Brown & Brown is one of the largest U.S. insurance brokers. Has a very strong track record of industry top-line growth as well as industry-leading margins. Here to tell us more about it is Brown & Brown's President and CEO, Powell Brown. We also have with us Brown's Chief Financial Officer, Cory Walker. With that, I'll turn it over to Powell.
Thank you very much. Good afternoon, everybody. Today. See if this is going to work for me. I'd like to begin by saying in the history of our company, there have really been three defining moments that I think would merit just a quick discussion. In 1980, we were roughly a $2 million business, and we had a 16% operating profit. Two years later, we doubled the size of the company, basically organically, $4 million, but the operating margin was cut in half. We worked twice as hard for the same amount of money. At that point, we decided to put into effect a way that we would constantly and consistently improve the operations of our company. Obviously, being efficient, grow organically, grow by acquisition, but specifically in a way that we are very margin-focused, in addition to being growth-focused.
Defining moment number 2 was in 1993 when we merged with a firm called Poe & Associates. That enabled us to become a publicly traded company through a reverse merger. The smaller of the two companies, Brown & Brown, actually effectively took over the bigger of the two companies, Poe & Associates, so a $35 million company was taking over a $50 million company, and we were known for a period of time called Poe & Brown. In 1999, we changed back to the name of Brown & Brown, which was the older of the two firms. Third defining moment, for sake of this discussion, was this last year when we crossed the billion-dollar revenue mark, and we don't believe that bigger is necessarily better. We just want to be bigger and better.
For those of you that have seen the back of our annual report, there's a big $2 billion sign which has been signed by a number of our teammates. 18 months ago at our annual sales meeting, I challenged everyone that wanted to participate in getting our company from $1 billion to $2 billion to sign this particular document. It's about three feet high and about four feet wide, and it's been framed, and it hangs on the wall right outside of my office. We talk a lot about it. As you notice, there's not a timeframe associated with it, and there's not a margin associated with it. That's not because there isn't, that's just because it's not for public consumption.
Having said that, if we wanted to be a $2 billion company tomorrow or last week, there are ways to do that, but not probably in a prudent way, and we're not going to do it that way. We're going to do it in a very prudent financial, financially invest in where we think it will best benefit our teammates, our customers, and our shareholders long term. This is last year's revenue distribution. I would start by bringing your attention to the largest component, retail. Retail was 60% of our revenue, $608 million of revenue last year, and effectively for the last five years, has not grown organically. In the second quarter of this year, it grew very slightly, 30 basis points in Q2.
Something that we're proud of. It's the engine of our company and something that we think that as the economy moves back towards a more normal, which there's no such thing, normal state. In the middle market economy, this will help propel the growth of our company. Second piece will be national programs. 17.9% of our business. Last year, $181 million. That's before we made the acquisition of Arrowhead. Arrowhead was announced in the end of last year and closed on January 9th. Announced revenues of about $107 million in revenue. Of that $107 million, about $80 million of it goes into the program space, $27 million-ish goes into the services space with a TPA that they have embedded in their business. One of the things that you find interesting inside of that business is we do a lot of business for a number of trading partners.
One of those trading partners, one of our large trading partners, is a firm called Zurich. Zurich specializes in, and among all these other things that they do as a global insurance company, they do a lot of automobile insurance. They have a segment where they write franchise auto dealerships, which they do primarily through a direct sales force and very limited agency distribution, as I understand it. They have something called the Automotive Aftermarket Program. That would be repair shops, brake shops, mufflers, things like that, and they have a direct sales force. They have given us that program to help expand the written premium in that program effective 10/1. They have 168 teammates, which will become Brown & Brown Arrowhead teammates effective 10/1. The vast majority of them live in Kansas City.
We're really excited because they want to grow and double this business in five years. On a premium basis, it's roughly $160 million of premium. On a revenue basis, think in year one, it's probably somewhere in the $20 million-$25 million range. The margin associated with that will be lower initially, and as it grows, it will become higher and more in line with our program business. You'd say, what is the margin? The margin in year one, I would want you to think, would be 10%-15%, but I'd say 10% to be safe. We should probably start receiving meaningful revenue come 11/1, but it will start going into our internal growth numbers effective 1/1. Once again, that's a partnership where they have allowed us to expand that relationship, which we think will be mutually beneficial.
