Good afternoon, and welcome to Arthur J. Gallagher & Company's Second Quarter 2022 Earnings Conference Call. Today's call is being recorded. 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 securities laws. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the cautionary statements 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. Good afternoon, everyone. Thank you for joining us for our second quarter 2022 earnings call. On the call with me today is Doug Howell, our CFO; as well as the heads of our operating divisions. We had another excellent quarter of financial performance. For our combined Brokerage and Risk Management segments, we posted 22% growth in revenue, 10.7% organic growth, net earnings growth of 35%, adjusted EBITDAC growth of 23% and adjusted earnings per share growth of 19%. I'm extremely proud of how our nearly 41,000 colleagues around the globe performed during the quarter in the first half of the year. So let me give you some more detail on our second quarter Brokerage segment performance. During the quarter, reported revenue growth was 25%. Of that, 10.8% was organic. We did have a tailwind of about 1 point from an infrequent large life case that I'll touch on in a minute. Rollover revenues were about $240 million, consistent with our June IR Day expectations. Net earnings growth was 36%. And as expected, we posted adjusted EBITDAC margins of 32%, an outstanding quarter for the Brokerage team. Let me walk you around the world and break down our organic, starting with our PC operations. Our U.S. retail business posted 11% organic, with strong new business, retention and continued renewal premium increases. Risk Placement Services, our U.S. wholesale operations, posted organic of 8%. This includes more than 15% organic in open brokerage and 4% organic in our MGA programs and binding businesses. New business was consistent with second quarter of '21, while retention was down just a bit from last year, as we noted in our June IR Day. Shifting outside the U.S. Our U.K. businesses posted organic of 8% with excellent new business overall and another double-digit organic growth…

Thanks, Pat, and hello, everyone, an excellent second quarter and terrific count. Today, I'll touch on organic margins and the Corporate segment using our earnings release and then make some comments using our CFO commentary document posted on our website. I'll end then with my typical comments on M&A, debt and cash. Okay, starting with the earnings release to the Brokerage segment organic table on Page 3. Fantastic headline all-in brokerage organic of 10.8%. As Pat said, we did benefit by about 1 point or so because of a large group live case found in late June. With or without that, a great quarter by our sales team. As for the rest of '22, during our June IR Day, we said third and fourth quarter would be somewhere around 8% due to a tough benefits compare. As we sit today, we're still seeing third quarter around that 8%, reflecting about 1 point of that tough benefits compare, and we're becoming more bullish in fourth quarter, call it nicely over 8% in the fourth quarter. That would lead to full year Brokerage segment organic growth of over 9%. So today, we're forecasting full year organic growth better than what we were seeing at our June IR Day. Next, turning to Page 5 to the Brokerage segment adjusted EBITDAC margin table. Headline all-in adjusted EBITDAC margin of 32%, right in line with our June IR day expectation. Recall what we've been saying all year, because of the roll-in impact of the acquired reinsurance operations, which has substantial quarterly seasonality and because there are still expenses returning as we come out of the pandemic, those in combination create quarterly margin change volatility. As a recap, we posted adjusted margins up 50 basis points in the first quarter, down 97 basis points here in…

Thanks, Doug. Daryl, I think we're ready to open it up to questions.

Our first questions come from the line of Elyse Greenspan with Wells Fargo.

My first question, Pat, in June, I had asked you about recession. You said you guys were not seeing it. And if you were going to see an impact on your business, it wouldn't be in your results until 2023. So I recognize, right, that we're sitting here 6 months in advance of hitting next year. But as you think about how things can play out from an economic slowdown, we have inflation, still good property casualty pricing, how could that all shake out from an organic growth perspective next year to say if you see things today?

