Welcome to Marsh & McLennan Companies' conference call. Today's call is being recorded. Third quarter 2013 financial results and supplemental information were issued earlier this morning. They are available on the company's website at www.mmc.com. Before we begin, I'd like to remind you that remarks made today may include statements relating to future events or results, which are forward-looking statements, as that term is defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to inherent risks and uncertainties, and a variety of factors may cause actual results to differ materially from those contemplated by the forward-looking statements. Please refer to the company's most recent SEC filings, which are available on the MMC website, for additional information on factors that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today.
I now turn this over to Dan Glaser, President and CEO of Marsh & McLennan Companies.
Thank you. Good morning. Thank you for joining us to discuss our third quarter results reported earlier today. I'm Dan Glaser, President and CEO of MMC. Joining me on the call today is Mike Bischoff, our CFO. I'd also like to welcome our operating company CEOs, Peter Zaffino of Marsh, Alex Moczarski of Guy Carpenter, Julio Portalatin of Mercer, and John Drzik of Oliver Wyman. Also with us is Keith Walsh, Head of Investor Relations. Following my comments, Mike will discuss our financial results in more detail. We'll take your questions. Before I turn to the quarter, I would like to take a moment to recognize our Vice Chairman, David Nadler, who will retire at year-end after 13 years with the company.
David leaves MMC with my personal appreciation, as well as that of our executive committee and the board of directors for a job exceedingly well done. Marsh & McLennan's performance in the third quarter included 15% growth in adjusted operating income. This result underscores our journey to be an elite company as we successfully execute our four pillar strategy to create sustainable long-term shareholder value. As a global growth company, the first pillar of our strategy is to grow revenue and earnings. We have consistently delivered underlying revenue growth. We have also steadily expanded adjusted EPS in recent years, including increases of 13% in 2011, 16% last year, and 17% through nine months of this year. At the same time, we continued to execute on our other three pillars by maintaining low capital requirements, intelligently managing the risk profile of the firm, and generating strong key free cash flow.
Our results reflect significant investment in our businesses that we absorb on an ongoing basis. In addition, an increasing portion of our growing cash flow is available for dividends, acquisitions, and share repurchase. We believe a balanced approach to deployment of capital will contribute to long-term earnings growth and maximize total return to shareholders. Now let's look at our third quarter results in more detail. Both Risk and Insurance Services and Consulting delivered double-digit growth in adjusted operating income and excellent margin improvement as they have each quarter this year. Our consolidated adjusted margin rose 150 basis points to 14.1%. Underlying revenue growth again exceeded the increase in underlying operating expenses, as it has for 21 of the past 22 quarters. We expect to continue to achieve operating leverage while making investments across our businesses.
The operational improvements we have embedded over the last several years have led to higher colleague productivity, efficiencies in our global real estate footprint, and reduced professional liability costs. At the same time, we are continuously investing in areas that will support future growth and drive additional efficiencies. We are investing in growth markets and new offerings, building sales capacity, expanding distribution, creating innovative analytical platforms and capabilities, and making strategic hires and acquisitions. We are confident we have a powerful engine to generate revenue and earnings growth in both segments. Risk and Insurance Services produced another quarter of excellent profitability as adjusted operating income rose 14%. Underlying revenue increased 3% at Marsh and 5% at Guy Carpenter. The adjusted margin expanded to 15.2%, the segment's highest third-quarter margin in a decade, and an increase of 130 basis points from the prior year.
At Marsh, revenue was $1.2 billion as all major geographic regions contributed to 3% underlying revenue growth. The international division expanded 6%, led by growth of 15% in Latin America, 7% in Asia Pacific, and 3% in EMEA. In the U.S.-Canada division, underlying growth was 1%. Revenue growth was driven by client revenue retention, supported by strong new business, which totaled over $250 million in the third quarter. Guy Carpenter continued its solid financial performance and long-term trend of underlying revenue growth. Revenue was $262 million in the third quarter, an increase of 5% on an underlying basis. This is an impressive performance in an environment where Guy Carpenter is experiencing higher risk retentions by clients and softening pricing conditions. Growth was broad-based across North America, International, Global Specialties, and U.K. Facultative, led by double-digit gains in Continental Europe Canada, and Global Marine.
Consulting's performance in the third quarter was outstanding. Revenue was $1.4 billion, up 4% on an underlying basis, the segment's best performance in the last five quarters. Adjusted underlying expense growth of 1% reflects the benefit of prior actions and expense control. This produced adjusted operating income of $231 million, an increase of 13%, marking the segment's third consecutive quarter of double-digit growth. The segment's margin increased 150 basis points to 16%, Consulting's highest third-quarter margin in its history. This marked improvement has occurred while navigating challenging macroeconomic conditions. Mercer had an excellent third quarter. Revenue was $1.1 billion, an increase of 4% on an underlying basis. Health and Investments continued to lead the way with increases of 5% and 8% respectively. Retirement had an increase in project work, resulting in 2% growth, and Talent grew 2% as well. Growth was achieved across all geographic regions.
