The executive offices of our corporate segment and certain subsidiary and branch facilities of our brokerage and risk management segments are located at 2850 Golf Road, Rolling Meadows, Illinois, where we own approximately 360,000 square feet of space, and can accommodate 2,000 employees at peak capacity.
Measures and Other” beginning on page 32 for a reconciliation of the non-GAAP
measures for adjusted total revenues, organic commission, fee and supplemental revenues and adjusted EBITDAC to the comparable GAAP measures, as well as other important information regarding these measures.
We are engaged in providing insurance brokerage and consulting services, and third-party property/casualty claims settlement and administration services to entities in the U.S. and abroad. We believe that one of our major strengths is our ability to deliver comprehensively structured insurance and risk management services to our clients. Our brokers, agents and administrators act as intermediaries between underwriting enterprises and our clients and we do not assume net underwriting risks. We are headquartered in Rolling Meadows, Illinois, have operations in 49 countries and offer client-service capabilities in more than 150 countries globally through a network of correspondent brokers and consultants. In 2019, we expanded, and expect to continue to expand, our international operations through both acquisitions and organic growth. We generate approximately 69% of our revenues for the combined brokerage and risk management segments domestically, with the remaining 31% derived internationally, primarily in Australia, Bermuda, Canada, the Caribbean, New Zealand and the U.K. (based on 2019 revenues). We expect that our international revenue as a percentage of our total revenues in 2020 will be comparable to 2019. We have three reportable segments: brokerage, risk management and corporate, which contributed approximately 68%, 14% and 18%, respectively, to 2019 revenues. Our major sources of operating revenues are commissions, fees and supplemental and contingent revenues from brokerage operations and fees from risk management operations. Investment income is generated from invested cash and fiduciary funds, clean energy investments, and interest income from premium financing.
The following provides information that management believes is helpful when comparing revenues before reimbursements, net earnings, EBITDAC and diluted net earnings per share for 2019 and 2018. In addition, these tables provide reconciliations to the most comparable GAAP measures for adjusted revenues, adjusted EBITDAC and adjusted diluted net earnings per share. Reconciliations of EBITDAC for the brokerage and risk management segments are provided on pages 35 and 41 of this filing.
* For 2019, the pretax impact of the brokerage segment adjustments totals $10.4 million, with a corresponding adjustment to the provision for income taxes of $0.9 million relating to these items. The pretax impact of the risk management segment adjustments totals $5.5 million, with a corresponding adjustment to the provision for income taxes of $1.3 million relating to these items. The pretax impact of the corporate segment adjustments totals $17.9 million, with an adjustment to the benefit for income taxes of $3.9 million. For the Corporate segment, the clean energy related adjustments are described on pages 47 to 48.
For 2018, the pretax impact of the brokerage segment adjustments totals $51.0 million, with a corresponding adjustment to the provision for income taxes of $12.9 million relating to these items. The pretax impact of the risk management segment adjustments totals $(3.2) million, with a corresponding adjustment to the provision for income taxes of $(1.0) million relating to these items. There was no pretax impact of the corporate segment adjustments, with an adjustment to the benefit for income taxes of $30.9 million.
harden, buyers of insurance (such as our brokerage clients), have historically tried to mitigate premium increases and the higher commissions these premiums generate, including by raising their deductibles and/or reducing the overall amount of insurance coverage they purchase. As the market softens, or costs decrease, these trends have historically reversed. During a hard market, buyers may switch to negotiated fee in lieu of commission arrangements to compensate us for placing their risks, or may consider the alternative insurance market, which includes self-insurance, captives, rent-a-captives,
could generate for us approximately $5.0 million to $6.0 million of net after tax earnings per quarter.
Our current estimate of the 2020 annual net after tax earnings, including IRC Section 45 tax credits, which will be produced from all of our clean energy investments in 2020, is $80.0 million to $100.0 million.
- See Revenue Recognition in Notes 1, 2 and 4 to our 2019 consolidated financial statements for information with respect to the impacts a new accounting standard, relating to revenue recognition, had on our financial position and operating results.
- See Income Taxes in Notes 1 and 19 to our 2019 consolidated financial statements.
Current accounting guidance related to business combinations requires us to estimate and recognize the fair value of liabilities related to potential earnout obligations as of the acquisition dates for all of our acquisitions subject to earnout provisions. The maximum potential earnout payables disclosed in the notes to our consolidated financial statements represent the maximum amount of additional consideration that could be paid pursuant to the terms of the purchase agreement for the applicable acquisition. The amounts recorded as earnout payables, which are primarily based upon the estimated future operating results of the acquired entities over a two-
The fair value of these earnout obligations is based on the present value of the expected future payments to be made to the sellers of the acquired entities in accordance with the provisions outlined in the respective purchase agreements, which is a Level 3 fair value measurement. In determining fair value, we estimate the acquired entity’s future performance using financial projections developed by management for the acquired entity and market participant assumptions that were derived for revenue growth and/or profitability. We estimate future payments using the earnout formula and performance targets specified in each purchase agreement and these financial projections. We then discount these payments to present value using a risk-adjusted rate that takes into consideration market-based rates of return that reflect the ability of the acquired entity to achieve the targets. Changes in financial projections, market participant assumptions for revenue growth and/or profitability, or the risk-adjusted discount rate, would result in a change in the fair value of recorded earnout obligations. See Note 3 to our 2019 consolidated financial statements for additional discussion on our 2019 business combinations.
See Note 3 to our 2019 consolidated financial statements for a discussion of our 2019 business combinations. We did not have any material dispositions in 2018 and 2017.
information with respect to one or more of these measures, although they may not use the same or comparable terminology and may not make identical adjustments. The non-GAAP
information we provide should be used in addition to, but not as a substitute for, the GAAP information provided. We make determinations regarding certain elements of executive officer incentive compensation, performance share awards and annual cash incentive awards, partly on the basis of measures related to adjusted EBITDAC.
amounts related to the adjustments were computed using the normalized effective tax rate for each respective period.
• Net gains on divestitures, which are primarily net proceeds received related to sales of books of business and other divestiture transactions, such as the disposal of a business unit through sale or closure.
• Acquisition integration costs, which include costs related to certain of our large acquisitions, outside the scope of our usual tuck-in
strategy, not expected to occur on an ongoing basis in the future once we fully assimilate the applicable acquisition. These costs are typically associated with redundant workforce, extra lease space, duplicate services and external costs incurred to assimilate the acquisition with our IT related systems.
• Workforce related charges, which primarily include severance costs (either accrued or paid) related to employee terminations and other costs associated with redundant workforce.
• Lease termination related charges, which primarily include costs related to terminations of real estate leases and abandonment of leased space.
impact of net gains on divestitures, acquisition integration costs, workforce related charges, lease termination related charges and acquisition related adjustments and the period-over-period impact of foreign currency translation, as applicable, (and for the Corporate segment, the clean energy related adjustments described on pages 47 to 48). Adjusted EPS is Adjusted Net Earnings divided by diluted weighted average shares outstanding. This measure provides a meaningful representation of our operating performance (and as such should not be used as a measure of our liquidity), and for the overall business is also presented to improve the comparability of our results between periods by eliminating the impact of the items that have a high degree of variability.
- For the brokerage segment, organic change in base commission and fee revenues, supplemental revenues and contingent revenues excludes the first twelve months of such revenues generated from acquisitions and such revenues related to divested operations in each year presented. These revenues are excluded from organic revenues in order to help interested persons analyze the revenue growth associated with the operations that were a part of our business in both the current and prior year. In addition, organic change in base commission and fee revenues, supplemental revenues and contingent revenues exclude the period-over-period impact of foreign currency translation. For the risk management segment, organic change in fee revenues excludes the first twelve months of fee revenues generated from acquisitions and the fee revenues related to operations disposed of in each year presented. In addition, change in organic growth excludes the period-over-period impact of foreign currency translation to improve the comparability of our results between periods by eliminating the impact of the items that have a high degree of variability, or are due to the limited-time nature of these revenue sources.
measure allows readers of our financial statements to measure, analyze and compare the growth from our brokerage and risk management segments in a meaningful and consistent manner.
- A portion of our brokerage business includes the development and management of “micro-captives,” through operations we acquired in 2010 in our acquisition of the assets of Tribeca Strategic Advisors (which we refer to as Tribeca). A “captive” is an underwriting enterprise that insures the risks of its owner, affiliates or a group of companies. Micro-captives are captive underwriting enterprises that are subject to taxation only on net investment income under IRC Section 831(b). Our micro-captive advisory services are under investigation by the Internal Revenue Service (which we refer to as IRS). Additionally, the IRS has initiated audits for the 2012 tax year, and subsequent tax years, of over 100 of the micro-captive underwriting enterprises organized and/or managed by us. Among other matters, the IRS is investigating whether we have been acting as a tax shelter promoter in connection with these operations. While the IRS has not made specific allegations relating to our operations or the pre-acquisition
activities of Tribeca, an adverse determination could subject us to penalties and negatively affect our defense of the class action lawsuit described below. We may also experience lost earnings due to the negative effect of an extended IRS investigation. From 2017 to 2019, our micro-captive operations contributed less than $2.9 million of net earnings and less than $4.5 million of EBITDAC to our consolidated results in any one year. Due to the fact that the IRS has not made any allegation against us, or completed all of its audits of our clients, we are not able to reasonably estimate the amount of any potential loss in connection with this investigation.