Well, I think it's not all that different than the discussion that we had in June. We're seeing -- literally, we look at this daily, an interesting pattern of our underlying clients' business is doing well. They're still recruiting people. Our benefits HR folks are as busy as they can possibly be. We watch for adjustments, both in terms of audits and endorsements, and those are all positive right now. To put that in perspective, we have -- we do have a baseline on that during the pandemic, and it was -- that was obviously substantially upside down. So we do have a good feel for that, and we feel good about it. Inflation, as Doug said, really has an impact on about 20% of our expenses. I think that's probably good research on the team's part in terms of what's really subject to that, that we'll be watching. As you know, we're going into budget time in the next 6 weeks or so, and there's a lot of discussion around this. So don't hold me to it, but I think that we're pretty -- in a pretty good spot. And I think our mix of business bodes well. I think that the -- the way our expenses shake out, an awful lot of those expenses are variable, I think that's good. A lot of upside for our salespeople this year, obviously. And I think that with rate increases, with interest rates up, it's a pretty good environment for a broker.

So let me pile on that a little bit because we don't want whiteboarding on that. Like that, we're not seeing daily indications of our customers' growth slowing at this point. And admittedly, that's looking at current and recent past activity. And I think your question is really more about a future slowdown. So when we looked at that, what kind of cooling might we see, whether it's a recession or just a slowdown in the economy because, obviously, not every recession is the same, we do a lot of work on that. And we see -- if it happens, when I say if, more like a normal recession, maybe more like 1990, '91, and again, of what happened maybe in 2000, 2001, and before 9/11. We do not see next year being a clinch like the subprime financial shock recession of '07 or '08 or the pandemic recession for a few months of '20. So it's also important to note that these more normal recessions in the early '90s and early 2000s, both lasted about 8 months. So we see it more like that. It's also -- it's an important point to remember that brokers -- we are in a very large portion of our revenues based on the amount of premium placed. If it goes up because of rate or because of exposure, frankly, we're a little bit different on that. So for us, we think that like taking a look at nominal GDP is the bigger factor for our revenue much more than real GDP. So absolute sales, payroll, like Pat said, and property values are what premiums are placed on. So when you say, what thoughts next year what will premium rate increases do? And you heard us say that we don't see them slowing over the next year or so. And then really, our spread between new business and loss, we're proficient broker. So selling more insurance than we lose every year. So when we put all that together for next year, the brokerage business during a normal recession during an inflating premium rate environment can still post terrific organic results. So that's how we're seeing it now. And I talked to you about on the expense side during June that we think that we have some mitigating factors for that 20% that might be highly exposed to the inflation component of that. So it's a long answer to your question between Pat and I on it, but we think '23 could still be a year of terrific organic growth.

But let me load in another thought to, Elyse, we didn't talk about June. But if you go back to 2007, 2008, you go back to the pandemic clinches, we were -- we learned again, which we have through many tough times that our clients will stop paying their people before they stop paying their premiums. And that's a pretty good business to be in regardless of the economy.

My second question is maybe more short term. Doug, you said the fourth quarter brokerage outlook is a little bit better, right, than at the June IR Day. What's the reason for that?

I just think sustained rate increases, and our teams are doing a great job of selling more than we're losing. So I think that just the environment seems to be better. We're starting to see data come out of what's happening with second quarter rates versus first. And there might have been just a little bit of rate drop in the first quarter, and that seems to be back on a positive slope now. So you see that kind of in first quarters when you go back over the last few years that maybe rate increases aren't quite as big as they are in later quarters because you get -- for the carriers, they get the full year of the premium in the books by being maybe a little bit more competitive in the first quarter. Second quarter bounced back up again. I think that we've had a chance to look at what's in our pipeline. So I would say it's on all fronts, we're just feeling more optimistic about where we're seeing the second half.

And then one last one. You guys gave the M&A color, so it seems like you still have a good pipeline. Have you -- do you think there could be any timing shift in when deals get closed, if people are concerned about a recession? I mean if they're just potentially waiting to get a better multiple or have you not observed that in the past or do you not expect that to happen this time around?

No. I think brokers are opportunistic, smart people. If I had a business to sell, now is when I'd sell it.

Our next question has come from the line of Yaron Kinar with Jefferies.

And congrats on a good quarter. First question, the large life case that you mentioned, what's the margin profile on that? Is that accretive or dilutive to the overall Brokerage business?

