Good morning, welcome to Arthur J. Gallagher & Co.'s fourth quarter 2013 earnings conference call. Participants have been placed on a listen-only mode. Your line will be open for questions following the presentation. Today's call is being recorded. If you have any objections, you may disconnect at this time. 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 certain risks and uncertainties that will be discussed on this call and which are also described in the Company's reports filed with the Securities and Exchange Commission. Actual results may differ materially from those discussed today. 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, Brenda, good morning, everyone. Welcome to our fourth quarter and year-end conference call. We appreciate you being with us this morning. Today, I'm joined by Doug Howell, our Chief Financial Officer, and the heads of our operating divisions. Simply said, I could not be any prouder of our team and our results in the fourth quarter and full year of 2013. We were working toward a strong finish as we entered the fourth quarter, the team surpassed even my high expectations. I simply could not have asked for better performance from our team. Literally, every division across the globe contributed to our record results. Combined brokerage and risk management had adjusted revenue of 18%, 6.2% of that was organic. 22% growth in adjusted EBITAC. These are outstanding results. Brokerage and risk management segments combined grew our adjusted revenue in the year $369 million.
This is a real testament to our sales culture. Every one of us in the company understands everywhere in the world that we get up every day, we understand that our number one job is to keep the clients we have and to attract new clients. We all understand that nothing happens until somebody rings the cash register. We continue to get stronger and stronger every quarter, every year. Today, we've proven that any account of any size, anywhere in the world, we can serve. That is exciting. On the mergers and acquisitions front, 2013 was a banner year. We completed 31 transactions, two of which were really sizable. Bollinger in the Northeast and Giles in the U.K. added significantly to our revenue base in both locations. Including the other 29 completed acquisitions, we approached $400 million of acquired revenue and $130 million of annualized EBITAC.
We paid a blended multiple of about 7.6 times, which we believe is a fair and reasonable multiple, we only had to use about a quarter of the aggregate purchase price in our stock. All our partners had choices. I'm proud they chose to join Gallagher, I want to welcome them to our growing family. Our pipeline going into 2014 is very robust. We expect 2014 to be another strong merger and acquisition year. In 2013, our workforce expanded by about 2,600 people, almost all of whom joined us through the merger and acquisition process. We like to say that we added 2,600 more brains, who working in our culture, in our niches, and our specialties, add incredible firepower. These new colleagues add tremendously to our capabilities and our opportunity to continue to grow. Let me add some color now by business line.
I'll start with property casualty retail in the United States. We had a strong new business year, a great acquisition year, and solid retention of accounts in the year. We saw rate increases throughout the year, and we saw the economy show signs of getting healthier. Think about this, only about 1%, in fact, less than 1% of our organic growth came from rate and the economy this quarter. For 2014, as we look at the rates, we expect the property casualty market to remain stable, with increases on most lines being somewhere on the order of 2% to 3%. The one exception to that would be larger property schedules in areas that have not experienced severe losses, and frankly, those customers deserve a decrease after a number of years of benign weather.
My continued surveys of our people show underwriters continue to account underwrite, and they understand that there is loss cost inflation. Managements have shown discipline for three years, and carrier managements continue to tell us to expect the same in the future. They must maintain their discipline, because if they don't, they won't have a return. Adequate returns can only be driven by underwriting profits. If discipline remains and rates are flat to up 2% to 3%, we should see solid organic growth from our new business efforts. On our wholesale business, we had strong organic growth in 2013, and we see business startups, primary market discipline continuing to present our wholesaler RPS, Risk Placement Services, with great opportunities. RPS is the largest MGA operation in the United States, according to Business Insurance magazine.
Our program business is seeing good growth opportunities, and our open market brokerage is receiving good submission activity. On our benefits business, 2013, we were lifted by our clients' and prospects' need for help with the new Health Care Act. Sorting through new regulations, consulting around exchanges, and helping clients decide how all of this fits into their HR strategy will continue to be a boom for us in 2014. Our international property casualty business has been our fastest growing business. Not only did we do one of our largest acquisitions in 2013, that was Giles, but our organic growth in the international PC world was the highest of the group. We were strong in the U.K., Australia, Canada, Mexico, and the Caribbean.
Our opportunities to expand outside the United States are growing because we now have platforms around the world that allow us to pursue bolt-on and folded acquisitions, and we will see more activity in that regard in 2014. Our risk management business had 9.3% organic growth in 2013, and we successfully concluded a number of customer-based investments in systems, people, and capabilities. This is leading us to our best new business start in 2014 in seven years. Plus, we have a carrier outsourcing arrangement that we started January 1st that will be over $12 million in revenue. We continue to see great opportunities to be an outsourced partner to the underwriting community. Our investments in Gallagher Bassett are paying off in customer wins in what is a very competitive environment, and GB was named the best U.S. TPA by the voting readers of Business Insurance magazine.
Finally, our shareholders had a great win in 2013. Shareholders received a 40% return, including dividends, for the full year in 2013. At our last board meeting, we increased our dividend again. Okay. 2013 is over. We're off and running in 2014. The moves we made, acquisitions, organic hires, systems investments in 2013, should put us in a very good position for continued growth in 2014. We are bullish. Most importantly, this is really critical. As I travel throughout our global network, I can tell you that our unique Gallagher culture is thriving. Teamwork is everywhere. Clients are being served exceptionally well. Our people are turned on, excited by our growing capabilities, and really believe we're just getting started. Doug?
