Commission revenues increased by $14.3 million or 4% in 1999. This increase, generated by the Insurance Brokerage Services segment, is the result of new business production partially offset by lost business. Commission revenues increased by $22.9 million or 7% in 1998. This increase is the result of new business production partially offset by lost business.
Fee revenues increased by $22.6 million or 11% in 1999. This increase, generated primarily from the Risk Management Services segment, resulted from strong new business production of $42.3 million and favorable retention rates on existing business partially offset by lost business of $22.7 million. Fee revenues increased by $27.1 million or 15% in 1998. This increase, also generated primarily from Risk Management Services, resulted from new business production of $39.0 million and favorable retention rates on existing business partially offset by lost business of $14.5 million.
Investment income and other increased by $9.3 million or 49% in 1999. This increase is due primarily to higher returns on funds invested with outside fund managers which were positively affected by robust equity markets during 1999 and a gain of $3.0 million recognized in 1999 which resulted from the sale of a portion of Gallagher's interests in limited partnerships that operate qualified affordable housing projects. In 1998, investment income and other decreased $6.0 million or 24% due primarily to lower returns on funds invested with outside fund managers which were adversely affected by volatility in global equity markets during 1998. In addition, Gallagher liquidated a portion of its investment portfolio, thereby reducing the aggregate value of these portfolios by $24.0 million during 1998.
Gallagher's revenues vary from quarter to quarter generally as a result of the timing of policy inception dates which traditionally are heaviest in the third quarter. Expenses, on the other hand, are fairly uniform throughout the year. See Note 12 to the Consolidated Financial Statements.
As discussed in Note 13 to the Consolidated Financial Statements, Gallagher has three operating business segments; Insurance Brokerage Services, Risk Management Services and Financial Services, as well as a Corporate segment.
The Insurance Brokerage Services segment includes Gallagher's retail, reinsurance and wholesale brokerage operations. Total revenues in 1999 were $397.7 million, a 4% increase over 1998. This increase is due primarily to new business production offset by lost business. United States revenues of $364.5 million were up 4% over 1998. Revenues in 1999 from foreign operations, principally in the United Kingdom and Bermuda, were up 3% or $855,000 over 1998. Earnings before income taxes in 1999 increased 8% over 1998 principally as a result of increased revenues. Total revenues in 1998 were $381.6 million, an increase of 7% over 1997. This increase again is due to new business production partially offset by lost business. United States revenues of $349.3 million were up 7% over 1997 mainly due to new business partially offset by lost business. Revenues
The Financial Services segment is responsible for Gallagher's diversified investment portfolio which includes investment strategies--trading, marketable securities--available for sale, tax advantaged investments, investments accounted for using the equity method, real estate partnerships and notes receivable from investees. Revenues in 1999 were $19.8 million or 116% more than revenues in 1998 and earnings before income taxes increased $7.2 million or 142% over 1998. These increases are due primarily to more favorable returns on funds invested with outside fund managers and a gain of $3.0 million recognized in 1999 which resulted from the sale of a portion of Gallagher's interests in limited partnerships that operate qualified affordable housing projects. Revenues in 1998 decreased 62% from 1997 and earnings before income taxes in 1998 decreased 77% from 1997. These decreases relate to $9.0 million and $13.8 million of non-recurring gains in revenues and earnings before income taxes, respectively, recognized in 1997 and less favorable returns on funds invested with outside fund managers due to equity market conditions in 1998. Financial Services' revenues are generated principally in the United States.
expanded investment activity. As of December 31, 1999 and 1998, there were no borrowings outstanding under this agreement. The Credit Agreement requires the maintenance of certain financial covenants and Gallagher is in compliance with these covenants.