It's about the same. So it doesn't have the leverage as you would see in some of the other incremental amount.

Okay. And then was FX -- did that have an impact on margins or only on revenues?

We adjust that out of our margin profile. So it would be just on the revenue side.

Okay. And then another one. I know you said you're still -- you haven't fully closed the books on clean coal, holding on hope that maybe you do see some extension come through in D.C. I guess, with the Democrats kind of coming to agreement in the Senate this week or actually today, I think, is it so premature to say what you've learned from that? Or if there is maybe an increasing chance of that clean coal credit continuing or extending?

Well, it's a 742 page draft bill that we're doing a lot of word searches on it. I'm not seeing how it's in that, but if you get into the kind of vote-a-rama in the Senate next week to see what other senators might want to include in the package or look at it, I think that -- we're never out of it until -- we're not. And even if it doesn't come through in this package, it could be later in the year or 2. So it doesn't cost us that much to carry the plant. Our utility partners have been very understanding about this. They're not pressing us to decommission. So if you -- that we have to carry it for another 6 months, we will. But if it happens, it would be great. If not, we're in the cash harvesting era just like we thought about for the last 15 years, we're at that point now. So harvesting the cash is pretty nice.

Our next question is come from the line of David Motemaden with Evercore.

I appreciate all the detail just on the midterm policy endorsements, audits. And I guess I'm wondering just on the Employee Benefits business, maybe you could talk about what you're seeing there on HR consulting and benefits consulting specifically with the pipeline? Any changes there? Any signs of weakness at all that you're seeing?

I'll tell you. It's really interesting to see. As you can imagine, I think we talked about this when the pandemic hit, that business shutdown in a quarter. And now -- and what an interesting turnaround for our clients. Now their biggest problem is attracting and retaining. So there is this demand, frankly, at a level that exceeds what we saw prepandemic. And I think in that case, things were kind of going along well. Everything was kind of fine. And then everyone tried to come down to the lowest amount of employee base they could. Now they're coming back. Their businesses are back. As we said, when we looked at our adjustments and endorsements and audits, our clients' businesses so far are robust, and that's a demand -- that creates a demand for more people. So I mean I can't get specific with you by exactly which practice group. It's the entire consulting part of our employee, human resource and human capital business is doing extremely well this year.

Yes. Let me add to that. There's -- during the pandemic, people were all about cost containment. And so they cut down their cost and they were cut any discretionary costs. It's regardless of what happens with this recession. And all the Fed actions, I think -- I don't -- I just don't believe that it's going to have a dramatic impact on unemployment. So I think that employers are really thinking about attracting, retaining and motivating their talent. So I just don't see any type of 8 months or yearlong recession putting a dent in the employment numbers. So employers are still going to have to make sure they're out there competing for talent, and that's where we really provide value. So I don't see this like the pandemic or in 2008. Again, we see it a lot, if it happens, like '90 and 2000, and there is still more for talent back then too.

I'll give you an example, David. This is one that kind of floored me in the last month. I won't mention any names, but we have a sizable client that has engaged us on a multimillion dollar contract to improve and help them with their communication with their employee base. This is a significant client, obviously, but they are willing to spend multiple millions of dollars in an outreach to existing employees to make sure they understand why they've got it so great being part of their organization. And communicating what are in the benefits plans, why they take care of them, how they're educating, what the career path is, what the growth of the company means, all those things that go into a solid communication plan, how cool is that?

No. I mean that is exciting. So yes, it definitely doesn't sound like, at least now you're seeing really any sign of the slowdown. So I guess, maybe just switching gears, if I think about, if we do see a slowdown in next year, I guess one thing that I've noticed the past couple of quarters in the press release sort of in the fine print, there's been mention of office consolidations. And I believe you spoke, Doug, I think last -- on the June call, about the agile workforce strategy. So I guess, could you maybe just talk a little bit more about what you're doing on the real estate front? And if maybe that could be a bigger benefit or a bigger lever to pull if we do get into a tougher revenue backdrop? And maybe if you could put some numbers around potential saves, that would also be helpful?

