The following selected consolidated financial data for each of the five years in the period ended December 31, 2013 have been derived from our consolidated financial statements. Such data should be read in conjunction with our consolidated financial statements and notes thereto in Item 8 of this annual report.
The following discussion and analysis should be read in conjunction with our consolidated financial statements and the related notes included in Item 8 of this annual report. In addition, please see “Information Regarding Non-GAAP Measures and Other” on page 26 for a reconciliation of the non-GAAP measures for adjusted total revenues, organic commission, fee and supplemental commission revenues and adjusted EBITDAC to the comparable GAAP measures, as well as other important information regarding these measures.
We have generated positive organic growth in the last twelve quarterly periods in both our brokerage and risk management segments. Based on our experience, we believe we are seeing continued evidence of moderate rate increases and our customers are increasingly optimistic about their business prospects. The first quarter 2013 Council of Insurance Agents & Brokers (which we refer to as the CIAB) survey indicated that rates were up, on average 5.2% across all sized accounts. The second quarter 2013 CIAB survey indicated that rates were up, on average 4.3% across all sized accounts. The third quarter 2013 CIAB survey indicated that rates were up, on average 3.4% across all sized accounts. The fourth quarter 2013 CIAB survey had not been published as of the filing date of this report, but we anticipate that the trends evident in the third quarter 2013 survey continued into the fourth quarter. Rates continued to rise throughout 2013 as insurance carriers tightened their underwriting standards and pressed for higher pricing and deductibles on renewals in critical areas such as property and workers compensation. In addition, insurance carriers are still trying to reduce their exposure to property risks with catastrophic-loss exposure on the eastern coast of the U.S. due to the on-going impact of “Superstorm Sandy.” The third quarter 2013 survey also indicated that carriers have tightened terms and conditions and lowered limits for exposures, such as storm surge, flood and off-site power, among others. However, the overall firming market appears to have moderated during the second half of 2013. The CIAB represents the leading domestic and international insurance brokers, who write approximately 80% of the commercial property/casualty premiums in the U.S.
Our acquisition program finished strong and our integration efforts are on track. During the fourth quarter of 2013, the brokerage segment completed 13 acquisitions with annualized revenues of $193.5 million, bringing the total for 2013 to 30 acquisitions with annualized revenues of $369.9 million.
As a result of our acquisition program and subsequent centralization efforts, during the fourth quarter of 2013 we took actions to contract our management ranks and related support staff, mostly in our international operations. As a result, pretax charges in the brokerage and risk management segments totaled $6.6 million and $1.5 million, respectively and should generate annual workforce cost savings of $9.0 million and $2.3 million, respectively.
In our corporate segment, earnings from our clean energy investments contributed $63.7 million to net earnings in 2013. We anticipate our clean energy investments to generate between $65.0 million and $80.0 million to net earnings in 2014. We expect to use these additional earnings to continue our mergers and acquisition strategy in our core brokerage and risk management operations.
We achieved these results by, among other things, demonstrating expense discipline and headcount control, continuing to pursue our acquisition strategy and generating organic growth in our core businesses. In 2013, we continued to expand our international operations through both acquisitions and organic growth. By the end of 2013, 23% of our revenues were generated internationally in our combined brokerage and risk management segments, compared with 21% in 2012. We expect this international revenue trend to continue in 2014.
In 2013, the insurance market continued to show signs of “firming” (as opposed to traditional “hardening”) across many lines and geographic areas. In this environment, rates increased at a moderate pace, clients could still obtain coverage, businesses continued to stay in standard-line markets and there was adequate capacity in the insurance market. It is not clear whether this firming is sustainable given the uncertainty of the current economic environment. Despite the official end of the recession and recent signs of an economic recovery, the deterioration in the economy that began in the fall of 2008 continued to adversely impact us in 2013, and could continue to do so in future years as a result of potential reductions in the overall amount of insurance coverage that our clients may purchase due to reductions in, among other things, their headcount, payroll, properties and the market value of their assets. Such reductions could also adversely impact our commission revenues in future years if the property/casualty insurance carriers perform exposure audits that lead to subsequent downward premium adjustments. We record the income effects of subsequent premium adjustments when the adjustments become known and, as a result, any improvement in our results of operations and financial condition may lag an improvement in the economy.
Twenty-eight plants are under long-term production contracts with several utilities. The remaining six plants are in various stages of engineering, negotiating, finalizing and signing long-term production contracts. Several of the remaining six plants could be in production starting in late 2014 with the balance expected to be in production in 2015.
We also own a 46.54% controlling interest in Chem-Mod, which has been marketing The Chem-Mod™ Solution proprietary technologies principally to refined fuel plants that sell refined fuel to coal-fired power plants owned by utility companies, including those plants in which we hold interests. Based on current production estimates provided by licensees, Chem-Mod could generate for us approximately $3.6 million of net after-tax earnings per quarter.
Our current estimate of the 2014 annual after-tax earnings that could be generated from all of our clean energy investments in 2014 is between $65.0 million to $80.0 million. If we continue to have success in entering additional long-term production contracts, we could generate more after-tax earnings in 2015 and beyond.
We establish or adjust valuation allowances for deferred tax assets when we estimate that it is more likely than not that future taxable income will be insufficient to fully use a deduction or credit in a specific jurisdiction. In assessing the need for the recognition of a valuation allowance for deferred tax assets, we consider whether it is more likely than not that some portion, or all, of the deferred tax assets will not be realized and adjust the valuation allowance accordingly. We evaluate all significant available positive and negative evidence as part of our analysis. Negative evidence includes the existence of losses in recent years. Positive evidence includes the forecast of future taxable income by jurisdiction, tax-planning strategies that would result in the realization of deferred tax assets and the presence of taxable income in prior carryback years. The underlying assumptions we use in forecasting future taxable income require significant judgment and take into account our recent performance. The ultimate realization of deferred tax assets depends on the generation of future taxable income during the periods in which temporary differences are deductible or creditable.
Adjusted presentation - We believe that the adjusted presentation of our 2013, 2012 and 2011 information, presented on the following pages, provides stockholders and other interested persons with useful information regarding certain financial metrics that may assist such persons in analyzing our operating results as they develop a future earnings outlook for us. The after-tax amounts related to the adjustments were computed using the normalized effective tax rate for each respective period.
Adjusted ratios - Adjusted compensation expense ratio and adjusted operating expense ratio are defined as adjusted compensation expense and adjusted operating expense, respectively, each divided by adjusted revenues.
EBITDAC - We define this measure as net earnings before interest, income taxes, depreciation, amortization and the change in estimated acquisition earnout payables.
Diluted net earnings per share (as adjusted) - We define this measure as net earnings adjusted to exclude the after-tax impact of net gains realized from sales of books of business, acquisition integration costs, New Zealand earthquake claims administration, South Australia and claim portfolio transfer ramp up fees/costs, workforce related charges, lease termination related charges, acquisition related adjustments the period-over-period impact of foreign currency translation, as applicable, divided by diluted weighted average shares outstanding.
Allocations of investment income and certain expenses are based on reasonable assumptions and estimates primarily using revenue, headcount and other information. We allocate the provision for income taxes to the brokerage and risk management segments as if those segments were computing income tax provisions on a separate company basis. As a result, the provision for income taxes for the corporate segment reflects the entire benefit to us of the IRC Section 45 credits generated, because that is the segment which produced the credits. The law that provides for IRC Section 45 tax credits substantially expires in December 2019 for our fourteen 2009 Era Plants and in December 2021 for our twenty 2011 Era Plants. We anticipate reporting an effective tax rate of approximately 37.0% to 39.0% in both our brokerage segment and our risk management segment for the foreseeable future. Reported operating results by segment would change if different allocation methods were applied.
