Gallagher's executive offices and certain subsidiary and branch facilities are located at Two Pierce Place, Itasca, Illinois, where Gallagher leases approximately 225,000 square feet of space. The lease commitment on this property expires February 28, 2006. In September 2000, Gallagher acquired an equity interest in the limited partnership that owns the Two Pierce Place property. Gallagher generally operates in leased premises. Certain office space leases have options permitting renewals for additional periods. In addition to minimum fixed rentals, a number of leases contain annual escalation clauses generally related to increases in an inflation index. See Note 11 to the Consolidated Financial Statements for information with respect to Gallagher's lease commitments at December 31, 2000.
Fluctuations in premiums charged by insurance companies have a direct and potentially material effect on the insurance brokerage industry. Commission revenues are generally based on a percentage of the premiums paid by insureds and normally follow premium levels. For more than a decade and into 1999, lower premium rates prevailed among property/casualty insurance carriers resulting in heavy competition for market share. This "soft market" (i.e., lower premium rates) generally resulted in flat or reduced renewal commissions.
In recent years, natural catastrophes have resulted in billions of dollars in underwriting losses to the insurance market. Substantial mergers, both domestically and internationally, have resulted in fewer insurance companies. Increased property replacement costs and increasingly large litigation awards have caused some clients to seek higher levels of insurance coverage. These factors would generally have the effect of generating higher premiums to clients and higher commissions to Gallagher. In spite of these forces, there have been mitigating factors including favorable equity markets, increased underwriting capital causing heavy competition for market share and improved economies of scale following consolidations, all of which tended to lower premium rates. The net result is property/casualty premium rates have remained low through mid-1999.
Underwriting losses and the downward turn in equity markets in 2000 have placed insurers in the situation of having to replenish depleted reserves. To accomplish this, many carriers began to increase premium rates in the latter part of 1999 and throughout 2000, across many sectors of the insurance marketplace. These increases are viewed as a "hardening of the market" (i.e., higher premium rates), and generally, result in increased commission revenues. Although a hardening market contributes positively to Gallagher's results, the longevity of a hard market and its effect on Gallagher's business are difficult to predict.
Gallagher's results of operations for periods prior to 2000 have been restated for acquisitions accounted for as poolings of interests as if they had operated as part of Gallagher prior to the date of merger. Gallagher continues to search for merger partners which complement existing operations, provide entry into new markets, add new products and enhance local sales and service capabilities. For the effect of these restatements, in the aggregate, on year- to-year comparisons, see Note 2 to the Consolidated Financial Statements.
Fee revenues increased by $22.4 million or 11% in 1999. This increase, also generated primarily from Risk Management Services, resulted from new business production of $42.5 million and favorable retention rates on existing business partially offset by lost business of $22.7 million.
Gallagher's foreign operations recorded earnings before income taxes of $7.9 million, $5.0 million and $5.3 million in 2000, 1999 and 1998, respectively. The increase in 2000 is due primarily to new business and the $1.2 million write-off in 1999 of intangible assets associated with lost business. The decrease in 1999 is due primarily to new business offset by the intangible asset write-off just described. See Notes 12 and 14 to the Consolidated Financial Statements.
The Risk Management Services segment includes Gallagher's third party claims administration operations which are principally engaged in providing claims management services. Total revenues in 2000 were $232.3 million or 20% over 1999 due to strong new business production and favorable retention rates on existing business. Domestic revenues of $210.4 million in 2000 were up 17% over 1999 due primarily to new business and substantially less lost business than in 1999. In 2000, foreign revenues of $21.9 million, principally from the United Kingdom and Australia, increased 57% over 1999 due to new business production and a significant increase in revenues from Australian operations for claims work performed as a result of tainted aviation fuel in Australia. Earnings before income taxes in 2000 of $33.2 million increased 43% over 1999 due primarily to revenue increases and moderate increases in expenses. Total revenues in 1999 were $193.6 million or 11% over 1998 due mainly to new business production. In 1999, domestic revenues increased 11% over 1998 due primarily to new business partially offset by lost business. In 1999, foreign revenues of $13.9 million, principally from the United Kingdom and Australia, increased 16% over 1998 due principally to new business partially offset by revenues from Australian operations for claims work performed as a result of a pervasive and extended power outage in New Zealand in 1998. Earnings before income taxes in 1999 increased 42% over 1998 due primarily to increased revenues offset by a moderate increase in expenses.
