Ladies and gentlemen, you are currently holding for today's Brown & Brown, Inc. second quarter 2011 earnings release conference. At this time, we are admitting additional participants and plan to be underway shortly. We appreciate your patience in holding and please remain on the line. Please stand by. Good morning and welcome to the Brown & Brown, Inc. earnings conference call. Today's conference is being recorded. Please note that certain information discussed during this call, including answers given in response to your questions, may relate to future results and events or otherwise be forward-looking in nature and reflect our current views with respect to future events, including financial performance. Such statements are intended to fall within the safe harbor provisions of the securities laws.
Actual results or events in the future are subject to a number of risks and uncertainties and may differ materially from those currently anticipated or desired, or referenced in any forward-looking statements made as a result of a number of factors, including those risks and uncertainties that have been or will be identified from time to time in the company's reports filed with the Securities and Exchange Commission. Additional discussion of these and other factors affecting the company's business and prospects are contained in the company's filings with the Securities and Exchange Commission. With that said, I would now like to turn the conference over to Mr. Powell Brown, our President and Chief Executive Officer.
Thank you, Laura. Good morning, everyone. We're calling in this morning from the Advocator Group in the Boston area, and I'd like to thank Mike Crowe and his team for doing a great job. We're going to have a board meeting here the next two days, and are really excited about it. Markets in certain areas and certain lines of coverage are seeking rate increases. Most markets are not willing to lose a renewal. New business pricing continues to be aggressive. There is a pricing gap that continues between new and renewal pricing. We're pleased to announce that we've completed $47 million of annualized revenue year-to-date. Now I'd like to turn it over to Cory for our financial report.
Thanks, Powell. Our net income for the second quarter of 2011 of $37 million was down 10.2% from last year's second quarter net income of $41.2 million. Our earnings per share for the second quarter of 2011 of $0.26 is $0.03 lower than the $0.29 in the second quarter of 2010. The difference in the quarterly earnings per share results can be summarized in three areas. One, the change in the estimated acquisition earnout payable, which accounted for nearly $0.01 of that difference. Reduced profit-sharing contingency income, which accounted for about $0.018. Thirdly, reduced other income, which accounted for $0.008, which in aggregate, all that is almost $0.04. From a revenue standpoint, commissions and fees for the quarter increased 2%, or $4.9 million to $246 million from the $241.1 million we earned last year's second quarter.
Included in our press release is our table that summarizes the total growth rates and the internal growth rates from our core commissions and fees, which of course, excludes profit-sharing, contingent commissions, and revenues from books of businesses or other operations that were sold. In the second quarter of 2011, we received only $2.3 million of profit-sharing contingencies. That's $4.2 million less than the $6.4 million that we received last year in the second quarter. The decrease is primarily due to the fact that last year we earned $3 million in profit-sharing contingencies from one of the workers' compensation carriers that wanted to reduce their exposures. Therefore, we were asked to move the business. Thus, we did not receive any profit-sharing contingencies from that carrier in 2011.
Additionally, in the second quarter of 2010, we received $750,000 of profit-sharing contingent commissions from the FIU program, which was not received this year. At the end of the first quarter this year, we had estimated that we might receive between $3 and $4 million in the second quarter. It turned out that the $1 million difference relates primarily to our wholesale brokerage division that now looks like it might come in the third quarter instead. Therefore, we now are estimating that we may receive an additional $6 to $7 million in the third quarter. Then for the fourth quarter, whatever we receive from FIU is what we'll get, which, if there is a hurricane that hits Florida in 2011, that number will be zero.
If we're fortunate enough not to have any hurricanes, we could possibly receive as much as $1 million in the fourth quarter on contingencies. If you look at the internal growth schedule, we did have a negative internal growth rate of -4.8%. If you exclude the negative impact this quarter of Proctor Financial, which we discussed in our first quarter conference call, our negative internal growth rate was -4%. Our total core commissions and fees for the quarter increased 4.3%, or $10.1 million of total new commissions and fees. Within that net number was $21.3 million of acquired revenues. That means that we had $11.3 million less commissions and fee revenues on the same-store sales basis. Hence the 4.8% negative internal growth rate.
As the internal growth rate schedule indicates, the vast majority of the negative growth relates to our National Retail Division and our Proctor Financial operation. Powell will discuss each of these divisions in a minute. Moving on to our other income. Our investment income was just up slightly over the second quarter of 2010. Our other income was $1.8 million less than last year's second quarter. That was primarily due to the fact that last year we recognized a gain that resulted from a lawsuit that we won against former producers for violating their employment agreements. Looking at our pre-tax profit margin for the second quarter of 2011, it was 24.9%. That's compared to the 2010 second quarter profit margin of 27.9%. That's a 3 percentage point decline.
If you exclude the impact of the changes in the acquisition earn-out liability, which was $2.1 million, the reduction in the other income, which was $1.8 million, and the net reduction in the profit-sharing contingent income of $4.2 million, the 2011 second quarter pre-tax margin was only 40 basis points lower than the comparable 2010 quarter. That difference is more than accounted for by some delayed revenues from Proctor Financial, which Powell will talk about a little bit later. In fact, the operating profit margins in most of our divisions showed an improvement when you exclude the Proctor numbers. Employee benefits and compensation as a percentage of total revenues for the second quarter of 2011 was 51%. For the second quarter of 2010, employee compensation benefits as a percentage of total revenue was 49.8%.
When you exclude the $4.2 million of additional profit-sharing contingencies in 2010 and the $1.8 million of additional other income, the employee compensation benefits in the second quarter of last year would've only been 51.1%, which is only 10 basis points different than the current quarter. The total dollar increase on the net basis in employee compensation benefits was approximately $4.5 million between the two quarters. $7.3 million of this net total was attributable to just the standalone new acquisitions since last year. Excluding the impact of these standalone acquisitions, we actually had $2.8 million in less compensation benefits on a semi same-store sales basis, that is primarily related to reductions in salaries and bonuses.