Financial information relating to our brokerage segment results for 2013, 2012 and 2011 (in millions, except per share, percentages and workforce data):
Commissions and fees - The aggregate increase in commissions and fees for 2013 was principally due to revenues associated with acquisitions that were made during 2013 ($216.8 million). Commissions and fees in 2013 included new business production and renewal rate increases of $246.8 million, which was offset by lost business of $165.7 million. The aggregate increase in commissions and fees for 2012 was principally due to revenues associated with acquisitions that were made during 2012 ($200.1 million). Commissions and fees in 2012 included new business production and renewal rate increases of $205.7 million, which was offset by lost business of $151.6 million. The organic change in base commission and fee revenues was 6% in 2013, 4% in 2012 and 3% in 2011. Commission revenues increased 19% and fee revenues increased 12% in 2013 compared to 2012. Commission revenues increased 16% and fee revenues increased 24% in 2012 compared to 2011.
Investment income and gains realized on books of business sales - This primarily represents interest income earned on cash, cash equivalents and restricted funds and one-time gains related to sales of books of business, which were $5.2 million, $3.9 million and $5.5 million in 2013, 2012 and 2011, respectively. Offsetting the one-time gains related to sales of books of business in 2012 was a non-cash loss of $3.5 million we recognized related to our acquisition of an additional 41.5% equity interest in CGM Gallagher Group Limited (which we refer to as CGM), which increased our ownership in CGM to 80%. The loss represents the decrease in fair value of our initial 38.5% equity interest in CGM based on the purchase price paid to acquire the additional 41.5% equity interest in CGM. Investment income in 2013 decreased compared to 2012 primarily due to lower levels of invested assets in 2013. Investment income in 2012 increased compared to 2011 primarily due to higher levels of invested assets in 2012.
The increase in compensation expense in 2013 compared to 2012 was primarily due to an increase in the average number of employees, salary increases, one-time compensation payments and increases in incentive compensation linked to our overall operating results ($132.1 million in the aggregate), increases in employee benefits expense ($21.7 million), deferred compensation ($8.4 million), stock compensation expense ($1.6 million) and temporary staffing ($0.9 million) offset by a decrease in severance related costs ($5.9 million). The increase in employee headcount in 2013 compared to 2012 primarily relates to the addition of employees associated with the acquisitions that we completed in 2013 and new production hires.
The increase in compensation expense in 2012 compared to 2011 was primarily due to an increase in the average number of employees, salary increases, one-time compensation payments and increases in incentive compensation linked to our overall operating results ($127.6 million in the aggregate), increases in employee benefits expense ($24.9 million), severance related costs ($11.1 million), stock compensation expense ($1.8 million) and temporary staffing ($1.2 million), offset by a decrease in deferred compensation ($3.4 million). These increases were partially offset by a decrease in the earnout compensation charge $7.0 million discussed below. The increase in employee headcount in 2012 compared to 2011 primarily relates to the addition of employees associated with the acquisitions that we completed in 2012 and new production hires.
During 2011, we recognized $7.0 million of compensation expense for an earnout obligation related to a prior year acquisition. Pursuant to ASC Subtopic 805-10-55-25 (formerly EITF 95-8), the portion of the earnout obligation that will be paid to our existing employees by the sellers once the earnout is settled, must be recorded as compensation expense in our consolidated statement of earnings.
Operating expense - The following provides non-GAAP information that management believes is helpful when comparing 2013 operating expense to 2012 and 2012 operating expense to 2011 (in millions):
The increase in operating expense in 2013 compared to 2012 was due primarily to increases in technology expenses ($12.6 million), professional and banking fees ($8.7 million), outside consulting fees ($7.5 million), real estate expenses ($7.9 million), meeting and client entertainment expenses ($6.0 million), employee expense ($4.0 million), licenses and fees ($3.6 million), office supplies ($3.3 million), business insurance ($2.8 million), outside services expense ($2.4 million), bad debt expense ($1.6 million), slightly offset by a favorable foreign currency translation ($2.1 million), lease termination charges ($0.6 million), interest expense ($0.4 million) and other expense ($0.1 million). Also contributing to the increase in operating expense in 2013 were increased expenses associated with the acquisitions completed in 2013.
The increase in operating expense in 2012 compared to 2011 was due primarily to a unfavorable foreign currency translation ($1.6 million) and increases in technology expenses ($12.2 million), professional and banking fees ($6.8 million), meeting and client entertainment expenses ($6.6 million), outside consulting fees ($5.1 million), real estate expenses ($4.3 million), office supplies ($4.2 million), licenses and fees ($3.2 million), employee expense ($2.4 million), outside services expense ($1.4 million), bad debt expense ($0.8 million) and lease termination charges ($0.6 million), offset by decreases in business insurance ($3.3 million) and other expense ($0.3 million), offset. Also contributing to the increase in operating expense in 2013 were increased expenses associated with the acquisitions completed in 2013.
Depreciation - The increases in depreciation expense in 2013 compared to 2012 and in 2012 compared to 2011 were due primarily to the purchases of furniture, equipment and leasehold improvements related to office expansions and moves, and expenditures related to upgrading computer systems. Also contributing to the increases in depreciation expense in 2013, 2012 and 2011 were the depreciation expenses associated with acquisitions completed during these years.
Change in estimated acquisition earnout payables - The change in the expense in 2013 compared to 2012 and 2012 compared to 2011 was due primarily to adjustments made to the estimated fair value of earnout obligations related to revised projections of future performance. During 2013, 2012 and 2011, we recognized $11.9 million, $9.3 million and $8.3 million, respectively, of expense related to the accretion of the discount recorded for earnout obligations in connection with our 2013, 2012 and 2011 acquisitions. During 2013, 2012 and 2011, we recognized $9.3 million, $5.7 million and $14.5 million of income, respectively, related to net adjustments in the estimated fair market values of earnout obligations in connection with revised projections of future performance for 77, 45 and 22 acquisitions, respectively.
The risk management segment accounted for 19% of our revenue in 2013. The risk management segment provides contract claim settlement and administration services for enterprises that choose to self-insure some or all of their property/casualty coverages and for insurance companies that choose to outsource some or all of their property/casualty claims departments. In addition, this segment generates revenues from integrated disability management programs, information services, risk control consulting (loss control) services and appraisal services, either individually or in combination with arising claims. Revenues for risk management services are substantially in the form of fees that are generally negotiated in advance on a per-claim or per-service basis, depending upon the type and estimated volume of the services to be performed.
The following provides non-GAAP information that management believes is helpful when comparing 2013 EBITDAC and adjusted EBITDAC to 2012, and 2012 EBITDAC and adjusted EBITDAC to 2011 (in millions):
Investment income - Investment income primarily represents interest income earned on our cash and cash equivalents. Investment income in 2013 decreased compared to 2012 primarily due to lower levels of invested assets in 2013. Investment income in 2012 remained relatively unchanged compared to 2011.
