Elsewhere, we generally operate in leased premises related to the facilities of our brokerage and risk management operations. We prefer to lease office space rather than own real estate related to the branch facilities of our brokerage and risk management segments. Certain of our office space leases have options permitting renewals for additional periods. In addition to minimum fixed rentals, a number of our leases contain annual escalation clauses generally related to increases in an inflation index. See Note 15 to our 2017 consolidated financial statements for information with respect to our lease commitments as of December 31, 2017.
The following selected consolidated financial data for each of the five years in the period ended December 31, 2017 have been derived from our consolidated financial statements. Such data should be read in conjunction with our consolidated financial statements and notes thereto in Item 8 of this annual report.
We are engaged in providing insurance brokerage and consulting, and third party 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 32 other countries and offer client-service capabilities in more than 150 countries globally through a network of correspondent brokers and consultants. In 2017, 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 2017 revenues). We expect that our international revenue as a percentage of our total revenues in 2018 will be comparable to 2017. We have three reportable segments: brokerage, risk management and corporate, which contributed approximately 62%, 13% and 25%, respectively, to 2017 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.
Note 2 to our 2017 consolidated financial statements included in this report contains information regarding the potential impact a new revenue recognition accounting standard could have on our future financial presentation. We will adopt the new standard as of January 1, 2018, using the full retrospective method to restate each prior reporting period presented. We anticipate the cumulative effect of the adoption will be an increase to retained earnings as of January 1, 2016. The primary impacts of the new standard to our segments are anticipated to be as follows:
With respect to the risk management segment, under the new standard, we will record the full amount of claim revenue upon notification of the claim and defer certain revenue to reflect delivery of services over the claim handling period. We anticipate the net impact of the new standard will require more initial revenue deferral and revenue recognition over a longer period of time than under the old accounting standard. We do not expect a material change to annual risk management segment revenue, net earnings and EBITDAC on an absolute basis under the new accounting standard.
In our corporate segment, net after tax earnings from our clean energy investments was $132.7 million and $114.4 million in 2017 and 2016, respectively. Our current estimate of the 2018 annual net after tax earnings, including IRC Section 45 tax credits, which will be produced from all of our clean energy investments in 2018, is $105.0 million to $115.0 million. We expect to use the additional cash flow generated by these earnings to continue our mergers and acquisition strategy in our core brokerage and risk management operations.
The following provides information that management believes is helpful when comparing revenues, net earnings, EBITDAC and diluted net earnings per share for 2017 and 2016. In addition, these tables provide reconciliations to the most comparable GAAP measures for adjusted revenues, adjusted EBITDAC (non-GAAP measure) and adjusted diluted net earnings per share. Reconciliations of EBITDAC for the brokerage and risk management segments are provided on pages 37 and 44 of this filing.
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, risk retention groups and capital market solutions to transfer risk. According to industry estimates, these alternative markets now account for 50% of the total U.S. commercial property/casualty market. Our brokerage units are very active in these markets as well. While increased use by insureds of these alternative markets historically has reduced commission revenue to us, such trends generally have been accompanied by new sales and renewal increases in the areas of risk management, claims management, captive insurance and self-insurance services and related growth in fee revenue. Inflation tends to increase the levels of insured values and risk exposures, resulting in higher overall premiums and higher commissions. However, the impact of hard and soft market fluctuations has historically had a greater impact on changes in premium rates, and therefore on our revenues, than inflationary pressures.