In October, Mercer announced that it had signed up 52 employers onto its private U.S. healthcare exchanges. Since that time, Mercer has signed up an additional 4 employers and now has 34 that will offer benefits through Mercer Marketplace, its active exchange, and 22 employers that are offering Mercer's Medicare retiree exchange solution. In total, Mercer's exchanges will cover over 220,000 employees, retirees, and family members for 2014. Oliver Wyman returned to positive revenue growth in the third quarter, with underlying revenue increasing 2% to $365 million. The revenue increase was driven by financial services, Oliver Wyman's largest practice, which represents approximately 40% of its revenue. Oliver Wyman's sequential improvement in revenue performance was broad-based across major regions, including North America and Europe. In summary, MMC's performance in the third quarter and through the first nine months of the year was excellent.
Our results show that the company's strong earnings momentum continues. We will host an investor day in New York on March 11th, where we will provide more insight into MMC's operational and financial strategies. We hope you will join us. Let me turn it over to Mike.
Thank you, Dan, good morning, everyone. In the third quarter, MMC's revenue was $2.9 billion, an increase of 4% on an underlying basis. Adjusted operating income increased 15%. The consolidated margin increased 150 basis points to 14.1%, adjusted EPS grew 18% to $0.46. These results are on top of 18% growth in adjusted EPS in the third quarter of last year. Investment income was $0.01 higher than anticipated in the quarter, this was more than offset by a higher tax rate that negatively impacted EPS by approximately $0.02. For the nine months of this year, MMC's revenue was $9.1 billion, an increase of 3% on an underlying basis. Adjusted operating income increased 15%, with the margin increasing 190 basis points from 15.8% to 17.7%. GAAP EPS for the nine months increased 14% to $1.89, adjusted EPS grew 17% to $1.91. Investment income.
The recognition of carried interest from Trident III led to investment income of $14 million this quarter. While it is difficult to forecast, we anticipate approximately $10 million in investment income in the fourth quarter. Taxes. The corporate tax rate in the U.K. was reduced in July. While this will benefit us going forward, the value of our U.K. deferred tax asset was reduced, which is the main reason for the increase in this quarter's tax rate to 32.4%. MMC's tax rate for the first nine months of this year was 30.2%, which is more representative of our underlying tax rate. Interest expense in the third quarter decreased from $44 million last year to $40 million this quarter. When we funded our $250 million debt maturity in February from available cash, we indicated that we planned to enter the debt markets later in the year.
In September, the company issued $500 million of debt, comprised of $250 million of five-year senior notes and $250 million of 10-year maturities. Proceeds from the new debt issuance were used in October to redeem $250 million of our existing senior notes due in 2015. This new funding allowed us to refinance at lower interest rates, while at the same time extending the average maturity of our debt portfolio. The cost of the early extinguishment of the 2015 debt was $24 million, or $0.03 per share. This expense will be included in both GAAP and adjusted fourth quarter results. Cash utilization. Cash on the balance sheet at quarter end was $2.2 billion. The increase from last quarter reflects strong operating cash flows in the $500 million debt financing.
Our cash utilization in the third quarter included $150 million to repurchase 3.6 million shares of stock, marking six consecutive quarters of share buybacks. Year-to-date, we have purchased 10 million shares of our stock for $400 million. In the quarter, approximately $140 million of cash was used for dividends, which reflects the recent 9% dividend increase and $20 million related to acquisitions. With that, I am happy to turn it back to Dan.
Thank you, Mike. Operator, we are ready to begin Q&A.
Thank you, sir. If you would like to ask a question, please signal by pressing star one on your telephone keypad. If you are using a speakerphone today, please make sure your mute function has been turned off or pick up your handset to ensure that our equipment can hear your signal. Again, that is star one if you'd like to ask a question. We'll take our first question from Michael Zaremski with Credit Suisse.
Hi. Thanks. Good morning.
Good morning.
In Risk and Insurance Services, U.S. and Canadian organic growth has been trending a very low single digits on an organic basis. Could you talk to the market dynamics and outlook and also how Marsh McLennan Agency's middle markets strategy has been impacting the segment's growth rate? Thanks.
Okay. First of all, I'll just say that in the RIS segment, we have Marsh, and we have Guy Carpenter, your question is really pertaining more to Marsh than it is to the entire segment. I'll hand off to Peter, who can give us a little bit more detail.
Sure. Thanks, Dan. First, I'd like to highlight some of the real strong performance we had in the quarter and year-to-date. Latin America, as Dan said in his opening, we had 15% growth. Asia Pac was seven, and despite economic headwinds in EMEA, we had 3%. We recognize in the U.S. and Canada division, we have had modest growth at 1% in the quarter. It's a seasonably low quarter for Marsh and the U.S. and Canada division. We have had in the quarter some negative variability from some of the programs we have within the segment, and we would expect growth to be higher in the future than what we have reported in this particular quarter. Some of the fundamentals are quite strong.
New business through the nine months is up year-over-year, and as we mentioned, we had record new business when we look at the comparables year-over-year. Overall, again, it's been a little bit lumpy. If you look at our comparisons to competitors, you have to remember, we don't report Latin America in our U.S. and Canada division, and also, employee health and benefits for the core brokerage in the U.S. is reported in Mercer. To answer the second part of your question on agency, they've had good organic growth, where we would expect them to be in line with their comparables in the middle market in the U.S. They've been growing organically, have been making a contribution, and exactly where we thought they would be on the revenue and margins at this point in time.