Compensation expense - The following provides non-GAAP information that management believes is helpful when comparing 2013 compensation expense to 2012 and comparing 2012 compensation expense to 2011 (in millions):
The increase in compensation expense in 2013 compared to 2012 was primarily due to increased headcount and increases in salaries ($30.0 million), employee benefits ($4.2 million), deferred compensation ($0.8 million), and stock compensation ($0.4 million), offset by a favorable foreign currency translation ($4.2 million), decreases in New Zealand earthquake claims administration ($5.5 million), temporary-staffing expense ($1.1 million), severance related costs ($0.8 million) and South Australia and claim portfolio transfer ramp up costs ($0.3 million).
The increase in compensation expense in 2012 compared to 2011 was primarily due to increased headcount, unfavorable foreign currency translation ($0.3 million), increases in salaries ($19.3 million), increases in employee benefits ($3.7 million), South Australia ramp up costs ($1.5 million) and stock compensation ($0.3 million), offset by decreases in GAB Robins integration costs ($9.2 million), New Zealand earthquake claims administration ($7.6 million), temporary-staffing expense ($3.5 million) and severance related costs ($1.4 million) and deferred compensation ($0.5 million).
Operating expense - The following provides non-GAAP information that management believes is helpful when comparing 2013 operating expense to 2012 and comparing 2012 operating expense to 2011 (in millions):
Amortization - Amortization expense remained relatively the same in 2013 compared to 2012 and in 2012 compared to 2011. Historically, the risk management segment has made few acquisitions. We made no material acquisitions in this segment in 2013 or 2012. Based on the results of impairment reviews in 2012, we wrote off $0.1 million of amortizable intangible assets related to the risk management segment acquisitions. No indicators of impairment were noted in 2013 or 2011.
Expenses related to royalty income of Chem-Mod were $21.2 million, $16.5 million and $3.2 million in 2013, 2012 and 2011, respectively, which include non-controlling interest of $19.2 million, $14.6 million and $1.7 million, respectively.
The increased pretax loss in 2013 compared to 2012 was due primarily to increased production which generates increased pretax operating losses. The increased pretax loss in 2012 compared to 2011 was due primarily to increased production which generates increased pretax operating losses.
In 2013, other net revenues primarily consisted of a gain of $9.6 million that we recognized in connection with the acquisition of an additional ownership interest in twelve of the 2009 Era Plants from one of the co-investors. See Note 12 to the consolidated financial statements for additional discussion of this acquisition transaction. We have consolidated the operations of the limited liability company that owns these plants effective March 1, 2013. In 2013, other net revenues also includes a gain of $2.6 million related to three foreign currency derivative investment contracts that Gallagher executed in September 2013 in connection with the signing of an agreement to acquire The Giles Group of Companies, headquartered in London, England. These contracts were designed to hedge a portion of the GBP denominated purchase price consideration of this acquisition. The derivative investment contracts were exercised on October 31, 2013 and the Giles transaction closed in early November 2013. In 2012, other net revenues of $1.4 million consisted of equity income from our venture capital fund investments. In 2011, $0.5 million of equity income from our venture capital fund investments was offset by the net $0.3 million impairment write-down of our investment in a biomass energy venture.
Compensation expense - Compensation expense for 2013, 2012 and 2011, respectively, includes salary and benefit expenses of $11.4 million, $9.8 million and $6.2 million and incentive compensation of $12.7 million, $5.0 million and $7.4 million, respectively.
The increase in salary and benefit expenses in 2013 compared to 2012 was primarily due to additional headcount and salary and benefits expense increases. The increase in salary and benefit expenses in 2012 compared to 2011 was primarily due to a $2.4 million increase in pension expense and additional headcount and salary and benefits expense increases.
Operating expense - Operating expense for 2013 includes banking and related fees of $3.0 million, external professional fees and other due diligence costs related to 2013 acquisitions of $7.5 million, operating expenses, professional fees and non-controlling interest related to royalty income of $21.2 million and other corporate and clean energy related expenses of $1.0 million and a biannual company-wide meeting ($3.8 million).
Operating expense for 2011 includes banking and related fees of $3.1 million, company-wide award and sales meeting expense of $0.7 million, external professional fees and other due diligence costs related to 2011 acquisitions of $4.6 million, operating expenses, professional fees and non-controlling interest related to royalty income of $3.2 million and other corporate and clean energy related expenses of $4.3 million.
Interest expense - The increase in interest expense in 2013 compared to 2012 is due to interest on the $200.0 million note purchase agreement entered into on September 19, 2013 ($4.0 million), interest on the $50.0 million note purchase agreement entered into on July 10, 2012 ($1.1 million) and increased interest on borrowings from our Credit Agreement ($2.0 million). The increase in interest expense in 2012 compared to 2011 is primarily due to interest on the $125.0 million and $50.0 million note purchase agreements entered into on February 10, 2011 and July 10, 2012, respectively ($1.7 million), and increased interest on borrowings from our Credit Agreement ($0.5 million).
Depreciation - The depreciation expense in 2013 increased significantly compared to 2012, and primarily relates to the assets of the additional ownership interests in the twelve 2009 Era Plants that we acquired from a co-investor in first quarter 2013. The depreciation expense in 2012 and 2011 were relatively unchanged and primarily relate to corporate-related office build outs and expenditures related to upgrading computer systems.
Interest and banking primarily includes expenses related to our debt. Clean energy investments include the operating results related to our investments in clean coal production and Chem-Mod. Acquisition costs include professional fees, due diligence and other costs incurred related to our acquisitions. In 2013, acquisition costs include a gain of $2.6 million on the derivative investment contract discussed above. Corporate consists of overhead allocations mostly related to corporate staff compensation and, in 2013 and 2011, costs related to a biannual company-wide award, cross-selling and motivational meeting for our production staff and field management. Legacy investments include the operating results related to the wind-down of our legacy investment portfolio.
The following table provides a summary of our clean coal plant investments as of December 31, 2013 (in millions):
Cash provided by operating activities was $349.9 million, $343.0 million and $284.0 million for 2013, 2012 and 2011, respectively. The increase in cash provided by operating activities in 2013 compared to 2012 was primarily due to favorable timing differences in the payment of accrued liabilities and an increased amount of non-cash charges in 2013 compared to 2012, partially offset by cash used in 2013 in the production and sale of refined coal at the plants qualified to receive refined coal tax credits under IRC Section 45. The increase in cash provided by operating activities in 2012 compared to 2011 was primarily due to favorable timing differences in the payment of accrued liabilities and the realization of other current assets, and an increased amount of non-cash charges in 2012 compared to 2011. Our cash flows from operating activities are primarily derived from our earnings from operations, as adjusted for realized gains and losses, and our non-cash expenses, which include depreciation, amortization, change in estimated acquisition earnout payables, deferred compensation, restricted stock, and stock-based and other non-cash compensation expenses. Cash provided by operating activities can be unfavorably impacted by the amount of IRC Section 45 tax credits recognized compared to the amount of tax credits actually used during the respective periods. Excess tax credits generated during the period result in an increase to our deferred tax assets, which is a net use of cash related to operating activities.
When assessing our overall liquidity, we believe that the focus should be on net earnings as reported in our consolidated statement of earnings, adjusted for non-cash items (i.e., EBITDAC), and cash provided by operating activities in our consolidated statement of cash flows. Consolidated EBITDAC was $504.9 million and $432.1 million for 2013 and 2012, respectively. We believe that EBITDAC items are indicators of trends in liquidity. From a balance sheet perspective, we believe the focus should not be on premium and fees receivable, premiums payable or restricted cash for trends in liquidity. Net cash flows provided by operations will vary substantially from quarter to quarter and year to year because of the variability in the timing of premiums and fees receivable and premiums payable. We believe that in order to consider these items in assessing our trends in liquidity, they should be looked at in a combined manner, because changes in these balances are interrelated and are based on the timing of premium payments, both to and from us. In addition, funds legally restricted as to our use relating to premiums and clients’ claim funds held by us in a fiduciary capacity are presented in our consolidated balance sheet as “Restricted Cash” and have not been included in determining our overall liquidity.