Yes. I think when we talked about it early, when we were coming out of the pandemic, we thought there could be $30 million or $40 million or $50 million of annualized savings coming from real estate. I think we're still on target about that. I think we're harvesting maybe about $8 million a year on that effort, and there's a couple of big office footprints that are coming up here in the next year that I think that maybe will be a little bit more on that over this next year. What are we doing? We're going to an office footprint that basically is covering 50% or so of the number of employees that we have. We're bringing technologies to bear, so their ads are within the work, so they're not dedicated locations. For those employees that have to come in every day, clearly, they have a designated spot. And we're finding that the employees are responding to it very well, especially in cities where there is a substantial commute. So I see us continuing to do that. I don't know whether it would be a more rapid exercise if we had a normal recession over the next year. I think the pace that we're making change is the pace that the organization has. And you got to -- either you wait until the lease expires and then downsize or you get out of it and you end up paying the rent to the rest of the term. So I think a paced and measured approach to that is where we are, and I don't see that changing if there was this normal recession happening over the next year.

I'll tell you, again, on the anecdote side, these plans were a foot, Doug, leading the charge on this prior to the pandemic. And I don't know about your experience. But my experience in telling people that this isn't their workstation anymore or that, that office is -- it's not a good experience. And people being able to go home and get their job done and come back in the office where we do believe the social connections are important, and we're not eliminating our footprints but allowing them to plug in, in a plug-and-play way on the days that they should be there for customer contact, for employee meetings. It's kind of like the pandemic was a real helper.

Yes, I know it sounds like -- sorry, go ahead.

And that is really, if you don't get the -- you leave the office is too big, it can kind of look like there's no vibe going out in the office. So we do a lot of things to make sure that we can track the workforce. The footprint responds to the workforce. It's like going into a restaurant and every other table is empty, it doesn't feel like there's much of a vibe. Same number of people in a smaller restaurant, you walk out saying, wow, that was really a happening place tonight. So we're trying to make those experiences when people come into the office, more collaborative, more near one each other, and it's actually working then. We were just in London not too long ago, and there's a real bounce in everybody step when they come into a full office.

Yes. Doug is just trying to do the age thing on me because I go to a full restaurant, I can't hear...

Yes. No, I agree with all of those changes. And so yes, it sounds like $20 million to $30 million of a benefit, but it sounds like that's maybe a bit more gradual unless things change.

Yes. I mean over a couple of years, 3.5 years. we'll get it.

Our next questions come from the line of Greg Peters with Raymond James.

You provided a pretty robust answer about the recession and -- or a potential recession and its effect on your brokerage business. But in your answer, you kind of didn't really talk about its effect on the Risk Management business. So maybe -- or if you did, I missed it, so -- because I was more focused on Brokerage. So maybe you could pivot and just tell us about your whiteboard sort of conclusions on the effect of a potential recession on the Risk Management business?

I don't think there was substantial employment changes in a normal recession. So with Gallagher Bassett being so tight, to the number of people employed in places where there might be slips and falls, et cetera, I think that -- I'm not saying they're immune to it in this next normal recession, but I think that they're pretty resilient in that right now. Same thing with the Benefits business, there's still competition for talent. I think that there's -- you heard Pat say that there's 11 million open jobs right now for -- and there's 5 million people out work or something like that. So I think that I personally believe that this next -- if there's a slowdown, it's about drying up excess demand versus supply. And Scott pays claims on what the supply is not the demand. And we sell stuff on supply, not demand. So I think that -- I think as business...

Yes. And Greg, you heard us say that of all the lines of cover right now that are adjusted by Gallagher Bassett where comp is still one line that's not -- and it's our core business in the U.S. is not back to prepandemic claim counts. So it takes a while to build that back. But that's, as Doug said, directly connected to the employee head count. And so employee head count -- if employee head counts get slashed, that will have an impact on Scott's business, if they stay stable. And what we're seeing on the Benefit side is aggressive hiring, aggressive attempts of retention. And I think we're in pretty good shape.