Our non-cash stock-based compensation cost was $2.7 million in the second quarter of 2011, which is consistent with our previous guidance on the increased cost, which includes our new stock incentive plan that was implemented in the first quarter of 2011. In the current quarter, other operating expenses increased as a percentage of total revenues by 40 basis points to 14.2% of total revenues. The total dollar increase in other operating expenses was $1.4 million. $2.6 million of this aggregate total was attributable to just the new standalone acquisitions since last year. On a comparable, again, semi same-store sales basis, those offices had an aggregate reduction in other operating expenses of approximately $1.2 million. These decreases were broad-based, small reductions in many expense line items such as occupancy costs, supplies, and telephone costs.
Amortization and depreciation expense increased in aggregate over the 2010 second quarter as a result of our acquisitions this year. Interest expense is consistent with the expected quarterly expense of approximately $3.6 million. Our change in estimated acquisition earn-out payables was a debit of $1.6 million this quarter versus a credit of $533,000 in the second quarter of 2010. It has a net delta loss difference between the two quarters of $2.1 million, which is almost $0.01. The debit that occurred in 2011 quarter occurred as a result of several acquisitions performing better than what we originally predicted at the date of each of the respective acquisitions. Our effective tax rate for 2011 is currently expected to run approximately 39.7% range, which is just slightly higher than last year's effective tax rate. With that quarterly overview, I'll turn it back to Powell.
Thank you, Cory. Florida retail was down 1.1% versus 2.5% last year. Property rates are down 5% to up 10%. Liability rates are flat to down 5%. Exposure units are generally flat to down slightly. Auto rates and work comp exposures are flattish. The most competitive pricing areas in Florida are from Jacksonville out into the Panhandle to Panama City or Pensacola. There are certain national markets that are willing to use their property capacity, and they're very active in new business being written in Florida, and there are certain regional markets that are also very active in new business. Florida retail as a group, had a net decline of $451,000 for the quarter. However, last year in the second quarter, there was a $518,000 accounting adjustment to reduce our SAB 101 reserve for future policy cancellations. That did not have a corresponding adjustment in the second quarter this year.
Thus, when you aggregate all the individual offices, some were up and some were down, but the aggregate, there was a net positive growth of $67,000. National retail, -8.1% versus -3.3%. In the Southeast, excluding Florida, property rates are down 5% to up 5%. GL rates are typically flat to down 5%. Auto rates are flat. Work comp rates are flat to down 10%, and exposure units typically are flat to up slightly on certain accounts. The marketplace markets are looking for rate on renewals, and a few of those carriers are willing to walk away if they cannot get a flat renewal. Most markets continue to be aggressive on new business, and regional carriers are the most competitive. In the Northeast, property GL and auto rates are flat. We're seeing downward pressure on auto rates in North Jersey a bit. Work comp rates are flat to up 5%.
Basically, exposure units in the Northeast are flat to down slightly. Construction, flat to possibly up slightly in areas. The markets are saying they need slight increases. We're seeing low single-digit increases stick on some accounts. Once again, no market wants to lose a renewal. In the Midwest, property rates are flat to up slightly, and GL rates are flat to down slightly. Auto rates are flat. Work comp rates are up a several percent, and exposure units are typically flat-ish. In the construction area, GL rates are flat to down 10%, and we're seeing the payrolls on bigger contractors or some of ours down substantially in the Midwest. In Texas, coastal property rates via E&S markets are up 5% to 15%, yet certain standard markets want rate increases and others are gutting the pricing. Smaller standard market property is basically flat.
GL rates are down 5% to 10%. Work comp rates are down 10%, and certain national carriers are tightening up on their work composition in Texas, while the former state fund remains very competitive. That said, there were a handful of offices that experienced a unique set of circumstances that contributed to the vast majority of the downdraft in Q2, and I'd like to elaborate on several of those for your benefit. One office saw a former owner, a number of years retired, come back into the business and take several accounts. The result was a reduction in over $1 million of revenue, and there's current litigation ongoing in this matter.
Another office that writes employee benefits in a particular state for school boards has seen a dramatic impact on their business, down approximately $1 million plus, due to, one, the reduction in teachers, and two, increased competition in their state employee benefits plan. Another office had a large life case last year in Q2 without a corresponding case this year. One office that focuses on large contractors in the Midwest renewed all of their accounts, but due to the dramatic shrinkage in exposure units in their accounts, their revenues were down substantially for the quarter. Finally, there was a timing of $700,000 of revenue that came into Q1 last year that was received in Q1 this year, so we didn't have a corresponding revenue stream in Q2 this year.
Couple these offices I just described with a higher than normal loss business for a handful of other offices, and you get our national retail results. The remaining offices not discussed in national retail performed well, with a slight decrease in revenues overall. In Western retail, we are down 3.7% versus down 3% last year. Property rates are flat to down 10%. GL rates are flat to down 5%. Auto rates are flat. Work comp rates are down 5%-5%, except on accounts with bad loss ratios, and we'll talk about those in a moment. Exposure units are generally flat, some may be down slightly. On a market standpoint, we're seeing carriers on accounts under $50,000 in premium trying to get rate, and some of it is sticking. Larger accounts are still very competitive. Anything over $100,000 in premium attracts a lot of attention. Back to work comp.
It's all about underwriting now. We're seeing more declines on new business submissions due to bad loss ratios than before. If the account has a debit mod, we're going to say, "You're going to have to start paying more." Credits are going away from the carriers. If you have a credit mod, there's still favorable terms that can be achieved, i.e., flat or down is still available. The major comp players in California are starting to get rate, i.e., some tightening. In the state fund, we're seeing on loss challenge accounts. In the employee benefits arena, small group under 50 lives, we're seeing rates up 5%-15%, and large group over 50 lives, we're seeing up 5%-10%. Certain carriers are breaking out compensation on larger groups, as we've previously discussed. Some are asking us to get our clients to sign disclosure statements.