One of the many reasons we are very excited about Arrowhead, we did not anticipate that upon investing in that organization, but it's a reflection of the quality management team and the organization that they have built, and we are expanding upon. That's in bucket number two. Bucket three is wholesale brokerage. Last year, we did $157 million of revenue. As you know, that's large transactional business and binding authority business. That's where we've seen the most rate pressure in the segment. That, I believe, will mitigate somewhat in the future in terms of the amount of increase, and we'll talk about that in a moment. Our services business, which is a work comp TPA, two Medicare set-aside businesses, a Social Security disability advocacy firm, and a specialty flood claims business.
This is distribution of revenue across the country and in London. Sometimes we're asked the question, do you have too much concentration in Florida? We would say, we don't believe so. Although Florida and the economy has continued to bump along, we think it's starting to stabilize, and it will get better. If we could find three good agencies in Florida today, we'd buy all three. If we could find three Arrowheads, which there aren't three Arrowheads out there, we'd buy all three of them today, too. My point is our acquisition strategy is not to fill in the blanks, or to get the white out. It is to acquire good people who run good businesses who attract and retain more good people. Our revenue.
Our revenue has grown over a period of time that we're proud of. We ran into the headwinds of the economy. 2007 was really the change in the Florida property market, specifically the Citizens Property Insurance Corporation. The economy, of which impacted our business significantly as well. This is probably the chart that you're the most interested in, or one of those that you'd be most interested in, which is internal growth. You'd say, what is a business like Brown & Brown capable of growing now or into the future? The gold would be organic growth. The blue would be acquired growth. Our answer, simply put, would be low to mid-single digits in a normal operating environment. We grew 90 bps in Q1 and 320 bps in Q2.
What we don't want is you to think that there's going to be an incremental bump from 3.2 to 5.6 or some number north of that yet because the economy is stabilizing in the places that we operate in, but we think it's going to continue to be in the lower single-digit environment for the rest of the year. I say that because this has been something that we have either been criticized on or applauded for, but more criticized in the last five years. As you know, in October, actually, in the October conference call last year, I made a statement that I was prepared to hold the margin flat or potentially take it down in the very short term in order to grow our business organically. We have grown our business organically for the last two quarters. That does not make a trend.
It makes, in Cory's mind, a mini trend. I don't believe it's a trend till we've grown at least a year, and we anticipate and plan on doing that. Having said that, we are very focused on growing our business organically, but I want to make sure everybody in the room knows that we are a very focused company on operating our business efficiently. I don't want anybody to walk out of here because there will probably be a question which I am going to anticipate is, have your margins actually gone down? I am going to tell you that, no, I am going to say no. You say, well, how do you say that? In the first two quarters of the year, we have effectively $6 million less in profit sharing and contingent revenue, number one.
Number two, we have a one-time sales contest, which is somewhere in the $6 million-$7 million of expense range this year that will not be replicated next year in its current form. We may do additional sales contests or reward programs, which actually reward performance and continue to bind our teammates together over a long period of time. It's an important distinction. What have we had over the last couple of years? You know the weak economy and reduction of exposure units. That's been the biggest impact on our business. We would say somewhere between two-thirds and three-quarters of the impact to our business, positively or negatively most recently, has been exposure unit shrinkage and declining insurance rates. What are we seeing now? Is the middle market economy stabilizing?
Depending on the places you are in the country, we are starting to see places where they seem to have hit the bottom, stabilizing some up slightly, not up tremendously, but slightly, and some rate increases are sticking. Let's talk about that before we go forward. Some people would ask, "What do you think is going to happen to the insurance rate environment in the near to intermediate term?" There is two camps. The camp on my left, your right, would be that work comp combined ratio is at 122 going north. Personal lines is 116-118 and going north. Personal auto and homeowners is high and hot and running a temperature. That means that in the near to intermediate term, in the standard marketplace, we have to see extended rate increases.
This camp over here, my right, your left, would be where we reside, which is, there is a $550 billion worth of surplus written against $490 billion of premium, and the traditional ratio is one and a half to one premium to surplus, or two to one. If you take that 550, you could effectively double it to get to 1.1 trillion, and that would be a levered insurance marketplace. There is a balance. If in fact there is not an event, natural disaster between now and the end of this year, i.e. hurricane season, that the excess and surplus lines marketplace, the rates will not go up as much.