The Council of Insurance Agents & Brokers (which we refer to as the CIAB) fourth quarter 2017 survey had not been issued as of the date of this report. The first three 2017 quarterly surveys indicated that U.S. commercial property/casualty rates decreased by 2.5%, 2.8% and 1.3% on average across all lines, for the first, second and third quarters of 2017, respectively. We expect a similar trend to be noted when the CIAB fourth quarter 2017 survey report is issued, which would signal some stability in the market. In 2018, we see stable U.S. retail property/casualty rates and continued growth in property/casualty exposures. We also see U.S. employment growth and uncertainty surrounding the Affordable Care Act as tailwinds for our employee benefit units. Internationally, we see the U.K. and Canadian retail property/casualty markets similar to U.S. retail, more softening in London Specialty, but an improving market in Australia and New Zealand. Overall, we believe the global rate environment is flat to improving and exposure units are increasing in certain lines and geographies. In addition, our history of strong new business generation, solid retentions and enhanced value-added services for our underwriting enterprise partners should all result in further organic growth opportunities around the world. Based on our experience, underwriting enterprises appear to be making rational pricing decisions. In lines and accounts where rate increases or decreases are warranted, the underwriters are pricing accordingly. As underwriting enterprises reach their profitability targets in lines, rates may start to flatten. In summary, in this environment, premium levels are stable, clients can still obtain coverage, businesses continue to stay in standard-line markets and there is adequate capacity in the insurance market. It is not clear whether the rate retraction will reverse in the current economic environment. The CIAB represents the leading domestic and international insurance brokers, who write approximately 85% of the commercial property/casualty premiums in the U.S.
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. We believe that the production and sale of refined coal at these plants are qualified to receive refined coal tax credits under IRC Section 45. The 14 plants which were placed in service prior to December 31, 2009 (which we refer to as the 2009 Era Plants) can receive tax credits through 2019 and the 20 plants which were placed in service prior to December 31, 2011 (which we refer to as the 2011 Era Plants) can receive tax credits through 2021.
31 plants are under long-term production contracts with several utilities. We are not in current active negotiations for long-term production contracts for two of the 2009 Era Plants. For one of the 2011 Era Plants, we are in early stages of negotiations for a long-term production contract.
Income Taxes - See Income Taxes in Notes 1 and 17 to our 2017 consolidated financial statements.
Uncertain tax positions are measured based upon the facts and circumstances that exist at each reporting period and involve significant management judgment. Subsequent changes in judgment based upon new information may lead to changes in recognition, derecognition and measurement. Adjustments may result, for example, upon resolution of an issue with the taxing authorities, or expiration of a statute of limitations barring an assessment for an issue. We recognize interest and penalties, if any, related to unrecognized tax benefits in our provision for income taxes. See Note 17 to our 2017 consolidated financial statements for a discussion regarding the possibility that our gross unrecognized tax benefits balance may change within the next twelve months.
Tax law requires certain items to be included in our tax returns at different times than such items are reflected in the financial statements. As a result, the annual tax expense reflected in our consolidated statements of earnings is different than that reported in the tax returns. Some of these differences are permanent, such as expenses that are not deductible in the returns, and some differences are temporary and reverse over time, such as depreciation expense and amortization expense deductible for income tax purposes. Temporary differences create deferred tax assets and liabilities. Deferred tax liabilities generally represent tax expense recognized in the financial statements for which a tax payment has been deferred, or expense which has been deducted in the tax return but has not yet been recognized in the financial statements. Deferred tax assets generally represent items that can be used as a tax deduction or credit in tax returns in future years for which a benefit has already been recorded in the financial statements. 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. Accordingly, we adjusted our deferred tax asset and liability balances in 2017 to reflect this rate change.
Intangible Assets/Earnout Obligations - See Intangible Assets in Note 1 to our 2017 consolidated financial statements.
Net gains realized from sales of books of business, which are primarily net proceeds received related to sales of books of business and other divestiture transactions.
Acquisition related adjustments, which include change in estimated acquisition earnout payables adjustments, impacts of acquisition valuation true-ups, impairment charges and acquisition related compensation charges.
The impact of foreign currency translation, as applicable. The amounts excluded with respect to foreign currency translation are calculated by applying current year foreign exchange rates to the same periods in the prior year.
For the litigation settlement, home office lease termination/move and tax adjustments for the corporate segment, see page 52 for a more detailed description of their nature.
Organic Revenues (a non-GAAP Measure) - For the brokerage segment, organic change in base commission and fee revenues excludes the first twelve months of net commission and fee revenues generated from acquisitions and the net commission and fee revenues related to operations disposed of in each year presented. These commissions and fees 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, change in base commission and fee revenue organic growth excludes 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 impact of, and 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 due to the limited-time nature of these revenue sources.