Thanks, Pat. Good morning, everyone. It's nice to have a great quarter, and I'm encouraged about our prospects in 2014. We'll start on page two with the brokerage segment. Like Pat said, a terrific quarter and a terrific year. In the quarter, you'll see the integration costs related to Bollinger and Giles, which were right in line with what we discussed in our last conference call. You'll also see severance primarily related to management redundancies as we consolidate a number of our similar international operations under common leadership. That process is going very well. Looking towards 2014, expect to see $0.03 per quarter in total for integration and severance as we continue to bring our various operations together. Staying with brokerage, turning to page three, to the revenue table at the top. Some flavor behind the organic 5.8%.
First, you should know that we did have a few non-recurring wins that fueled organic by about 20 to 30 basis points in the fourth quarter. Those are great wins to have. Not likely recurring revenues next year in the fourth quarter. Second, when I look at the organic across our various brokerage units, all performed very close to the mid 5% range in the U.S. That's our retail units, our wholesale units, and our benefits units. They were all right near the average. International, as Pat said, was in the upper single digits. Third, you heard it from Pat. It deserves a special mention. I went back and I looked at the last 12 quarters of organic growth. During that time, there's not been one single quarter where more than 1% of our organic growth came from rate and exposure. We just sell more than we lose.
We're not overly sensitive to slightly up or slightly down rates. We grew even during a time of a sputtering economy. It simply shows that we should have continued organic growth, especially as the economy gathers steam, even should rates become a little bit flattish. Moving to the brokerage comp operating tables on page three, then to the overall adjusted EBITAC margin on page four. Comp is down, operating is flat, which resulted in EBITAC being up 100 basis points. That is right in line with what we thought in our last call. Some comments behind the margin. First, as we discussed last quarter, Bollinger and now Giles too, are seasonally a bit smaller in the fourth quarter.
To the extent they were a little drag on margins, that was offset by a little bit of margin lift coming from the non-recurring wins I mentioned just before. Either way, they just offset each other. Second, recall that a year ago, we took the proactive step to reduce our workforce to offset most of the underlying inflation in salaries, benefits, and health and welfare. As we come into 2014, while we do have some operational improvement initiatives, and I do feel like we can continue to shift more work to lower cost labor locations, there is some underlying workforce inflation. We're now back to our message track of about 18 months ago. If we don't have greater than 3% organic growth, don't model much of any margin expansion other than about 80 basis points because of Bollinger and Giles, which run higher margins.
Third, it's time for my annual reminder. Recall that our brokerage segment is extremely seasonal with our first quarter by far the smallest. Please make sure you factor that seasonality into your quarterly spreads. When you get done, step back and make sure you don't see much of any year-over-year margin expansion in the first quarter. Moving to the brokerage segment non-EBITAC line items for 2014. For amortization, assume about $39 million of expense per quarter. For acquisition earn out amortization expense, assume about $4 million per quarter. For depreciation, assume about $11 million of expense per quarter. As we do more M&A, for every dollar we spend, you need to increase amortization by about 1% of the purchase price per quarter, and that will get you close. Let's shift to the risk management segment back on page two.
As we discussed on our last call, you'll see the ramp-up costs associated with our new insurance carrier relationship. You'll also see severance as that segment also consolidated some leadership roles. As we convert IT systems for the carrier runoff book, expect to see about $1 million to $1.5 million a quarter in integration costs running through the third quarter of 2014. Turning to page four, to the risk management organic table. It was a strong quarter and a strong year, and as Pat mentioned, with the good new business pipeline and with our new carrier relationship, we should have revenue growth in the upper single digits in 2014. Let's move to the bottom of page four, to the compensation table. You saw it in Pat's comments, and you also see that our comp ratio spiked up in the fourth quarter.
We got hit with a few more really severe medical claims right at the end of the year, which cost us nearly $2 million. It looks like it is just a blip, and it's unfortunate that it hit us late in the year. Flipping to page five, you'll see that we had nice improvement in our operating expense ratio in the risk management segment. This is even while we invested some of that on client service enhancements. Nice work by the team on that one. Moving down to the adjusted EBITAC margin for risk management, we hit the 15.8% for the year, which was very close to our target of 16 points. Looking forward to 2014, we are again targeting 16 points of adjusted margin, which at that level, still provides us the opportunity to make further investments into the business.
Finally, on risk management, as for the non-cash items, assume about $6 million a quarter of depreciation and about $1 million a quarter amortization expense in 2014, you'll be close. Let's shift to page five, to the corporate segment. In total, the fourth quarter was right in line with our forecast. A little better earnings from clean energy was offset by a little bit more acquisition costs related to Giles, but right in line. For the year, our clean energy investment team nearly doubled their earnings from 2012, they are already hard at work optimizing existing plants and rolling out the remaining plants. We should better 2013's earnings, we are still seeing those investments as a nice funding source for our M&A program.
When modeling the corporate segment, we encourage you to model the segment using the shortcut table format that we provide on page 14 of our investor supplement. We've now provided our first range of estimates for 2014 for all four components of the corporate segment. Interest, M&A, and corporate are relatively straightforward, you've heard me say this before, when it comes to the clean energy line item, earnings for the year can be difficult to predict, we provided a wide range. Please make sure your models and note highlight that possibility. Please take a look at the note on page 15 of the supplement. It explains that because we're so seasonally small in the first quarter, we are likely to warehouse between $0.15-$0.19 of credits in the first quarter, which then get recognized over the following three quarters.