Like I said, we talked about that last quarter. In the wholesale division, we're up one versus up one last quarter. The brokerage property, cat property is up 5%-15%, and RMS 11 continues to impact the marketplace, specifically in Houston, but in other areas as well. General liability rates are leveling off a bit. Exposures are typically flat to up slightly. In professional liability rates, EPLI and D&O rates are down 5%-7%. Typically, small and middle market revenues on accounts are up slightly. We're starting to see some increase in claims due to wage and hour losses. We're seeing lots of technology and medical company startups. On our E&O business, we're seeing revenues down slightly on renewal accounts, and anything in the financial institution area, rates are up. From a binding authority standpoint, property rates are flat to down slightly.
London, interestingly enough, is trying to increase rates, unsuccessfully, up 5%-15%. That's the desired rate increase. The domestic markets are still flattish, as I said earlier on rates. RMS v11.0 is still creating challenges for binding markets. Some of those markets are saying, "Just wait till we get this figured out." It's a somewhat fluid state, changing daily or weekly. GL rates are flat to down slightly. Construction GL is flat to down 5%-10%. Professional liability is generally flat. Exposures are flat to down 5%. In the programs arena, professional programs down 5.4% versus down 3.1%. Dental rates are flat to down slightly. Lawyers are down 5%-10% in rate, depending on the type and number of attorneys. CalSurance Associates continues to see rate pressure on the book with exposures down 5%-10%.
In special programs, we're down 12% versus down 3.1%. Proctor is seeing rates are down. In Q1, we estimated that Proctor's revenues would be down $500,000 in revenue in Q2 and down $2.8 million in Q3. Their revenues were actually down $2.4 million in Q2 due to a timing issue, and we believe them to be down approximately $1 million to $1.5 million in Q3. We still think they're going to meet or exceed original budget of $37 million in core revenue for the year. FIU rates were flattish. Ex-wind business continues to be priced very competitively, the state has not yet addressed the A rates on properties over $10 million in TIV. We talked a little bit about Citizens in the past. We thought those were going to be addressed after the session, which that has not been addressed.
Finally, one of our other special programs, Acumen RE Management, had a $700,000 revenue move from Q2 of this year into Q3. It's just a timing issue. From a services standpoint, we were down 80 basis points versus down 30 basis points in Q1. From an acquisition standpoint, we're very pleased. We've closed $47 million year to date in annualized revenues, as I said earlier. In the second quarter, we closed $26.5 million in six transactions. Acquisition opportunities continue to be good. We're very pleased with our activity. As we've discussed in the past, organizations sell on their own timeframe, we continue to look for good firms that fit culturally with Brown & Brown. In conclusion, our results in Q2 were unusual, primarily due to the reduction in other income and over $4 million less in profit-sharing contingencies.
We're pleased with the improvement in Florida retail and continued positive internal growth in wholesale. As Cory pointed out, we have three items that impacted our quarterly earnings $0.04 over a compared period last year for the second quarter. Carrier results in Q1 continue to deteriorate on a combined basis from 101.1 to 103.3, interestingly, premium to surplus fell from 0.77 to 0.75, March of 2010 to March of 2011. This is a new record level based on quarterly data back to 1986. With that, I'd like to turn it back over to you, Laura, to open it up for questions.
Ladies and gentlemen, the question and answer session will be conducted electronically. If you would like to ask a question, please do so by pressing the star key followed by the digit 1 on your touch-tone telephone. If you are using a speakerphone, make sure that your mute function is turned off to allow your signal to reach our equipment. Once again, that is star 1 if you would like to ask a question. We'll take our first question from the line of Keith Walsh with Citi.
Hey, good morning, gentlemen. It was a very helpful discussion about some of the one-off items there or in each of the offices. Can you talk a little bit about excluding Proctor within your book? When I think about the market now, it seems prices are still soft, but maybe decelerating, the decline is decelerating. Exposures seem to be a little better. Is there something going on with new business or retention? If you could just talk to that a little bit.
Yeah, no, we tried to give you a little color around it in the national retail scenario. You're correct in saying relative to several offices. In our business right now, we're seeing rates, depending on where you are around the country, rate pressure upward some areas of the country. As I said, up here in the Northeast, we're seeing it stick a little bit more. I'm talking excluding coastal property, number 1, and we continue to see rates move around because nobody wants to lose a renewal. I alluded to in the Southeast outside of Atlanta and some of those areas that carriers are willing to walk away on business if it goes below a flat renewal.
We continue to write a lot of new business, and in most of our offices, we do not see a change in historical retention ratios. However, as I allude to in 1 example in national retail, where we write a lot of business with large contractors, that office was dramatically impacted downward. They renewed all their business, but the exposure units were down substantially. It's very difficult to make a broad statement, Keith. We continue to write a lot of new business, and our historical retention ratios in most offices are the same.
Okay. Just another on revenue. It seemed the trend heading before this quarter, four consecutive quarters of just improving organic. I think the consensus out there was probably you guys were going to be flat to up in the second half of the year, this quarter kind of throws a monkey wrench into that, it seems like. You did a nice job explaining some of the things, but is that now off the table for the second half of the year? Is this a new trend we're looking at, or should we just go back to what we had been seeing previously?
Well, let's go back to what we talked about in Q1. What we said was that obviously we were pleased with the incremental improvement in our internal growth rate. Yet, I don't remember my exact terms, we thought we would probably see more of historical performance between now and the end of the year. That was not broadly defined, but knowing that there were some people on this call that thought because we were negative 1.1, that we were going to go positive in Q2. Cory and I thought, tried to articulate that we didn't think that because we haven't seen improvement in middle market as much as some people may have thought. I don't know if those people are on the phone or if somebody thought that on the call today. That's what my recollection was, Keith, relative to that.