On December 7, 2018, a class action lawsuit was filed against us, our subsidiary Artex Risk Solutions, Inc. (which we refer to as Artex) and other defendants including Tribeca, in the Unites States District Court for the District of Arizona. The named plaintiffs are micro-captive clients of Artex or Tribeca and their related entities and owners who had IRC Section 831(b) tax benefits disallowed by the IRS. The complaint attempts to state various causes of action and alleges that the defendants defrauded the plaintiffs by marketing and managing micro-captives with the knowledge that the captives did not constitute bona fide
- The aggregate increase in base commissions and fees for 2019 was due to revenues associated with acquisitions that were made during 2019 and 2018 ($382.8 million) and organic revenue growth. Commissions and fees in 2019 included new business production and renewal rate increases of $486.6 million, which was offset by lost business of $353.8 million. The aggregate increase in base commissions and fees for 2018 was due to revenues associated with acquisitions that were made during 2018 and 2017 ($200.4 million) and organic revenue growth. Commissions and fees in 2018 included new business production and renewal rate increases of $456.6 million, which was offset by lost business of $273.9 million. The aggregate increase in commissions and fees for 2017 was due to revenues associated with acquisitions that were made during 2017 and 2016 ($169.6 million) and organic revenue growth. Commissions and fees in 2017 included new business production of $378.9 million, which was offset by lost business and renewal rate decreases of $264.3 million. Commission revenues increased 14% and fee revenues increased 12% in 2019 compared to 2018, respectively. The organic change in base commission and fee revenues was 6% in 2019 and 5% in 2018.
- This primarily represents (1) interest income earned on cash, cash equivalents and restricted funds and interest income from premium financing and (2) net gains related to divestitures and sales of books of business, which were $75.3 million, $10.2 million and $3.4 million in 2019, 2018 and 2017, respectively. During 2019, we recognized a one-time,
compensation payments and increases in incentive compensation linked to our overall operating results ($243.7 million in the aggregate), increases in employee benefits expense - $34.2 million, acquisition integration expense - $9.9 million, severance related costs - $2.9 million, stock compensation expense - $2.9 million, deferred compensation - $2.2 million, acquisition related costs - $2.6 million, temporary staffing - $2.0 million, partially offset by a decrease in earnout related compensation charges - $1.6 million. The increase in employee headcount in 2019 compared to 2018 primarily relates to the addition of employees associated with the acquisitions that we completed in 2019 and new production hires.
The increase in compensation expense in 2018 compared to 2017 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 ($197.1 million in the aggregate), increases in employee benefits expense - $24.4 million, severance related costs - $10.9 million, deferred compensation - $2.4 million, temporary staffing - $1.2 million, partially offset by decreases in stock compensation expense - $0.8 million and earnout related compensation charges - $0.4 million. The increase in employee headcount in 2018 compared to 2017 primarily relates to the addition of employees associated with the acquisitions that we completed in 2018 and new production hires. The increase in severance related costs is due to the elimination or restructuring of approximately 325 positions that took place during 2018.
- The increase in depreciation expense in 2019 compared to 2018 was due primarily to the impact of purchases of furniture, equipment and leasehold improvements related to office expansions and moves, and expenditures related to upgrading computer systems being offset by fixed assets being fully depreciated in 2019. The decrease in depreciation expense in 2018 compared to 2017 was due primarily to the impact of purchases of furniture, equipment and leasehold improvements related to office expansions and moves, and expenditures related to upgrading computer systems being offset by fixed assets being fully depreciated in 2018. Also contributing to the increases in depreciation expense in 2019 was the depreciation expense associated with acquisitions completed in 2019.
- The increases in amortization in 2019 compared to 2018 and 2018 compared to 2017 were due primarily to amortization expense of intangible assets associated with acquisitions completed during these years. Expiration lists, non-compete
agreements and trade names are amortized using the straight-line method over their estimated useful lives (two to fifteen years for expiration lists, three to five years for non-compete
agreements and two to fifteen years for trade names). Based on the results of impairment reviews in 2019, 2018 and 2017, we wrote off $0.1 million, $10.6 million and $6.2 million of amortizable intangible assets related to the brokerage segment acquisitions.
period subsequent to the acquisition date. The fair value of these earnout obligations is based on the present value of the expected future payments to be made to the sellers of the acquired entities in accordance with the provisions outlined in the respective purchase agreements. In determining fair value, we estimate the acquired entity’s future performance using financial projections developed by management for the acquired entity and market participant assumptions that were derived for revenue growth and/or profitability. We estimate future earnout payments using the earnout formula and performance targets specified in each purchase agreement and these financial projections. Subsequent changes in the underlying financial projections or assumptions will cause the estimated earnout obligations to change and such adjustments are recorded in our consolidated statement of earnings when incurred. Increases in the earnout payable obligations will result in the recognition of expense and decreases in the earnout payable obligations will result in the recognition of income.
- We allocate the provision for income taxes to the brokerage segment using local statutory rates. The brokerage segment’s effective tax rate in 2019, 2018 and 2017 was 24.2% (24.7% on a controlling basis), 25.0% (25.3% on a controlling basis) and 34.8% (35.2% on a controlling basis), respectively. In fourth quarter 2017, new tax legislation was enacted in the U.S., which lowered the U.S. corporate tax rate from 35.0% to 21.0% effective January 1, 2018. The impact of the adjustment of our deferred tax asset and liability balances in 2017 to reflect the U.S. rate change on the provision for income taxes in the brokerage segment was immaterial. See the U.S. federal income tax law changes and SEC Staff Accounting Bulletin No. 118 in the Corporate Segment below for an additional discussion of the impact of the U.S. enacted tax legislation, commonly referred to as the Tax Cuts and Jobs Act. We anticipate reporting an effective tax rate of approximately 23.0% to 25.0% in our brokerage segment for the foreseeable future.
- Investment income primarily represents interest income earned on our cash and cash equivalents. Investment income in 2019 increased compared to 2018 primarily due to increases in interest income from our U.S. operations. Investment income in 2018 decreased compared to 2017 primarily due to lower levels of invested assets in 2018.
The increase in compensation expense in 2019 compared to 2018 was primarily due to increased headcount and increases in salaries ($26.0 million in the aggregate), employee benefits - $3.0 million, severance related costs - $1.6 million, stock compensation expense - $1.1 million and deferred compensation - $0.6 million, partially offset by a favorable foreign currency translation - $5.2 million and a decrease in temporary-staffing expense - $1.1 million.
The increase in compensation expense in 2018 compared to 2017 was primarily due to increased headcount and increases in salaries ($36.8 million in the aggregate), severance related costs - $3.4 million, employee benefits - $3.1 million, temporary-staffing expense - $2.4 million and deferred compensation - $0.1 million, partially offset by a favorable foreign currency translation - $1.6 million and a decrease in stock compensation expense - $1.4 million. The increase in severance related costs is due to the elimination or restructuring of approximately 75 positions that took place during 2018.
The increase in operating expense in 2019 compared to 2018 was primarily due to increases in outside consulting fees - $5.4 million, technology expenses - $4.1 million, meeting and client entertainment expense - $2.4 million, lease termination related charges - $1.6 million, other expense - $1.1 million, licenses and fees - $0.9 million, real estate expense - $0.7 million, business insurance - $0.6 million, partially offset by decreases in professional and banking fees - $4.6 million, office supplies - $1.2 million, employee expense - $0.2 million and bad debt expense - $0.2 million.
- The change in expense from the change in estimated acquisition earnout payables in 2019 compared to 2018 and 2018 compared to 2017, were due primarily to adjustments made in 2019, 2018 and 2017 to the estimated fair value of an earnout obligation related to revised projections of future performance. During 2019, 2018 and 2017, we recognized $0.8 million, $1.3 million and $0.5 million, respectively, of expense related to the accretion of the discount recorded for earnout obligations in connection with our 2018 and 2017 acquisitions, respectively. During 2019, we recognized $2.4 million of income related to net adjustments in the estimated fair value of earnout obligations related to revised projections of future performance for four acquisitions. During 2018, we recognized $6.0 million of income related to net adjustments in the estimated fair value of earnout obligations related to revised projections of future performance for three acquisitions. During 2017, we recognized $1.1 million of expense related to net adjustments in the estimated fair value of earnout obligations related to revised projections of future performance for two acquisitions.
- We allocate the provision for income taxes to the risk management segment using local statutory rates. The risk management segment’s effective tax rate in 2019, 2018 and 2017 was 25.1%, 26.4% and 38.2%, respectively. In fourth quarter 2017, new tax legislation was enacted in the U.S., which lowered the U.S. corporate tax rate from 35.0% to 21.0% effective January 1, 2018. The impact of the adjustment of our deferred tax asset and liability balances in 2017 to reflect the U.S. rate change on the provision for income taxes in the brokerage segment was immaterial. See the U.S. federal income tax law changes and SEC Staff Accounting Bulletin No. 118 in the Corporate Segment below for an additional discussion of the impact of the U.S. enacted tax legislation commonly referred to as the Tax Cuts and Jobs Act. We anticipate reporting an effective tax rate on adjusted results of approximately 24.0% to 26.0% in our risk management segment for the foreseeable future.