It all washes out by the end of the year, it does produce some volatility in our quarterly results. Some comments on capital management. Since our last call, we announced that we closed on a $600 million round of private placements that we will draw down in late February, we also filed a $200 million at-the-market or dribble out equity offering. Between our free cash flow in 2014, the dribble out, our line of credit, the ability to use stock and acquisitions, we are well-positioned to continue our M&A program. As for shares outstanding, it's looking like the fully diluted weighted shares outstanding for the first quarter will be about 138 million shares. As for the remaining quarters, that will mostly depend on our M&A levels.
When I step back and I boil it all down, in 2013, our combined core operations were up double digits on all measures, we doubled our earnings on clean energy. Clearly an outstanding year. As we move into 2014, we are in an era of rational rate setting. It seems the economy is getting better by most all measures, we have an M&A pipeline that's pages long with fine agencies and brokers that want to join us. We have a team that's highly experienced and embedded in a rock-solid culture that we think will excel in 2014. I like what we did this year, I think next year holds good things, too. Back to you, Pat.
Thank you, Doug. Brenda, we're ready for questions, hopefully some answers.
Thank you. The call is now open for questions. If you have a question, please pick up your handset and press *1 on your telephone at this time. If you are on speakerphone, please disable that function prior to pressing *1 to ensure optimum sound quality. You may remove yourself from the queue at any point by pressing *2. Again, that's *1 for questions. Our first question comes from the line of Sean Dargan with Macquarie. Please proceed with your question.
Thank you. Just was wondering about the tax rate in brokerage. Was there anything unusual there?
No. We did drop down a percentage, that's basically because of the weight of our international operations that are in lower tax locations. We hope to see continued downward movement in that, we dropped a point this year just because of that.
Okay, great. Thanks. Just a forward-looking question. Is there any appetite to increase your leverage to fund future acquisitions? You still thinking at kind of 2 times EBITDA?
Yeah, I think so. I think that when we do a 2 times EBITDA is probably right where we want to be. There'll be some times where it runs up to 2.2.3, and then as the earnings move into the financial statements, it'll drop back down around 2. That still gives us plenty of cushion related to our covenants. Still keeps us in the investment grade level. I think that somewhere in that 2 range is right where we want to be.
What is that cushion at now?
Well, we think that investment grade trips at about 2.75 times EBITDA. Our covenants are at 3.25.
Okay. Thank you very much.
Sure. Thanks, Sean.
Thank you. Our next question comes from the line of Gregory Locraft with Morgan Stanley. Please proceed with your question.
Thanks, congrats guys on the year and the quarter. Excellent job.
Thank you, Greg. Appreciate the comment.
I thought that in the commentary you were quite bullish on the top-line outlook for 2014 and beyond. Given where pricing is, I feel very good on top line. Can you talk a bit about margins? Because the corporation is kind of perched at levels that we've never seen before on the margin front. Really, you got to go back to 2004. What I'm wondering is, can you compare and contrast Gallagher today versus maybe 2004 when margins last peaked, and how can you kind of run through the previous peaks and keep going higher from here to grow margins specifically? Again, we feel really good on the top-line outlook as it seems you do as well.
Yeah, Greg, thanks for the comment. Just an overarching comment on margins. Actually, if you go back to 2004 with the changes in stock-based compensation, when you look at just the differences in accounting, our margins are actually better than ever before in the brokerage space. We feel very good about that. Our risk management has always been kind of in this 15%-17% range when it comes. That's just the nature of the business.
Which is a leading margin in that industry, by the way.
We feel good about the margins at that level. Do we see opportunity for margin expansion going forward? I've said that if we're not above 3% organic, we probably won't see much other than the impact of acquisitions, which could increase it or decrease it depending on the franchises that we buy. By and large, we're in an interesting era right now. If you look at our operating expenses, we have driven that down into the 16%-17% range. We just don't spend money on things that aren't people. We think that we have opportunities to continue to leverage our offshore centers of excellence that do tremendous work for us, and we think there are some technology opportunities as we roll it in. Behind the scenes here, the retail business has converted all of its different agency systems onto one platform here.
I think only a couple acquisition locations haven't been converted on yet. We're making some improvements in technology, but there is underlying inflation. Where do we see margins going long term? Give us 5% organic growth for the next three years, sure, you'd see some organic expansion. At 3%, it's going to be tough to have much more, but again, we think that we're well positioned. We've never cut our 401(k). We've never cut back on benefits that we provide to our employees. We've done a good job of keeping our workforce well paid throughout the entire recession and still today. Our future when it comes to workforce, we think of a 60% comp ratio and about a 16% or 17% operating expense ratio is a good spot for a brokerage like us to be.
Any commentary on the other segment, on the risk management?
You heard in my comments that we got hit with some medical claims right at the end of the year, but we think that there's a line of sight in that business to keep 16 points of margin. If they can grow in the upper single digits, we think that's tremendous. No margin compression and organic growth that might be approaching double digits. I don't think it'll hit double digits. We think that's good for that franchise. This is a labor-intensive business. There's some really exciting things that are going on inside of Gallagher Bassett right now that really provides some nice value to our clients. We think if we can run that for 16 points at upper single digits organic growth, that's a good spot for us to be.
Okay, great. Shifting gears, reinsurance brokerage. Do you guys do anything there? I thought in the quarter you made a move into that space. I'm just trying to size the move and your appetite for growing reinsurance brokerage.