They will start to mitigate or shrink the size of the increase because it's a very opportunistic market in order to try to capture some of those opportunities. If in fact there's not an event next year, this time next year, the standard market, the increases will continue to mitigate through to next year, then I think all bets are off. That does not mean it's going to go into a soft market. We don't have enough transparency. There's a lot of time between now and then relative to the insurance world. Core commissions and fees. This is the internal growth schedule as you break it out. The one that I want to point everybody's attention to, there's two. The big one is retail. That's 30 bps positive in Q2. That was 60% of our revenue last year.
It'll be roughly 55% of our revenue this year with the addition of Arrowhead. That right there is the engine of our company. As the middle market economy, as I said earlier, starts to stabilize and come up, that's a very positive piece that's inside of our company. One of the ways that you could see that on an individual office basis, as an example, would be the number of additional premiums on clients versus return premiums. These are on audits. At the end of a 12-month period, the company comes in and audits the payrolls, the sales, the number of automobile units, whatever the exposure unit is, it's auditable. Then if there's an additional premium associated with an increase over the estimated exposure units at the beginning of the year, you have to pay that premium.
If you actually have to return the premium, the premium and the resulting commission has to go back. I point that out because it's very important. Number two would be right here in wholesale brokerage. Wholesale brokerage, as I said, that's a very opportunistic market driven by lots of property risks based in coastal communities. Having said that, if rates moderate slightly, that could slow down a little bit. That doesn't mean it stops growing. It just means it might moderate from 8% growth. This is the average rate increase. Now this is, I have to say, MarketScout and Hales. This would be more anecdotal than deeply scientific. I think there's great value in this because it shows, one, from where we've come to where we are.
Basically, when you hear the risk-bearing community say that they're getting 10% rates on their books and 8% and all that's on the business that they renew. There continues to be a big gulf on the new business written and the renewal rates charged on their business. If we went out to Garden City and there was a beer distributor and XYZ Insurance Company wrote that account last year for $100,000 in premium, and you could submit the same account to the same company under a different name, which you can't, but if you could, it would be somewhere in the neighborhood of $85,000-$90,000 in premium with all the exposures being the same. That's the difference in new business pricing and renewal pricing on a very broad statement.
This is kind of a blended mix, which is basically saying, what are rates going up? Rates are going up 3%, 4%, 5%, because there are some that are going down, some that are holding flat, and there are some that are up 10%. Back to our margins. We are a very focused company. We're focused on several main things. This is one of them. We are a fiercely independent company, which happens to be a sales and service organization that's focused on efficiency. Efficiency is driven by our margins. There are some people that think that we are not as margin focused for some reason. I would like to tell you that we are just as focused on our efficiency today as we ever have been.
What you're seeing is a period of time where we are trying to make sure that we have the right incentives in place for our teammates to grow and have good, great, and exceptional performance and be rewarded accordingly. Some of that is a little misleading this year because we have this one-year plan, which is a significant expense. It's going to cost somewhere between $6 million and $7 million in the P&L this year, payable next year in March, specifically. Why do I say that?
To get to our $2 billion goal. When we get to the $2 billion goal, if you happen to still do then what you're doing now, and I hope you are, because we're going to be doing what we're doing, we're going to have a very good margin, we're going to be growing our business organically, and we're going to have systems in place which will reward people who, particularly those who did an outsized job on driving that performance going forward. If anybody has a question in a moment on that, I'll be more than happy to talk about it, but that's something we get a lot of questions about. This is just an example of how we stratify our businesses. We look at them by line of business, by office, by actually we compare and contrast departments in individual offices against each other.
You could be in Syracuse, Santa Barbara, or Sarasota, Florida. We're comparing one of these departments against each other. We're looking at them in lots of different ways, but we want to know, number one, how we do what's in the best interest of our customer. Two, we want to figure out how we can grow our business organically and we can do it more efficiently. Acquisitions. We did $88 million, $89 million of acquisitions last year. We've done $123 million of acquisitions this year. Somebody might say, "Well, you said that you did the Arrowhead acquisition, and that was $107 million of revenue. It doesn't seem like you've done that many acquisitions this year so far." The answer is, relatively speaking, you're correct, but we still done $123 million of acquisitions this year, which we're very pleased about.