Our policy for funding our defined benefit pension plan is to contribute amounts at least sufficient to meet the minimum funding requirements under the IRC. The Employee Retirement Security Act of 1974, as amended (which we refer to as ERISA), could impose a minimum funding requirement for our plan. We were not required to make any minimum contributions to the plan for the 2013 and 2012 plan years. The minimum funding requirement under the IRC was $0.3 million in 2011. This level of required funding is based on the plan being frozen and the aggregate amount of our historical funding. The plan’s actuaries determine contribution rates based on our funding practices and requirements. Funding amounts may be influenced by future asset performance, the level of discount rates and other variables impacting the assets and/or liabilities of the plan. In addition, amounts funded in the future, to the extent not due under regulatory requirements, may be affected by alternative uses of our cash flows, including dividends, acquisitions and common stock repurchases. During 2013, 2012 and 2011, we made discretionary contributions to the plan of $6.3 million, $7.2 million and $7.2 million, respectively. We are considering making additional discretionary contributions to the plan in 2014 and may be required to make significantly larger minimum contributions to the plan in future periods. See Note 11 to our consolidated financial statements for additional information required to be disclosed relating to our defined benefit postretirement plans. We are required to recognize an accrued benefit plan liability for our underfunded defined benefit pension and unfunded retiree medical plans (which we refer to together as the Plans). The offsetting adjustment to the liabilities required to be recognized for the Plans is recorded in “Accumulated Other Comprehensive Earnings (Loss),” net of tax, in our consolidated balance sheet. We will recognize subsequent changes in the funded status of the Plans through the income statement and as a component of comprehensive earnings, as appropriate, in the year in which they occur. Numerous items may lead to a change in funded status of the Plans, including actual results differing from prior estimates and assumptions, as well as changes in assumptions to reflect information available at the respective measurement dates. In 2013, the funded status of the Plans was significantly impacted by an increase in the discount rates used in the measurement of the pension liabilities at December 31, 2013 (resulting in a $19.5 million decrease in the benefit obligation at December 31, 2013). In addition, also favorably impacting the funded status were favorable returns on the plan’s assets in 2013, which, combined with the $6.3 million of discretionary contributions made to the plan in 2013, resulted in an increase in the plan’s invested assets of $27.5 million at December 31, 2013. The net change in the funded status of the Plan in 2013 resulted in a decrease in noncurrent liabilities in 2013 of $47.0 million. While the change in funded status of the Plans had no direct impact on our cash flows from operations in 2013, 2012 and 2011, potential changes in the pension regulatory environment and investment losses in our pension plan have an effect on our capital position and could require us to make significant contributions to our defined benefit pension plan and increase our pension expense in future periods.
Acquisitions - Cash paid for acquisitions, net of cash acquired, was $727.7 million, $344.1 million and $264.8 million in 2013, 2012 and 2011, respectively. The increased use of cash for acquisitions made in 2013 compared to 2012 was primarily due to two large acquisitions that occurred in 2013. The increased use of cash for acquisitions made in 2012 compared to 2011 was primarily due to the increase in the number of acquisition that occurred in 2012. In addition, during 2013, 2012 and 2011 we issued 5.1 million shares ($223.1 million), 6.0 million shares ($203.6 million) and 3.2 million shares ($90.6 million), respectively, of our common stock as consideration paid for acquisitions. We completed 31, 60 and 32 acquisitions in 2013, 2012 and 2011, respectively. Annualized revenues of entities acquired in 2013, 2012 and 2011 totaled approximately $383.9 million, $231.7 million and $277.0 million, respectively. In 2014, we expect to fund our acquisitions using debt and cash from operations and our common stock on occasion (for example, to effect a tax-free exchange, or if our overall acquisition activity warrants it).
During 2012, we issued 425,000 shares of our common stock and paid $3.5 million in cash related to earnout obligations of five acquisitions made prior to 2009 and recorded additional goodwill of $0.1 million. During 2011, we issued 245,000 shares of our common stock, paid $8.2 million in cash and accrued $18.3 million in liabilities related to earnout obligations of 19 acquisitions made prior to 2009 and recorded additional goodwill of $30.0 million.
Clean Energy Investments - During the period from 2009 through 2013, we made significant investments in clean energy operations capable of producing refined coal that we believe qualifies for tax credits under IRC Section 45. Our current estimate
of the 2014 annual after-tax earnings, including IRC Section 45 tax credits, that will be generated from all of our clean energy investments in 2014 is $65.0 million to $80.0 million. The IRC Section 45 tax credits generate positive cash flow by reducing the amount of Federal income taxes we pay, which is offset by capital expenditures related to the redeployment, and in some cases relocation of refined coal plants. We anticipate positive net cash flow related to IRC Section 45 activity in 2014. With the expected increased earnings from the IRC Section 45 investments in 2015 through 2021, and the anticipated minimal capital expenditures during that same period, we anticipate that the annual positive net cash flow during those years will continue to increase. We anticipate that this favorable impact on the amount we will pay the IRS in 2014 and in future years from IRC Section 45 investments will allow us to use these positive cash flows to fund acquisitions. Please see “Clean energy investments” beginning on page 38 for a more detailed description of these investments (including the reference therein to risks and uncertainties).
Our Credit Agreement provides for a revolving credit commitment of up to $600.0 million, of which up to $75.0 million may be used for issuances of standby or commercial letters of credit and up to $50.0 million may be used for the making of swing loans as defined in the Credit Agreement. We may from time to time request, subject to certain conditions, an increase in the revolving credit commitment up to a maximum aggregate revolving credit commitment of $850.0 million.
The note purchase agreements and the Credit Agreement contain various financial covenants that require us to maintain specified levels of net worth and financial leverage ratios. We were in compliance with these covenants as of December 31, 2013.
At-the-Market Equity Program - On November 20, 2013, we entered into an Equity Distribution Agreement with Morgan Stanley & Co. LLC, pursuant to which we may offer and sell, from time to time, up to $200 million of our common stock through Morgan Stanley as sales agent. Pursuant to the agreement, shares may be sold by means of ordinary brokers’ transactions, including on the New York Stock Exchange, at market prices prevailing at the time of sale, at prices related to the prevailing market prices, or at negotiated prices, in block transactions, or as otherwise agreed upon by us and Morgan Stanley.
Shelf Registration Statement - On November 20, 2013, we filed a shelf registration statement on Form S-3 with the SEC, registering the offer and sale from time to time of an indeterminate amount of our common stock. We have used this registration statement, and expect to continue using this registration statement, to register shares sold under our at-the-market equity program referred to above. The availability of the potential liquidity under this shelf registration statement depends on investor demand, market conditions and other factors. We can make no assurances regarding when, or if, we will issue any additional shares under this registration statement.