We have a reinsurance business, and we've done reinsurance forever. You will recall, Greg, that we sold our Gallagher Re to Aon about six years ago. That was an effort that we had afoot to try to go after some of the larger treaties that were being placed around the world. Very exciting. In the fourth quarter, we're joined in a partnership by Grahame Chilton, who comes out of Benfield in the startup of a firm called Capsicum, which is an effort to start a new reinsurance venture that is primarily based on his past relationships. We've also done a small acquisition in that space in 2013, 2012 actually. We do see opportunities to grow. What you're not going to see us do is throw huge expense dollars at that. We think we've got an opportunity to build something out with Grahame. We're excited about that.
He's obviously a well-known person in that industry. He's been very successful. Pleased to have him as a teammate, and we think we'll do great things there, but it's not going to be something where we spend millions and millions of dollars to find out if we can do it.
Okay. If I may, and I don't know if it's appropriate, but did you take a look at the Towers business when it came up?
We did, and we did not bid.
Okay, perfect. Thanks, guys. Again, great year, great quarter for you.
Thank you very much, Greg.
Our next question is coming from the line of Joshua Shanker with Deutsche Bank. Please proceed with your question.
Good morning, everyone.
Good morning, Josh.
Good morning. I want to talk about a history of selling appetite for smaller potential acquisitions and contrast that with interest rates. Thinking about four years ago versus two years ago versus today, what are sellers interested in receiving for their businesses, and does that have a component in how much you're willing to pay based on the cost of cash, basically?
Good question. I think Pat said in his comments that if you just look at all 31 of our acquisitions this year, we ended up paying a blended multiple on EBITA of about 7.6 times, between 7.5 and 7.6 times EBITA. That multiple, frankly, has probably moved up one turn in the last four or five years. Is that interest rate correlated, or is it growth correlated? We see it probably as more growth correlated. Most of the operations that we're looking at now do have line of sight to some growth that's consistent with our levels. Do I see it necessarily correlated whether interest rates are at 4% or 5%? We're just not seeing that. It doesn't translate quite to that level quite yet.
If we're thinking about the 10-year rising, that doesn't put a ceiling on multiples insofar as that money's more expensive, or you don't view it that way, or they don't view it that way, or how should I think about the relationship?
I don't think there's been a view right now that 1% movement in the 10-year influences that pricing. Clearly, if the 10-year goes up 5%, 7%, 10%, multiples would come down. It's just not that tightly correlated.
Okay. Thank you very much, and congratulations on the year.
Thank you, Josh.
Thanks, Josh.
Our next question is coming from the line of Bob Glasspiegel with Janney Montgomery Scott. Please proceed with your question.
Good morning, team.
Morning, Bob.
Question on with the Sedgwick Tinker to Evers to Chance sale in the TPA market. I was wondering if you could just chat a little bit about how that, if at all, changes the competitive landscape. The valuation seemed to be on the rich side from a pretty savvy buyer. What are the implications of this as you see it?
Well, Bob, first of all, this is Pat. I think we all know that KKR is very smart money, they've made a very big bet in a business that we believed in without hesitation for 30 plus years. There have been times over that 30 plus years, actually 40 plus years, that we've been questioned as to whether or not we're going in the right direction. I think it proves the point that this is a very dynamic business and a great business. We believe that the claims business is an area that we can excel. It is a competitive landscape. It doesn't change one wit what our strategy is with regard to that business. It just, I think, proves the fact that it's a very valuable business.
If the price got to 13, 14, 15, EV, EBITDA, is there any price that you become a seller versus a buyer? Is this just a business you love regardless of where the private market valuations go?
This is a business I love regardless of valuations, let me tell you why. If you figure that Bob Robert Hartwig is right at the Insurance Information Institute, that there's something on the order of $1.5 trillion of premium paid in the property casualty world globally, you realize that some 60%-65% of that premium turns into a claim every single year, where's the money in the insurance business? It's in the claims. Where's the opportunity to help our clients save money? It's in the outcomes as to how well you do those claims. We think we can prove that our outcomes are superior. When you see major insurance companies outsourcing their business to Gallagher Bassett, essentially saying that their capital will be better served by our handling their claims, the world is coming our way, Bob. We ain't getting out.
Fair answer. Less significant question on the supplemental and contingents continue to sort of outperform your sort of guidance going forward. The business has been profitable. Perhaps there wasn't a lot of cats. Underwriters are paying more for good business. As we look into 2014, is there anything we should be thinking about north, south in the trends there, and did the acquisitions change the sort of run rate materially?
Yeah. Good question. First, in the fourth quarter, if you recall, on our third quarter call, we had a $couple million that was of timing that shifted from the third to the fourth. When you look at the fourth quarter, that fueled that a little bit, but we talked about that in the third quarter. Looking towards 2014, there are a couple things that are going on. As we add scale, especially internationally, we see opportunities there to increase our contingents and our supplementals. We see domestically, we're holding in there on contingents and supplementals domestically. Flat year would be a good year, we think. If loss ratios continue to improve, maybe there's some upside there. We are seeing a little bit of a dynamic, and remember, we're doing this right as we speak here. We're still in the middle of negotiating some of our relationships.