For the second half of the year, we're still looking at probably a negative scenario.
When we said in the first quarter that we thought that we would be operating between now and the end of the year, that was 90 days ago, in a similar operating environment, we're sticking by that. From a historical performance scenario, Cory, do you want to allude to that?
Yeah. Keith, I do think that the second half of the year will reflect something closer to what we saw in the first quarter as opposed to a slight aberration with a handful of our offices this quarter. Does that answer it?
It does. Last question, just on contingents. If you could just remind us what % of your contingents are driven by profitability of P&C companies. It just seems like, the outlook for 2012 has got to be reduced on the contingents at this point, if you could talk to that.
Yeah. Well, I would say generally, off the top of my head, all of our profit sharing is based on profitability. That is always a function of it, Keith. There might be other criteria like persistency or new business or something like that, but the core foundation of profit-sharing commissions really is profit sharing.
The fact that the loss ratios are going up, I think your assessment is correct that profit sharing in 2012 should be lower because the loss ratios are going up.
Okay. Thanks a lot, guys.
Our next question comes from the line of Mark Hughes with SunTrust.
Thank you. Good morning.
Morning.
The pricing gap between the new and renewal business, you described that there still is a gap there. How did that compare to, say, Q1 or Q4? Then through the last cycle, how does that normally trend when the markets start to firm up? Does those close entirely, or what would you expect going forward?
Well, I would say that it's similar to Q1 and probably similar to Q4. I think I said the last time on the call, if you take an account that you submit or you get a renewal account and the market is looking for a 4% rate increase and you negotiate it down to a 1% or 2% rate increase. If you took the same account, which you wouldn't, but if you took the same account and it was a different operation, meaning all the same exposure units, and you submitted to the exact same carrier, I've said before that that could be priced 10%-15% less than expiring. Mark, to your comment, depending on when a market changes, I normally think of property sort of leading the way, and can there still be a change in the new and renewal business pricing in a firming market?
The answer is yes, the gap closes. In a perfect world, static state, you would think they would be the same, but the answer is the market is inefficient. That inefficiency is not bad, but that inefficiency creates the opportunity for us to write a lot of new business and do good things for our existing customers. Have we seen that gap close? No, not yet.
Okay. Corey, the expectation for the change in the earn-out liability, should we normally assume that's going to be flat? Is there something about the trend in these recent acquisitions that would make us think that would be a positive number similar to this quarter?
No, our goal is when we make the acquisition, we have to predict what that earn-out will be three years from the date of the original acquisition. You've heard my diatribes before about how much noise this 141 R creates. The fact of the matter, the only thing that really does matter is how good of a predictor we are on the date of acquisition. In this case, our objective is always to be 100% accurate, but you'll never be 100% accurate. We always would hope that half would be up and half would be down and net to zero.
In this particular quarter, there were situations where we had acquisitions that did perform better than we anticipated, and there were an acquisition where it was an early termination because we wanted to combine the offices that moved their earn-out closer to their maximum, and that's what created it. In the future, I would hope it would be lower, but I tell you, it's such that it's a very unpredictable number, and it doesn't mean anything other than create noise. All we can do is highlight it for you, and that's why we have it as a special line item. But the positive is when it is a debit, it does mean that the earn-outs are doing better than what was originally predicted. But that's just a point estimate 3 years before it actually happens.
I would hope in the future it'd be less, but I can't assure that.
Thank you.
Our next question comes from the line of Michael Grasher with Piper Jaffray.
Thank you. Good morning. Just wanted to follow up on the exposures issue. I know you've mentioned the large contractor account where they renewed everything, but the exposure units fell. Is there any area or any line of business, I guess, where you are actually seeing exposure units accelerating across the board? Maybe accelerating is too strong, but up modestly.
Yeah, I think that I wouldn't use the term accelerating. Are there areas of the country and classes of business, and I think it's real specific to the office and what they are soliciting. For example, if you went to our Atlanta office and you asked them about the contractors that they've worked on recently and/or their existing business, the contracting business has been down so low there that they're seeing slight increases on their accounts. Does that mean that they're back close to where they were? Not even close. There are stories, Mike, like that across the country, but when we go into offices, I ask the entire team, all of our teammates in the office, how many accounts do you see that have 25% exposure increases? Very few hands will ever go up. When they do, they're unusual type of accounts.
I give you an example. I was in an office recently where one was a manufacturer of a medical product, an invasive medical product. That was the scenario. Their exposure units were up 25%. The next one was a technology company. You start asking, does anybody have 15% or 10% or 5%? Most of the accounts are flat-ish as a very broad statement. That's how we go into it on our renewal books, and we talk to people in our offices about it, but we're not seeing anybody expanding dramatically in terms of their exposure units.
Those are just on the renewal accounts you're speaking to there. How about just new business where they're establishing new accounts?
Yeah. In the new business, you'd like to think that you may know a historical perspective on their exposure units. We may not know all of that up front. We get that in the process, and if we get it for the underwriter upfront, some are growing and some aren't growing. As a general rule, I would say more are flat to potentially up or down slightly.
Okay. Second question would be around workers' comp reform. There's been numerous states that have enacted some sort of reform, be it positive or negative for underwriters. How does that impact your business and your approach to the market?
Sure. Well, work comp reform creates an opportunity for us. You've heard us talk about in the past in Florida, we'll just use that as an example. In Florida, there was meaningful tort reform in 2003 for workers' compensation. As a result, rates went down an average, compounded average, of 60+% since 2003. On January 1 of this year, Mike, as we've talked about before, rates went up, I think, an average of 7.8%. That is an opportunity for us not only to do a good job for our existing clients, but to work on new business and bring those solutions to our prospects. Couple that, go to the other end of the United States, go to Washington State. Washington State is one of four monopolistic states left.
Right.