The corporate segment reports the financial information related to our clean energy and other investments, our debt, certain corporate and acquisition-related activities and the impact of foreign currency translation. See Note 14 to our 2019 consolidated financial statements for a summary of our investments at December 31, 2019 and 2018 and a detailed discussion of the nature of these investments. See Note 8 to our 2019 consolidated financial statements for a summary of our debt at December 31, 2019 and 2018.
Financial information relating to our corporate segment results for 2019, 2018 and 2017 (in millions, except per share and percentages):
• Revenues from consolidated clean coal production plants represents revenues from the consolidated IRC Section 45 facilities in which we have a majority ownership position and maintain control over the operations at the related facilities.
• Royalty income from clean coal licenses represents revenues related to Chem-Mod
LLC’s licensees. The increase in royalty income in 2018 compared to 2017 was due to increased production of refined coal by Chem-Mod
LLC were $17.5 million, $4.1 million and $2.3 million in 2019, 2018 and 2017, respectively. These expenses are included in the operating expenses discussed below. In 2019, Chem-Mod
• Loss from unconsolidated clean coal production plants represents our equity portion of the pretax operating results from the unconsolidated IRC Section 45 facilities. The production of refined coal generates pretax operating losses.
In 2018, we recorded $0.9 million of gain from our legacy investments.
Operating expense for 2019 includes banking and related fees of $4.7 million, external professional fees and other due diligence costs related to 2019 acquisitions of $17.4 million, other corporate and clean energy related expenses of $35.8 million, $11.9 million of clean energy related costs as described on pages 47 and 48 (see note 3), corporate related data and branding initiatives of $11.9 million, a net realized loss related to foreign exchange hedge contacts of $3.3 million and a net unrealized foreign exchange remeasurement loss of $2.1 million.
The increase in interest expense in 2019 compared to 2018 and 2018 compared to 2017 was due to the following:
Depreciation expense in 2019 was lower compared to 2018. Depreciation expense in 2018 was flat compared to 2017.
- The amounts reported in this line for 2019, 2018 and 2017 primarily include noncontrolling interest earnings of $29.8 million, $31.7 million and $28.0 million, respectively, related to our investment in Chem-Mod
- On December 22, 2017, the U.S. enacted tax legislation commonly referred to as the Tax Act, which significantly revises the U.S. tax code by, among other things, lowering the corporate income tax rate from 35.0% to 21.0%, limiting the deductibility of interest expense, implementing a territorial tax system and imposing a repatriation tax on earnings of foreign subsidiaries. See discussion of the various impacts of the Tax Act below.
SEC Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act (which we refer to as SAB 118) describes three scenarios associated with a company’s status of accounting for income tax reform. Under the SAB 118 guidance, we made reasonable estimates for certain effects of tax reform in our 2017 consolidated financial statements. We recognized provisional amounts for our deferred income taxes and repatriation tax based on reasonable estimates. As of the date of this Annual Report on Form 10-K,
we have completed our analysis and finalized our estimates under SAB 118. Finalization of the previous estimates under SAB 118 have been recorded as discrete items in 2018.
See Note 19 to our consolidated financial statements for a discussion of our assessment of the impact of the Tax Act.
- The Tax Act repealed the corporate Alternative Minimum Tax (which we refer to as AMT) for years beginning January 1, 2018, and provides that existing AMT credit carryovers will be utilized or refunded beginning in 2018 and ending in 2021, according to a specific formula. We have AMT credit carryovers that are currently reflected as deferred tax assets in the December 31, 2019 consolidated balance sheet, which we expect to be fully utilized or refunded to us by tax year 2021.
- The Tax Act introduced the U.S. Base Erosion and Anti-Abuse Tax (which we refer to as BEAT), effective January 1, 2018. We have finalized our analysis and determined that our base erosion payments do not exceed the threshold for applicability for the years ended December 31, 2019 and 2018, and we do not currently anticipate any significant long-term impact from the BEAT on our effective income tax rate in future periods.
- Under the Tax Act, the deductibility of “net interest” for a business is limited to 30% of adjusted taxable income. Interest that is disallowed can be carried forward indefinitely. We have evaluated the impact and determined there is no limit on our interest deductibility for federal income tax purposes for the years ended December 31, 2019 and 2018.
- The Tax Act contains provisions that may further limit deductions for entertainment expenses. We determined that our ability to deduct entertainment expenses will be further limited as a result of the Tax Act.
(3) Clean Energy Related Adjustments - During third quarter of 2019, we and/or our 46.5% owned affiliate, Chem-Mod
costs related to implementing a new accounting standard related to how companies recognize revenue, which was effective beginning in January 2018. These charges are included in the table above in the corporate line. A new accounting pronouncement, ASU No. 2016-09,
During the third quarter of 2015, we settled litigation against certain former U.K. executives and their advisors for a pretax gain of $31.0 million ($22.3 million net of costs and taxes in third quarter). Incremental after-tax
expenses that arose in connection with this matter were $8.8 million in 2017.
charges were $7.9 million in 2017. These charges are presented in the corporate segment.
impact of such legislation-principally the partial taxation of foreign earnings, nondeductible executive compensation and entertainment expenses. Under the SEC Staff Accounting Bulletin No. 118 guidance, in our December 31, 2017 consolidated financial statements, we recognized provisional amounts for deferred income taxes and repatriation tax based on reasonable estimates and interpretations of the new tax legislation. The ultimate impact of the new tax legislation did differ from our estimated amounts as of December 31, 2017, due to, among other things, changes in interpretations and assumptions we made, or additional regulatory or accounting guidance that was issued with respect to the new tax legislation. In fourth quarter 2018, the IRS issued clarifying guidance related to the new tax legislation which resulted in us recognizing a tax benefit of $8.9 million in the quarter. Any additional taxes associated with the ongoing impact of the tax legislation had a de minimis impact on our cash taxes paid due to tax credits generated from our clean energy investments.
We have investments in limited liability companies that own 29 clean coal production plants developed by us and five clean coal production plants we purchased from a third party on September 1, 2013. All 34 plants produce refined coal using propriety technologies owned by Chem-Mod
The following table provides a summary of our clean coal plant investments as of December 31, 2019 (in millions):
and relinquish control of the plants, thereby becoming a noncontrolling, minority investor. In any limited liability company where we are a noncontrolling, minority investor, the membership agreement for the operations contains provisions that preclude an individual member from being able to make major decisions that would denote control. As of any future date we become a noncontrolling, minority investor, we would deconsolidate the entity and subsequently account for the investment using equity method accounting.
We currently have no construction commitments related to our refined coal plants.
(1) The IRS will not release the factors for 2020 until April or May 2020. Based on our analysis of the factors used in the IRS’ phase out calculations, it is our belief that there will be no phase out in 2020.
See the risk factors regarding our IRC Section 45 investments under Item 1A, “Risk Factors.” for a more detailed discussion of these and other factors could impact the information above. See Note 14 to our 2019 consolidated financial statements for more information regarding risks and uncertainties related to these investments.
Liquidity describes the ability of a company to generate sufficient cash flows to meet the cash requirements of its business operations. The insurance brokerage industry is not capital intensive. Historically, our capital requirements have primarily included dividend payments on our common stock, repurchases of our common stock, funding of our investments, acquisitions of brokerage and risk management operations and capital expenditures.
Historically, we have depended on our ability to generate positive cash flow from operations to meet a substantial portion of our cash requirements. We believe that our cash flows from operations and borrowings under our Credit Agreement will provide us with adequate resources to meet our liquidity needs in the foreseeable future. To fund acquisitions made during 2019, 2018 and 2017, we relied on a combination of net cash flows from operations, proceeds from borrowings under our Credit Agreement, proceeds from issuances of senior unsecured notes and issuances of our common stock.
Cash provided by operating activities was $1,119.2 million, $765.1 million and $854.2 million for 2019, 2018 and 2017, respectively. The increase in cash provided by operating activities in 2019 compared to 2018 was due to the following items: decreases in 2019 compared to 2018 of $48.0 million of payments on acquisition earnouts in excess of original estimates, $45.9 million of income tax payments and $30.0 million discretionary contribution made to our defined benefit plan in 2018. Also contributing to the increase in cash provided by operating activities in 2019 compared to 2018 were timing differences between years in the collection of receivables and direct bill revenues, and the payment of accrued liabilities. The decrease in cash provided by operating activities in 2018 compared to 2017 was due to the following items: $30.0 million discretionary contribution made to our defined benefit plan in 2018, and increases in 2018 compared to 2017 of $14.3 million of severance related payments, $9.4 million of prepaid marketing costs, and $6.7 million of payments on acquisition earnouts in excess of original estimates. Also contributing to the decrease in cash provided by operating activities in 2018 compared to 2017 were timing differences between years in the collection of receivables related to accrued supplemental, contingent and direct bill revenues, and income taxes.