Okay. That's helpful. Lastly, this is probably for Mike Bischoff. Is there any kind of sensitivity or you can give us around the pension-related expenses and cash contributions if the assumptions are changed at the end of the year? I believe since the plans are open, there could be a material impact to the expense level as well running through the income statement. Thank you.
Mike, do you want to take that?
Sure, I'd be happy to. You're absolutely right on two categories. First, pension expense, and second, contributions into our pension plans. Let me deal with pension expense first to put it into context. The main driver of the change in pension expense on a GAAP basis year-over-year is interest rates. Over the last five years, we've seen interest rates go down dramatically. I should say this is more in the intermediate and longer-term rates where the discount rate is calculated. We've absorbed, through our P&L, approximately $250 million of additional pension expense during that time period. Your question is very appropriate, what's the outlook going forward? The irony of pension expense accounting is that you do a measurement at year-end, you don't take the average of where interest rates or the discount rate would be over the course of the year.
You do it at year-end. For that reason, it's very hard to anticipate where pension expense would be. I would just point you to say that there's two interest rates that you should track. One is obviously the U.S. rate, and the other one's the U.K. rate, because we have a very large U.K. pension plan. The second part of your question deals with cash contributions into the plan, and you can see that we're on track, including the pre-funding of some of our obligations to fund about $650 million into our global pension plans this year. We would think that that would be markedly reduced for two reasons. At this point in time, we do not plan to make any discretionary contributions into our global plans.
As we've indicated, $250 million of the funding for this year was dedicated to pre-funding of future obligations in the U.K. that would cover the 2014, 2015, and 2016 time period.
Very helpful. Thank you.
Next question, operator.
We'll go next to Greg Locraft with Morgan Stanley.
Thanks. Good morning, congrats on another nice quarter.
Thank you.
I wanted to ask about your healthcare exchange initiative, really two questions around that. First, your large competitor is guiding to a lot of seasonality in their consulting segment, partially due to the way the revenues flow in, revenues and costs flow due to the healthcare exchanges. Do you have similar seasonality as they do? Therefore, it might be a big fourth quarter. Where will we see that? Which division should we be modeling that in? The other question on healthcare exchange is just could you compare and contrast your initiative relative to others in the marketplace?
Julio. The first question first.
Thank you. I am going to start off by saying that we have a large business, of course, in total Mercer that is quite over $4 billion in revenue. Any movement in the exchange in one quarter or the other would have some impact, but not significant impact in the overall results of Mercer. It is a very large organization. Specific to your question about whether or not you're going to see a fourth quarter bump or not in revenue. Let me just say, simply, no, even though a lot of the work and a fair amount of work is done in all of our H&B business that we work on in the third and fourth quarter of this year, the actual exchange contracts themselves incept on January 1st, in this case, 2014. The revenue will be earned throughout the 2014 year.
There will be little, in fact, there'll be no revenue in fourth quarter 2013, there will be appropriate revenue throughout the year in 2014.
Thank you, Julio.
Okay.
The second question, it was, if I paraphrase, Greg, how would you compare Mercer Marketplace with the competitive offerings in the market?
Yeah. Great question, Greg, because I know with everything that's going on, sometimes it's difficult to see what are the distinctive factors. I want to really focus on a couple of things that I think has been out there, first, allow me to level set a bit. Mercer Marketplace supports both a fully insured and self-insured funding model, and funding models. Mercer Marketplace also offers a panel of carriers for either structure. Mercer Marketplace offers core medical, and in addition to core medical, also voluntary and ancillary products. Of our clients on the platform to date, roughly about 75% of them have chosen fully insured model, and the remainder have chosen self-insured model. This is a reflection of the more middle-market representation in our book. Generally, mid-market companies have fully insured, and they've chosen to continue their fully insured under the Mercer Marketplace model.
Our larger clients, again, determine that they are most advantaged by staying in self-funded options, they continue to use those on the Mercer Marketplace. Even in an active exchange, no matter what the model, each employer group is rated separately. In our exchange, we ensure that competitive pricing is taking place for each one of our clients as we work with carriers to design programs for them and their group. A self-insurance funding model tends to be lower cost overall for larger groups due to savings on risk changes as well as premium taxes. These advantages don't necessarily go away when you go onto the exchange. Overall, when you combine what we believe is a very large availability of choice, we have 30 carriers, as an example, on our particular exchange.
Some of them, of course, work just in the core medical space, and some of them in the ancillary and voluntary space. When you compare all those advantages, we think we're very well positioned as we look at the competition and the future.
Perfect. Thank you, Julio.
Okay. Thanks. One quick follow-up on that is just, can you remind us what the economic model is around the exchanges, both from a revenues and a margins perspective?
Sure. Julio?
Okay. Thank you, Dan. There's a lot of discussion going on and speculation about how big this market is going to be in time and certainly, how quickly it's going to develop. I'm not going to get too crazy about the speculation of that. I'll leave that for others. Based on what we have seen in our own book and through this sales season, I think we know that there's significant interest by our clients. I think the concept is obviously something that generates that interest, and the trend is certainly here to stay. That said, it's anyone's guess as to how big this ultimately will become, no matter what the outcome, we think we're very well positioned.