I was just -- as you were providing the answer, I was recalling an old and I never really tested it out to know whether it was true or not. But as a recession -- as there was an onset of recession that claim counts -- workers' comp claim counts actually increase as more employees sharing the worst would slip and fall in advance of actually facing the Grim Reaper, I don't know if that's something that is...

I think that's an old life tale.

Yes. Yes. Exactly.

That as workers' comp premium rates increase, and we're not fully into big jumps in workers' comp. But if we get a harder market in workers' comp that will push more people to self-insurance, and that leads to pretty good growth for Gallagher Bassett, too. So when they look at self-insurance and alternatives. So if we go into a recession, but workers' comp rates go up as medical costs inflate, et cetera, you might have more people looking for self-insurance with Gallagher Bassett paying the claims.

Is it -- is it your view that the work from home versus work from work is one of the contributing factors to the lower claim count in workers' comp, at least from what you're seeing in Gallagher Bassett?

No, not really.

Okay. Two other questions. From your property answer regarding where your real estate footprint, should I infer that about 20,000 or so of your employees are in full work from home if you said your property is target your real estate footprint is...

No, no, no. Gallagher Bassett has moved to a more virtual environment and that people are embracing that and really like that. The Brokerage business is allowing agile work. We're working to be agile and to be flexible. But these office footprints can actually handle everybody coming in at the same time, and we are encouraging people to come in.

Yes. I think, Greg, the number of people that actually are designated as purely work from home employees might be in the 8,000 person range.

A big part of that is GB.

Right.

I'm sorry, what was that last answer, Pat?

A big part of that is Gallagher Bassett.

Okay. And the final, just a detailed question, and I'm sure you've probably provided this before, but I just forget. Is there any cadence to how the cash flow comes out from the energy business as we think about the annual sort of -- is it heavier in the first quarter, are you harvesting it, or is it spread out evenly, et cetera?

That probably more closely correlates to the day that we do our estimated tax payments because we can anticipate using those credits. And therefore, we would pay less than estimated tax payment.

That's done on a quarterly basis, correct?

That's right.

Our next question has come from the line of Mark Hughes with Truist Securities.

Pat, the renewal premium number you gave us the 10.5%, was that sort of the global P&C market?

Wait a minute, Mark. I don't think I gave you the renewal premiums. Take a look.

Well, I understand you asked about the global second quarter renewal premiums, that's both rate and exposure of 10.5%, yes, that's right. And that's higher....

That was 8% in the first quarter. Do I have that right?

I'd have to pull up the script on that, but ...

I do think that's right.

Okay. All right. And then I'll say this slightly tongue in cheek, but also seriously. West Virginia Senator, Joe Manchin, does he like the clean coal business?

I think he does. I mean, he's got a lot of interest in it. The real question is, is he willing to sponsor a change in this as a part of a compromised plan? So we'll find that out over the next week or 10 days or 10 months, right? I don't think there'll be a focus -- it's a pretty small program to be honest. So I think that they're trying to get a deal done. Is this something that he's willing to champion? Maybe not, but we'll see what happens when we get into next week.

In the MGA business within wholesale, the 4% organic, do you think that will continue at that level? Or is there anything unusual this quarter?

No, I think it's pretty -- it's just the nature of some of those programs and MGU...

Yes, It should hold.

Should hold, not be better.

That's pretty -- that stuff is pretty subject, Mark, to the economy. It's bars opening, restaurants opening, contractors starting with the wheelbarrow. Houses that get hit by hail a lot.

Yes. Okay. And then did I hear you comment on workers' comp pricing. I know you talked about claims frequency and a lot of other factors. But how about pricing in the quarter flat?

On rate amount, it's growing. It's actually showing some nice mid-single-digit type growth numbers right now.

But rates are flat.

That's right.

It seems to be in line that our carrier partners are happy to continue to grow and are satisfied with the results.

Our next question is coming from the line of Meyer Shields with KBW.

Just a couple of quick ones. First off, when we look at supplementals and contingents, as a percentage of core commissions and fees, they're down year-over-year. Is that reinsurance?