We are seeing a little bit of a dynamic of some carriers pushing to move from a supplemental back into a contingent. If that would happen, you'd have a little bit of timing where instead of recognizing supplementals in 2014, you'd get it as a contingent in 2015. Overall, we think that the carriers are seeing the value of what we're providing. We think that the volume and the loss ratio outcomes that are coming with it, I think that we're in a stable position to a slightly better position in 2014.
The carriers are having great years, Bob, that helps us.
Yeah, it just seems like we're at the point in the cycle historically, given the profitability is higher and it's tougher to grow, they're usually in a position where they're willing to pay a little bit more to get this profitable business. I would think for a given combined ratio, contingents and supplementals might be rising for the brokers. Would you argue with that, or is that a fair point?
I think it's a fair point.
Okay, thank you.
Thanks, Bob.
Our next question comes from Sarah DeWitt with Barclays. Please go ahead with your question.
Hi, good morning.
Good morning.
Given your comments that less than 1% of brokerage organic growth came from pricing and exposure, is there any reason why you shouldn't exceed that 3% hurdle organic growth rate, even if P&C prices flatten or turn slightly negative?
No.
No, I think the question was is we actually sell about 5% more than we lose. Would we see margin expansion below 3%? I'm sorry, there's two questions in there. We've said that we wouldn't see margin expansion below 3%, but can we see organic growth above 3% with flat rate? The answer is yes.
Yes.
Right. Yeah, I was just focusing on the organic. Okay, great. What's more important, the economy or P&C pricing for your organic growth?
The economy.
Yeah, actually, if you go back and look at it, in some of our investor presentations, we plot out what rate increases are versus our organic. Even in times when the rates were dropping 10%, 15%, we were showing organic growth plus or minus break even. You can see there that the economy does have the ability. If you go back from, let's say, 2003, 2004 through 2007, even with substantial rate decreases going on in the insurance pricing, we had a robust economy, and we were still growing gangbusters back then.
Okay, great. Finally, could you elaborate a little more on this carrier outsourcing deal that you won at Gallagher Bassett, and what sort of opportunity do you see that as longer term?
Well, it's a great arrangement wherein we've essentially taken over a claims organization for an insurance company. Those people rolled into our employment, we, going forward, will be their outsource claim provider, and they'll be the capital provider and the underwriter. I see huge opportunity in this regard. If you take all the startup capital that's moved itself to Bermuda, wants to come onshore, one of the last things these carriers want to do is build infrastructure. Right? They want to come on board, and here's the analogy I use. If you want to get in the trucking business and you're an offshore capital provider, you can do that by coming onshore, getting the licensing you need, et cetera, making sure that you've got all the licenses and the rates and what have you, and you can hire an underwriting team, and you're in the business.
You don't want to have a bunch of adjusters sitting across 40 states waiting for accidents to happen. What we can do is say, "Look, when you have the accident, dial this 800 number. Our people are on-site as fast as can be. You've got a very professional adjudication team. We're all over this thing. We can manage every component of the claim from the early onset through the litigation, and you don't have to have infrastructure. By the way, we'll do it better than you'd do it if you hired your own claim people. We'll show you that and prove that with our outcomes." What's the opportunity there? Limitless.
Great. Thanks for the answer.
Thanks.
Thanks, Sarah.
Our next question comes from the line of Arash Soleimani with KBW. Please go ahead with your question.
Hi, thanks. Just had a couple quick follow-ups. I know you had mentioned before the joint venture with the reinsurance brokerage. I was just curious what drove the decisions again and at this particular point in time.
It's very simple. The individual became available.
Okay. Yeah, that is very simple. Fair enough. The other question, just in terms of the margins, I know we said there was kind of a one-off within the risk management. Just kind of looking forward to the fourth quarter of 2014, is it fair to kind of assume that roughly that 15.8 guidance that was originally in place for the fourth quarter of 2013 should materialize then?
We actually are targeting 16 points for the year. There might be a little tick up, a little tick below that on a quarter-by-quarter basis, we think we have good line of sight that our risk management segment can post 16 points of adjusted EBITAC margin for all of 2014, there might be a slight little variances on a quarter-by-quarter basis, I hope we don't have another handful of claims like we had next year.
No, definitely. Finally, you'd mentioned in the past that most of the competitors within brokerage tend to be smaller players. I guess, going forward, you'd mentioned in the comments today again that Gallagher can service clients of any size. Is there any shift in strategy looking forward the next couple of years to sort of compete more in the larger client space, or?
Well, Arash, let me answer that. We compete across the full spectrum. If you look at the insurance industry as a pyramid, at the top of the pyramid is the Fortune 1000. We're represented in that Fortune 1000. We do a very good job on a number of large accounts that would be brand names that I won't mention on a conference call that we're very proud to have as customers. As you go down that pyramid to the very bottom, which are small personal lines accounts, we play very well in the affinity space, which is very small accounts that are done electronically or by call center, what have you. The full spectrum we compete. There is no shift in strategy. We want to get stronger in every sector we play in.
If you look at the acquisition activity, to be a Business Insurance U.S. top 100 broker, number 100 last year did $22 million in total revenue. We believe there's about 18,000 agencies in America. Some say there's as many as 30,000, we believe there's about 18,000. That means there's 17,900 smaller than $20 million in revenue. We know this because we measure it. 85% of the time when we go out into competition in the field, we're competing with somebody who's smaller than we are. We compete 15% of the time with our larger competitors. No change in strategy. We continue to focus on each layer of that pyramid, we want to get bigger and stronger in every category. The important thing about that is it matters out in the marketplace.