Litigation and Regulatory Matters - 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 (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 (IRS). Additionally, the IRS has initiated audits for the 2012 tax year 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, if the IRS were to successfully assert that the micro-captives organized and/or managed by us do not meet the requirements of IRC Section
831(b), we could be subject to monetary claims by the IRS and/or our micro-captive clients, and our future earnings from our micro-captive operations could be materially adversely affected, any of which event could negatively impact the overall captive business and adversely affect our consolidated results of operations and financial condition. We may also experience lost earnings due to the negative effect of an extended IRS investigation on our clients’ and potential clients’ businesses. Annual renewals for micro-captive clients generally occur during the fourth quarter. Therefore, any negative impact from this investigation would likely have a disproportionate impact on fourth-quarter results. In 2017, 2016 and 2015, our micro-captive operations contributed less than $3.5 million of net earnings and less than $5.0 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.
Financial information relating to our brokerage segment results for 2017, 2016 and 2015 (in millions, except per share, percentages and workforce data):
* Prior to September 1, 2016, most of our India-based workforce was provided by a third party on a cost-pass-through basis. During 2016, we consummated a transaction whereby we now directly employ those associates thereby adding approximately 2,700 employees to our global workforce counts, of which approximately 2,200 employees were included in the 2016 number above. We revised the workforce number as of December 31, 2015 to conform to the current period presentation.
The following provides information that management believes is helpful when comparing EBITDAC and adjusted EBITDAC for 2017, 2016 and 2015 (in millions):
* For 2017 and 2016, we issued 1,041,000 shares and 1,998,000 shares, respectively, in connection with tax-free exchange acquisitions and repurchased 273,000 shares and 2,265,000 shares, respectively, to partially offset the impact of the issued shares. For 2015, we issued 7,300,000 shares in connection with tax-free exchange acquisitions and earnout payments. We did not repurchase any shares in 2015.
The increase in compensation expense in 2017 compared to 2016 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 ($149.6 million in the aggregate), increases in employee benefits expense ($15.8 million), deferred compensation ($6.4 million), severance related costs ($3.9 million) and stock compensation expense ($0.9 million), partially offset by decreases in temporary staffing ($1.2 million). The increase in employee headcount in 2017 compared to 2016 primarily relates to the addition of employees associated with the acquisitions that we completed in 2017 and new production hires.
The increase in compensation expense in 2016 compared to 2015 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 ($81.1 million in the aggregate), increases in employee benefits expense ($15.7 million), stock compensation expense ($4.7 million), deferred compensation ($3.5 million) and temporary staffing ($0.5 million), partially offset by decreases in severance related costs ($2.5 million) and earnout related compensation expense ($0.9 million). The increase in employee headcount in 2016 compared to 2015 primarily relates to the addition of employees associated with the acquisitions that we completed in 2016 and new production hires.
The decrease in operating expense in 2016 compared to 2015 was due primarily to favorable foreign currency translation ($3.2 million), decreases in business insurance ($15.3 million), technology expenses ($11.4 million), professional and banking fees ($5.6 million), licenses and fees ($3.7 million), other expense ($3.4 million), bad debt expense ($2.4 million), employee expense ($1.0 million), premium financing interest expense ($0.7 million), real estate expenses ($0.3 million), partially offset by increases in meeting and client entertainment expenses ($4.2 million), outside consulting fees ($2.9 million), office supplies ($1.3 million) and lease termination charges ($0.2 million). Also contributing to the increase in operating expense in 2016 were increased expenses associated with the acquisitions completed in 2016.
Depreciation - The increases in depreciation expense in 2017 compared to 2016 and in 2016 compared to 2015 were due primarily to the purchases of furniture, equipment and leasehold improvements related to office expansions and moves, and expenditures related to upgrading computer systems. Also contributing to the increases in depreciation expense in 2017, 2016 and 2015 were the depreciation expenses associated with acquisitions completed during these years.