It could have an impact on -- yes, that would be. And I think a good point on that, our supplementals and contingents, there is some difference in contract year-over-year. So it's always good look at those 2 in together, not individual. So -- but together, they were up 12% this quarter together.

Okay. Perfect. And then a second question on reinsurance. How comfortable are you with the idea that the breakage that you factored in goes away once we get into 2023? Is that can be a factor anymore?

I would say it's behind us. So we've done a really good job of holding the teams in. We're not having substantial attrition on that. In fact, I think we're in good shape on that. So I would not expect -- we anticipated what we give them breakage and the team is holding together -- that leadership team has done an amazingly good job.

I've talked about this quarter in and quarter out. I'm really, really happy with and proud of the fact that, that team joined us. 7% organic growth in the second quarter after the 2 to 3 years that they had prior to an acquisition getting completed in December. We're 9 months into this thing, and they're generating 7% organic. That's fantastic. And we were sitting there talking about breakage early on, is there going to be more -- and let's be honest, breakages, people left us and accounts in that business like to work with their team. And so people staying, producing -- the other thing I would comment on is the amount of interaction and the amount of help that reinsurance is to our retail brokerage operations on a global basis is exceeding our expectations. There are risk sharing pools in the United States that we've done longer and better than anybody in the marketplace and along comes a fresh look and fresh markets and a team that works together with us. The data sharing, the discussion of our partner markets and the sharing there, it's almost unbelievable to me on a multiple number of levels, how good a fit this is.

That's tremendously positive. And then one last question. I know this is nitpicky. But the large life deal that came in June, is that something that occurs next year? Is this a onetime deal?

Onetime deal.

We get them from time to time, but I wouldn't say that they're annually predictable year-over-year.

Right.

Then they themselves remain...

I'm sorry.

They bind when they bind. It's not like it's saying you've got to have this all put to bed by January 1, by October 1. It doesn't really drive necessarily with the calendar or fiscal year of the client. It's whenever they want to put these cases in place is when they were buying. So it would not be predictable quarter over quarter over quarter.

Our next question is come from the line of Weston Bloomer with UBS.

My first one is on -- just a follow-up on Willis Re. Obviously, good organic there of 7%. With investments ahead of schedule, I'm curious how you're thinking about growth and margin improvement in that business in 2023? Could we potentially see organic come in above the 7%? How should we think about potential margin improvement? Would it potentially grow faster than the core portfolio currently?

Well, that margin for the year is somewhere around 36%. So I think that we're very happy with that margin. I think holding that margin is the right answer for that business. It takes heavy investment. They've been underinvested for the last 3 or 4 years on that. So that is not a business, if you go back to our acquisition that was expecting substantial margin change on that. So we're happy with the margins the way they are. We think they're competitive. Sure, there will be opportunities for us to become more efficient, and we do that every year. We always become more efficient. But I think there's a ripe opportunity right now to hire brokers in that space that would like to join us. It's a hot thing going right now. So it would be nice to take and hire folks in that business. I think it's 34% for the year where we are.

Got it. And then my follow-up is just on M&A. Curious on what you're seeing on the international M&A market. Is that more attractive from a multiple perspective or a competition perspective right now? Or is maybe your term sheet disclosure more international U.S. weighted versus historical? Just kind of curious on what you're seeing.

It's not more international weighted. It's about the same and multiples around the world, you can throw a hat over.

Thanks, Weston. Thanks for being on the call, Weston. Nice to hear from you.

All of you by the way, Doug, let's not single in -- all right, I think that's our questions for now. I'd like to thank everyone on the call again for joining us. Obviously, we're excited. We had a fantastic second quarter and first half of 2022. I'd like to thank all our colleagues around the globe for their hard work, our carrier partners for their ongoing support and our clients for their continued trust. We look forward to speaking to you again at our September Investor Day meeting, and thank you all, everyone, for being with us.

Thank you. This does conclude today's conference call. You may disconnect your lines at this time. Thank you for your participation, and have a great night.