In the state of Washington, we talked about there was the possibility of meaningful reform and opening it up to the private market this year. That was defeated. It surprised us, and it surprised a lot of other people. It was defeated by an effort led by several interest groups in the state of Washington. I just heard yesterday that the rates in Washington, I believe, are going up across the board 30+% this year.
Would that have happened in a private market? I tend to doubt it. If in fact that market becomes privatized, that in turn creates a great opportunity for us because we will go to our existing clients and new prospects and offer work comp solutions. You look at someplace like California, which is always sort of the forefront of most of your minds relative to comp issues. What we're basically saying is, I would say carefully, but I would say that there are markets that are getting religion, and they are saying, if you have bad loss experience, you're going to not get the credits that you once got. If you have good loss experience, you can still get flat to slightly down renewals.
That's a long-winded answer of saying, Mike, that we think that reform generally is an opportunity for us, for our existing clients and new business.
That's helpful. Appreciate the detail on that. I guess the final question I had, just if you could give an update to the degree you will, around the litigation with your former employees. Is that having any impact at all on your Florida business or the MC environment?
As you know, we don't typically talk about ongoing litigation. However, we currently have an agreement in principle with the individuals that you have discussed. Several of the substantive terms have not been performed, thus, we're not at liberty to discuss at this time in detail.
Fair enough. Thanks very much.
Our next question comes from the line of Matthew Heimermann with JPMorgan.
Hi, good morning, everyone.
Hey, Matt.
Good morning.
Hi. Couple questions. First, just with respect to, I know growth has been on top of mind for everybody, I guess, as we've gone through the Q&A roll today. I think originally you discussed kind of 2011 being a transition year for growth. Certainly, the headwinds that you kind of started the year with haven't really eased all that much. I guess if we were looking to 2012, what factors need to change to actually get you into the positive growth column? Is it a function of rates changing, just having a little bit more of a more positive economic growth behind us? Just as you kind of survey the landscape, what factors do you feel are most important to kind of getting there?
Yeah, the most important factors by far, Matt, are exposure units. We have said before that the current rate environment, particularly in areas where you still hear us saying there are rate decreases or flattening. We don't need the market to firm up and rates to grow organically. We just need to have a little bit better economic operating environment for the middle market customers across the country. Remember, we're a middle market agency broker firm that basically is paid by commissions. We are still not seeing economic expansion in the middle market. That's the biggest single thing that impacts our business.
Just with respect to that, from the psyche of your clients right now, does that just come back to uncertainty with some of the issues we've talked about in the past in terms of healthcare legislation and what the actual implementation looks like? Is that just a function of maybe payrolls or employee counts not coming back in the middle market maybe as significantly, not that they're significant anywhere, but not getting maybe the relief you might be getting at the large end of the market. Are those the factors that still kind of we should think about in terms of maybe trying to gauge where we are on that front?
Yeah. I think that number one, in the middle market clients of ours, there was not a dramatic shift to optimism. There continues to be what I call a cautious view moving forward, and you've heard us talk about the bunker mentality. I don't think that owner of a business has come out of the bunker yet. That said, you will hear in our offices, if you were to ask individual offices, that you're seeing on some accounts, expansion of business without adding new individuals or employees. We have thought all along what we've read in national papers and hear on the news up until about 8 weeks ago, maybe it was 10 weeks ago, that the economy was doing better and everybody's feeling good and all that other stuff.
The answer is, we were sort of scratching our heads saying, we're not seeing that with our middle market customers and our new business prospects. I think that it's not as though they went from bunker mentality to joy and optimism to back to the bunker. It was more, they've been in a bunker the entire time, although it was just not as difficult, but it's still a difficult operating environment, but getting better. That's how I think that they view it.
Okay. That's fair. Then just one of the things I've struggled with, just looking at the brokers vis-à-vis some of the insurance underwriters, is in for the last several quarter, a number of the insurance underwriters have talked about Premium audit adjustments upward quite significantly in the work comp area, and that doesn't seem to be a trend that y'all have confirmed in your own commentary. Is there any color you could just add there? Because I'm curious if work The reason I'm asking is just why the difference, but also if work comp rates start to go up a little bit, how material. I guess I'm trying to gauge how material that is relative to payrolls still not looking like they've expanded either.
Right. First off, I'd say, I think you're focused on the right thing, which is payroll as opposed to rate, in the carriers and or the broker segment, number one. Number two, I only worked 3 years at an insurance carrier in the beginning of my career, so my comments might be slightly off, but my suggestion or commentary would be the following. If you ask in a normal year an insurance carrier, what percent of additional premiums or what impact of additional premiums on workers' compensation, what that impact has been to their total premium writings in the quarter, I would believe the answer will be somewhere between 2%-4% positive. 2%-4% of the total premium written would be as a result of payroll audits.
In this economic environment, my understanding in talking with people that we know at these firms, it's been kind of the reverse. The reverse is basically down 2%-4%. What they may be saying, and I don't know, and you might inquire about those carriers in question, is they may be saying that it's getting closer to flat or very slightly up. I don't know that. See, it's funny because when you hear carriers say that they're getting rate on their commercial book of, let's just say, 2%, that's on their renewal book. If they could tell you what their new business pricing is, their new business pricing is still down substantially in terms of if they know the comparative on expiring, which most of the times they don't talk about that. Some do, but not all.
I think there's a 2%-4% swing, positive or negative, as a result of premium audits on workers' compensation. I think my impression is that it's going back more towards flat as opposed to positive than it has been in the past.
Is it fair to say that when we've been in normal years in the past, when carriers have seen those audit premium adjustments, those aren't things that necessarily you would have seen? I guess I'd be curious from a commission standpoint, from your standpoint. Is that stuff that you just capture up front and it doesn't really flow through to you? I'm just trying to understand.
