you were able to ensure the continuity of your culture when you’re doing large deals.

Well, I think in that situation, you had very good strong stand-alone businesses that we could, in fact, get to meet the leadership of. I think you remember the story. We did fly to Australia, met leadership and gave them the choice. They were planning on going public in their own right. We met two leaders with – the entire top leadership. And basically, that evening said, "You’ve got a choice to make. You want to go public on your own or do you want to join us?" Steve Lockwood, who’s still with us, had that decision to make. I think he made a pretty good decision. Things are going great.

Yes. I think, Greg, on that one, in particular, too, is that – and this seems odd for the accountant to say this, but when you – on that deal, it was owned by an industrial conglomerate that really didn’t view brokerage as being its priority, insurance brokerage and I’ve got to say, for the way our sales leadership and our operational leadership came down to Australia, combined with Steve’s relentless focus on sales, we really – it was really the Australia business that needed a positive shot in the arm when it comes to embracing and supporting a sales culture and we think that what works at Gallagher are people that want to come in and sell insurance and we’ve worked hard over the number of years to show that we’re a broker run by brokers and so we like to sell insurance and that is the culture that we think really, really was the secret sauce to taking – it was running negative 7% organic in Australia when we bought it and we think we did a terrific job. It’s posting nice organic year in and year out since that – since we did that.

Canada, our Canadian operation was running negative organic as well.

Well, the accountant didn’t do too bad with his answer. So I’ll pivot to...

Remember, he’s been around 20 years, Greg.

Yes, I’m well aware. I’d like to pivot to the operations. Just the two things that stuck out. The employee benefits business clearly is still – I don’t want to say struggling but it hasn’t rebounded the way it was pre-pandemic. Can you – is there any ASC 606 issues as we think about the first quarter results relative to the year before? Or is there – is it expected that as we move through the year, there could be some benefit in that if the economies do recover?

There’s nothing noteworthy on 606 in the numbers, what could happen in the future. If you had a substantial recovery in covered lives compared to our estimates – covered lives compared to our estimates today, you could see some upside development in those estimates for the rest of this year. As you know, all that employee benefits business or most of it is a 1/1 renewal. We have to make our estimate of covered lives. And if there was a substantial surge in employment, it would probably pull up those estimates a little bit over the next three quarters as that develops.

Got it. You know I feel like I’ve hogged enough of your time. I’ll let others ask their questions. Thanks for the answers.

Thanks Greg.

Our next question comes from the line of David Motemaden with Evercore ISI. You may proceed with your question.

Hi, good evening.

Hi David.

I had a question, just following up on the benefits business and hoping to maybe get a bit more granular detail just in terms of how you’re thinking about organic throughout the rest of the year and specifically, I know you spoke about, in your response to the previous question, just about your estimates about covered lives and what those do for the year. So I’m wondering what your expectations are for the rest of the year just for covered lives, like what’s baked in that statement that you’re assuming we can get back to 2019 organic levels here in 2021?

Yes. So our assumptions in the 606 estimates are not substantial recovery in covered lives, different than where our brokers place the business as they put that to rest here in January. So there isn’t a substantial uptick in expectation. Also on that point, remember, that business didn’t fall off the cliff last year because the employers that we do are pretty stable employers and so while we didn’t have a substantial decrease in covered lives last year, and so I wouldn’t expect a substantial recovery of that for the rest of the year. So kind of flat where they renewed is what our expectations were used when we set that reserve – that estimate.

Where we see some opportunity to grow back is the fee business. That business was just – it was slammed shut at the end of the first quarter last year and those are projects that need to be done. They need professionals to do them, and I think that there will be some more demand there.

I mean the workforce talent is coming back, so, I think that’s – and that’s where we excel and that is helping employers with that.

Got it. No, that’s helpful and I’m sorry if I missed it, but did you talk about how that’s trending thus far in the second quarter just on the consulting arrangements?

We didn’t comment but we’re happy to. Not a substantial difference sitting here on April 29, as we saw, let’s say, on March 29. But there is – there are some green shoots. Our consultants are getting some more calls so I think that you’ll see a little bit more active summer and fall.