Our cash flows from operating activities are primarily derived from our earnings from operations, as adjusted, for our non-cash
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 2019, 2018 and 2017 plan years. Funding requirements are 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 2018 we made a $30.0 million discretionary contribution to the plan in order to minimize the potential impact of having to make required minimum contributions to the plan in future periods. During 2019 and 2017 we did not make discretionary contributions to the plan.
See Note 13 to our 2019 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.
financing note from Rolling Meadows, Illinois and an Illinois state EDGE tax credit. Incentives from these two programs could total between $60.0 million and $90.0 million over a fifteen-year period. The net capital expenditures in 2017 primarily related to capitalized costs associated with expenditures on the implementation of new accounting and financial reporting systems and several other system initiatives that occurred in 2017. In 2020, we expect total expenditures for capital improvements to be approximately $146.0 million, part of which is related to expenditures on office moves and expansions and updating computer systems and equipment.
- Cash paid for acquisitions, net of cash and restricted cash acquired, was $1,266.8 million, $784.8 million and $376.1 million in 2019, 2018 and 2017, respectively. The increased use of cash for acquisitions in 2019 compared to 2018 was primarily due to an increase in the number and size of acquisitions in 2019 than occurred in 2018. The increased use of cash for acquisitions in 2018 compared to 2017 was primarily due to an increase in the number and size of acquisitions in 2018 than occurred in 2017 and we used less of our common stock to fund acquisitions in 2018. In addition, during 2019, 2018 and 2017 we issued 1.9 million shares ($166.1 million), 0.8 million shares ($60.8 million) and 1.0 million shares ($59.6 million), respectively, of our common stock as payment for a portion of the total consideration paid for acquisitions and earnout payments. We completed 49, 48 and 39 acquisitions in 2019, 2018 and 2017, respectively. Annualized revenues of businesses acquired in 2019, 2018 and 2017 totaled approximately $468.2 million, $339.8 million and $172.3 million, respectively. In 2020, we expect to use new debt, our Credit Agreement, cash from operations and our common stock to fund all, or a portion of acquisitions we complete.
gains of $75.3 million, $10.2 million and $3.4 million, respectively. We received cash proceeds of $81.0 million, $14.5 million and $3.2 million, respectively, related to these transactions.
On January 8, 2019, we sold a travel insurance brokerage operation that was initially purchased in 2014. In first quarter 2019, we recognized a one-time,
interest rate hedging transactions related to this private placement. We realized a net cash loss of approximately $1.2 million on the hedging transactions that will be recognized on a pro rata basis as an increase in our reported interest expense over the life of the debt.
• $40.0 million of 5.29% senior notes due in 2034; and
interest rate hedging transactions related to this private placements. We realized a net cash loss of approximately $8.9 million on the hedging transactions that will be recognized on a pro rata basis as an increase to our reported interest expense over ten years.
On June 13, 2018, we closed and funded offerings of $500.0 million aggregate principal amount of private placement senior unsecured notes (both fixed and floating rate), which was used in part to fund the $50.0 million June 24, 2018 Series K notes maturity. The weighted average maturity of the $450.0 million of senior fixed rate notes is 13.6 years and their weighted average interest rate is 4.42% after giving effect to net hedging gains. The interest rate on the $50.0 million of floating rate notes would be 3.14% using three-month LIBOR on February 3, 2020. In 2017 and 2018, we entered into pre-issuance
On June 13, 2017, we completed a $648.0 million aggregate principal amount of private placement senior unsecured notes (both fixed and floating rate). We funded $250.0 million on June 27, 2017, $300.0 million on August 2, 2017 and $98.0 million on August 4, 2017, which was used in part to fund the $300.0 million August 3, 2017 Series B notes maturity. The weighted average maturity of the $598.0 million of senior fixed rate notes is 11.6 years and their weighted average interest rate is 4.04% after giving effect to hedging gains. The interest rate on the $50.0 million of floating rate notes would be 3.39% using three-month LIBOR on February 3, 2020. In 2016 and 2017, we entered into pre-issuance
In 2019, we declared $323.9 million in cash dividends on our common stock, or $1.72 per common share. On December 20, 2019, we paid a fourth quarter dividend of $0.43 per common share to shareholders of record as of December 6, 2019. On January 29, 2020, we announced a quarterly dividend for first quarter 2020 of $0.45 per common share. If the dividend is maintained at $0.45 per common share throughout 2020, this dividend level would result in an annualized net cash used by financing activities in 2020 of approximately $338.4 million (based on the outstanding shares as of December 31, 2019), or an anticipated increase in cash used of approximately $17.3 million compared to 2019. We can make no assurances regarding the amount of any future dividend payments.
with the SEC, registering the offer and sale from time to time, of an indeterminate amount of our common stock. The availability of the potential liquidity under this shelf registration statement depends on investor demand, market conditions and other factors. We make no assurances regarding when, or if, we will issue any shares under this registration statement. On November 15, 2016, we also filed a shelf registration statement on Form S-4
- We have in place a common stock repurchase plan approved by our board of directors. During the year ended December 31, 2019, we did not repurchase shares of our common stock. During the year ended December 31, 2018, we repurchased 0.1 million shares of our common stock at cost of $11.3 million. During the year ended December 31, 2017, we repurchased 0.3 million shares of our common stock at cost of $17.7 million. Under the provisions of the repurchase plan, we are authorized to repurchase approximately 7.3 million additional shares at December 31, 2019. The plan authorizes the repurchase of our common stock at such times and prices as we may deem advantageous, in transactions on the open market or in privately negotiated transactions. We are under no commitment or obligation to repurchase any particular number of shares, and the plan may be suspended at any time at our discretion. Funding for share repurchases may come from a variety of sources, including cash from operations, short-term or long-term borrowings under our Credit Agreement or other sources.
directors are eligible to receive awards under the LTIP. Awards which may be granted under the LTIP include non-qualified
In connection with our investing and operating activities, we have entered into certain contractual obligations and commitments. See Notes 8, 14 and 17 to our 2019 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 our note purchase agreements and Credit Agreement, operating leases and purchase commitments as of December 31, 2019 are as follows (in millions):
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, 2019, we are unable to make reasonably reliable estimates of the period in which cash settlements may be made with the respective taxing authorities. Therefore, $11.5 million of unrecognized tax benefits have been excluded from the contractual obligations table above. See Note 19 to our 2019 consolidated financial statements for a discussion on income taxes.
See Note 8 to our 2019 consolidated financial statements for a discussion of the terms of the Credit Agreement and note purchase agreements.
- Our total unrecorded commitments associated with outstanding letters of credit, financial guarantees and funding commitments as of December 31, 2019 are as follows (in millions):
Sheet Debt section below for a discussion of other letters of credit. All but one of the letters of credit represent multiple year commitments that have annual, automatic renewing provisions and are classified by the latest commitment date.
Since January 1, 2002, we have acquired 556 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 2016 to 2019 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 operating results of the acquired entities over a two-
- 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, 2019 and 2018 that was recourse to us.
Arthur J. Gallagher & Co. and its subsidiaries, collectively referred to herein as we, our, us or the company, provide insurance brokerage, consulting and third party claims settlement and administration services to both domestic and international entities through three reportable operating segments. Our brokers, agents and administrators act as intermediaries between underwriting enterprises and our clients.
public entities, and, to a lesser extent, individuals, in the areas of insurance placement, risk of loss management, and management of employer sponsored benefit programs. Our risk management segment operations provide contract claim settlement, claim administration, loss control services and risk management consulting for commercial, not-for-profit,
captive and public entities, and various other organizations that choose to self-insure property/casualty coverages or choose to use a third-party claims management organization rather than the claim services provided by underwriting enterprises. The corporate segment reports the financial information related to our debt and other corporate costs, clean energy investments, external acquisition-related expenses and the impact of foreign currency translation. Clean energy investments consist of our investments in limited liability companies that own 34 commercial clean coal production facilities producing refined coal using Chem-Mod LLC’s proprietary technologies. We believe these operations produce refined coal that qualifies for tax credits under IRC Section 45.
Whether we are paid a commission or a fee, the vast majority of our services are associated with the placement of an insurance (or insurance-like) contract. Accordingly, we recognize approximately 80% of our commission and fee revenues on the effective date of the underlying insurance contract. The amount of revenue we recognize is based on our costs to provide our services up and through that effective date, including an appropriate estimate of our profit margin on a portfolio basis (a practical expedient as defined in Topic 606). Based on the proportion of additional services we provide in each period after the effective date of the insurance contract, including an appropriate estimate of our profit margin, we recognize approximately 15% of our commission and fee revenues in the first three months, and the remaining 5% thereafter. These periods may be different than the underlying premium payment patterns of the insurance contracts, but the vast majority of our services are fully provided within one year of the insurance contract effective date.