As Dan mentioned earlier, we're very pleased with the clients that we've sold in the first year so far, and we're pleased with the pipeline that's developing not only for 2015, but also for mid-year 2014. We've been pretty consistent in saying that while we expect these changes to be a contributor to revenue and earnings in the medium term, in the short term, the impact will be modest.
Thanks, Julio
Okay, great. Thanks, congrats again on the quarter.
Thanks, Greg. Next question, please.
We'll go next to Larry Greenberg with Janney Capital.
Hey, good morning, everybody. A couple of questions. One, can you talk a little bit about the turnaround in the organic at Oliver Wyman, and how much of that might be Europe coming back? Just to stay with Julio, you're driving really strong margin improvement, and we know you're spending money on investment initiatives, and we're all fixated on the healthcare exchanges. Just wondering if you might be able to comment on some of the other initiatives you have in place that may be pretty specifically directed towards margin improvement.
Okay, Larry. Let's start with John on the turnaround. I'm not sure we would use that same word in terms of a full turnaround, but we're happy to see positive growth return. I only say that because when we think about turnaround, we generally think about profitability as well. John and his team have done a really superb job of fighting through some struggles on the top line and maintained it on the bottom line. From that standpoint, it's hats off to John and his team. John, you want to talk about the return to growth?
Sure. As Dan said, Larry, in his opening comments, our performance has been steadily improving through the year, and business has actually been strengthening in all of our major regions. To your question, Europe has contributed to that growth, and we do see improved conditions in Europe and expect that to be sustained. North America has also contributed, as has our international markets. Overall, we're seeing growth or improvement across the board, and expect that improvement to sustain. Looking ahead, based on the pipeline we're seeing, we expect to sustain positive revenue growth in Q4 and have good momentum going into 2014 in all of our major markets.
Turning to Julio, I just start by saying that we've been really pleased with both of our segments. With Marsh & Guy Carpenter, we started margin improvements several years ago, and that has created its own momentum and has sustained itself. We have every expectation that the consulting segment, albeit in its second year of significant margin improvement, will sustain margin improvements in the future. Julio, you want to take that?
Thanks, Dan. The third quarter represented another quarter of solid performance for Mercer. We continue to execute on our growth initiatives. We're delivering against our strategic priorities, and we're generating increasing earnings and margins, just as we have really over the last several quarters. Our revenue, as you know, is up. The areas that we continue to see improvement in are the ones we're investing in, of course, the health area and investments business overall. We're also seeing some good growth coming from our growth markets initiative to expand internationally, and we're seeing the beginning fruits of that labor. We're also seeing good margin improvement as well in those same areas where we traditionally had done some investments in different ways in the past. We continue to carefully manage expenses, as you can imagine.
You go in an organization, you have opportunity to really take a bird's eye view on what's going on. You make assessments where you need to disinvest, and at the same time, you make assessments where you need to invest more. We've been doing that and calibrating that over the last couple of years, and that's also going to be a discipline that we will continue to do as time goes on. As far as specific areas of investments that we're making in our business, we continue to be very focused on ensuring that when we think about investments, we think about them in short, medium, and long-term ways. Exchanges obviously is one thing that we've talked about, and I'm sure we'll continue to talk about as time goes on.
Talent and client-facing technology is very important to us as well, and we've put a lot of breadth of improvement, especially in an area that's like data and surveys. We see good margins there, and obviously, we're investing in those areas to bring that to be a larger portion of our portfolio. We're taking legacy systems, and we're obviously retiring some, investing in new generation systems. Salesforce.com was a big investment for us. We think that we'll be able to enhance our broadening of client relationships through having a good CRM tool, which also will continue to improve margin and hopefully top line over time. Retirement Studio, which is an enabling vehicle for us to be able to do some additional actuarial work for retirement, strategic hires, expansion in geographic growth areas like emerging markets, as I mentioned earlier, and platforms to expand our delegated investment solutions.
You see that continuing to move in the right direction profitably. All these things, I think, are things that we continue to look at, continue to invest. We continue to calibrate appropriately, again, disinvestment and investment. We'll continue to do that and run the company in a disciplined manner.
Okay. Thanks, Julio. Next question, please.
We'll go next to Dan Farrell with Sterne Agee.
Hi, good morning.
Good morning.
Of the roughly $2.2 billion of free cash on the balance sheet, can you give us the mix of international versus U.S. cash currently? Could you also talk about the outlook for getting cash from the international subs to the U.S. as we move through the rest of the year?
Okay. Mike, you want to handle that?
Yeah. The $2.2 million of cash at the end of the quarter-
Billion.
I'm sorry, billion.
Yeah, where'd that extra money go anyway? Of that $2.2 billion, it's actually $2.174 billion. $250 million of it, as I indicated, was paid down in October for funding the 2015 debt. When you look at our remaining cash, what we typically do during this time period is you see it grow because we're working towards the first quarter with regard to bonus payments. It's very typical for us to have higher levels of cash, not only at the end of the third quarter, but at the end of the fourth quarter. Going to the heart of your question, you'll also notice on a year-over-year basis, our cash is down when you look at it quarter-to-quarter, not sequentially.