No. We capture it, and it flows through to us. What I would tell you is, you get the good with the good, and you get the bad with the bad. What I mean by that is, in an expanding economy, you get clients growing, and then typically they're going to have net more premium audit positives. Those would be called additional premiums versus return premiums. That is put into our numbers and the growth of our business. On the flip side, when you have a shrinking economy, as we've been going through for the last several years, you get not only the downdraft on your renewals of accounts, but you get return premiums on top. I call that the double whammy, which is baked into the negative downdraft.
We've said before that, remember, a lag on a work comp policy, positively or negatively, could be up to 14 months. You'd say, "Well, why?" If we renew your business, Matthew Heimermann Inc., you're a manufacturer today? You've renewed it, and you have $10 million of sales. We go 12 months down the road, and actually, you knew that you actually had another contract in the pipeline, which was going to get you to $14 million, but you just have had this bunker mentality. You've been very cautious about updating your payrolls or your sales figures with us. At the end of the exposure period or the policy period next year, the carrier will have 60 days to come in and do a premium audit. In doing a premium audit, they will determine that Matthew Heimermann Inc.
did $14 million in sales, and they will send an additional premium. You would pay the additional premium to us. We will get our commission. They'll get their premium. Conversely, in a shrinking environment, if you had said your sales were $20 million, and when in actuality, the market was going down on your manufacturer product, and now it's $14 million, they're going to have a return premium of that $6 million, and we got to give that commission back to the carrier on that.
That's fair. That was my presumption. The takeaway is that some of the comments we're hearing on positive adjustments or two to four just aren't representative of what you're seeing in the business overall. Is probably the takeaway.
I think that's fair. I don't know how all those statements were made, but I find it unusual to say, broadly speaking, that somebody's comp book, which by the way, comp books, on average, they're heating up on the temperature. I call it running a slight temperature at about 114% combined ratio, and expected to go towards 120 year-end based on everything we can gather. If the book is growing, even if it's growing and the temperature is going up, profitability may be in question.
Sorry to take so long on this. One question for Cory is, I've asked this in the past, but just wanted to know any update thinking with respect to some of the maturities, or the maturity this year, then the capital structure in total from a maturity standpoint, given that it still seems to be a relatively favorable environment to be an issuer.
Matt, are you talking about our debt?
On the debt side, yeah.
We have $100 million that's coming due in September. That's already been replaced with another debt from our Prudential partners. The rates are going to go from 5.3% on the $100 million that's retiring, down to 4.5%. There's no other really change in our capital structure. We've got a lot of cash, don't really foresee any significant change right now. We're looking just to make acquisitions.
Yeah. No, I guess I was thinking more in the standpoint that I think your other maturity is 2016, and kind of whether it made sense to, even though you may not necessarily have a need burning a hole in your pocket, whether or not just with the environment we're in, whether it makes sense, because you certainly have the capacity, I think, from a financial leverage perspective, to maybe put another maturity out there.
At this time, we're not talking about it just because we've got so much of ready cash, and we're not considering that until a bigger deal comes along.
Okay. Fair enough. Thanks.
Our next question comes from the line of Brett Huff with Stephens Inc..
Good morning, Powell and Corey.
Good morning, Brett.
A question, I want to make sure that I'm hearing you right. It sounds like there's some room for hope on rates, which seems a little bit different than the past couple of quarters. If that's the case, even if it's small, given that it sounds like exposure units haven't changed much in the last couple of quarters, it sounds like they won't in the next couple of quarters, why would the second half organic growth still kind of look like the first quarter, if rates are getting a little bit better, or is that a wrong interpretation?
I don't know if I think that's a wrong interpretation. I think that basically, as we've said, if you consolidate my comments on the market, you have a lot of flat and down slightly, I think, in exposure units. There are some that are up slightly. We would say that I think that the expectation for our internal growth going forward is, as I said earlier, more similar to the historical range. As Corey alluded to earlier, we'd like to think that it would be closer to what you might have seen earlier in the year than what you've seen this quarter. That's kind of our best estimate right now.
Okay. As you guys looked at Proctor in 2012, even though there is some shifting between quarters, it sounds like your estimates, you are still feeling pretty good about the $37 million or so in contribution there. Is there anything that is happening in Proctor that should change, should cause a meaningful fluctuation as we go into 2012, or are the sort of rocky seas with Proctor sort of behind us once we get done with this year?
Don't think so, Brett. That is an interesting space, and we like that business. There is a couple 800-pound gorillas that operate in that space, that you always got to contend with from a competitive standpoint. We are not aware of anything right now that we would need to give additional color on.
Okay. The last question. On comp, the comp number I thought it came in better than we expected, and I am sure part of it was because the revenue was lighter than we thought. Any thoughts there on containing costs, are we seeing more competition for talent? Has anything changed meaningfully there that we should think about in terms of escalating comp costs going forward?
No, I don't think so. Remember, we want to get the best people on the team, and we are looking to add teammates, in terms of revenue-producing teammates through both M&A transactions and hiring them from other industries and teaching them the insurance business. No, we are very focused on high-quality people on the team, getting them, keeping them, retaining them, training them.
Okay. Last question. It seems like you guys are, I feel very strongly, you guys are running leaner than you have maybe ever in the past. When rate and/or exposure units goes up, how should we think about your margin versus historical margins?
We believe that we can go and approach back our historical operating results, and may be able to exceed those. Once again, what we're trying to do is grow our business. Obviously, we did not grow our business internally this quarter, it's something that we're focused on. We think that we have the discipline to drive the results in a normal operating environment.
Great. That's what I needed. Appreciate your time.
Our next question comes from the line of Doug Niewoehner with RBC Capital Markets.
Hi, all my questions have been answered. Thank you.
Okay. Thank you.
We'll take our next question from the line of Meyer Shields with Stifel Nicolaus.
Thanks. Good morning, everyone.
Morning.
Can you talk a little bit about what's actually driving the relative outperformance in wholesale? I hadn't heard a lot of the sort of quasi-specialty business moving back to the E&S markets, and I'm wondering what's actually distinctive in that segment.