For consulting and advisory services, we recognize our revenue in the period in which we provide the service or advice. For management and administrative services, our revenue is recognized ratably over the contract period consistent with the performance of our obligations, mostly over an annual term.
basis where available. In certain cases, it is impractical to assess a very large number of smaller contingent revenue contracts, so we use a historical portfolio estimate in aggregate (a practical expedient as defined in Topic 606). Because our expectation of the ultimate contingent revenue amounts to be earned can vary from period to period, especially in contracts sensitive to loss ratios, our estimates might change significantly from quarter to quarter. For example, in circumstances where our revenues are dependent on a full calendar year loss ratio, adverse loss experience in the fourth quarter could not only negate revenue earnings in the fourth quarter, but also trigger the need to reverse revenues previously recognized during the prior quarters. Variable consideration is recognized when we conclude, based on all the facts and information available at the reporting date, that it is probable that a significant revenue reversal will not occur in future periods.
costs are excluded from our gross revenues in our determination of total revenues. Sub-brokerage
related to the placement of certain business by our brokerage segment operations. We recognize this contra revenue in the same manner as the commission revenue to which it relates.
Where we operate under a contract with our fee established on a per-claim
Certain clients pay us additional fee revenues for our efficiency in managing claims or on the basis of claim outcome effectiveness. These amounts are in excess of the fee revenues discussed above. These revenues are variable, generally based on performance metrics set forth in the underlying contracts. We generally operate under multi-year contracts with fiscal year measurement periods. We do not receive these fees, if earned, until the following year after verification of the performance metrics outlined in the contracts. Each period we base our estimates on a contract-by-contract
(i) Costs to obtain - we incur costs to obtain a contract with a client. Those costs would not have been incurred if the contract had not been obtained. Almost all of our costs to obtain are incurred prior to, or on, the effective date of the contract and consist primarily of incentive compensation we pay to our production employees. Our costs to obtain are expensed as incurred as described in Note 4
Investment income primarily includes interest and dividend income (including interest income from our premium financing operations), which is accrued as it is earned. Net gains on divestitures 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 losses related to our equity portion of the pretax results of the clean coal production plants.
In our capacity as an insurance broker, we collect premiums from insureds and, after deducting our commissions and/or fees, remit these premiums to underwriting enterprises. We hold unremitted insurance premiums in a fiduciary capacity until we disburse them, and the use of such funds is restricted by laws in certain states and foreign jurisdictions in which our subsidiaries operate. Various state and foreign agencies regulate insurance brokers and provide specific requirements that limit the type of investments that may be made with such funds. Accordingly, we invest these funds in cash and U.S. Treasury fund accounts. We can earn interest income on these unremitted funds, which is included in investment income in the accompanying consolidated statement of earnings. These unremitted amounts are reported as restricted cash in the accompanying consolidated balance sheet, with the related liability reported as premiums payable to underwriting enterprises. Additionally, several of our foreign subsidiaries are required by various foreign agencies to meet certain liquidity and solvency requirements. We were in compliance with these requirements at December 31, 2019.
for trade names), while goodwill is not subject to amortization. The establishment of goodwill, expiration lists, non-compete
agreements and trade names and the determination of estimated useful lives are primarily based on valuations we receive from qualified independent appraisers. The calculations of these amounts are based on estimates and assumptions using historical and projected financial information and recognized valuation methods. Different estimates or assumptions could produce different results. We carry intangible assets at cost, less accumulated amortization, in the accompanying consolidated balance sheet.
Our tax rate reflects the statutory tax rates applicable to our taxable earnings and tax planning in the various jurisdictions in which we operate. Significant judgment is required in determining the annual effective tax rate and in evaluating uncertain tax positions. We report a liability for unrecognized tax benefits resulting from uncertain tax positions taken or expected to be taken in our tax return. We evaluate our tax positions using a two-step
process. The first step involves recognition. We determine whether it is more likely than not that a tax position will be sustained upon tax examination based solely on the technical merits of the position. The technical merits of a tax position are derived from both statutory and judicial authority (legislation and statutes, legislative intent, regulations, rulings and case law) and their applicability to the facts and circumstances of the position. If a tax position does not meet the “more likely than not” recognition threshold, we do not recognize the benefit of that position in the financial statements. The second step is measurement. A tax position that meets the “more likely than not” recognition threshold is measured to determine the amount of benefit to recognize in the financial statements. The tax position is measured as the largest amount of benefit that has a likelihood of greater than 50% of being realized upon ultimate resolution with a taxing authority.
• Level 1 - Valuations are based on unadjusted quoted prices in active markets for identical financial instruments;
• Level 3 - Valuations are based on pricing or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement of the financial instrument. Such inputs may reflect management’s own assumptions about the assumptions a market participant would use in pricing the financial instrument.
to these consolidated financial statements for the fair values related to the establishment of intangible assets and the establishment and adjustment of earnout payables. See Note 8 to these consolidated financial statements for the fair values related to borrowings outstanding at December 31, 2019 and 2018 under our debt agreements. See Note 13 to these consolidated financial statements for the fair values related to investments at December 31, 2019 and 2018 under our defined benefit pension plan.
million on January 1, 2016. The impact of the adoption of the new guidance resulted in changes to our accounting policies for revenue recognition, trade and other receivables, and deferred revenues as detailed in Note 4
to these consolidated financial statements. In implementing the full retrospective method of adoption, we applied the practical expedient, as defined in Topic 606, of using the benefit of hindsight to recognize contingent revenues (i.e., variable consideration) in 2017 and 2016.
assets and lease liabilities on its balance sheet and disclose key information about leasing arrangements. Topic 842 was subsequently amended by various standards, including ASU No. 2018-10,
Targeted Improvements. This new guidance offers specific accounting guidance for a lessee, a lessor and sale and leaseback transactions. Lessees and lessors are required to disclose qualitative and quantitative information about leasing arrangements to enable a user of the financial statements to assess the amount, timing and uncertainty of cash flows arising from leases. This new guidance is effective for first quarter 2019, and requires a modified retrospective adoption, applying the new standard to all leases existing at the date of initial application, with early adoption permitted. An entity may choose to use the standard’s effective date, rather than the beginning of the earliest comparative period presented, as the date of initial application. An entity would record the effects of initially applying the new guidance as a cumulative-effect adjustment to retained earnings. Consequently, an entity’s reporting for the comparative periods presented in the year of adoption would continue to be in accordance with the current guidance, including the current disclosure requirements.
assets are amortized to expense, and the discount amount related to lease liabilities is accreted to expense, over the lease term. The amortization of the right-of-use
Business Combinations (Topic 805): Clarifying the Definition of a Business. The new guidance clarifies the definition of a business with the objective of adding information to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The definition of a business affects many areas of accounting including acquisitions, disposals, goodwill and consolidation. The new guidance was effective for annual periods beginning after December 15, 2017, including interim periods within those periods, which we adopted effective January 1, 2018. The adoption of this new guidance did not have a material impact on our consolidated financial statements.
Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement. This new guidance modifies various disclosure requirements for fair value measurements, including in certain part those related to Level 3 fair value measurements. The new guidance is effective January 1, 2020, with early adoption permitted. Certain portions of the guidance must be adopted prospectively while others must be adopted retrospectively to all periods presented.
Disclosure Framework - Changes to the Disclosure Requirements for Defined Benefit Plans. This new guidance modifies various disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans. The new guidance is effective January 1, 2020, with early adoption permitted. Retrospective adoption is required. We do not expect adoption of either standard will have a material impact on our consolidated financial statements.
0.2 million that reduced accumulated other comprehensive income with a corresponding adjustment that increased retained earnings. See Note
Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. The new guidance eliminates Step 2 of the goodwill impairment test. Instead, the updated guidance requires an entity to perform its annual or interim goodwill impairment test by comparing the fair value of the reporting unit to its carrying value, and recognizing a non-cash
Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. This new accounting guidance requires deferral of certain implementation costs associated with a cloud computing arrangement, or hosting arrangement, thereby aligning deferral of such costs with implementation costs associated with developing internal-use
The fair value of these earnout obligations is based on the present value of the expected future payments to be made to the sellers of the acquired entities in accordance with the provisions outlined in the respective purchase agreements, which is a Level 3 fair value measurement. In determining fair value, we estimated the acquired entity’s future performance using financial projections developed by management for the acquired entity and market participant assumptions that were derived for revenue growth
and/or profitability. Revenue growth rates generally ranged from 4.5% to 20.0% for our 2019 acquisitions. We estimated future
payments using the earnout formula and performance targets specified in each purchase agreement and these financial projections. We then discounted these payments to present value using a risk-adjusted rate that takes into consideration market-based
Among other things, these acquisitions allow us to expand into desirable geographic locations, further extend our presence in the retail and wholesale insurance brokerage services and risk management industries and increase the volume of general services currently provided. The excess of the purchase price over the estimated fair value of the tangible net assets acquired at the acquisition date was allocated to goodwill, expiration lists, non-compete
agreements and trade names in the amounts of $975.7 million, $841.3 million, $11.7 million and $4.0 million, respectively, within the brokerage and risk management segments.
acquisitions, respectively, for which valuations were performed in 2019. We estimate the fair value as the present value of the benefits anticipated from ownership of
the subject customer list in excess of returns required on the investment in contributory assets necessary to realize those benefits.
acquisitions, for which a valuation was performed. The fair value of non-compete
agreements and trade names related to our acquisitions are amortized using the straight-line method over their estimated useful lives (one to fifteen years for expiration lists, one to six years for non-compete
Remaining performance obligations represent the portion of the contract price for which work has not been performed. As of December 31, 2019, the aggregate amount of the contract price allocated to remaining performance obligations was $503.8 million.