Gallagher had a $20.0 million unsecured revolving credit agreement (the "Credit Agreement") requiring repayment of any loans under the agreement no later than June 30, 2001. During 2000 and 1999, Gallagher
As of September 11, 2000, Gallagher and one of its significant subsidiaries entered into a three-year unsecured Revolving Credit Agreement (the "Revolving Credit Agreement") for loans and letters of credit with a group of five financial institutions. This agreement replaces the $20.0 million Credit Agreement and the $45.0 million line of credit facilities mentioned above. The Revolving Credit Agreement provides for short-term and long-term revolving credit commitments of $100.0 million and $50.0 million, respectively. All letter of credit arrangements issued under the Revolving Credit Agreement are applied against the $50.0 million long-term facility in the determination of net funds available for future borrowing. As of December 31, 2000, under this agreement, Gallagher has contingently committed to funding $41.7 million through letter of credit arrangements related to certain of its investments and insurance programs. The Revolving Credit Agreement requires the maintenance of certain financial covenants and Gallagher is in compliance with these covenants.
Effective with changes in the United States federal income tax laws in 1997, Gallagher no longer provides for federal income taxes on the undistributed earnings of its foreign subsidiaries which are considered permanently invested outside the United States. At December 31, 2000, Gallagher had $29.0 million of undistributed earnings from its foreign subsidiaries. See Note 12 to the Consolidated Financial Statements. Although not considered available for domestic needs, the undistributed earnings generated by certain foreign subsidiaries referred to above may be used to finance foreign operations and acquisitions.
Earnings per share is computed based on the weighted average number of common and common equivalent shares outstanding during the respective period. Common equivalent shares include incremental shares from dilutive stock options, which are calculated from the date of grant under the treasury stock method using the average market price for the period.
In its capacity as an insurance broker, Gallagher collects premiums from insureds and, after deducting its commissions and/or fees, remits these premiums to insurance carriers. Unremitted insurance premiums are held in a fiduciary capacity until disbursed by Gallagher. Various state and foreign agencies that regulate insurance brokers provide specific requirements that limit the type of investments that may be made with such funds. Accordingly Gallagher invests these funds in cash, money market accounts, commercial paper and certificates of deposit. Gallagher earns interest income on these unremitted funds, which is reported as investment income and other in the accompanying consolidated statements of earnings.
Investment strategies are considered trading securities and consist primarily of limited partnerships which invest in common stocks. Securities designated as trading are carried at fair value in the accompanying consolidated balance sheets, with unrealized gains and losses included in the consolidated statements of earnings. The fair value of investment strategies is determined by reference to the fair values of the underlying common stocks which are based on quoted market prices.
Intangible assets consist of the excess of cost over the value of net tangible assets of acquired businesses, non-compete agreements and expiration lists. The excess of cost over the value of net tangible assets is amortized over fifteen to forty years using the straight-line method. Non-compete agreements and expiration lists are amortized over two to ten years using the straight-line method. Accumulated amortization at December 31, 2000 and 1999 was $9,925,000 and $8,063,000, respectively. Amortization expense was
In 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 133 (SFAS 133), "Accounting for Derivative Instruments and Hedging Activities," as amended, which is effective for fiscal years beginning after June 15, 2000. Because of Gallagher's minimal use of derivatives, management anticipates that the adoption of SFAS 133 will not have a significant effect on Gallagher's consolidated operating results or financial position.
In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 (SAB 101), "Revenue Recognition in Financial Statements," as amended, which was effective no later than the fourth fiscal quarter of 2000 for calendar year companies. SAB 101 summarizes the SEC staff's views regarding the recognition and reporting of revenues in financial statements for certain types of transactions. In consideration of the views expressed in SAB 101, during the fourth quarter of 2000, Gallagher reexamined its historical application of generally accepted accounting principles relating to revenue recognition and the general terms underlying the types of transactions in which Gallagher provides services to its clients. As disclosed in Note 1, Gallagher's historical accounting policies related to revenue recognition are consistent with the general provisions of SAB 101. As a result, the adoption of the applicable provisions of SAB 101 by Gallagher in the fourth quarter of 2000 was not material to Gallagher's consolidated operating results or financial position.
In 2000, Gallagher acquired 60% of the net assets of MBR Pty Limited, an Australian company engaged in the reinsurance brokerage and services business in exchange for an initial cash payment of $2,100,000. Also in 2000, Gallagher acquired substantially all of the net assets of Joe E. Martin, Inc., an employee benefits broker and consultant, in exchange for an initial cash payment of $340,000. These acquisitions were accounted for as purchases. In 1999, Gallagher acquired substantially all of the net assets of R.W. Thom & Company, Inc., an insurance brokerage firm, in exchange for a cash payment of $250,000. This acquisition was also accounted for as a purchase. These purchase acquisitions were not material to either the 2000 or 1999 consolidated financial statements.