Yeah, I think there's two things. One, as you know, coastal property rates are up, as I said, 5%-15%, that helps. Two, depending on the market, be it brokerage or binding, the uncertainty/confusion that is surrounding RMS 11 is creating some opportunities for us. What I mean by that is, there may be scenarios where, in an open market, if you want to call it that, in binding authority, there would be lots of binding authority markets that would be quoting our renewals. Whereas if RMS 11, if the company is saying, "Just wait till we figure it out," the competition may not be able to quote a renewal on it, number one.
Conversely, if we have a market that's open, is not confused, and we're writing more potentially new business or taking it from a market that is sort of in a state that's kind of trying to figure it out, there's still just a lot of competitive forces at play, which we think are very positive for us and are really pleased with all the teammates in the wholesale division and everything they're doing. It's kind of a combination of rate pressure on the brokerage property, RMS 11 in a very broadly defined term. I know you don't want to hear that, and we don't either, but it is kind of amazing how one, I'm going to call it one Monte Carlo simulation model can drive so much confusion or create so much opportunity.
Right. Well, call this question the assertion that companies don't rely exclusively on the model, but that's.
Right
an issue.
Like I say, if a rating agency places a lot of value in the model, then somebody's forced into using it.
Yeah. No, that's absolutely true. Cory, is there any rule of thumb connecting the outperformance of newly acquired agents in a quarter and the adjustment to the earn-out?
It's not a quarter-by-quarter phenomenon. It's over the whole period of time. We've not made any specific tie-ins because out of all the acquisitions we do, some are doing better than our original projections, and some are doing a little bit worse. They kind of generally, we hope, average out. This particular quarter, it just went the other way that they did better. I don't think it's necessarily something that's as predictable. We try to make as good faith effort as possible to try to predict a point in time three years down the road on the earn-out, and just naturally it's going to change. Generally, we feel like we get the best acquisitions because we focus on the people. Generally, they do pretty well, but I'm not sure exactly how to answer your question.
I think you are. It's just there's not enough relationship on an individual quarterly basis.
Yeah. The unfortunate thing is that particular line item is nothing but noise because the only thing it is measuring is how good a predictor we are at the time we make the acquisition. You know my feelings on that one.
Understood. Last question, if I can. When we look at other income, for the first three quarters of 2010, it was above $1 million, and it's come down. I understand that that's related to, let's say, litigation in many cases. Should we expect the first and second quarters to be a good run rate for the next few?
Well, not necessarily. I think it will probably be slightly up in the second half. As a general rule, you can kind of look at between $400,000-$600,000 as kind of the normal baseline, which is additional rent income that we might have and other operating income that is normal. Anything outside that $400,000-$600,000 range is something that is a one-time occurrence, either a gain or loss on the sale of fixed assets or a book of business or a litigation settlement. As a general rule, I think you'll see that number be higher in the second half than it is right now for just this year. Again, it's not quite susceptible to accurate prediction as our normal operations.
Okay, great. Thanks very much, all.
Our next question comes from the line of Adam Klauber with William Blair.
Good morning, everyone. Thanks. Sorry if you said this before, what was the organic this quarter of the benefits versus second quarter last year?
You're talking about our services division?
Yes.
That was we were a negative 0.8 versus negative 0.3 in the first quarter.
Could you give some color? What's going on with benefit commissions as far as the new healthcare legislation? Is that having an impact?
Sure. The answer is, Adam, I would categorize it as very regional in nature. You might have something going on in South Florida that might not be going on exactly in Texas versus in Phoenix versus in Southern California. It might all be a little different on how the carriers are addressing it. A couple things that we're seeing. Carriers on small group that paid on a commission basis in certain areas of the country are sometimes moving towards per head per month. If you have a per head per month charge, the only way your revenue goes up in the future is to add more heads as opposed to if the rate goes up, you get a little bit more of the rate. That'd be number one.
Number two, in some scenarios where there are dominant market positions, meaning of a carrier, A, B, C carrier writes a dominant, they pay a certain commission to place the business, obviously with them, the traditional commissions. If there's another market that comes in that is more competitive, it is conceivable that the commission level that they would pay us might be lower. That is a conceivable scenario. Obviously, trying to do what's in the best interest of our customer. We have to do that because if we don't, obviously somebody else will, and that's how we lose the business.
The final thing that we're seeing is, I alluded to it briefly today, we talked about it in Q1, is certain carriers on large group, and large group is typically defined as over 100, but in certain states it's over 50, are asking us to have signed compensation disclosure agreements with our customers. That does not mean that they're not going to collect the money and then give us our commission levels. They're just breaking it out. We don't have a problem with that because we're talking with our customers about our compensation, and if they have additional questions, we want to provide as much transparency as they want into the way we're compensated, from whom we're compensated, how we're compensated, what we do for compensation.
It really is a regional thing barring certain national healthcare that are asking for disclosure statements signed across the country. That's a long-winded answer of saying, is there pressure on benefits commissions? Yes. Is there uncertainty around healthcare reform? Yes. Does that create an opportunity for us? Yes. We're selling a ton of new business to new prospects, which are becoming new customers for employee benefits. Finally, we believe that there will be no meaningful healthcare reform modifications prior to 2013 because of the presidential election.
Adam, I wanted to clarify something because when you started the conversation about the internal growth rate, what I was giving you is the internal growth rate of our service division. Everything that Powell was just talking about, the employee benefits and the healthcare, those were all embedded in our retail division, okay? The service division is primarily the TPA services, our Social Security set aside groups, as well as our Social Security disability advocacy.
Medicare set aside companies.
Those internal growth rates I gave you in the first part didn't have anything to do with the employee benefit healthcare side of it.
Okay. One final question. Could you give us an update on Citizens with the new legislation? Are homeowners' rates coming up, or is it a little too early to actually see the impact of that?