In 1988, Gallagher adopted a plan that has been extended through June 30, 2000 to repurchase its common stock. Under the plan, Gallagher repurchased 762,000 shares at a cost of $18.4 million, 430,000 shares at a cost of $8.7 million and 1,044,000 shares at a cost of $17.1 million in 1999, 1998 and 1997, respectively. The repurchased shares are held for reissuance in connection with exercises of options under Gallagher's stock option plans. Under the provisions of the plan, Gallagher is authorized to repurchase approximately 1,540,000 additional shares through June 30, 2000. Gallagher is under no commitment or obligation to repurchase any particular amount of common stock and at its discretion may suspend the repurchase plan at any time.
Computer programs that have time sensitive software may have recognized the date "00" as the Year 1900, rather than the Year 2000, which could have resulted in system failures or miscalculations causing disruptions of operations (the "Y2K" problem).
With respect to the Y2K problem, Gallagher completed the necessary modifications or replacements of its existing software so that its computer systems would function properly in the Year 2000 and beyond. Generally, these modifications and replacements and the associated costs were contemplated with normal enhancements and improvements being made in conjunction with updating financial reporting and operating
Premiums collected from insureds but not yet remitted to insurance carriers are restricted as to use by laws in certain states and foreign jurisdictions in which Gallagher's subsidiaries operate. These unremitted amounts are reported as restricted cash in the accompanying consolidated balance sheet, with the related liability reported as premiums payable to insurance companies. Additionally, one of Gallagher's United Kingdom subsidiaries is required by Lloyd's of London to meet certain liquidity requirements.
Marketable securities are considered available for sale and consist primarily of preferred and common stocks. Securities designated as available for sale are carried at fair value in the accompanying consolidated balance sheet, with unrealized gains and losses, less related deferred income taxes, excluded from net earnings and reported as accumulated other comprehensive earnings or loss. Gains and losses are recognized in net earnings when realized using the specific identification method. The fair value for marketable securities is based on quoted market prices.
In 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 133 (SFAS 133), "Accounting for Derivative Instruments and Hedging Activities," which was effective for fiscal years beginning after June 15, 1999. In June 1999, the FASB issued Statement of Financial Accounting Standards No. 137, which amends SFAS 133 to defer the effective date to fiscal years beginning after June 15, 2000. Because of Gallagher's minimal use of derivatives, management does not anticipate that the adoption of SFAS 133 will have a significant effect on Gallagher's consolidated operating results or financial position.
In 1998, the Accounting Standards Executive Committee of the AICPA issued Statement of Position 98-1 (SOP 98-1), "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." SOP 98-1, which has been adopted prospectively as of January 1, 1999, requires the capitalization of certain costs incurred in connection with developing or obtaining internal use software. Prior to the adoption of SOP 98-1, Gallagher expensed all costs related to software developed or obtained for internal use as incurred. The effect of adopting SOP 98-1 was not material to Gallagher's consolidated operating results or financial position.
In 1999, Gallagher acquired substantially all of the net assets of the following insurance brokerage firms in exchange for its common stock: Goodman Insurance Agency, Inc., 315,000 shares; Dodson-Bateman & Company, 295,000 shares; Associated Risk Managers of California, Insurance Producers, dba ARM of California, 198,000 shares; and Sternfels Insurance Agency, Inc., 96,000 shares. In addition, Gallagher acquired substantially all of the net assets of the following benefit consulting firms in 1999 in exchange for its common stock: Group Benefit Concepts, Inc., 91,000 shares; and Stanley E. Clarke & Associates, Inc., 61,000 shares. In 1998, Gallagher acquired substantially all of the net assets of twelve insurance brokerage firms and one benefits consulting company in exchange for 1,362,000 shares of its common stock. These acquisitions were accounted for as poolings of interests and, except for six of the 1998 acquisitions whose results were not significant, the consolidated financial statements for all periods prior to the acquisition dates have been restated to include the operations of these companies.
In 1999, Gallagher acquired substantially all of the net assets of R.W. Thom & Company, Inc., an insurance brokerage firm, in exchange for a cash payment of $250,000. This acquisition was accounted for as a purchase. In 1998, Gallagher acquired substantially all of the net assets of three insurance brokerage firms in exchange for initial cash payments of $1,920,000 and contingent notes payable of $1,600,000. These acquisitions were also accounted for as purchases. These purchase acquisitions were not material to either the 1999 or 1998 consolidated financial statements.