The amounts presented in the table above may not necessarily reflect our actual future cash funding requirements, because the actual timing of the future payments made may vary from the stated contractual obligation. In addition, due to the uncertainty with respect to the timing of future cash flows associated with our unrecognized tax benefits at December 31, 2013, we are unable to make reasonably reliable estimates of the period in which cash settlements may be made with the respective taxing authorities. Therefore, $9.2 million of unrecognized tax benefits have been excluded from the contractual obligations table above. See Note 14 to our consolidated financial statements for a discussion on income taxes.
On July 10, 2012, we entered into a note purchase agreement, with certain accredited institutional investors, pursuant to which we issued and sold $50.0 million in aggregate principal amount of our 3.99% Senior Notes, Series F, due July 10, 2020, in a private placement.
On June 14, 2013, we entered into a note purchase agreement, with certain accredited institutional investors, pursuant to which we issued and sold $200.0 million in aggregate principal amount of our 3.69% Senior Notes, Series G, due June 14, 2022, in a private placement.
On December 20, 2013, we entered into a note purchase agreement for a private placement of $600.0 million of Senior Notes. The agreement provides for three series of notes: Series H is $325 million at 4.58% due in 2024, Series I is $175 million at 4.73% due in 2026 and Series J is $100 million at 4.98% due 2029. Under the agreement, funding is expected to occur on February 27, 2014.
We use the Credit Agreement to post letters of credit and to borrow funds to supplement our operating cash flows from time to time. At December 31, 2013, $16.0 million of letters of credit (see below under Off-Balance Sheet Debt) were outstanding under the Credit Agreement. There were $530.5 million of borrowings outstanding under the Credit Agreement at December 31, 2013. Accordingly, at December 31, 2013, $53.5 million remained available for potential borrowings, of which $53.5 million may be in the form of additional letters of credit. We are under no obligation to use the Credit Agreement in performing our normal business operations. See Note 6 to our consolidated financial statements for a discussion of the terms of the Credit Agreement.
At December 31, 2013, we had posted two letters of credit totaling $9.8 million, in the aggregate, related to our self-insurance deductibles, for which we have recorded a liability of $9.0 million. At December 31, 2013, we had posted five letters of credit totaling $6.2 million to allow certain of our captive operations to meet minimum statutory surplus requirements and for additional collateral related to premium and claim funds held in a fiduciary capacity. These letters of credit have never been drawn upon.
Nature of Operations - Arthur J. Gallagher & Co. and its subsidiaries, collectively referred to herein as we, our or us or the company, provide insurance brokerage and risk management services to a wide variety of commercial, industrial, institutional and governmental organizations through three reportable operating segments. Commission and fee revenue generated by the brokerage segment is primarily related to the negotiation and placement of insurance for our clients. Fee revenue generated by the risk management segment is primarily related to claims management, information management, risk control consulting (loss control) services and appraisals in the property/casualty market. Investment income and other revenue are generated from our investment portfolio, which includes invested cash and restricted funds, as well as clean energy and other investments. We are headquartered in Itasca, Illinois, have operations in 24 countries and offer client-service capabilities in more than 140 countries globally through a network of correspondent insurance brokers and consultants.
In the preparation of our consolidated financial statements as of December 31, 2013, management evaluated all material subsequent events or transactions that occurred after the balance sheet date through the date on which the financial statements were issued for potential recognition in our consolidated financial statements and/or disclosure in the notes thereto.
We deduct brokerage expense from gross revenues in our determination of our total revenues. Brokerage expense represents commissions paid to sub-brokers related to the placement of certain business by our brokerage segment. We recognize this expense in the same manner as commission revenues.
Premiums and fees receivable in the accompanying consolidated balance sheet are net of allowances for estimated policy cancellations and doubtful accounts. The allowance for estimated policy cancellations was $4.2 million and $4.0 million at December 31, 2013 and 2012, respectively, which represents a reserve for future reversals in commission and fee revenues related to the potential cancellation of client insurance policies that were in force as of each year end. The allowance for doubtful accounts was $6.7 million and $6.6 million at December 31, 2013 and 2012, respectively. We establish the allowance for estimated policy cancellations through a charge to revenues and the allowance for doubtful accounts through a charge to operating expenses. Both of these allowances are based on estimates and assumptions using historical data to project future experience. Such estimates and assumptions could change in the future as more information becomes known which could impact the amounts reported and disclosed herein. We periodically review the adequacy of these allowances and make adjustments as necessary.
Investment income primarily includes interest and dividend income, which is accrued as it is earned. Gains on books of business sales represent one-time gains related to sales of brokerage related businesses, which are primarily recognized on a cash received basis. Revenues from clean coal activities include revenues from consolidated clean coal production plants, royalty income from clean coal licenses and income (loss) related to unconsolidated clean coal production plants, all of which are recognized as earned. Revenues from consolidated clean coal production plants represent sales of refined coal. Royalty income from clean coal licenses represents fee income related to the use of clean coal technologies. Income (loss) from unconsolidated clean coal production plants includes income (losses) related to our equity portion of the pretax results of the clean coal production plants and production based installment sale income from majority investors. Other net revenues primarily consist of our equity portions of the earnings from our investments in venture capital funds.
Cash and Cash Equivalents - Short-term investments, consisting principally of cash and money market accounts that have average maturities of 90 days or less, are considered cash equivalents.
Investments - We have a management investment committee that meets four to six times per year to review the valuation of our investments. For investments that do not have quoted market prices, we use various valuation techniques to estimate fair value and look for indicators of impairment. Factors that may indicate that an impairment could exist include, but are not limited to, reductions or changes to dividend payments, sustained operating losses or a trend of poor operating performance, recent refinancings or recapitalizations, unfavorable press reports, significant customer or revenue loss, litigation, losses by other companies in a similar industry, overall economic conditions, management changes and significant changes in strategy. In addition, in cases where the ultimate value of an investment is directly dependent on us for future financial support, we assess our willingness and intent to provide future funding in determining impairment.
If an indicator of impairment exists, we compare the investment’s carrying value to an estimate of its fair value. To estimate the fair value of our equity-method investments, we compare values established in recent recapitalizations or appraisals conducted by third parties. In some cases, no such recapitalizations or appraisals exist and we must perform our own valuations. This also requires us to exercise significant judgment. Even if impairment indicators exist, no impairment may be required if the estimated fair value is not less than the current carrying value or the decline in value is determined to be temporary and we have no intent to sell the investment, and it is more likely than not that we will not be required to sell the investment prior to a recovery in value. When we determine that an impairment is required, we record the impairment as a realized loss against current period earnings.
Stock-Based Compensation - We have several employee equity-settled and cash-settled share-based compensation plans. Equity-settled share-based payments to employees include grants of stock options and restricted stock units and are measured based on estimated grant date fair value. We have elected to use the Black-Scholes option pricing model to determine the fair value of stock options on the dates of grant. Restricted stock units are measured based on the fair market values of the underlying stock on the dates of grant. Shares are issued on the vesting dates net of the minimum statutory tax withholding requirements, as applicable, to be paid by us on behalf of our employees. As a result, the actual number of shares issued will be fewer than the actual number of restricted stock units outstanding. Furthermore, we record the liability for withholding amounts to be paid by us as a reduction to additional paid-in capital when paid.
Cash-settled share-based payments to employees include grants of performance units and stock appreciation rights. The fair value of the amount payable to employees in respect of cash-settled share-based payments is recognized as compensation expense, with a corresponding increase in liabilities, over the vesting period. The liability is remeasured at each reporting date and at settlement date. Any changes in fair value of the liability are recognized as compensation expense.