We capitalize costs incurred to fulfill contracts as “deferred contract costs” which are included in other current assets in our consolidated balance sheet. Deferred contract costs were $98.3 million and $91.6 million as of December 31, 2019 and 2018, respectively. Capitalized fulfillment costs are amortized on the contract effective date. The amount of amortization of the deferred contract costs was $355.9 million and $309.7 million for the year ended December 31, 2019, and 2018, respectively.
The amounts in work in process in the table above primarily are for capitalized expenditures incurred related to IT development projects in 2019 and 2018.
The carrying amount of goodwill at December 31, 2019 and 2018 allocated by domestic and foreign operations is as follows (in millions):
, we closed and funded offerings of $500.0 million aggregate principal amount of private placement senior unsecured notes (both fixed and floating rate), which was used in part to fund the $50.0 million June 24,
• $125.0 million of 4.34% senior notes due in 2028 (4.00% after giving effect to hedging gains);
• $75.0 million of 4.69% senior notes due in 2038; and
, at an interest rate of 1.40% plus three-month LIBOR, calculated quarterly.
interest rate hedging transactions related to this private placement. We realized a net cash loss of approximately $1.2 million on the hedging transactions that will be recognized on a pro rata basis as an increase in our reported interest expense over the life of the debt. We used the proceeds of these offering to repay certain existing indebtedness and fund acquisitions.
As previously disclosed, on January 30, 2020, we closed and funded an offering of $575.0 million aggregate principal amount of fixed rate private placement unsecured senior notes. The weighted average maturity of these notes is 11.7 years and the weighted average interest rate
is 4.23% per annum after giving effect to underwriting costs and the net hedge loss. In 2017 and 2018, we entered into pre-issuance
The note purchase agreements described above contain customary provisions for transactions of this type, including representations and warranties regarding us and our subsidiaries and various financial covenants, including covenants that require us to maintain specified financial ratios. We were in compliance with these covenants as of December 31, 2019. The note purchase agreements also provide customary events of default, generally with corresponding grace periods, including, without limitation, payment defaults with respect to the notes, covenant defaults, cross-defaults to other agreements evidencing our or our subsidiaries’ indebtedness, certain judgments against us or our subsidiaries and events of bankruptcy involving us or our material subsidiaries.
The terms of our Premium Financing Debt Facility include various financial covenants, including covenants that require us to maintain specified financial ratios. We were in compliance with these covenants as of December 31, 2019. The Premium Financing Debt Facility also includes customary provisions for transactions of this type, including events of default, with corresponding grace periods and cross-defaults to other agreements evidencing our indebtedness. Facilities B, C and D are secured by the premium finance receivables of the Australian and New Zealand premium finance subsidiaries.
The aggregate estimated fair value of the $3,923.0 million in debt under the note purchase agreements at December 31, 2019 was $4,254.2 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. The estimated fair value of this debt is based on the income valuation approach, which is a valuation technique that converts future amounts (for example, cash flows or income and expenses) to a single current (that is, discounted) amount. The fair value measurement is determined on the basis of the value indicated by current market expectations about those future amounts. Because our debt issuances generate a measurable income stream for each lender, the income approach was deemed to be an appropriate methodology for valuing the private placement long-term debt. The methodology used calculated the original deal spread at the time of each debt issuance, which was equal to the difference between the yield of each issuance (the coupon rate) and the equivalent benchmark treasury yield at that time. The market spread as of the valuation date was calculated, which is equal to the difference between an index for investment grade insurers and the equivalent benchmark treasury yield today. An implied premium or discount to the par value of each debt issuance based on the difference between the origination deal spread and market as of the valuation date was then calculated. The index we relied on to represent investment graded insurers was the Bloomberg Valuation Services (BVAL) U.S. Insurers BBB index. This index is comprised primarily of insurance brokerage firms and was representative of the industry in which we operate. For the purposes of our analysis, the average BBB rate was assumed to be the appropriate borrowing rate for us. The estimated fair value of the $520.0 million of borrowings outstanding under our Credit Agreement approximate their carrying value due to their short-term duration and variable interest rates. The estimated fair value of the $170.6 million of borrowings outstanding under our Premium Financing Debt Facility approximates their carrying value due to their short-term duration and variable interest rates.
Anti-dilutive stock-based awards of 1.0 million, 1.0 million and 1.3 million shares were outstanding at December 31, 2019, 2018 and 2017, respectively, but were excluded in the computation of the dilutive effect of stock-based awards for the year then ended. These stock-based awards were excluded from the computation because the exercise prices on these stock-based awards were greater than the average market price of our common shares during the respective period, and therefore, would be anti-dilutive to earnings per share under the treasury stock method.
directors are eligible to receive awards under the LTIP. The compensation committee of our board of directors determines the annual number of shares delivered under the LTIP. The LTIP provides for non-qualified
and incentive stock options, stock appreciation rights, restricted stock and restricted stock units, any or all of which may be made contingent upon the achievement of performance criteria.
The maximum number of shares available under the LTIP for restricted stock, restricted stock unit awards and performance unit awards settled with stock (i.e., all awards other than stock options and stock appreciation rights) is 2.8 million as of December 31, 2019.
The LTIP provides for the grant of stock options, which may be either 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.
Upon exercise, the option exercise price may be paid in cash, by the delivery of previously owned shares of our common stock, through a net-exercise
arrangement, or through a broker-assisted cashless exercise arrangement. The compensation committee determines all of the terms relating to the exercise, cancellation or other disposition of an option or stock appreciation right upon a termination of employment, whether by reason of disability, retirement, death or any other reason. Stock option and stock appreciation right awards under the LTIP are non-transferable.
During 2019, 2018 and 2017, we recognized $14.0 million, $13.7 million and $17.3 million, respectively, of compensation expense related to our stock option grants.
Options with respect to 13.2 million shares (less any shares of restricted stock issued under the LTIP - see Note 12 to these consolidated financial statements) were available for grant under the LTIP at December 31, 2019.
The total intrinsic value of options exercised during 2019, 2018 and 2017 amounted to $77.9 million, $54.2 million and $33.7 million, respectively. As of December 31, 2019, we had approximately $28.2 million of total unrecognized compensation expense related to nonvested options. We expect to recognize that cost over a weighted average period of approximately four years.
Other information regarding stock options outstanding and exercisable at December 31, 2019 is summarized as follows (in millions, except exercise price and year data):
plan that generally provides for distributions to certain of our key executives when they reach age 62 (or the one-year anniversary of the date of the grant for participants over the age of 61 as of the grant date) or upon or after their actual retirement. Under the provisions of the DEPP, we typically contribute cash in an amount approved by the compensation committee to a rabbi trust on behalf of the executives participating in the DEPP, and instruct the trustee to acquire a specified number of shares of our common stock on the open market or in privately negotiated transactions based on participant elections. Distributions under the DEPP may not normally be made until the participant reaches age 62 (or the one-year
anniversary of the date of the grant for participants over the age of 61 as of the grant date) and are subject to forfeiture in the event of voluntary termination of employment prior to then. DEPP awards are generally made annually in the first quarter. In addition, we annually make awards under sub-plans of the DEPP for certain production staff, which generally provide for vesting and/or distributions no sooner than five years from the date of awards, although certain awards vest and/or distribute after earlier of fifteen years or the participant reaching age 65
deemed to be invested in shares of our common stock are distributed in the form of our common stock and all other distributions are paid in cash.
In 2019, 2018 and 2017, the compensation committee approved $2.6 million, $0.9 million and $4.0 million, respectively, of awards under the sub-plans
referred to above, which were contributed to the rabbi trust in first quarter 2019, 2018 and 2017, respectively. During 2019, 2018 and 2017, we charged $2.4 million, $2.2 million and $1.9 million, respectively, to compensation expense related to these awards. There was $0.5 million of distributions from the sub-plans
We have a Deferred Cash Participation Plan (which we refer to as the DCPP), which is a non-qualified
million of awards in the aggregate to certain key executives under the DCPP that were contributed to the rabbi trust in the second and third quarters
. During 2019, 2018 and 2017 we charged $5.2 million, $3.0 million and $2.5 million to compensation expense related to these awards. There was $2.5 million and $3.6 million of distributions from the DCPP during 2019 and 2018, respectively. There were no distributions from the DCPP during 2017.