A reinsurance intermediary subsidiary of Gallagher includes only amounts relating to brokerage commission revenue in premiums and fees receivable in the accompanying consolidated balance sheets. The
premiums and claims receivable and payable, as well as the related excise taxes payable, associated with the reinsurance brokerage commission revenue, are not included in the accompanying consolidated balance sheets because they are not assets and liabilities of Gallagher. The excluded amounts are as follows (in thousands):
The cost or amortized cost and fair value of fixed maturities at December 31, 2000, by contractual maturity, are as follows (in thousands):
The following is a summary of other noncurrent assets (in thousands):
As of December 31, 2000, under this credit agreement, Gallagher has contingently committed to funding $41,700,000 through letter of credit arrangements related to one of its equity investments and to several of its other investments and insurance programs. Accordingly, Gallagher has $108,300,000 available for future borrowing. Terms of the credit agreement include various covenants that require Gallagher to maintain specified levels of tangible net worth and restrict the amount of payments on certain expenditures. Gallagher was in compliance with these covenants as of December 31, 2000. There were no borrowings under this credit agreement in 2000.
At December 31, 1999, Gallagher had a $20,000,000 variable rate (based on LIBOR plus .400%) unsecured revolving credit agreement. As of December 31, 1999, there were no borrowings outstanding under this credit agreement. Gallagher also had three line of credit facilities that totaled $45,000,000 in the aggregate as of December 31, 1999. Short-term borrowings under these facilities totaled $15,000,000 at December 31, 1999. The weighted average interest rates on the short-term borrowings were 7.2% and 6.1% during 2000 and 1999, respectively. In 2000, Gallagher paid the remaining loan balances under these facilities and terminated these agreements. These agreements were replaced by the $150,000,000 credit agreement mentioned above.
In addition, Gallagher has a non-employee directors' stock option plan which currently authorizes 940,000 shares for grant, with Discretionary Options granted at the direction of the Option Committee and Retainer Options granted in lieu of the directors' 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 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 following is a summary of all of Gallagher's stock option activity and related information (in thousands, except exercise price data):
Gallagher has a qualified contributory savings and thrift (401(k)) plan covering the majority of its employees. Gallagher's matching contributions (up to a maximum of 2% of eligible compensation) are at the discretion of Gallagher's Board of Directors and may not exceed the maximum amount deductible for federal income tax purposes. Gallagher contributed $4,638,000, $4,165,000 and $4,277,000 in 2000, 1999 and 1998, respectively. Effective January 1, 1999, Gallagher implemented a nonqualified deferred compensation plan for certain employees, who due to Internal Revenue Service rules, cannot take full advantage of the Gallagher matching contributions under the savings and thrift plan. The plan permits these employees to annually elect to defer a portion of their compensation until their retirement. Gallagher's matching contributions to this plan are also at the discretion of Gallagher's Board of Directors. Gallagher contributed $316,000 and $236,000 to the plan in 2000 and 1999, respectively. The fair value of the plan's assets as of December 31, 2000 and 1999, including employee contributions and investment earnings thereon, was $7,365,000 and $2,419,000, respectively, and has been included in other noncurrent assets and the corresponding liability has been included in other noncurrent liabilities in the accompanying consolidated balance sheets.
The discount rate used to measure the postretirement benefit obligation was 7.5% at December 31, 2000, 1999 and 1998. The transition obligation is being amortized over a 20 year period. For measurement purposes, a 7.5% annual rate of increase in the per capita cost of covered health care benefits was assumed for 2001. This rate was assumed to gradually scale down to 4.5% for 2009 and remain at that level thereafter. The assumed health care cost trend rate has a significant effect on the amounts reported and disclosed herein. A one percentage point change in the assumed health care cost trend rate would have the following effects (in thousands):
At December 31, 2000 and 1999, $19,789,000 and $16,380,000, respectively, of deferred tax assets have been included in other current assets in the accompanying consolidated balance sheets. During the period from 1994 to 1996, Gallagher provided for United States federal income taxes on the undistributed earnings of its foreign subsidiaries. Due to changes in the United States federal income tax laws effective in 1997, Gallagher no longer provides for United States federal income taxes on the undistributed earnings ($29,000,000 at December 31, 2000) of certain foreign subsidiaries which are considered permanently invested outside of the United States. The amount of unrecognized deferred tax liability on these undistributed earnings is $6,500,000 at December 31, 2000.
Quarterly operating results for 2000 and 1999 were as follows (in thousands, except per share data):
Gallagher has identified three operating segments in addition to its corporate operations. Insurance Brokerage Services encompasses operations that, for commission or fee compensation, place or arrange to place insurance directly related to the clients' funding of risk. This segment also provides consulting, for fee compensation, related to clients' risk financing programs. Risk Management Services includes Gallagher's third party administration, loss control and risk management consulting, workers' compensation investigations and insurance property appraisal operations. Third party administration is principally claims management services for Gallagher's clients. Financial Services is responsible for the management of Gallagher's diversified investment portfolio, which includes fiduciary funds, marketable and other equity securities, and tax advantaged and other strategic investments. It combines the invested assets of Gallagher in order to maximize the return to the company. Corporate consists primarily of unallocated administrative costs and the provision for income taxes which is not allocated to Gallagher's operating segments.