The gross realized gains on sales of marketable securities totaled $1,579,000, $3,054,000, and $2,257,000 for 1999, 1998 and 1997, respectively. The gross realized losses totaled $1,051,000, $1,179,000, and $346,000 for 1999, 1998 and 1997, respectively.
The following is a summary of deferred income taxes and other noncurrent assets (in thousands):
Significant components of investment income and other, including non- recurring gains, are as follows (in thousands):
The components of other comprehensive earnings, including the related income tax effects, consist of the following (in thousands):
Gallagher also has three variable rate line of credit facilities which total $45,000,000 in the aggregate and expire on April 30, 2000. Short-term borrowings under these facilities totaled $15,000,000 at December 31, 1999 and 1998. The weighted average interest rate on the short-term borrowings were 6.1% and 5.9% during 1999 and 1998, respectively.
The table below summarizes certain information about Gallagher's capital stock at December 31, 1999 and 1998 (in thousands, except per share data):
Options to purchase 20,000, 40,000 and 1,288,000 shares of common stock were outstanding during 1999, 1998 and 1997, respectively, but were not included in the computation of the dilutive effect of stock options. These options were excluded from the computation because the options' exercise prices were greater than the average market price of the common shares during the respective year and, therefore, would be antidilutive to earnings per share under the treasury stock method.
All of the aforementioned stock option plans provide for the immediate vesting of all outstanding stock option grants in the event of a change in control of Gallagher. A change in control of Gallagher is defined as the acquisition by a person (or entity) of the beneficial ownership of 50% or more of Gallagher's common stock; the cessation, for any reason, of a majority of directors of Gallagher to serve as directors during any two year period; or the approval by the stockholders of Gallagher of the sale of substantially all of the assets of Gallagher.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models
require the input of highly subjective assumptions including the expected stock price volatility. Because Gallagher's employee and director stock options have characteristics significantly different from those of traded options, and because changes in the selective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee and director stock options.
Other information regarding stock options outstanding and exercisable at December 31, 1999 is summarized as follows (in thousands, except exercise price data):
Gallagher accounts for the defined benefit pension plan in accordance with Statement of Financial Accounting Standards No. 87 (SFAS 87), "Employers' Accounting for Pensions." The difference between the present value of the pension benefit obligation at the date of adoption of SFAS 87 and the fair value of plan assets at that date is being amortized on a straight-line basis over the average remaining service period of employees expected to receive benefits.
Minimum aggregate rental commitments at December 31, 1999 under noncancelable operating leases having an initial term of more than one year are as follows (in thousands):
Quarterly operating results for 1999 and 1998 were as follows (in thousands, except per share data):
Gallagher has identified three operating segments in addition to its corporate operations. Insurance Brokerage Services encompasses operations that, for commission or fee compensation, place or arrange to place insurance directly related to the clients' funding of risk. This segment also provides consulting, for fee compensation, related to clients' risk financing programs. Risk Management Services includes Gallagher's third party administration, loss control and risk management consulting, workers' compensation investigations and insurance property appraisal operations. Third party administration is principally claims management services for Gallagher's clients. Financial Services includes alternative investment strategies and tax advantaged investments. It manages Gallagher's own investment portfolio while expanding these services in conjunction with the insurance products Gallagher markets. Corporate consists primarily of unallocated administrative costs and the provision for income taxes which is not allocated to Gallagher's operating segments.
The management of Arthur J. Gallagher & Co. (Gallagher) is responsible for the preparation and integrity of the consolidated financial statements and the related financial comments appearing in this annual report. The consolidated financial statements were prepared in accordance with accounting principles generally accepted in the United States and include certain amounts based on management's best estimates and judgments. Other financial information presented in this annual report is consistent with the consolidated financial statements.