Commission revenues increased by $5.6 million or 2% in 1996. This increase is the result of new business partially offset by lost business and modest renewal rate reductions. Commission revenues increased by $18.8 million or 8% in 1995. This increase is the result of new business production and, to a lesser extent, modest renewal rate increases partially offset by lost business.
Fee revenues increased by $9.6 million or 6% in 1996. This increase, generated primarily by Gallagher Bassett Services, Inc., resulted from new business production and modest increases in existing business partially offset by lost business. The rate of increase from 1995 to 1996 has been adversely affected by strong price competition in the insurance industry, causing some buyers to choose first dollar converge over self-funded plans. Fee revenues increased by $18.6 million or 13% in 1995. This increase, again generated primarily by Gallagher Bassett Services, Inc., resulted from strong new business production of $19.2 million and increases in existing business partially offset by lost business.
Investment income and other increased by $1.9 million or 9% in 1996. This increase is due primarily to an increase in unrealized gains on investment strategies accounted for on a trading basis, which are invested with outside fund managers. Investment income and other increased by $8.2 million or 60% in 1995. This increase is due primarily to a combination of significantly higher returns on funds invested with outside fund managers and a gain of $2.0 million recorded on the sale of a subsidiary in the fourth quarter of 1995. This increase is partially offset by a gain of $656,000 realized in closing out interest exchange agreements related to the retirement of the Company's debt agreement in the fourth quarter of 1994 and by a gain of $800,000 from the sale of two personal lines books of business also recorded in the fourth quarter of 1994.
The Company's overall tax rate of 34% in 1996 is less than the statutory federal rate. For 1996, the net effects of state and foreign taxes are substantially offset by the tax benefits of certain investments. The Company's overall tax rate of 38% in 1995 is greater than the statutory federal rate due primarily to the net effects of state and foreign taxes which are partially offset by the tax benefits generated by certain investments and by pre- acquisition income of pooled entities which was taxed to the previous owners. The Company's overall tax rate of 37% in 1994 is greater than the statutory federal rate, due primarily to the net effects of state and foreign taxes which are partially offset by the tax benefits generated by certain investments and by pre-acquisition income of pooled entities which was taxed to the previous owners. See Note 11 of the Notes to Consolidated Financial Statements.
The Company's foreign operations recorded operating earnings before income taxes of $4.2 million, $3.4 million, and $2.2 million in 1996, 1995, and 1994, respectively. The 1996 increase is due primarily to a decrease in compensation related costs at the Company's London subsidiaries. The 1995 increase is due primarily to stronger investment income. See Notes 11 and 12 of the Notes to Consolidated Financial Statements.
The Company's total revenues vary from quarter to quarter as a result of the timing of policy renewals and net new/lost business production, whereas expenses are fairly uniform throughout the year. See Note 13 of the Notes to Consolidated Financial Statements.
In February, 1993, the Company entered into a $20 million unsecured revolving credit agreement (the "Credit Agreement") with two banks. As provided for in an amendment effective in October, 1996, the loan maturity date has been extended and loans under the Credit Agreement are repayable no later than June 30, 2001, and bear floating interest rates over the term of the loan. The Company recognized a gain of $656,000 in closing out the interest rate exchange agreements related to the repayment of a loan under the agreement in 1994. The Credit Agreement remains in effect and as of December 31, 1996, there are no borrowings currently existing under this agreement.
The Company also has two term loan agreements (the "Term Loan Agreements") that have outstanding balances of $1.3 million and $1.0 million at December 31, 1996. Loans under the Term Loan Agreements are repayable in equal annual installments no later than January 11, 1998, and June 15, 1998, respectively, and bear interest rates over the terms of the loans of 6.64% and 6.30%, respectively.
The Company has line of credit facilities of $27.5 million which expire on April 30, 1997. As of December 31, 1996, $10.0 million in short-term borrowings existed under these facilities. These borrowings were used to finance expanded investment activity. No borrowings existed at December 31, 1995.
The Company paid $17.5 million in cash dividends on its common stock in 1996. The Company's dividend policy is determined by the Board of Directors and payments are fixed after considering the Company's available cash from earnings and its known or anticipated cash needs. In each quarter of 1996, the Company's Board of Directors declared a dividend of $ .29 per share which is $.04 or 16% greater than each quarterly dividend in 1995. In January, 1997, the Company announced a first quarter dividend of $.31 per share, a 7% increase over the quarterly dividend in 1996.
Due to changes in the United States federal income tax laws effective in 1994, the Company began providing for U.S. income taxes on the undistributed earnings of its foreign subsidiaries. The Company has not provided for U.S. income taxes on these undistributed earnings accumulated prior to 1994 ($19.2 million), which are considered permanently invested outside the United States. See Note 11 of the Notes to Consolidated Financial Statements. Although not available for domestic needs, the undistributed earnings generated by certain foreign subsidiaries referred to above may be used to finance foreign operations and acquisitions.