The reason for that is that we are, and have had, a strategy to bring back, in a tax-efficient manner, our international cash for U.S. funding purposes. Those funding purposes are acquisitions in the U.S., dividends, and share repurchase. We're in the process of moving more of our international funds, even as I'm speaking now, into the U.S. for share repurchase and for looking at bonus payments in the first quarter. Overall, we're working down our excess cash. We're bringing it into the U.S. in a tax-efficient manner, and it's a very good story with regard to returning capital to shareholders.
Can you give the mix of how much is U.S. now, or is it more appropriate to wait till fourth quarter, given you're in the process?
I think it's probably more appropriate to wait. I have right in front of me the treasury sheet that gives me on a daily basis what our mix is between the U.S. and global. I have that information, but I think it's probably just best to wait.
Thanks, Mike.
Any other questions, Dan?
Yeah. Also, just with regard to Guy Carpenter, I was wondering if you could talk about the outlook for growth going forward. You've had continued nice organic there, and I think your competitors have as well, maybe better than I would've thought, given some potential headwinds there that we're seeing on pricing. Maybe if you could talk about the outlook and then also maybe other revenue opportunities that could emerge because of some of the changes in the marketplace.
Alex, you want to take that?
Sure. Well, as you say, we've been on a good run of organic growth now for quite a while, despite, I would say, headwinds during all that while. I think that's down to the quality of our people, the quality of our offering, and the fact that we have good discipline. We've widened our net, we've segmented our client base, and we're coming up with discrete value propositions for each of those areas. I would point out a mutual segment that's very successful, an E&S segment that we just opened up. We've invested in Accident and Health , which we see as a growth area, of course, and areas such as agriculture, as well as overseas. We think that there's room to grow. We think that we're the employer of choice. We've got the best people. We're investing, and we will continue to grow, we believe.
Thanks, Alex.
Thank you very much.
Sure. Next question, please.
We'll go next to Meyer Shields with Keefe, Bruyette & Woods.
Thanks. Good morning. If I can follow up on that question, does the, I guess, recent merger of two slightly smaller reinsurance brokerages, does that change the competitive dynamics in your reinsurance markets?
Alex?
Clearly, there's a change because something just happened. We respect our competitors, we're focused on our clients and focused on growing, focused on having the best people investing right, and that's what we'll continue to do. We're not blind. We keep our eyes open, we move ahead.
Okay, fair enough.
Yeah. Meyer, we generally think competition is a good thing. Competition keeps us on our toes, makes sure that we're always innovating and creating additional value for clients. We have a lot of respect for our competitors, we believe our proposition is unique.
Yeah. The results have certainly been there. One quick numbers question. Can we get a sense of how many shares are typically issued over the course of a year for compensation?
Sure, absolutely. I would just say in a broader sense, we're now in passing our sixth consecutive quarter of share repurchase. When we were talking with you, I guess about 18 months ago, we committed to meaningful share repurchase, we're following through on that. Our view is that as we go forward, our uses of cash would very much remain continuing to invest in our business, although that's usually not lumpy because we've been doing it on a pretty consistent basis. Our dividend and growing our dividend year by year as we grow our earnings on some basis, maybe not fully aligned with that, but certainly in the ballpark. Acquisitions, then share repurchase. Mike, you want to take the specific question about the actual share count?
Yeah, Dan, I'd be happy to do that, I think it probably is good to put into context what you were describing, which is really what's the aggregate level of shares outstanding that we had with regard to our stock options and restricted stock units. Essentially, what was the overhang? If you go back and look, as recently as the end of 2009, when you combine those two, the overhang that we were dealing with or looking at was 69 million shares that would, we think, eventually come into the market, we would deal with that. If you look at it at the end of the third quarter, which is more specific to your question, the number is 31 million shares. Over the course of the last few years, we've really been absorbing and catching up with this overhang.
When we look at it, not only for this year, I'll give you a little bit of a projection on it, but going forward, we really feel that in aggregate, we're looking at about $15 million of shares issuance this year for the restricted stock, predominantly stock option exercise. Dealing with for many years, we had very limited exercise of stock options, now it's fairly high, we think that for this year it'll be about $10 million. Specifically answering your question, of the $14 million or $15 million shares that we're going to be dealing with this year, about $10 million of it is just with regard to stock options that are being exercised, the rest is just restricted stock. Really not a large number.
We think after this year, like I said, a little bit of projection, we think after this year, the heavy overhang is behind us, the uses or requirements for restricted stock and option exercise will decline significantly. Just completing what Dan was saying, we think we're through the most of the catch-up, if we continue meaningful share repurchase, which is our intent, we'll flatten out the share count perhaps even turn it downward.
That's fair enough. Thank you so much.
To our next question please, operator.
We'll go next to Jay Gelb with Barclays.
Thank you. First one for Mike, just to isolate the one-time items in 4Q. If I could just get those numbers again, the Trident benefit in 4Q, the new run rate interest expense, and the impact of redeeming the debt, because my sense is that all flow through adjusted, correct?