That said, acquisitions, as someone I know used to say, is a little bit like fishing. Sometimes the fish are biting, and sometimes the fish aren't biting. We're always proactively talking to people about selling their businesses and becoming part of Brown & Brown, and the most important thing in those discussions is cultural fit. Whether we can get to the price or not is a separate issue, because if we can't get to the price but there's a cultural fit, we're going to wish them well and go on down the way. If there's no cultural fit, it doesn't matter how much money one way or the other, high or low we're going to pay for it wouldn't be a good acquisition.
We're out talking to people to see if there's a cultural fit or an interest all the time, seeing when and why those people want to sell and as they come. The one thing you find interesting here is there has been less interest in selling businesses than I thought, and we thought, driven by the pending change in the tax structure. We thought there was going to be more activity around that. It hasn't driven as much activity as we thought. EPS growth, obviously we're trying to drive that. Our dividends per share is something that we've been very pleased about in terms of increasing it for 18 years. Yep, 18 years in a row. As you know, we have historically tried to pay out in the neighborhood of 25%-30% of our earnings in dividends and reinvest the rest.
To the extent that we can continue to do that and increase our dividends, we'd like to try to do that. Performance will dictate that in the future, and our board. With that said, I'd love to open it up to any questions anybody has about anything that I've said or more importantly, something that I haven't said. Laura.
Can you elaborate on the one-time that you just referred to?
Yeah. The question is, can we elaborate on the one-time producer incentive plan? Yes, and the very simple math is the following. If you had a $1 million book of revenue and you grow that business 5% or more, you will get a 5% bonus on the trailing book. Let's think about that for a minute. You grow your business 5%, so that's $1,050,000, and we're going to pay you $50,000 extra on the trailing book, one time only, payable in March of next year. If you grow your business 3%, you don't get paid anything other than the normal compensation. If you grow your book 12%, you get paid 5% on the trailing book. The very important distinction is it's a 5% kicker on those that grow 5% or more. Our total exposure potential would be $12.5 million-$13 million, excuse me, in total expense.
In 2012, we believe it's going to be more like something like $6 million-$7 million in terms of expense. Somebody might say, "Well, why'd you do that?" Which would be a good question, and the answer is pretty simple. We have a lot of great teammates, 6,200 to be exact, and a number of those people are in production roles, and a number of those producers handle the same number of clients that they did four years ago, but their income level is down because those businesses have shrunk. To incent desired performance and reward those people who've been working so hard for Brown & Brown and the team as a whole over the last several years by putting a one-time kicker in.
We're very pleased that it's in, and it's working very well, and if we knew now, then we'd do the same thing. Yes, ma'am.
Related. Do you think that organic growth is being driven by that plan?
The question is, do you think organic growth is being driven by that plan? I think that organic growth is a combination of several things. Number one, I think it has renewed interest and pushed desired behavior. Yes, that's part of it. Two, I believe that in many markets, the economy has stabilized more. Three, we're writing a lot of new business, which is good. It's a combination of things. It is not the only thing. That's the important distinction. Yes, sir.
Powell, I have a question about M&A.
Could you comment on the appetite of banks in competing for properties that you are interested in, as they kind of look for other revenue sources as spread revenue continues to contract?
Sure. As you may have heard me say before, I believe that there's only really two banks in the space that seem long-term committed, and those two banks would be Wells and BB&T. I think every smaller bank, although they're looking for other revenue streams, they're wondering how this all fits in long term. I've never met a banker that I thought could sell insurance. That's an important thing when you transition the leadership of an organization. That said, the appetite of the banks seem to have, not cut off totally, but I would say waned a little bit. There's one thing that sits out there that may never materialize, or it may materialize, and this would be a big driver in the appetite and the view of banks in the insurance brokerage business. Very simple. It's called the tying of credit to handling of your insurance.
If, in fact, there's any proof ever that that occurs in a bank, that bank and all banks from there on will not be able to get rid of their insurance operations quickly enough. I'm not alleging that that's occurring. I'm just saying if it's occurring, in light of all of the regulatory and things going on, that's something that banks have to be sensitive about. My instinct would be, if you asked one of those two banks, they would be very sensitive and quick, just like any other bank to say that doesn't happen. I'm not saying it does, but if it were to happen, that creates a big problem for any bank. Other questions?