The 2019, 2018 and 2017 restricted stock units vest as follows: 399,900 units granted in first quarter 2019, 420,200 units granted in first quarter 2018 and 477,500 units granted in first quarter 2017 vest in full based on continued employment through March 14, 2024
, respectively, while the other 2019, 2018 and 2017 restricted stock unit awards generally vest in full based on continued employment through the vesting period on the anniversary date of the grant. For certain of our executive officers age 55 or older, restricted stock units awarded in 2019, 2018 and 2017 are not subject to forfeiture upon such officers’ departure from the company after two years
On March 14, 2019, March 15, 2018 and March 16, 2017, pursuant to the LTIP and 2014 LTIP, the compensation committee approved 73,600, 78,200 and 86,250, respectively of provisional performance unit awards, with an aggregate fair value of $5.8 million, $5.3 million and $4.9 million, respectively, for future grants to our officers and key employees. Each performance unit award was equivalent to the value of one
basis as soon as practicable in 2022, 2021 and 2020, respectively. The 2019, 2018 and 2017 awards are subject to a three-year performance period that begins on January 1, 2019, 2018 and 2017, respectively, and vest on the three-year anniversary of the date of grant (March 14, 2022, March 15, 2021 and March 16, 2020). For certain of our executive officers age 55
On March 14, 2019, pursuant to our Performance Unit Program (which we refer to as the Program), the compensation committee approved provisional cash awards of $16.5 million in the aggregate for future grants to our officers and key employees that are denominated in units (206,800 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 three-year vesting period measured from January 1 of the year of grant. 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 EBITDAC (in 2018 and thereafter) or EBITAC (prior to 2018) 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 2019 provisional award will fully vest based on continuous employment through January 1, 2022. The ultimate award value will be equal to the trailing twelve-month price of our common stock on December 31, 2021, multiplied by the number of units subject to the award, but limited to between 0.5
On March 15, 2018, pursuant to the Program, the compensation committee approved provisional cash awards of $15.0 million in the aggregate for future grants to our officers and key employees that are denominated in units (219,000 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. Terms of the 2018 provisional award were similar to the terms of the 2019 provisional awards. Based on our performance for 2018, we granted 190,000 units under the Program in first quarter 2019 that will fully vest on January 1, 2021. During 2019, we charged $8.9 million to compensation expense related to these awards. We did not recognize any compensation expense during 2018 related to the 2018 provisional award under the Program.
On March 16, 2017, pursuant to the Program, the compensation committee approved provisional cash awards of $14.3 million in the aggregate for future grants to our officers and key employees that are denominated in units (255,000 units in the aggregate), each of which was equivalent to the value of one share of our common stock on the date the provisional awards were approved. Terms of the 2017 provisional award were similar to the terms of the 2018 provisional awards. Based on our performance for 2017, we granted 242,000 units under the Program in first quarter 2018 that will fully vest on January 1, 2020. During 2019 and 2018, we charged $10.3 million and $8.7 million to compensation expense related to these awards, respectively. We did not recognize any compensation expense during 2017 related to the 2017 provisional award under the Program.
On March 17, 2016, pursuant to the Program, the compensation committee approved provisional cash awards of $17.4 million in the aggregate for future grants to our officers and key employees that are denominated in units (397,000 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. Terms of the 2016 provisional award were similar to the terms of the 2017 provisional awards. Based on our performance for 2016, we granted 385,000 units under the Program in first quarter 2017 that will fully vest on January 1, 2019. During 2018 and 2017, we charged $11.7 million and $10.6 million to compensation expense related to these awards.
On March 11, 2015, pursuant to the Program, the compensation committee approved the provisional cash awards of $14.6 million in the aggregate for future grants to our officers and key employees that are denominated in units (315,000
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 $39.8 million, $34.9 million and $32.0 million in 2019, 2018 and 2017, respectively.
In 1992, we amended our health benefits plan to eliminate retiree coverage, except for retirees and those employees who had already attained a specified age and length of service at the time of the amendment. The retiree health plan is contributory, with contributions adjusted annually, and is funded on a pay-as-you-go
LLC 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
Solution qualifies for refined coal tax credits under IRC Section 45 when used with refined coal production plants placed in service by December 31, 2011 or 2009. Chem-Mod
LLC and therefore consolidate its operations into our consolidated financial statements. At December 31, 2019, total assets and total liabilities of this VIE included in our consolidated balance sheet were $16.3 million and $2.8 million, respectively. At December 31, 2018, total assets and total liabilities of this VIE included in our consolidated balance sheet were $14.0 million and $1.4 million, respectively. For 2019, total revenues and expenses were $81.9 million and $17.5 million, respectively. For 2018, total revenues and expenses were $73.7 million and $4.1 million, respectively. We are under no obligation to fund Chem-Mod’s operations in the future.
Solution in countries other than the U.S. and Canada. Such marketing activity has been limited to date.
C-Quest Technology LLC and C-Quest Technologies International LLC (which we refer to as together, C-Quest) -
At December 31, 2019, we held a noncontrolling 12% interest in C-Quest’s
possesses rights, information and technology for the reduction of carbon dioxide emissions created by burning fossil fuels. Thus far, C-Quest’s
is determined to be a VIE, but we do not consolidate this investment into our consolidated financial statements because we are not the primary beneficiary or decision maker.
housing developments and real estate entities have been determined to be VIEs, but are not required to be consolidated due to our lack of control over their respective operations. At December 31, 2019, total assets and total liabilities of these VIEs were approximately $5.3 million and $0.4 million, respectively.
We have operating leases primarily related to branch facilities, data centers, sales offices, and agent locations, automobiles and office equipment. Many of our leases include both lease (fixed rent payments) and non-lease
components for all leases. Variable lease payments, such as periodically indexed and/or market adjustments, are presented as lease expense in the period in which they are incurred. Since we did not elect the short-term policy election, we record leases of 12 months or less on the balance sheet.
As our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at the lease commencement date in determining the present value of the lease payments. We consider qualitative factors including our derived credit rating, notched adjustments for collateralization, lease term, and, if significant, adjustments to our collateralized rate to borrow in the same currency in which the lease is denominated.
We present all noncash transactions related to adjustments to the lease liability or right-of-
We have not received or pledged any collateral related to derivative arrangements at December 31, 2019.
The notional and fair values of derivatives designated as hedging instruments are as follows at December 31, 2019 and 2018 (in millions):
(1) Included within foreign exchange contracts at December 31, 2019 were $342.0 million of call options offset with $342.0 million of put options, and $12.1 million of buy forwards offset with $43.8 million of sell forwards. Included within foreign exchange contracts at December 31, 2018 were $276.4 million of call options offset with $276.4 million of put options, and $23.1 million of buy forwards offset with $72.9 million of sell forwards.
(1) During 2019, the amount excluded from the assessment of hedge effectiveness for our foreign exchange contracts recognized in accumulated other comprehensive loss were a loss of $0.2 million.
In connection with our investing and operating activities, we have entered into certain contractual obligations and commitments. See Notes 8 and 14 to these 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, Credit Agreement, Premium Financing Debt Facility, operating leases and purchase commitments at December 31, 2019 were as follows (in millions):
Note Purchase Agreements, Credit Agreement and Premium Financing Debt Facility -
financing note from Rolling Meadows and an Illinois state Economic Development for a Growing Economy (which we refer to as EDGE) tax credit. Incentives from these two programs could total between $60.0 million and $90.0 million over a fifteen-year period. We have earned approximately $18.1 million of EDGE credits from inception through December 31, 2019.
Total rent expense, including rent relating to cancelable leases and leases with initial terms of less than one year, amounted to $148.1 million in 2019, $140.0 million in 2018 and $137.7 million in 2017.
Sheet Debt section below for a discussion of other letters of credit. All of the letters of credit represent multiple year commitments that have annual, automatic renewing provisions and are classified by the latest commitment date.
to three-year period subsequent to the acquisition date. The aggregate amount of the maximum earnout obligations related to these acquisitions was $982.9 million, of which $565.0 million was recorded in our consolidated balance sheet as of December 31, 2019 based on the estimated fair value of the expected future payments to be made.
facility, which we use as a placement facility for certain of our insurance brokerage operations. At December 31, 2019, we had posted seven letters of credit totaling $6.3 million to allow certain of our captive operations to meet minimum statutory surplus requirements plus additional collateral related to premium and claim funds held in a fiduciary capacity, one letter of credit totaling $0.9 million for collateral related to claim funds held in a fiduciary capacity by a recent acquisition, and one letter of credit totaling $0.5 million as a security deposit for a 2015 acquisition’s lease. These letters of credit have never been drawn upon.
Our commitments associated with outstanding letters of credit, financial guarantees and funding commitments at December 31, 2019 were as follows (all dollar amounts in table are in millions):
Since commitments may expire unused, the amounts presented in the table above do not necessarily reflect our actual future cash funding requirements.
We are a defendant in various legal actions incidental to the nature of our business including but not limited to 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, investigations and reviews by regulatory and taxing authorities into various matters related to our business, including our operational, compliance and finance functions. Neither the outcomes of these matters nor their effect upon our business, financial condition or results of operations can be determined at this time.
On July 17, 2019, Midwest Energy Emissions Corp. and MES Inc. (which we refer to together as Midwest Energy) filed a patent infringement lawsuit in the United States District Court for the District of Delaware against us, Chem-Mod
A portion of our brokerage business includes the development and management of “micro-captives,” through operations we acquired in 2010 in our acquisition of the assets of Tribeca Strategic Advisors (which we refer to as Tribeca). A “captive” is an underwriting enterprise that insures the risks of its owner, affiliates or a group of companies. Micro-captives are captive underwriting enterprises that are subject to taxation only on net investment income under IRC Section 831(b). Our micro-captive advisory services are under investigation by the IRS. Additionally, the IRS has initiated audits for the 2012 tax year, and subsequent tax years, of over 100
million in EBITDAC to our consolidated results in any one year. Due to the fact that the IRS has not made any allegation against us or completed all of its audits of our clients, we are not able to reasonably estimate the amount of any potential loss in connection with this investigation.