Defined Benefit Pension and Other Postretirement Plans - We recognize in our consolidated balance sheet, an asset for our defined benefit postretirement plans’ overfunded status or a liability for our plans’ underfunded status. We recognize changes in the funded status of our defined benefit postretirement plans in comprehensive earnings in the year in which the changes occur. We use December 31 as the measurement date for our plans’ assets and benefit obligations. See Note 11 to our consolidated financial statements for additional information required to be disclosed related to our defined benefit postretirement plans.
During 2013, 2012 and 2011, we recognized $11.9 million, $9.3 million and $8.3 million, respectively, of expense in our consolidated statement of earnings related to the accretion of the discount recorded for earnout obligations in connection with our acquisitions. In addition, during 2013, 2012 and 2011 we recognized $10.2 million, $5.9 million and $14.5 million of income, respectively, related to net adjustments in the estimated fair value of the liability for earnout obligations in connection with revised projections of future performance for 79, 46 and 22 acquisitions, respectively. The aggregate amount of maximum earnout obligations related to acquisitions made in 2010 and subsequent years was $462.3 million as of December 31, 2013, of which $162.7 million was recorded in the consolidated balance sheet as of that date based on the estimated fair value of the expected future payments to be made. The aggregate amount of maximum earnout obligations related to acquisitions made in 2009 and subsequent years was $384.8 million as of December 31, 2012, of which $139.8 million was recorded in the consolidated balance sheet as of that date.
The unaudited pro forma results above have been prepared for comparative purposes only and do not purport to be indicative of the results of operations which actually would have resulted had these acquisitions occurred at January 1, 2012, nor are they necessarily indicative of future operating results. Annualized revenues of entities acquired in 2013 totaled approximately $383.9 million. Total revenues and net earnings recorded in our consolidated statement of earnings for 2013 related to the 2013 acquisitions in the aggregate were $107.4 million and $2.1 million, respectively.
We are a party to a note purchase agreement dated July 10, 2012, with certain accredited institutional investors, pursuant to which we issued and sold $50.0 million in aggregate principal amount of our 3.99% Senior Notes, Series F, due July 10, 2020, in a private placement. These notes require semi-annual payments of interest that are due in January and July of each year.
On December 20, 2013, we entered into a note purchase agreement with certain accredited investors, for a private placement of $600.0 million of Senior Notes. The agreement provides for three series of notes: Series H is $325.0 million at 4.58% due in 2024, Series I is $175.0 million at 4.73% due in 2026 and Series J is $100.0 million at 4.98% due 2029. Under the agreement, funding is expected to occur on February 27, 2014. These notes will require semi-annual payments of interest that will be due in February and August of each year. We will incur approximately $1.3 million of debt acquisition costs that will be capitalized and amortized on a pro rata basis over the life of the debt.
Under the terms of the note purchase agreements, we may redeem the notes at any time, in whole or in part, at 100% of the principal amount of such notes being redeemed, together with accrued and unpaid interest and a “make-whole amount”. The “make-whole amount” is derived from a net present value computation of the remaining scheduled payments of principal and interest using a discount rate based on the U.S. Treasury yield plus 0.5% and is designed to compensate the purchasers of the notes for their investment risk in the event prevailing interest rates at the time of prepayment are less favorable than the interest rates under the notes. We do not currently intend to prepay any of the notes.
Credit Agreement - On September 19, 2013, we entered into a $600.0 million unsecured multicurrency credit agreement (which we refer to as the Credit Agreement), which expires on September 19, 2018, with a group of fifteen financial institutions. The Credit Agreement replaced a $500.0 million unsecured revolving credit facility (that was scheduled to expire on July 14, 2014), which was terminated upon the execution of the Credit Agreement. All indebtedness, liabilities and obligations outstanding under the previous facility were fully paid and satisfied, except for the letters of credit (which we refer to as LOCs) which became LOCs under the Credit Agreement. We incurred no early termination fees in connection with replacing the previous credit facility.
At December 31, 2013, $16.0 million of letters of credit (for which we had $9.0 million of liabilities recorded at December 31, 2013) were outstanding under the Credit Agreement. See Note 13 to our consolidated financial statements for a discussion of the letters of credit. There were $530.5 million of borrowings outstanding under the Credit Agreement at December 31, 2013. Accordingly, at December 31, 2013, $53.5 million remained available for potential borrowings, of which $53.5 million may be in the form of additional letters of credit.
The estimated fair value of the $925.0 million in debt under the note purchase agreements at December 31, 2013 was $979.4 million due to the long-term duration and fixed interest rates associated with these debt obligations. No active or observable market exists for our private long-term debt. Therefore, the estimated fair value of this debt is based on discounted future cash flows, which is a Level 3 fair value measurement, using current interest rates available for debt with similar terms and remaining maturities. To estimate an all-in interest rate for discounting, we obtain market quotes for notes with the same terms as ours, which we have deemed to be the closest approximation of current market rates. We have not adjusted this rate for risk profile changes, covenant issues or credit rating changes. The estimated fair value of the $530.5 million of borrowings outstanding under our Credit Agreement approximate their carrying value due to their short-term duration and variable interest rates.
The LTIP provides for the grant of stock options, which may be either tax-qualified incentive stock options or non-qualified options and stock appreciation rights. The compensation committee determines the period for the exercise of a non-qualified stock option, tax-qualified incentive stock option or stock appreciation right, provided that no option or stock appreciation right can be exercised later than seven years after its date of grant. The exercise price of a non-qualified stock option or tax-qualified incentive stock option and the base price of a stock appreciation right cannot be less than 100% of the fair market value of a share of our common stock on the date of grant, provided that the base price of a stock appreciation right granted in tandem with an option will be the exercise price of the related option.
On March 13, 2013, the compensation committee granted 1,665,000 options to our officers and key employees that become exercisable at the rate of 34%, 33% and 33% on the anniversary date of the grant in 2016, 2017 and 2018, respectively. On March 16, 2012, the compensation committee granted 1,355,000 options to our officers and key employees that become exercisable at the rate of 34%, 33% and 33% on the anniversary date of the grant in 2015, 2016 and 2017, respectively. On
During 2013, 2012 and 2011, we recognized $7.7 million, $7.2 million and $7.1 million, respectively, of compensation expense related to our stock option grants.
The following is a summary of our stock option activity and related information for 2013, 2012 and 2011 (in millions, except exercise price and year data):
In the first quarter of each of 2013, 2012 and 2011, the compensation committee approved $8.0 million, $7.3 million and $6.5 million, respectively, of cash awards in the aggregate to certain key executives under the Deferred Equity Participation Plan that were contributed to the rabbi trust in the second quarter of 2013 and the first quarters of 2012 and 2011, respectively. The fair value of the funded cash award assets at December 31, 2012 was $41.6 million and has been included in other noncurrent assets in the accompanying consolidated balance sheet. In the second quarter of 2013, we instructed the trustee for the Plan to liquidate all investments held under the Plan, other than our common stock, and use the proceeds to purchase additional shares of our common stock on the open market. As a result, the Plan sold all of the funded cash award assets and purchased 1.2 million shares of our common stock at an aggregate cost of $52.4 million during the second quarter of 2013. During 2013, 2012 and 2011, we charged $7.2 million, $5.4 million and $4.6 million, respectively, to compensation expense related to these awards.