That's correct.
Mike?
Dealing with interest expense, the run rate, I think for the last couple of quarters is about $40 million. We did just issue debt. The average cost of that debt, though, is 3.3%. The calculation, when you look at it on a quarter-over-quarter basis, won't be much of an increase. With regard to the extinguishment of the debt, it's already occurred. We know it's $24 million. That's $0.03. The third part of your question, I think, dealt with investment income, predominantly the carried interest with regard to Trident III. We do not do the calculations. That calculation is done by the private equity firm that manages and oversees Trident III.
It's a fairly complex calculation that they have to go through every one of the investments that they have, because it has to do with regard to the partner interest and what part of that partner interest no longer can be clawed back. I do have some sympathy for them when they're going through the calculation and giving us that information, trying to give it to us on a timely fashion. That's why we say it's very difficult to forecast, because it has to do with the harvesting of their profits and how it impacts the specific part of the carried interest that could not be clawed back. That's a long way of saying, we don't know for sure, but we would put it in the $10 million range for the fourth quarter.
That's helpful. Thanks, Mike. My separate broader question is on the opportunity for Risk and Insurance Services margin expansion. That spread between organic revenue growth and underlying expense growth seems to be widening over the past eight quarters. Perhaps you can just give us a bit more perspective on what you're doing on the expense front to keep that low.
Sure. Let's just start by saying that if you look at our expenses in total, our comp and benefit expenses have actually been rising over the last several years. It's not just salary inflation, which runs about 3% a year for the people who are still at the company, but it's also pension expense, as we've mentioned before, and some other areas of benefits. The comp and ben line has been rising. The real story is the great job that we've been doing on all other expenses. From that standpoint, it's everything from premises to T&E to meetings, and there's literally about 30 categories of expense that we've been pretty focused on and relentless to make sure that everything is on a need-to-have basis as opposed to a nice-to-have basis.
A big part of the story, frankly, over the last four years that you have seen in the RIS segment, and that which you have begun to see in the consulting segment, is the ability during a year to do things which will benefit you in future years. To wear that within your P&L. What you're seeing here is not a one-year story. It's basically a couple of years that roll forward as a benefit.
In with the things that we're doing with respect to comp and ben. Now, let me just say, our expectation is for some pretty reasonable growth in margin in the coming couple of years. The way we look at it, though, we actually put margin third on our hit parade. We look at growth in revenues first, both organic and through acquisition. We look at earnings, and our focus really is driving earnings, in particular EPS, and we've said, "You stick with us over a 10-year period, we'll give you a CAGR of EPS of 13% or so." We've been delivering on that basis. We're not saying it's every year or every quarter, but we certainly think we will do it over the long term.
The last point is margin, and we seek margin expansion, and we'll always have margin expansion if we continue to have expense growth less than revenue growth. Now, to be sure, as the margin gets higher and higher in either segment, the ability to deliver margin expansion of significant levels reduces because the air that you would need between expense growth and revenue growth gets wider and wider as the margin goes up. It would be bad leadership and management if we looked at those businesses and said, "Now that the margin is terrific, we want more air, so we want you to be investing less in day-to-day in those businesses." We're very open.
We don't see it in front of us now. Certainly over the years, we would expect, as these margins keep improving, that at some point in time, we won't be as focused on double-digit operating income growth. We would remain very focused on double-digit EPS growth, but it would shift slightly. We don't see that in front of us today.
Right. Essentially, you're saying next couple of years, pretty clear glide path to continued margin improvement and EPS growth, I'm sorry, earnings growth in the RIS segment.
Correct.
Thanks, Dan.
Sure. Next question, please.
We'll go next to Brian Meredith with UBS.
Hi. Two quick questions. One, just back on the exchanges, just quickly. Of the new clients that you've got, I guess 56, I'm just curious, how many of those are actually existing benefits administration clients for Mercer? What's the actual new business that you're actually getting versus just putting somebody in exchange?
Okay, just one thing, Brian. As you recall, if you go back a quarter or two, we were saying that anytime you're in a business where it has some real innovation going forward, the focus is on existing clients, explaining to current clients what the alternatives are. I'll hand over to Julio to give you the details, but certainly our belief was very much that this was going to be in the first iterations, existing clients as opposed to new clients. Go ahead, Julio.
Right. Thanks, Dan. Of H&B clients, of the 34 clients in the active space, one of them is actually new to Mercer. Again, this was expected. As Dan mentioned, we expected to have a lot of discussions with our clients as we were trying to design responses to different changes that were happening in the marketplace under ACA and others. We have a really solid pipeline, though, I want to say again, for both mid-year enrollments and also 2015. I also want to make sure it's very clear that on our existing clients, we still see opportunity for expanding because we have a great breadth of additional ancillary and voluntary products that we traditionally have not worked with clients on. That gives us a potential for opportunity on the upside.
Of course, in most cases, we are brokering additional lines of coverage as we expand these relationships and adding new services, such as a full plan administration that we may or may not have had in the past. Also, we get the opportunity, as I said, for ancillary products, which tend to have higher commission than core medical. We have a lot of opportunity, even with our current clients, to expand our relationship with them and broaden it even further.