The bigger we get, as I said in my prepared remarks, we add brain power to the organization. That improves our niche capability, it improves our specialties, it helps us in the risk management world, it helps us in the small account world. When, again, you go to a business that's as vast as the insurance business is, our growth opportunities in virtually every category are almost limitless. Yes, we will continue to compete hard in that upper middle market and into the larger accounts, we see great opportunities to expand through the whole spectrum.
Okay. Thank you for that answer. That was very thorough.
Thanks.
Thanks, Arash.
Our next question is coming from the line of Michael Nannizzi with Goldman Sachs. Please go ahead with your question.
Thanks. I have just a couple questions. I think you've touched on the benefits business in the past. Could you give us a little bit more color on what's happening there? Maybe break out a bit more, if we could, on the organic growth, the competitive environment, M&A, and how you're building out your strategy in that area. Thanks.
Sure. I'd love to tackle that, and if you've got any further questions, I'm happy to have Jim Durkin chime in. The benefits business, I think we've been fortunate that a number of years ago, we organized ourselves into separating the benefits from the property casualty arena. We have been building a benefits business as a separate organization called Gallagher Benefit Services for the last 20+ years. We believed 20 years ago that that was a separate expertise, and I think we've been proved right in that regard. Today, what we find ourselves as is more of a consultant than a broker in that business. The insurance companies have consolidated down to very few players, and it's not really about going out and getting a cheap price for a client on their benefits business.
It really is about stepping back and looking at what their HR strategy is, what their total pay strategy is, and seeing if we can't help them both design that strategy as well as implement how benefits fit in that business. Now, that's become extremely complicated. 15 years ago, we didn't have a compliance person on staff. Today, we have 25 compliance people, 17 of them are lawyers. We're not running a law firm. These are helping our clients with the compliance obligations they have under the law. That goes all the way back to ERISA and comes through to PPACA. It's a very complicated business once you get 200 lives or more in your group, and we're very good at that. Now, what that's fueling is heavy acquisition opportunity.
If you're a smaller broker with a bunch of 200-300 to 1,000-5,000 life cases, you can't deal with the new law. Just that simple. You think you can, you start down that road, you can't. What's happening is that the smarter entrepreneurs that have got great client relationships are joining Gallagher Benefit Services so they could go out to their clients, which is exactly what they should be doing and saying, "We really do have the capability to handle all this complicated stuff that you're facing as it relates to benefits." The organic growth there is about in line to a little bit better than our PC growth, I think that that will increase as the mandates and as the complications of the new law become more apparent to our clients.
I think we have a position now in a competitive state where many of our smaller competitors are telling their clients not to worry, we're on top of it. When they begin to find out how really complicated this act is, we think that there could be thousands of pages of regs coming out. I think our organic growth will continue to surpass what we're seeing in other lines. It's a very exciting time for us. Our people are working incredibly hard. Every small account is trying to figure out what to do. Every client is trying to figure out whether they want to use an exchange. Do they want to go to defined contribution? Are they going to stay with defined benefits? Are they going to be self-insured? Are they going to be fully insured? What are they going to do? They can't sort that out themselves.
They need help, that's a real boom for us.
Would you at some point consider breaking that out so we can see that? It's obviously a very different business from just if it's more of a consultative capacity, it's certainly a very different business from the brokerage business.
Well, it's really not. I say that we're more consultative in that, but in all fairness, our property casualty business is very consultative as well. You get down into the affinity, and it's a straight price play. When you look at what we're doing as a property casualty broker, it's the same. We really do think of them as very similar businesses and spend an awful lot of time trying to make sure we cross-sell those businesses.
I see. Have you spoken about kind of what the margin, how big that business is and just as a percentage of the total and what the sort of margin profile of that business is? Have you given that information?
Yeah, we have. We're between $500 million and $600 million in revenue on it, and the margins in that are in the mid-20s% to upper 20s%, margin too. It performs in line with the broader brokerage business, depending on where you measure it. We have given that.
Got it. Great. Thanks. One question I have is on the supplementals and contingents. What is the margin on those relative to your traditional commissions?
Well, it depends. I mean, we don't actually have. Generally, the supplementals and contingents fund a lot of our field management bonus pools and everything. That's really where they. Supplementals and contingents are not, in most cases, subject to formulas for the field production staff. It's a higher margin, clearly, but most of it goes. We've always said 70%-75% of it hits the bottom line, something like that.
Got it. Okay. Last, you mentioned talking about, in a prior comment, was it partnering with alternative capital in reinsurance, or was it partnering with new startups on the insurance side? I wasn't totally clear.
No, we started a partnership with Grahame Chilton in the U.K., we're calling the business Capsicum Re, and it's a reinsurance brokerage operation.
I see. Do you view that as a prototype for potentially doing similar transactions in the U.S. or with Bermudians, or potentially?
No, we don't really see that as something we'd probably be doing in the United States, but we've done partnership arrangements around the globe before. We started in Perth, Australia, with an equity investment that then went to 100% majority. We have a good partnership in the Caribbean with who we think is the strongest broker down there, which we own 80%. You might recall that a year ago, we took a position in our Mexican partner. We like that approach around the globe.
Got it. Great. Thank you.
Thank you.
Our next question comes from the line of Mark Hughes of SunTrust. Please proceed with your question.
Thank you.
Good morning, Mark.
Hey, good morning. I think you had mentioned that this was the best new business start in seven years. Could you expand on that? Are you talking about the business in its entirety, and are you taking into account just the growth through acquisitions?