Let’s hope.

Got it. No, that’s helpful and then maybe just stepping back, a bigger picture question. Sort of on the M&A theme but I’m just sort of – I’m wondering just how you guys are thinking about broader acquisitions as opposed to team lift-outs and sort of how you weigh both potential. Very similar ways of growth but obviously different in terms of the way the financials work. So just wondering how you think about both of those avenues.

Yes. Let me be real clear, David. I think these players in the market, they want to ignore contracts, lift teams, litigate and call that a cheaper way to get talent. Let me see if I can clean up my comments. I don’t like that. We like to see people that have built companies, entrepreneurial in nature, have a culture, respect their clients, respect their people and sell ongoing enterprises to us. Do we recruit individual people? Absolutely. And do we bring teams across? Yes, we do. But the other method isn’t for us.

Got it. Yup. That makes sense. That’s all that I have. I’ll let others ask their questions in the queue. Thank you.

Thanks David

Our next question comes from the line of Mark Hughes with Truist. You may proceed with your question.

Hi Mark.

Yeah, thank you. Good afternoon.

Hi Mark.

Hello. Hey, on the Risk Management business, I’ll ask a question about claims. You say that year-over-year, clearly, frequency or claims counts are going to be up. But it sounds like Q4 and Q1 and maybe even so far in Q2 are holding relatively steady. Is that the right way to think about that?

Yes. I think there’s a little bit of a crossover here, Mark. As COVID claims started to decline, we started to see regular workers’ comp claim go up. You’ll have a little bit of that in the second quarter but not much. I think the COVID claims are pretty well through our process at this point, and then the regular workers’ comp claims will far exceed that going forward. So that might be what you’re seeing in that number.

On just the pricing environment, there’s some talk of moderation. You all seem to be pretty consistent that the trends are holding steady, similar rates of increase. I think in the text, you might have pointed to higher rates of increase in the second quarter. Are you seeing any sort of moderation?

No, we’re not. I think we’re seeing consistent demand for proper pricing. We’ve been a couple of years now into some hardening numbers. So I do think that over time, that will moderate but we’re not seeing any lack of discipline in the market at this point and underwriters are continuing to ask for increases.

Yes. When you look at the dollar – the year-over-year dollar-over-dollar increases, the dollars are still going up. The rate or the percentage might not be as big because you’re on a bigger base, but there’s still rate increases happening everywhere. Even workers’ comp is getting rate at this point.

Then Doug, any green shoots about extending the clean energy legislation?

There’s a lot of infrastructure packages out there, and I think that there’s opportunity to realize this process does contribute some pretty good value to the environment. So there’s always hope. If we get an opportunity to – in the infrastructure package or in the tax reconciliation process that might come through, there’s always hope on that.

Thank you.

Sure.

Thanks Mark.

Our next question comes from the line of Yaron Kinar with Goldman Sachs. You may proceed with your question.

Hi, good afternoon everybody. My first question on the contingent commissions. If I’m doing my math correct, I think I get to like 120 basis points or so of margin expansion coming from contingents. Does that resonate?

What did you assume as the margin on it?

About 70%.

Yes, it might be a little thick. I mean a lot of the contingent commissions go to – when it comes to the leadership variable comp, there’s a piece of that that fuels it. So 70% might be a little rich, but some of it, yes, maybe 100 basis points, maybe not 120.

Okay, OK. So you got like 60 basis points of, call it, organic margin expansion, 100 coming from contingents and the rest coming from cost saves, if I wanted to divide it into buckets?

Probably almost a point from regular trough then – and when you take out the contingents and you can’t take out the margin from that.

Okay, OK. That’s helpful and did I hear you say that you’re switching over to cash EPS in 2022?

No. I think what I was saying is that in the clean energy segment, you’re going to start seeing $120 million to – $125 million to $150 million of additional cash flows that will come through our cash flow statement. We’ll obviously make sure that we call that out every quarter on how much is that because it’s the rundown of that deferred tax asset that sits on our balance sheet that moves from being a noncash asset into a cash asset. So we’ll make sure we highlight it as we go forward.