Well, remember when we talked about it last time, the issue where the rates will go up are around the sinkhole legislation, Adam. I haven't seen it yet, but I know that it's going to be occurring if it's not already occurring. The bigger issue that we talked about and have been asked about before is the A rating of the larger properties. What we said on Q1 was we thought that the governor was going to call this legislature back in for a special session and basically address that head on and increase rates another 10% on commercial residential properties. Think condos, apartments, certain assisted living facilities. That has not occurred.
That's surprising to us because in facilities like QBE, in FIU, which we write on QBE paper, their big competition has been historically Citizens and to a lesser extent, the Excess and Surplus lines market, which is continuing to be. What we alluded to, I think, in Q1 is as the rates for Citizens go up, the competition that Citizens was presenting will probably be supplanted by the E&S market.
Okay. Thank you very much.
Our next question comes from the line of John Fox with Fenimore Asset Management.
Hey, good morning, everyone. I have two questions. First, I'm a little unclear on the impact that Proctor had this quarter. Could you just go through that on the internal side?
Okay. Proctor this quarter was down $2.4 million in revenue this quarter. We had said to everybody that we thought they were going to be down about $500 and then be down about $2.8 in Q3. That's what we said in Q1. Going forward, they were down 2.4%, and we're saying in Q3, we think they're going to be down somewhere between 1% and 1.5%.
Okay. That's in special programs?
That's in special programs.
Okay, terrific. Then I think for Cory, do you have an estimate, Cory, for cash payments you'll make this year for earn-outs?
Well, year-to-date, we've made cash payments roughly about $86 million. Okay? The second half of the year, it will be up. Will it be equivalent to the $86 million? It's going to be somewhere $130 million, probably $140 million right now, but we got $86 million year-to-date.
Okay. I'm sorry. That's for earn-outs or for acquisition?
That's for total acquisition cost.
Right. I was looking for just the earn-out piece, which was $358,000 in the first quarter.
Oh. Well.
You don't know about that.
I don't know if we-
$358,000? Is that the one?
Yeah, it's in the financing section of the cash flow statement.
But-
I'll just call you back on it, if that's okay.
Yeah. I mean.
The total amount, acquisitions and earn-outs, is $86.
That's correct.
Okay, thank you.
Our next question comes from the line of Dan Farrell with Sterne Agee.
Hi, good morning. You mentioned the M&A environment. You still feel that the pipeline is looking good. Could you talk about the competitive environment in terms of closing deals and where pricing of deals are right now?
Sure. We think that pricing of deals remains in the historical range that we've talked about before. That's typically 6 to 7 times an operating profit definition. Everybody can define it a little differently. We define it EBITDA, is in our definition, because there's very little D. As it relates to a pipeline and then the sourcing of deals, what we've said is we meet with lots of people and talk to them about Brown & Brown and talk to them about their business and try to figure out if there's a cultural fit. For every 10 firms that we meet with, there's a group of them, maybe 5, let's say, 5 or 6, that up front you could probably determine they're maybe just not a fit. That's okay because you want to learn that up front.
Of those that we determine that there's a fit, let's make this easy for the math purposes. If we had four that we were going to give term sheets to, typically we get two of those, plus or minus slightly. Let's say we have 50% quoted or offered to close ratio. We feel like acquisitions, as we've talked about in the past, go in waves, and you can plant seeds today, and that's going to bear fruit six years from now, or it could be 90 days from now. Just using the current location as an example, I can tell you that we at Brown & Brown met Mike Crowe and his team four years ago. We met and thought very highly of them, it was just not an opportunity at the time to do a transaction.
We did a transaction here last fall in September, as you know. What happened? Well, they continued to grow their business. We stayed in touch, and over a three-year period, continued to foster a deeper, better relationship. Mike and his team continued to grow and prosper, we figured out a way to make it obviously mutually beneficial, and they joined our team in September. Every deal is a little different, Dan, I think the important thing is we want to be out talking to people all the time, which we are. We're focused on doing this for a long term. As you know, there's really, we call it 4 types of buyers in the space.
You have people like us and some of the other publicly traded firms that have a history and have done it for a long period of time, have a defined culture, and it's a long-term play, a long-term investment in operating environment. 2, you have banks. We've said that we believe that banks in aggregate are net sellers of insurance assets. We obviously closed on one this last quarter. It seems to us that Wells and BB&T are the only two banks that are committed long term to the insurance space. That assumes that they don't change their mind on their view on insurance for whatever reason, they might sell it. If there was a regulatory environment change such that they couldn't own it in the future, that might change it. The third would be private equity.
Private equity, as we all know, is typically short term in nature, I would say 3-7 years. We all know that you can't define and develop a very significant culture in that short period of time. That's going to attract a different type of seller as well. Finally, it would be kind of, I call it the crosstown rival, which is the smaller local or regional agency that has probably been competing head-to-head with that firm, do they ultimately come together? That's a possibility. Ultimately, one of the good things about Brown & Brown, we believe in our acquisition strategy, and this is pretty commonly known about Brown & Brown, is there are three things that we say with certainty. Number one, we pay with cash. Hard to argue with greenbacks.
Number 2, we do what we say and say what we do, i.e., when we give a term sheet and we do due diligence, we do not start negotiating from there. We stick to the original terms and conditions. 3, we can close quickly because we have everything done in-house. Having said that's an observation of ours. It's not a criticism of anybody else's, but I think that's pretty widely known about us out there, and it's something that we're proud of because we view ourselves as operators that we happen to do a lot of acquisitions as opposed to the alternative.
Thank you. That was helpful.
There are no further questions in the queue at this time. I would now like to turn the conference back over to Mr. Brown or Mr. Walker for any additional or closing remarks.
Okay. Thank you, Laura. We appreciate everybody's time. Have a wonderful day. We'll talk to you next quarter.
Ladies and gentlemen, this does conclude today's conference. We thank you for your participation.