No, I was talking about Gallagher Bassett in particular, Mark. We just had a really good start to the year. We haven't put any numbers out there, we're not publishing any numbers, but that's a business that can be lumpy because they're oftentimes dealing with large accounts. You typically win less than 50% of what you're working on. For January one, we won a lot more than 50%. It was a very good start.
Mark, we're seeing some really nice receptivity by prospects for some of the enhancements that we're making in our systems and our capabilities. I think that there's a good message that's going out that we're outcome based on what they should be. The outcomes that we produce are better than what they were doing before, whether they were the carrier or a different TPA. We're being able to demonstrate that better. That's translated into some nice new sales for us.
Right. How about the underlying claims frequency in the risk management business? Any change in trend there?
It's up about 1.5%-2%, Mark.
About the same?
Yeah.
About the same.
And then-
That is an interesting proxy for the economy, by the way.
Right. In the wholesale business, I think you mentioned startups. Are the startups accelerating, and are you seeing any distinction? Are you seeing small businesses perhaps?
When I make those comments, I'm speaking all about small businesses. Our MGAs in particular do well when strip malls are filling up, taverns are starting, stuff that the regular market's not going to participate in. We need that economic activity to fuel those MGAs, and we're seeing good activity there.
Is it getting better? Is it accelerating?
Yes, I would say it is accelerating.
Yeah. Okay. Thank you very much.
Thanks, Mark.
Thanks, Mark.
Our next question comes from the line of Dan Farrell with Sterne Agee. Please proceed with your question.
Hi, good morning.
Good morning, Dan.
It's just a question on brokerage margin again. Once you get past the 3% sort of inflationary pressure on expense that you talk about, can you remind us how you think about the mix of fixed and variable costs? I'm just trying to think about in excess of 3%, how much could potentially fall to the bottom line.
Well, listen, it's a complicated question or an answer, but here we go. First and foremost, if you assume workforce inflation that we've had for the last five years, which has basically been not that much. If you assume that when you get over 3% organic growth, 60% of that growth should contribute to margin because we pay the producer about 30% of it, and we have field management. You get into the volume issues. Is that growth coming because we're just changing the zeros on a policy? Clearly, that's more margin accretive than it is if we're having to go out and compete for new business where we're providing substantial quotes lots of proposals, and if it's a heavy service load, new client where there's lots of certificates of insurance, a lot of auto ID cards, then that's not as margin accretive.
It depends on the nature of this. If it's just zeros on the policy, assume 60% of that should contribute to the bottom line. If it's just giving more bid bonds. If our construction practice goes on, and they're proposing on 1,000 projects, and we're having to provide the insurance quotes on each of those, and only one of them closes, that's not as profitable as it is if we got a contractor that just continues to grow as an existing customer. A complicated answer, but by and large, when you get over 3%, there's a little bit that can hit the bottom line in total, and in this wage environment, in this workforce environment at this point.
Okay, thanks. On the clean energy, your guidance, I think of range of $63 million-$80 million. If I was to compare that to your ultimate targets, which combined with the royalty income, looks like it would be more like $110 million annually. How much potential is there going forward to close that gap further? What needs to be done? Also, can you just update us on any update with regard to maybe monetizing your ownership within ChemMod?
All right. First, let's work backwards. On monetizing ChemMod, we're going through a strategic alternatives process with that. We put that on hold a little bit towards the end of 2013, we'll pick that up again here in 2014. In terms of the opportunity to further expand more production out of existing plants, we're constantly trying to optimize the use of existing plants. We still have six plants that haven't been moved to their final resting places yet. That activity, there's a good pipeline for that. We're proposing on a lot of locations. Where would I like to be by the end of 2014? I would like to have all plants at least in permanent installation construction by that time. I think that's a realistic goal. Do we have a line of sight of improving off of 2014's range? Yes, we do.
We think that there is still further opportunity for that. Remember, our objective, however, is to get these all in, then monetize down so that we own between 20% and 40% of the plants. We have a portfolio of 34 plants, so that vagaries in any one plant, whether it's running today or not running, whether it's down for service or not, it kind of washes out in the diversification across the portfolio of plants. We do have good line of sight to that. There is good positive momentum on construction, chemistry, tax accounting, all of these things, we see there's good momentum in this space. 2014 should be another year of ramping up to better position us for 2015.
Great. Thank you very much.
Thanks, Dan.
Thank you. Ladies and gentlemen, as a reminder, if you wish to ask a question at this time, please press star one on your telephone keypad. Our next question is coming from the line of John Campbell with Stephens. Please proceed with your question.
Hey, guys. Good morning.
Morning, John.
Pat, you mentioned in last year's 4Q call that you guys were just seeing some positive momentum just building through, I guess, just increasingly positive audits. If you can just talk a little bit about how you're seeing that this year versus just last year.
Sure. I think the natural yin and yang in the business is that as you're approaching a renewal, carriers want to make sure that their exposure units are quoted appropriately, and clients want to make sure that they lowball it. Between the lowball and the end audit, you get back to what's the right number. We are in positive audit territory. We have been for a number of years. I think we're probably approaching what is more like parity, though, where the actual exposure units that are being placed on the policy at renewal are kind of closer to what they actually should be. We are in positive territory, this is not 20%-30%. These are small incremental audits that do give us line of sight into what we've been saying for a number of quarters, is an improving economy.