On December 7, 2018, a class action lawsuit was filed against us, our subsidiary Artex Risk Solutions, Inc. (which we refer to as Artex) and other defendants including Tribeca, in the United States District Court for the District of Arizona. The named plaintiffs are micro-captive clients of Artex or Tribeca and their related entities and owners who had IRS Section 831(b) tax benefits disallowed by the IRS. The complaint attempts to state various causes of action and alleges that the defendants defrauded the plaintiffs by marketing and managing micro-captives with the knowledge that the captives did not constitute bona fide
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 $350.0 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, 2019 consolidated balance sheet is above the lower end of the most recently determined actuarial range by $2.4 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.
Between 1996 and 2007, we developed and then sold portions of our ownership in various energy related investments, many of which qualified for tax credits under IRC Section 29. We recorded tax benefits in connection with our ownership in these investments. At December 31, 2019, we had exposure on $108.0 million of previously earned tax credits. Under the Tax Act, we expect that these previously earned tax credits will be refunded for tax years beginning 2018 and ending in 2021, according to a specific formula. In 2004, 2007 and 2009, the IRS examined several of these investments and all examinations were closed without any changes being proposed by the IRS. However, any future adverse tax audits, administrative rulings or judicial decisions could disallow previously claimed tax credits.
We have ownership interests in several underwriting enterprises based in the U.S., Bermuda, Gibraltar, Guernsey, Isle of Man and Malta that primarily operate segregated account “rent-a-captive”
facilities enable our clients to receive the benefits of owning a captive underwriting enterprise without incurring certain disadvantages of ownership. Captive underwriting enterprises, or “rent-a-captive”
facilities, are created for clients to insure their risks and capture any underwriting profit and investment income, which would then be available for use by the insureds, generally to reduce future costs of their insurance programs. In general, these companies are set up as protected cell companies that are comprised of separate cell business units (which we refer to as Captive Cells) and the core regulated company (which we refer to as the Core Company). The Core Company is owned and operated by us and no insurance policies are assumed by the Core Company. All insurance is assumed or written within individual Captive Cells. Only the activity of the supporting Core Company of the rent-a-captive
At December 31, 2019 and 2018, our underwriting enterprise subsidiary had reinsurance recoverables of $45.7 million and $68.5 million, respectively, related to liabilities established for ceded unearned premium reserves and loss and loss adjustment expense reserves. These reinsurance recoverables relate to direct and assumed business that has been fully ceded to our reinsurers or captives and have been included in premiums and fees receivables in the accompanying consolidated balance sheet.
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. Earnings before income taxes in the table below include the impact of intercompany interest expense between domestic and foreign legal entities. Domestic intercompany interest income and offsetting foreign intercompany interest expense were $40.1
million in 2017. Significant components of earnings before income taxes and the provision for income taxes are as follows (in millions):
The total amount of net unrecognized tax benefits that, if recognized, would affect the effective tax rate was $9.4
. 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 for certain foreign intangible assets and various net operating loss carryforwards that may not be utilized in the future.
million at December 31, 2019 and 2018, respectively, of foreign subsidiaries which are considered permanently invested outside of the U.S. The amount of unrecognized deferred tax liability on these undistributed earnings is not expected to be material at December 31, 2019 and 2018. There are only select jurisdictions for which the company regards the undistributed earnings as no longer permanently reinvested. We have recognized the deferred tax liability associated with these undistributed earnings during 2019, however, such liability was also not material. For U.S. federal income tax purposes, we now recognize current income tax expense on undistributed earnings of foreign subsidiaries in accordance with the provisions of the Tax Act
For the year ended December 31, 2017, we have determined that our net deferred tax asset required revaluation as a result of the Tax Act. At that time, we recognized a provisional $1.0
% of foreign corporations must include in their income a one-time
inclusion of all accumulated post 1986 undistributed foreign earnings as of December 31, 2017. We previously recognized a provisional income tax expense of $40.0
million as a result of this repatriation tax. In the 2018 consolidated financial statements, we finalized the repatriation tax by recognizing a benefit of $2.9
- We previously recorded an immaterial provisional benefit based on our intent to fully expense all qualifying expenditures as of December 31, 2017. This resulted in a decrease to our current income taxes payable and a corresponding increase in our deferred tax liability. In our 2018 consolidated financial statements, we finalized the cost recovery analysis with no change to the provision for income taxes.
The following is a reconciliation of our end of period cash, cash equivalents and restricted cash balances as presented in the consolidated statement of cash flows for the years ended December 31, 2019, 2018 and 2017 (in millions):
components of our accumulated comprehensive earnings (loss) attributable to controlling interests consist of the following:
During 2019, 2018 and 2017, $7.0 million, $4.9 million and $5.0 million, respectively, of expense related to the pension liability was reclassified from accumulated other comprehensive loss to compensation expense in the statement of earnings. During 2019, 2018 and 2017, $5.2 million of expense, $5.7 million of income and $5.2 million of expense, respectively, related to the fair value of derivative investments, was reclassified from accumulated other comprehensive loss to the statement of earnings. During 2019, 2018 and 2017, no
Our brokerage segment is primarily comprised of our retail and wholesale insurance brokerage operations. The brokerage segment generates revenues through commissions paid by underwriting enterprises and through fees charged to our clients. Our brokers, agents and administrators act as intermediaries between underwriting enterprises and our clients and we do not assume net underwriting risks.
fee basis. Our risk management segment also provides risk management consulting services that are recognized as the services are delivered.
Financial information relating to our segments for 2019, 2018 and 2017 is as follows (in millions):
We have audited the accompanying consolidated balance sheet of Arthur J. Gallagher & Co. (Gallagher) as of December 31, 2019 and 2018, 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, 2019, and the related notes and the financial statement schedule listed in the Index at Item 15(2)(a) (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated financial position of Gallagher at December 31, 2019 and 2018, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2019, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), Gallagher’s internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework), and our report dated February 7, 2020 expressed an unqualified opinion thereon.
agreements and trade names. Gallagher established these allocations using a third-party valuation firm.
Auditing the accounting for these acquisitions involved a high degree of subjectivity in evaluating management’s estimates. Specifically, the identification and measurement of intangible assets and earnout obligations, as well as the sensitivity of the respective fair values to the underlying significant assumptions. Gallagher, with the assistance of a third-party valuation firm, used the discounted cash flow method to measure the fair value of these intangible assets and earnout obligations. The significant assumptions used to estimate the fair value of the intangible assets and earnout obligations included discount rates, estimated useful lives, revenue growth rates, attrition rates, projected profit margins and the expected rate of return. These assumptions are forward-looking and could be affected by future economic and market conditions.
To test the estimated fair value of the acquisitions noted above, our audit procedures were performed with the assistance of our valuation specialists and included, among other things, an evaluation of (1) the identification of intangible assets, such as acquired customer lists, trade names and noncompetition agreements against the terms of the purchase agreements, (2) the fair value measurement of earnout obligations, specifically the terms of the arrangements and the conditions that must be met for the arrangements to become payable, as noted in the agreements; and (3) the significant assumptions, including discount rates, estimated useful lives, revenue growth rates, attrition rates, projected profit margins and the expected rate of return, used in valuing these intangibles. Specifically, when evaluating the noted assumptions, we compared the assumptions to the historical results of the acquired company, past performance of similar acquisitions, Gallagher’s history related to similar acquisitions, and current market conditions.
As described in Note 1 to the financial statements, Gallagher accounts for its brokerage and risk management revenue transactions by deferring a portion of the revenue to reflect delivery of services over the contract period. Total deferred revenue as of December 31, 2019 was $337.1 million and $166.6 million, for the brokerage and risk management segments, respectively, which represents the remaining performance obligations under contracts Gallagher has with its customers.
We obtained an understanding of Gallagher’s key revenue recognition processes and tested the design and operating effectiveness of revenue recognition controls, including controls over management’s review of the significant revenue deferral assumptions. We also tested controls over the completeness and accuracy of the inputs used in the determination of the estimated deferred revenue, including reconciliation controls.
issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework).
In conducting our assessment of the effectiveness of its internal control over financial reporting, we have excluded 26 of the 49 entities acquired in 2019, which are included in our 2019 consolidated financial statements. Collectively, these acquired entities constituted approximately 0.8% of total assets as of December 31, 2019, approximately 1.9% of total revenues, and approximately 3.6% of net earnings for the year then ended.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheet as of December 31, 2019 and 2018, 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, 2019, and the related notes and the financial statement schedule listed in the Index at Item 15(2)(a) (collectively referred to as the “consolidated financial statements”) of Gallagher and our report dated February 7, 2020 expressed an unqualified opinion thereon.