Arthur J. Gallagher & Co. (the Company) provides insurance broker and risk management services to a wide variety of commercial, industrial, institutional and governmental organizations. Commission revenue is principally generated through the negotiation and placement of insurance for its clients. Fee revenue is generated by providing other risk management services including claims management, information management, risk control services and appraisals in either the property/casualty market or human resource, employee benefit market. The Company operates through approximately 150 offices throughout the United States and six countries abroad.
The accompanying consolidated financial statements include the accounts of the Company and all subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. Certain reclassifications have been made to the prior years' financial statements in order to conform to the current year presentation.
Premiums collected from insureds but not yet remitted to insurance carriers are restricted as to use by laws in certain states and foreign jurisdictions in which the Company's subsidiaries operate. Additionally, the Company's United Kingdom subsidiaries are required by Lloyd's of London to meet certain liquidity requirements.
In 1993, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 115 (SFAS 115), "Accounting for Certain Investments in Debt and Equity Securities." The standard requires that securities designated as available for sale be carried at fair value, with unrealized gains and losses, less
Investment strategies are considered trading securities and consist primarily of limited partnerships which invest in common stocks. Fair value is determined by reference to the fair value of the underlying common stocks which is based on quoted market prices.
Fixed assets are carried at cost. Furniture and equipment with a cost of $71,108,000 at December 31, 1996 ($64,414,000 at December 31, 1995) are depreciated using the straight-line method over the estimated useful lives of the assets. Leasehold improvements with a cost of $8,177,000 at December 31, 1996 ($7,938,000 at December 31, 1995) are amortized using the straight-line method over the shorter of the estimated useful lives of the assets or the lease terms.
The Company grants stock options for a fixed number of shares to employees with an exercise price equal to the fair value of the shares at the date of grant. The Company accounts for stock option grants in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and, accordingly, recognizes no compensation expense for the stock options granted to employees.
In 1996, the Company also acquired a majority equity interest in a risk management company, which was accounted for as a purchase.
In 1994, the Company retired its $20 million variable-rate (based on LIBOR plus .4%) unsecured revolving credit agreement that was due in 1998. In connection with the retirement, the Company also recognized a gain of $656,000 on the settlement of interest rate exchange agreements that had been entered into in 1993 to fix the rate of interest payable on the revolving credit agreement. The credit agreement remains in effect and expires on June 30, 2001. As of December 31, 1996, there were no borrowings outstanding under this agreement.
The Company also has line of credit facilities of $27,500,000 which expire on April 30, 1997. Short-term borrowings under these facilities totaled $10,000,000 at December 31, 1996. No borrowings existed under these facilities at December 31, 1995. The weighted average interest rate on short-term borrowings during 1996 was 6.875%.
In addition, the Company has a non-employee director's stock option plan which currently authorizes 200,000 shares for grant, with Discretionary Options granted at the direction of the Option Committee and Retainer Options granted in lieu of their annual retainer. Discretionary Options shall be exercisable at such rates as shall be determined by the Committee on the date of grant. Retainer Options shall be cumulatively exercisable at the rate of 25% of the total Retainer Option at the end of each full fiscal quarter succeeding the date of grant. The excess of fair market value at the date of grant over the option price for these nonqualified stock options is considered compensation and is charged against earnings ratably over the vesting period.
The Company accounts for stock option grants in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and, accordingly, recognizes no compensation expense for stock options granted to employees. Statement of Financial Accounting Standards No. 123 (SFAS 123), "Accounting for Stock-Based Compensation," requires disclosure of pro forma information regarding net earnings and earnings per share, using pricing models to estimate the fair value of stock option grants. Had compensation expense for the Company's stock option plans been determined based on the estimated fair value at the date of grant consistent with the methodology prescribed under SFAS 123, approximate net earnings and earnings per share would have been as follows:
Information regarding options outstanding and exercisable at December 31, 1996 is summarized as follows:
The following assumptions were used in determining the actuarial present value of the plan's projected benefit obligation:
The Company has a contributory savings and thrift plan covering the majority of its employees. Company contributions are at the discretion of the Company's Board of Directors and may not exceed the maximum amount deductible for federal income tax purposes. The Company contributed $2,396,000, $1,035,000, and $879,000 in 1996, 1995 and 1994, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The Company also has a foreign defined contribution plan which provides for basic contributions by the Company and voluntary contributions by employees which are matched 100% by the Company, up to a maximum of 5% of salary, as defined. Net expense for foreign retirement plans amounted to $1,383,000 in 1996, $1,703,000 in 1995 and $1,611,000 in 1994.
The components of the net periodic postretirement benefit cost include the following:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax liabilities and assets as of December 31 are as follows:
The consolidated financial statements include liabilities of $107,053,000 at December 31, 1996 ($116,866,000 at December 31, 1995) after elimination of intercompany balances applicable to foreign operations.
The Board of Directors has an Audit Committee composed entirely of outside Directors. Ernst & Young LLP has direct access to the Audit Committee and periodically meets with the Committee to discuss accounting, auditing and financial reporting matters.
We have audited the accompanying consolidated balance sheet of Arthur J. Gallagher & Co. as of December 31, 1996 and 1995, and the related consolidated statements of earnings, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.