Got it, OK. Thank you very much and congrats on the quarter.

Thanks.

Thanks.

Our next question comes from the line of Meyer Shields with KBW. You may proceed with your question.

Thanks. I guess the big dumb question that I’m struggling with is that if we’re seeing rate increases hold flat and we assume that the economy comes back, wouldn’t that point to organic growth on a year-over-year basis well above 5%?

Hope so.

Part of that, though too, is remember, our job is to help our client structure programs that actually mitigate some of the rate increase. It’s hard to mitigate exposure growth unless you want to take more deductibles or lower limits. Rate increases, there’s some – you can do the same thing, but if somebody adds two or three more trucks, you’ve got to insure those other two or three more trucks. So if exposure units overtake the recovery from rate on that, the programs that we designed, you’d see more of that hitting the bottom line. But if it’s just purely rate, you can mitigate some of that through different program structure.

Okay, that’s very helpful and then if I can dig just a little deeper on the claims – the workers’ compensation claims that you’re seeing in the trends. Is there a material difference to your revenues when you’re handling traditional work comp claims versus COVID?

Well, there’s two different – there’s different pieces and there’s the liability piece and then there’s the medical-only piece in traditional workers’ comp. I think that the longer-tail liability type workers’ comp claim is more profitable to us than just the kind of the recurring medical-only claims, where we’re basically paying the bills on it. So you would see that – you would – the revenues that come off of a liability-related workers’ comp claim would probably exceed the COVID claims.

Okay. Perfect. Good. That’s very helpful. Thanks a lot.

Thanks Meyer.

Our last question comes from the line of Phil Stefano with Deutsche Bank. You may proceed with your question.

Yes, thanks and good evening. Just a few quick ones. Most have been asked and answered. But – so as we think about the appropriate base for our margin for first quarter 2022, is it the 39.2% that was printed? Or should we make some kind of adjustment for the margin benefit from the contingents and supplementals?

Okay. So you’re asking about a year from now in first quarter 2022?

No it would...

I’ll help you think that out a second here as I think that, yes, when you look at our 39.2%, the base should probably start from – you heard the earlier question. We probably got a little lift from contingent commissions in that number, so you want to start off a little bit lower base and let’s say by then, we’re holding half of our savings, long-term savings compared to where we are today. Maybe there’s $30 million worth of costs that are back into the structure by that time and spread that across $1.8 billion or $1.9 billion. That’s probably the right way to think about next year.

Okay, but it’s fair to say any of this lumpy stuff should probably be normalized for.

Say that again, I’m sorry.

It’s fair to say that – I mean the lumpy kind of impacts like a contingent over-earning, we should probably normalize for that as we think about the forward margin.

Yes, I think so. Yes.

Okay, all right. Perfect and then from the Risk Management segment, I guess, there was a comment around it being in the upper single digits for the next few quarters. Is the right way to think about this year-over-year or sequentially? I guess in my mind, when I think about your comment about claim counts being kind of flattish fourth quarter to first quarter, it feels like that’s reflected in the revenues and as we think about claim counts expanding with the economy opening back up, I guess, maybe 2021 is kind of one of the businesses where I look at this sequentially as opposed to on a year-over-year basis. Is that off base?

Either way, as long as you understand that last year’s second quarter there was a trough and there will be some recovery out of it this year relative to that quarter, but if you’re basing it off the last two quarters and want to do a run rate that way, it’s probably not a bad way to do it either.

Okay. All right. Perfect. That’s all I had.

Thank you, Phil. Well, thank you again, everybody, for being on today this afternoon. We really appreciate it. We delivered an excellent first quarter, and I’d like to thank all of our Gallagher professionals for their hard work, our clients for their trust and our carrier partners for their support. I’m confident that we can deliver another great year of financial performance in 2021 and truly believe we’re just getting started. Thanks for being with us.

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 evening.