There is going to be a revenue pickup from putting existing clients in exchanges because of the other services, plus just it's a different revenue model. Is that correct?
Yeah. We expect it. Time will tell because we're just launching now, right? The 2014 clients are launching as we speak. They're obviously coming in and looking at what we have to offer, and time will tell in the near future as to how the average revenue per client actually behaves.
Great. Then one quick one on the reinsurance, if I may. I wonder if you could tell a little bit about the supply of kind of alternative capital right now coming in for one more renewals. Is there still a reasonable amount of demand from pension funds and stuff to actually invest in this business? Then what impact do you think it has on One One?
Alex?
Yeah. Clearly, it's the big subject in the reinsurance world. We estimate around $45 billion and growing of interest, looking to be deployed because not that amount is deployed. I think the insurance companies are taking a balanced look. They're going to use traditional reinsurance. They're going to use this new capital. The effect on us, clearly, it's a bit of a headwind. On the other hand, we're seeing that because of the way we have our revenues, either from a fee structure or a capped
cap commission, the effect is being mitigated somewhat. We're actually getting a lot of new cap business. I think our revenues are probably double what they were last year to date. It's providing a lot of options to our clients. Where there are options, there's need for advice, and that's what we're doing. We're making sure we understand the appetite of the suppliers of capital and the appetite or demand of those who need it and try to match that. We're kind of excited about this, though we recognize that it just makes life more interesting.
Got you. How much of your business right now is fees or cap commission, you're not going to see the impact?
Well, I would rather not give you that indication right now.
It's actually a relatively small piece.
It's a relatively small amount given the.
Got you.
Yeah.
Yeah. It's a relatively small piece. Next question, please.
Thanks.
We'll go next to Michael Nannizzi with Goldman Sachs.
Sure. Most of my questions have been answered. I had a question on the exchange. I'm trying to understand. I think if someone moves to an exchange, I'm guessing part of the reason they do that is to kind of divorce themselves from rising healthcare costs. Can you talk about why a company would move to an exchange to self-insure? Is it really just to outsource the management of the benefits, or is there another aspect to that decision that I'm missing?
Julio, you want to take that question?
Yeah. There are several reasons why companies consider exchanges. Certainly, to give their employees the opportunity to have a wider range of choice as to how they design the specific benefits in relation to their needs. That's a big impetus. Second impetus, of course, is yes, clients are looking for the opportunity to understand how they might be able to structure programs for better cost control as time goes on and time goes into the future. That's usually as a result of moving from a defined benefit type of health offer to defined contribution. We actually saw many of our clients convert, at least for this time period, and stay under the defined benefit piece, which means that they would continue to be potentially vulnerable to increases in medical inflation.
Over time, I'm sure they'll make decisions as to how best to be able to do that, might move to a defined contribution. Thirdly, yes, there are a lot of requirements under the new ACA for administration and considerable costs associated with that, and they want to make sure that they can put themselves in a position where they can rely on someone who already has the experience to do that, and hopefully more efficiently and more effectively for them and their employees. There are several other reasons as well as each individual circumstance is evaluated, and we design programs to address those needs.
Yeah. One of the benefits in bending the cost curve is not about necessarily clients moving from defined benefit to defined contribution, but it's using the services of Mercer to bend the cost curve through wellness programs and comparison shopping between different medical providers. It's a very broad subject. I would just remind everyone that the health benefit is one of the core benefits that people look at when they're deciding which company to give their services and time to. Companies will have to be relatively cautious because there is a war for talent out there, and it would take a very brave company and perhaps even to go very quickly to say, "We want to get out of healthcare," because if your competitors don't, then you may be opening yourself up to some talent vulnerability.
I guess, on that point, how do you weigh the decision, Dan, to move or not move to an exchange with your employee base? I'm guessing to the extent you did, you probably already know which exchange you would go with.
Yeah, I pretty much have that one down. Julio is sitting right next to me on my right. For us, when we first looked at Mercer Marketplace, the first thing that we said was, "We want in." Because it created greater flexibility to individual colleagues to make choices which were relevant to them and their family sizes and a whole slew of other things. To me, it was very flexible. What we didn't want to do was crowd out existing Mercer clients and put ourselves in front of the queue, so to speak. Just to be clear, Marsh & McLennan Companies will be joining Mercer Marketplace at the point in time that Mercer Marketplace says we'll make the catch without impacting any other clients.
Got it. Understand. Thank you.
Sure. I think, operator, we have time for one or two more questions. Next question, please.
Thank you. We'll go next to Jay Cohen with Bank of America Merrill Lynch.
Thank you. Two questions. The first is, on the consulting business, do you see a natural limit to the margins, given that business model? Because clearly, you need to be investing in the business as you do. Is there a natural limit to the margin, ceiling if you will? Secondly, just to make sure I got the numbers. When you talked about the number of lives in Mercer Marketplace, I think you said 220,000. Is that in both the active and retiree exchanges?
Okay. Let me take the first question first. The 220,000 lives are both in the active and the retiree space and count both existing employees and their families.