Powell, on the Sorry.
Yeah, sure.
I'm the only one behind you.
Yeah.
On the organic revenue growth from Arrowhead in the first quarter of 2013, how much of a bump could that be, since it would be included in internal growth?
I don't know enough yet about the renewal cycle, it's a little premature to say that. Just think, the way I would want you to look at it is twofold. We bought a business. It was $107 million of revenue, and that business is now getting a $20 million-$25 million additional revenue component to it at a little lower margin that we talked about, number one. Number two, you could say on $1 billion, roughly $1.15 billion-$1 billion, whatever, we're going to be somewhere between $1.15 billion and $1.2 billion at the end of the year. That business is getting an additional $20 million-$25 million of revenue in all of 2012. We just don't know when all the effective dates are on that business. If there's a big date and it's April 1, it's all outside of the first.
I would also probably make the argument, what about January 1? I don't know the business yet well enough to know.
Okay. Thank you.
Yes, sir.
Can we just follow up on the question that I asked just earlier? That $12 and a half million-$13 million.
Yes
One-time incentive. Is this primarily a retention tool?
No. The question was, is the one-time incentive a retention tool? The answer is, I don't know what you want to call it. We don't look at it as a retention tool. We look at it as a reward or a stimulant for trying to grow our business organically and a reward for all the great things all these people have done, which is a performance-based or tied-in reward system. The reason I said it was $12 and a half million-$13 million, that's the maximum expense that it could be. If everybody that was a commissioned producer that qualifies grew their book 5% or more, that's how much it would cost. We believe about 50% of those individuals, or 60%, we hope it's more than that, actually qualify.
As you may know or may not know, we have stock incentive plans that are currently in place, and we're always looking for creative ways to reward performance that are both beneficial to the teammate and the shareholder long term. We're very mindful of that, too. Got to be a performance hook. That's a long way of saying I don't look at it that way, but you might, but I don't. Does that answer your question?
Other questions? Yes, sir.
Thanks. Given how decentralized the businesses and the reliance on exposure units and pricing, what is under your control to control the margin and maybe get to a 40% margin outside of general improvement in exposure units and pricing?
Okay. Well, remember, I'd like to take everybody back. The question is about how do our margins increase, and do they go back to one level that we aspired to in the past or almost reached? I think there's a couple ways to look at it. When we announced a goal of $1 billion of revenue and a 40% margin, that was actually not for the investment community. That was to galvanize, at the time, an organization that was $375 million to effectively triple. Two and a half, triple. Having said that, the investment community got onto that, and rightfully so, because it had never been done. Nobody in the history of the publicly traded brokerage space that I'm aware of had operated at that kind of big, audacious goal.
Having said that, we got very close, and then the economy started to slow down. When we went from $1 billion to $2 billion, basically, I made the decision that we would announce that we're going to go to $2 billion, and there's not going to be a time or a margin associated with it. Because in doing so, some people may think that we're not as focused on efficiency, code word for margin, or we're going to have to do something differently, which we might. I don't know if we will or not, relative to the platform as we continue to go forward. Decentralization is a hallmark of our company, and being rewarded on your individual P&L responsibility is how our business runs. I say this because the question is a very valid one.
If we take you forward to the $2 billion number, we will operate more efficiently than we do today, and we were growing our business organically, barring an unusual economic slowdown. That's what we want. That's the message that we want out there. I'm not trying to be evasive. I'm trying to tell everybody in this room that in a normal, which there's no such thing, operating environment, I've said that we can grow our business organically, low to mid-single digits. In that environment, we have the ability to increase our margins more than they are today. We feel really good about that, knowing that our margins are higher than our other publicly traded peers, but we're looked at differently, and we appreciate that. We're going to continue to be very focused on it. We'll improve.
How's that for a nice, vague answer for you? I wanted to make sure and beat around the bush enough for you. No, all joking aside, that's a very serious thing to us. I know we've said that. It is interesting because we get this feedback, and I say this lightly, but I'm serious, we had 60 months, five full years of you in the investment community questioning us about growing organically, and we have the best margins in the industry. It's something that we're proud of. Then we make the decision we're going to grow organically, and we implement things, and we did what we've done, and we grow organically, and then everybody wants to jump back on the margin thing, which by the way, is great. I got it. We got it. It is kind of funny.