It's not an economy that we see going robust. We are not seeing, for instance, on the benefits side, any kind of real addition of headcount to our clients' employment. People are doing everything they can to hold back on that, which does translate, however, into a very successful growth with our temporary health firms. We are in positive territory. It's not huge, but clients' businesses are doing better.
Yeah, let me just put it in perspective financially for you. We're talking in all of 2012, I think our net positive audits were $1 million, and in 2013, it was a similar number. In the depths of the recession, we might have had just net negative audits of half a million dollars to $1 million, something like that. It just doesn't swing that much for us as a broker.
Okay, great. Then Doug, just on the new debt, all in interest expense, around $17 million or so a quarter. Is that pretty fair?
The blended rate on that $600 million was 4.7% on $600 million. 4.7 times $600 million is about $14 million a quarter.
On the new debt.
On the new debt, right.
Yeah. Okay, great. Thanks, guys.
Thanks, John.
Our next question is coming from the line of Alex-
Oh, I misspoke. It's $7 million a quarter. Sorry, guys.
Okay. Our next question is from Alex Lopez with Portales Partners. Please proceed with your question.
Good morning, guys.
Good morning, Alex.
I guess just following up on the notion of cross-selling. What kind of top-line opportunities do you see moving forward, i.e., how much can this add to your top line?
Well, cross-selling is one of those things that's the Holy Grail, right? We've studied our books of business across our divisions. Where we've been exceptionally good is making sure that our wholesaling operation garners the opportunities that our property casualty division has in the E&S market. We now have captured about 50% of our E&S placements into our own wholesaler Risk Placement Services. We've probably captured 85%-90% of the placements that the organization makes in London into our London Specialty Group. Where we have great opportunity, and we have not had the depth of penetration that I'd like to see, is between our property casualty operation and our employee benefits operation. We think there's great opportunity there. All in cross-selling, though, I would say for 2013, between benefits and PC, probably contributed about $9 million of total revenue to the company.
Great, thanks. Congrats on the year.
Thank you very much. I appreciate the comment.
Our next question is coming from the line of Christopher Layden with William Blair. Please proceed with your question.
Hi, good morning.
Good morning, Chris.
Just a quick one on acquisition activity. Seems like it's picking up a little bit in the U.K. and Europe. Are you guys seeing anything attractive going on there in the underlying environment or more just opportunistic buying for the pipeline?
Well, I think it's two things. First, on the economy, the U.K. economy is actually doing pretty well right now. There's been some nice recovery there on the fundamentals. We're seeing that as a nice opportunity. I also think, though, it's more the aspect that when we bought Heath Lambert a couple of years ago, it really made a statement that we have a serious interest in the retail presence across the U.K. Before, we've been primarily a wholesaler and a London market broker. I think it's just we're getting presented with more opportunities. We think that there's a view now with the Giles acquisition, that we have a focus on the retail space. The brokers over there are very keenly aware of what we do here in the U.S.
They like our niches, they like our resources. I think they see that there's an opportunity from them moving from a small independent to teaming up with Gallagher. It's a great opportunity from the ground. I think we're just getting presented with more opportunities also.
Also, I'd say, Chris, the U.K. market in the brokerage space got very overheated a number of years ago. There were a number of these opportunities that we looked at. The multiples were off the Richter scale. You now have private equity firms that are having to bite the bullet and realize that they've got to exit. Expectations and pricing has come much more into line with what we're comfortable paying. It's been a great opportunity as one of the people that kept their powder dry to be able to move into that market and actually get reasonable multiples to bring these teams aboard, as Doug said, who are excited to be part of what we're building as a team.
Great. Are the multiples similar over there to what you sort of quoted for the full year?
Yes.
Okay. Just a quick follow-up on the benefits conversation. Any thoughts from your guys end on the Liazon acquisition by Towers Watson? Are you rethinking your strategic approach to exchanges and sort of how are you looking at the selling season going into 2014?
No, the Liazon acquisition by Towers, we've been very pleased with how Towers has reacted and their commitment to us. Towers spent a very significant amount of money for that acquisition. They're not going to buy that business to wreck it. In fact, we've had very good discussions with them on the fact that they want Gallagher Benefit Services to continue to be clearly one of their strongest partners. We've had good success with that platform. We have about 32,000 employees that are presently signed up to be on that platform. We see line of sight to probably over 100,000 employees going onto the platform sometime during 2014. We think it'll be a good partnership. We've also been very clear, Chris, that this is not our only exchange.
We view the exchanges as platforms and markets, our job is to consult with clients as to where the best place for them to place their employees will be. If that's a state exchange for one client and Liazon for another, that's how we're going to play it. We're a pure consultant.
Okay, great. That's really helpful. Thanks a lot.
Thank you, Chris.
Thank you. It seems we have no further questions at this time. I'd like to turn the floor back over for closing comments.
Great. Thank you, Brenda. Again, everyone, thank you for being with us this morning. We are really pleased with our 2013 results, and you could probably tell by the tenor in the room here, we're pretty darn excited about 2014 opportunities. I think we're building an exceptional franchise that has phenomenal prospects for continued growth. Consider this one little factoid. We did our first $400 million of total revenue in 1995, and we grew the enterprise by that much in 2013. As I said earlier, we really believe we're just getting started. Thanks for being with us this morning. We appreciate it, and we look forward to talking with you at the end of the first quarter.
Thank you. This does conclude today's teleconference. You may disconnect your lines at this time.