That takes care of that one. In terms of the consulting segment's margin overall, I would say there's no natural cap to those businesses, but recognize that the consulting segment is different than RIS. It has lower levels of aggregated recurring revenue streams, it's more about the mechanics of the business in terms of how the P&L is arrived at. Naturally, there's higher levels of acquisition costs because you always have to find the next project, the next account in some parts of the business. Now, both Julio and John are working to find ways of making the business stickier with clients and more recurring.
I would doubt that it would ever be at the levels of RIS, where in insurance, people just say, "Hey, I buy an insurance policy year after year, and it's not as cyclical, and I don't really care about what economic conditions are. I might change my deductible or terms and conditions, but I'm buying that policy." It's different on the consulting side. While there's no natural cap, I think that the idea that there's two elements to it, one, the P&L construction, there's less recurring revenue. Two, on the people side, the consulting segment, in general, has some of our most highly educated, world-renowned experts, and you pay for those experts. From that standpoint, there's a bit of a constraint just on the comp and ben side.
Got it. Thanks, Dan.
Sure. Okay, I think we have time for one more question, then we'll call it a morning.
Thank you. We'll take our final question from Charles Sebaski with BMO Capital Markets.
Good morning. Thank you. Have a final wrap-up here on the healthcare exchange and margin accretion. I guess, Julio, when you talked about the breakdown of sort of the 25% that are still using a self-insured model within the exchange, within the Mercer Marketplace. If I was to think of a current Mercer benefit client that's a self-insured client, a larger corporate America client, was going to transition to a Mercer Marketplace exchange, continue on a self-insured basis, is there any margin change in that client? Outside of ancillary, I understand all that different, just on the core service, is there a margin difference?
Julio?
It's difficult to discount the impact that ancillary and voluntary products will have on that margin and relationship we have with our client. If you were to take an apples-to-apples client situation, it usually ends up when they go on the actual Marketplace, there's a potential, even under self-insured, for that margin to hopefully improve, to be quite honest with you because over time, they will continue to sell, like I said, via voluntary and ancillary. We made a conscious decision when we went in, unlike potentially others, that we wanted to have that as a very important platform, a part of the platform. It's difficult to distinguish it when we made it as part of our major strategy and a strong part of the platform and value proposition for all of our clients that come onto Mercer Marketplace.
Okay. I think I understand. The other question I have quickly is on the brokerage side of the business, on the risk side and the Marsh Agency business. I guess when I look at the revenue basis, I know recently you said at a presentation that Marsh Agency got about $450 million of revenue. I guess I would have thought the risk business would have had more growth. I guess my question would be is, on the traditional Marsh client pre-agency, what is the retention, both on number of clients and fee basis been on that piece of the business?
Sure. Well, let me just start by speaking broadly, then I'll hand it over to Peter. First of all, the RIS segment, we're very happy with the level of growth and the consistency over many quarters. We've grown organically 14 quarters in a row within RIS. When we look at the overall Marsh business in total, there's been a good mixture of high levels of revenue retention as well as new business. We look at that business, and we're pretty comfortable. As Peter was mentioning earlier, we have an ethos in this shop of not calling out individual small items and trying to make everything an exception. We wear our results.
To give Peter a little bit of a pass, what he was alluding to earlier was that there was a little bit of timing in the U.S. and Canada, and there was one particular program within the agency which is non-recurring, which used to be a pretty big program, and a government agency decided not to buy it. That has had an impact in a quarter where we don't expect it be a recurring impact. I'll hand over to Peter and see if he wants to elaborate at all on that.
No, thanks, Dan. That was very thorough. What I would add is that
I want to emphasize again that the fundamentals of the core business are strong. New business is strong. Client retention is very strong. Overall, the performance, looking at it in one quarter, you can draw conclusions, but I try to take a look at it over a longer period of time, and I'm very confident that we're going to perform very well. Just a reminder that there's six different businesses that we report in that segment. It's U.S., Canada, Marsh McLennan Agency, we have an MGA, we have STARS, which is our STARS platform technology business. We have programs, we have private clients. When you take that all in the mix, they don't all move in the same direction in a particular quarter. Again, Dan had highlighted some of the anomalies.
There are a few more. Overall, I can assure you that the fundamentals are quite strong.
Yeah. I wasn't talking about this quarter. I probably should have said that per se. It's just sort of, I look at Marsh, ex Guy Carpenter, ex fiduciary, look at Marsh revenue. I've got about $5.5 billion for 2013 and at just over $5.2 billion in 2011. I look over that time period and go, okay, we've got $400 million of agency revenue build up and go, I would have thought that 5.2 plus 400 plus some organic growth from the traditional business would have had overall Marsh level just higher, just on a theoretical basis, not like this quarter and anything like that.
No, that's fair enough. I just want to draw it to a close, but I would, as a reminder, just go back into the notes and have a look at the consumer business, which we pulled out of Marsh, the couple of hundred million dollars, and now it's counted within Mercer. In those numbers that you were citing, you would have to restate it for that consumer business.
Okay.
Okay. Thanks, Charles, and thank you, everybody. I'm very happy everybody was able to join us on the call this morning. I would also like to thank our clients for their support and our colleagues for their hard work and dedication in delivering such fine results. Have a good day, everybody.
Again, that does conclude today's conference. We do thank you for your participation.