Just think about that for just a moment, for five years of grow organically, and then we'd grow organically for two quarters and quick, right back on the margins. Just keep it in mind. I say that, I'm not trying to change anybody's attitude. We're going to get better and more efficient anyway, and it's going to all work out, but I just thought you might find that interesting. Any other questions? Cory, is there anything else that you think we ought to talk about?
No.
No? Jay, is there anything else that you think we ought to talk about today?
I think we got one last one over here.
Yes, ma'am.
One more on the exposure units that are impacting the organic growth. That's reflective of what time period?
You mean when I said the two-thirds to three-quarters impact?
Yeah. Well, if you look at the organic growth, part of that's being driven by exposure units.
Yeah.
Those audits are effectively over what time period?
Oh.
Is that at the end of 2012?
No.
Second half of 2011, I mean, or a little bit earlier?
Yeah, no. Remember that audits are going on all the time. There's a 12-month policy period, and then the carriers typically have 60 days to audit after that. Inherently, there's a lag. Let's talk about what that lag looks like. You could have a business that renewed their coverage in November of 2011, and they're a manufacturer, and they estimated $10 million of sales. At the end of 2012, November of 2012, they end their policy year. They end with $12 million in sales. The auditor might not get there till the 15th of December, and it's processed in the first part of January. That 20% increase in sales and the corresponding premium and additional commission we receive is not processed until January of 2013.
All of a sudden, there's a potential drag out of the improvement of the economy with our customers to see it 12 and 14 and 16 months out from the date that they renew. Not everybody renews it the same day, as you know. There are big dates, January, April, July, October, and December 31st, around key dates. That's, Laura, what we kind of talked about and we mean by that. Yeah. Let me give you an example. In our specialty claims business, Colonial Claims, we bought a business that specializes in flood adjusting. Heretofore, it's been one of the driest years in history, and we all read about the drought in the Midwest and this and that. Then in the last, let's say two weeks, there's been a lot of rain. A lot.
Now, nobody hopes for floods, there hasn't been a lot of flooding, but there's been some. All of a sudden, their business is highly dependent upon natural occurrences, rainfall. When there's excessive rainfall, there can be flooding and backups and things like that, therefore, that helps generate that business. It's just an example of how exposures can be impacted widely with natural events. It's just like, I know some people used to ask us how Florida would be impacted if we were hit by a Category Five hurricane, implying that the investment community wanted Florida to be hit by a Category Five hurricane, which in turn would drive rates up, which would force organic growth. We're not asking for a Category Five hurricane. We're not asking for any hurricane.
The bottom line is, if you live in Florida, it's not a question of if. It's when there will be another hurricane. The question is, what is the magnitude of that hurricane, and what's the damage associated with it? What other questions? Laura? Would you like to come up and stand next to me?
Can you give us an update on what's happening with Citizens in Florida?
Sure. Citizens Property Insurance Corporation, as you know, there's lots of politics and lots of interest around Citizens. They have been raising rates slightly, 10% a year, That's a positive thing. Our governor is currently low on the approval rating, personal approval rating, He's doing some very difficult things. One of the things is trying to become more financially prudent in the Citizens area. What does that mean? Right now, this is public information. I have not seen them yet, There are several proposals in front of Citizens to depopulate or take out very large segments of homeowners' policies. That means move them from the Citizens to a private market.
The governor has continued to stress his interest in moving business out of Citizens into private insurance companies, In doing so, moving the risk bearer or the market technically of last resort back to the market of last resort. Remember in 2007, it became the market of first choice. It was the most competitive market going. That has slowly subsided, and there's people that are now migrating typically back over to the excess and surplus lines marketplace. You may remember that we've talked about last year, we did $65 million of premium with Citizens. That's roughly $6.5 million of revenue with the Citizens. When it moves to another market, it will move to a non-standard or excess and surplus lines market, which would also be at a 10% commission.
There's not some embedded big pickup where we go from a 10% commission to a 15% commission, and all of a sudden, $6.5 goes to $10 million and there's this windfall. That's not the case. It's going to go from Citizens, if it's there, into an E&S market, which will also be a 10% commission.
Fred, we're going to have to stop it there. Powell, thank you very much. Please join me in thanking Powell from Brown & Brown.