At December 31, 2013, and 2012, we recorded $26.3 million (related to 2.1 million shares) and $5.6 million (related to 0.8 million shares), respectively, of unearned deferred compensation as an offset to capital in excess of par value in the accompanying consolidated balance sheet. The total intrinsic value of our unvested common stock under the plan at December 31, 2013 and 2012 was $96.4 million and $21.1 million, respectively. During 2013, 2012 and 2011, cash and equity awards with an aggregate fair value of $1.4 million, $0.7 million and $0.5 million, respectively, were vested and distributed to employees under this plan.
As discussed in Note 8 to our consolidated financial statements, on May 10, 2011, our stockholders approved the LTIP, which replaced our previous stockholder-approved 2009 LTIP. The LTIP provides for the grant of a stock award either as restricted stock or as restricted stock units. In either case, the compensation committee may determine that the award will be subject to the attainment of performance measures over an established performance period. Stock awards and the related dividend equivalents are non-transferable and subject to forfeiture if the holder does not remain continuously employed with us during the applicable restriction period or, in the case of a performance-based award, if applicable performance measures are not attained. The compensation committee will determine all of the terms relating to the satisfaction of performance measures and the termination of a restriction period, or the forfeiture and cancellation of a restricted stock award upon a termination of employment, whether by reason of disability, retirement, death or any other reason. The compensation committee may grant unrestricted shares of common stock or units representing the right to receive shares of common stock to employees who have attained age 62.
The agreements awarding restricted stock units will specify whether such awards may be settled in shares of our common stock, cash or a combination of shares and cash and whether the holder will be entitled to receive dividend equivalents, on a current or deferred basis, with respect to such award. Prior to the settlement of a restricted stock unit, the holder of a restricted stock unit will have no rights as a stockholder of the company. The maximum number of shares available under the LTIP for restricted stock, restricted stock units and performance unit awards settled with stock (i.e., all awards other than stock options and stock appreciation rights) is 1.2 million. At December 31, 2013, 0.5 million shares were available for grant under the LTIP for such awards.
On March 13, 2013, pursuant to our Performance Unit Program (which we refer to as the Program), the compensation committee approved provisional cash awards of $10.5 million in the aggregate for future grants to our officers and key employees that are denominated in units (269,000 units in the aggregate), each of which was equivalent to the value of one share of our common stock on the date the provisional award was approved. The Program consists of a one-year performance period based on our financial performance and a two-year vesting period. At the discretion of the compensation committee and determined based on our performance, the eligible officer or key employee will be granted a percentage of the provisional cash award units that equates to the EBITAC growth achieved (as defined in the Program). At the end of the performance period, eligible participants will be granted a number of units based on achievement of the performance goal and subject to approval by the compensation committee. Granted units for the 2013 provisional award will fully vest based on continuous employment through January 1, 2016. For certain of our executive officers age 55 or older, awards granted under the Program in 2013 are no longer subject to forfeiture upon such officers’ departure from the company after two years from the date of grant. The ultimate award value will be equal to the trailing twelve-month stock price on December 31, 2015, multiplied by the number of units subject to the award, but limited to between 0.5 and 1.5 times the original value of the units determined as of the grant date. The fair value of the awarded units will be paid out in cash as soon as practicable in 2016. If an eligible employee leaves us prior to the vesting date, the entire award will be forfeited. We did not recognize any compensation expense during 2013 related to the 2013 provisional award under the Program. Based on company performance for 2013, we expect to grant 263,000 units under the Program in first quarter 2014 that will fully vest on January 1, 2016.
On March 8, 2011, pursuant to the Program, the compensation committee approved the provisional cash awards of $14.4 million in the aggregate for future grants to our officers and key employees that are denominated in units (464,000 units in the aggregate), each of which is equivalent to the value of one share of our common stock on the date the provisional award was approved. Terms of the 2011 provisional award were similar to the terms discussed above for the 2012 provisional award. Based on our performance for 2011, we granted 432,000 units under the Program in the first quarter of 2012 that will fully vest on January 1, 2014. During 2013 and 2012, we charged $10.1 million and $7.5 million, respectively, to compensation expense related to these awards.
We were not required under the Internal Revenue Code (which we refer to as IRC) to make any minimum contributions to the plan for each of the 2013 and 2012 plan years. We were required under the IRC to make minimum contributions of $0.3 million to the plan for the 2011 plan year. This level of required funding is based on the plan being frozen and the aggregate amount of our historical funding. During 2013, 2012 and 2011, we made discretionary contributions of $6.3 million, $7.2 million and $7.2 million, respectively, to the plan.
We also have a qualified contributory savings and thrift (401(k)) plan covering the majority of our domestic employees. For eligible employees who have met the plan’s age and service requirements to receive matching contributions, we match 100% of pre-tax and Roth elective deferrals up to a maximum of 5.0% of eligible compensation, subject to Federal limits on plan contributions and not in excess of the maximum amount deductible for Federal income tax purposes. Effective January 1, 2014, employees must be employed and eligible for the plan on the last day of the plan year to receive a matching contribution, subject to certain exceptions enumerated in the plan document. Matching contributions are subject to a five-year graduated vesting schedule. We contributed $36.8 million, $33.0 million and $30.5 million to the plan in 2013, 2012 and 2011, respectively.
We also have a nonqualified deferred compensation plan, the Supplemental Savings and Thrift Plan, for certain employees who, due to Internal Revenue Service (which we refer to as the IRS) rules, cannot take full advantage of our matching contributions under the 401(k) plan. The plan permits these employees to annually elect to defer a portion of their compensation until their retirement or a future date. Our matching contributions to this plan (up to a maximum of the lesser of a participant’s elective deferral of base salary, annual bonus and commissions or 5.0% of eligible compensation, less matching amounts contributed under the 401(k) plan) are also at the discretion of our board of directors. We contributed $2.8 million, $2.5 million and $2.1 million to a rabbi trust maintained under the plan in 2013, 2012 and 2011, respectively. The fair value of the assets in the plan’s rabbi trust at December 31, 2013 and 2012, including employee contributions and investment earnings, was $148.2 million and $116.7 million, 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 sheet.
We also have several foreign benefit plans, the largest of which is a defined contribution plan that provides for us to make contributions of 5.0% of eligible compensation. In addition, the plan allows for voluntary contributions by U.K. employees, which we match 100%, up to a maximum of an additional 5.0% of eligible compensation. Net expense for foreign retirement plans amounted to $18.1 million, $16.0 million and $12.3 million in 2013, 2012 and 2011, respectively.
Chem-Mod LLC - At December 31, 2013, we had a 46.54% controlling interest in Chem-Mod. Chem-Mod possesses the exclusive marketing rights in the U.S. and Canada, for technologies used to reduce emissions created during the combustion of coal. The refined coal production plants discussed below, as well as those owned by other unrelated parties, license and use Chem-Mod’s proprietary technologies, The Chem-Mod™ Solution, in the production of refined coal. The Chem-Mod™ Solution uses a dual injection sorbent system to reduce mercury, sulfur dioxide and other emissions at coal-fired power plants.
C-Quest Technology LLC - At December 31, 2013, we held a non-controlling 8% interest in C-Quest’s global operation. C-Quest possesses rights, information and technology for the reduction of carbon dioxide emissions created by burning fossil fuels. Thus far, C-Quest’s operations have been limited to laboratory testing. C-Quest is determined to be a VIE, but due to our lack of control over the operation of C-Quest, we do not consolidate this investment into our consolidated financial statements. We also have options to acquire an additional 19% interest in C-Quest’s global operations for $9.5 million at any time on or prior to August 15, 2016. On August 1, 2013, we loaned the majority owner $2.0 million at a 2% interest rate, which matures on May 15, 2014. The loan can be paid in cash or by delivery of an additional 4% ownership interest in C-Quest’s global operations. If the loan is paid by delivery of the additional 4% ownership interest, our option would be reduced to 15% and the remaining purchase price would be reduced to $7.5 million.
On March 1, 2013, we purchased an additional ownership interest in twelve of the 2009 Era Plants from one of the co-investors. For nine of the plants, our ownership increased from 24.5% to 49.5%. Our investment in these plants had been accounted for under the equity method of accounting and will continue to be accounted for under the equity method. For three of the plants, our ownership went from 25.0% to 60.0%. Our investment in these plants had been accounted for under the equity method of accounting. As of March 1, 2013, we consolidated the operations of the limited liability company that owns these three plants. For 2013, total revenues and expenses recorded in our consolidated statement of earnings related to this acquisition were $128.3 million and $133.5 million, respectively.
The remaining six plants are in various stages of seeking and negotiating long-term production contracts.
We have a non-controlling, minority interest in twelve plants. We also have agreements in principle with co-investors for the sale of majority ownership interests in six additional plants. We may sell ownership interests in some or all of the remaining plants to co-investors.
We are aware that some of the coal-fired power plants that purchase the refined coal are considering changing to burning natural gas or shutting down completely for economic reasons. We and our partners are prepared to move the refined coal productions plants to other, generally higher volume, coal-fired power plants. If these potential developments were to occur, we estimate those plants will not operate for 12 to 18 months during their movement and redeployment, which could have a material impact on the amount of tax credits that are generated by these plants.
In connection with our investing and operating activities, we have entered into certain contractual obligations and commitments. See Notes 6 and 12 to our consolidated financial statements for additional discussion of these obligations and commitments. Our future minimum cash payments, including interest, associated with our contractual obligations pursuant to the note purchase agreements and Credit Agreement, operating leases and purchase commitments at December 31, 2013 were as follows (in millions):
Off-Balance Sheet Commitments - Our total unrecorded commitments associated with outstanding letters of credit, financial guarantees and funding commitments at December 31, 2013 were as follows (in millions):
Since January 1, 2002, we have acquired 279 companies, all of which were accounted for using the acquisition method for recording business combinations. Substantially all of the purchase agreements related to these acquisitions contain provisions for potential earnout obligations. For all of our acquisitions made in the period from 2011 to 2013 that contain potential earnout obligations, such obligations are measured at fair value as of the acquisition date and are included on that basis in the recorded purchase price consideration for the respective acquisition. The amounts recorded as earnout payables are primarily based upon estimated future potential operating results of the acquired entities over a two- to three-year period subsequent to the acquisition date. The aggregate amount of the maximum earnout obligations related to these acquisitions was $462.3 million, of which $162.7 million was recorded in our consolidated balance sheet as of December 31, 2013 based on the estimated fair value of the expected future payments to be made.
Off-Balance Sheet Debt - Our unconsolidated investment portfolio includes investments in enterprises where our ownership interest is between 1% and 50%, in which management has determined that our level of influence and economic interest is not sufficient to require consolidation. As a result, these investments are accounted for under the equity method. None of these unconsolidated investments had any outstanding debt at December 31, 2013 or 2012 that was recourse to us.
At December 31, 2013, we had posted two letters of credit totaling $9.8 million in the aggregate, related to our self-insurance deductibles, for which we had a recorded liability of $9.0 million. At December 31, 2013, we had posted five letters of credit totaling $6.2 million to allow certain of our captive operations to meet minimum statutory surplus requirements and for additional collateral related to premium and claim funds held in a fiduciary capacity. These letters of credit have never been drawn upon.
(1) The guarantee has no collateral. The mortgage loan has a lien on real property with an appraised value of approximately $11.0 million.
Litigation, Regulatory and Taxation Matters - We are the defendant in various legal actions incidental to the nature of our business, including matters related to employment practices, alleged breaches of non-compete or other restrictive covenants, theft of trade secrets, breaches of fiduciary duties and related causes of action. We are also periodically the subject of inquiries and investigations by regulatory and taxing authorities into various matters related to our business. Neither the outcomes of these matters nor their effect upon our business, financial condition or results of operations can be determined at this time.
Contingent Liabilities - We purchase insurance to provide protection from errors and omissions (which we refer to as E&O) claims that may arise during the ordinary course of business. We currently retain the first $5.0 million of each and every E&O claim. Our E&O insurance provides aggregate coverage for E&O losses up to $175.0 million in excess of our retained amounts. We have historically maintained self-insurance reserves for the portion of our E&O exposure that is not insured. We periodically determine a range of possible reserve levels using actuarial techniques that rely heavily on projecting historical claim data into the future. Our E&O reserve in the December 31, 2013 consolidated balance sheet is above the lower end of the most recently determined actuarial range by $1.6 million and below the upper end of the actuarial range by $4.2 million. We can make no assurances that the historical claim data used to project the current reserve levels will be indicative of future claim activity. Thus, the E&O reserve level and corresponding actuarial range could change in the future as more information becomes known, which could materially impact the amounts reported and disclosed herein.
We and our principal domestic subsidiaries are included in a consolidated U.S. Federal income tax return. Our international subsidiaries file various income tax returns in their jurisdictions. Significant components of earnings before income taxes and the provision for income taxes are as follows (in millions):
We file income tax returns in the U.S. and in various state, local and foreign jurisdictions. We are routinely examined by tax authorities in these jurisdictions. At December 31, 2013, we had been examined by the IRS through calendar year 2010. Subsequent to December 31, 2013, we have been contacted by the IRS to commence an examination of calendar years 2011 and 2012. A number of foreign, state and local examinations are currently ongoing. It is reasonably possible that our gross unrecognized tax benefits may change within the next twelve months. However, we believe any changes in the recorded balance would not have a significant impact on our consolidated financial statements.
and other tax credits of $5.7 million begin to expire, if not utilized, in 2018. We expect the historically favorable trend in earnings before income taxes to continue in the foreseeable future. Accordingly, we expect to make full use of the net deferred tax assets. Valuation allowances have been established primarily with respect to various state net operating loss carryforwards that may not be utilized in the future.
We have audited the accompanying consolidated balance sheet of Arthur J. Gallagher & Co. (Gallagher) as of December 31, 2013 and 2012, and the related consolidated statements of earnings, comprehensive earnings, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2013. Our audits also included the financial statement schedule listed in the Index at Item 15(2)(a). These financial statements and schedule are the responsibility of Gallagher’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
In conducting our assessment of the effectiveness of its internal control over financial reporting, we have excluded eighteen of the thirty-one entities acquired in 2013, which are included in our 2013 consolidated financial statements. Collectively, these acquired entities constituted approximately 6.2% of total assets as of December 31, 2013 and approximately 2.3% of total revenues and approximately 1.3% of net earnings for the year then ended.
Based on our assessment under the framework in Internal Control - Integrated Framework, management concluded that our internal control over financial reporting was effective as of December 31, 2013. In addition, the effectiveness of our internal control over financial reporting as of December 31, 2013 has been audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in their attestation report which is included herein.
In our opinion, Arthur J. Gallagher & Co. maintained in all material respects, effective internal control over financial reporting as of December 31, 2013, based on the COSO criteria.