Change in estimated acquisition earnout payables - The change in the expense from the change in estimated acquisition earnout payables in 2017 compared to 2016 and 2016 compared to 2015 was due primarily to adjustments made to the estimated fair value of earnout obligations related to revised projections of future performance. During 2017, 2016 and 2015, we recognized $19.7 million, $16.9 million and $16.2 million, respectively, of expense related to the accretion of the discount recorded for earnout obligations in connection with our 2017, 2016 and 2015 acquisitions. During 2017, 2016 and 2015, we recognized $9.6 million, $15.2 million and $24.9 million of expense, respectively, related to net adjustments in the estimated fair market values of earnout obligations in connection with revised projections of future performance for 106, 101 and 103 acquisitions, respectively.
Financial information relating to our risk management segment results for 2017, 2016 and 2015 (in millions, except per share, percentages and workforce data):
* Prior to September 1, 2016, most of our India-based workforce was provided by a third party on a cost-pass-through basis. During 2016, we consummated a transaction whereby we now directly employ those associates thereby adding approximately 2,700 employees to our global workforce counts, of which approximately 300 employees were included in the 2016 number above. We revised the workforce number as of December 31, 2015 to conform to the current period presentation.
The following provides non-GAAP information that management believes is helpful when comparing 2017 and 2016 EBITDAC and adjusted EBITAC and 2016 and 2015 EBITDAC and adjusted EBITDAC (in millions):
Fees - The increase in fees for 2017 compared to 2016 was primarily due to new business of $69.5 million and higher international performance bonus fees, which were partially offset by lost business of $30.5 million. The decrease in fees for 2016 compared to 2015 was primarily due to lost business of $68.2 million, which was offset by new business and the impact of increased claim counts (total of $58.8 million) in 2016. Organic change in fee revenues was 5% in 2017, 1% in 2016 and 11% in 2015.
Items excluded from organic fee computations yet impacting revenue comparisons in 2017, 2016 and 2015 include the following (in millions):
Compensation expense - The following provides non-GAAP information that management believes is helpful when comparing 2017 and 2016 compensation expense and 2016 and 2015 compensation expense (in millions):
The increase in compensation expense in 2017 compared to 2016 was primarily due to increased headcount and increases in salaries ($17.2 million in the aggregate), unfavorable foreign currency translation ($1.1 million), temporary-staffing expense ($2.1 million), deferred compensation ($1.3 million), employee benefits ($1.0 million) and stock compensation expense ($0.7 million), partially offset by a decrease in severance related costs ($1.0 million).
The increase in operating expense in 2017 compared to 2016 was primarily due to increases in professional and banking fees ($7.6 million), outside consulting fees ($3.6 million), other expense ($2.2 million), employee expense ($1.7 million), technology expenses ($0.9 million), meeting and client entertainment expense ($0.8 million), licenses and fees ($0.6 million), business insurance ($0.6 million), office supplies ($0.6 million), outside services ($0.4 million), partially offset by decreases in real estate expenses ($1.0 million), bad debt expense ($0.3 million) and lease termination related charges ($0.3 million).
The decrease in operating expense in 2016 compared to 2015 was primarily due to decreases in business insurance ($5.7 million), other expense ($2.7 million), real estate expenses ($2.3 million), bad debt expense ($1.8 million), licenses and fees ($1.4 million), meeting and client entertainment expense ($0.9 million), employee expense ($0.9 million), technology expenses ($0.4 million), office supplies ($0.4 million), lease termination related charges ($0.4 million), partially offset by increases in professional and banking fees ($4.4 million), outside consulting fees ($2.8 million) and outside services ($0.3 million).
Depreciation - Depreciation expense increased in 2017 compared to 2016 and 2016 compared to 2015, which reflects the impact of purchases of furniture, equipment and leasehold improvements related to office expansions and moves and expenditures related to upgrading computer systems.
Provision for income taxes - 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 2017, 2016 and 2015 was 38.2%, 38.2% and 38.0%, 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 25.0% to 27.0% in our risk management segment for the foreseeable future.
The corporate segment reports the financial information related to our clean energy investments, our debt, and certain corporate and acquisition-related activities. See Note 13 to our 2017 consolidated financial statements for a summary of our investments at December 31, 2017 and 2016 and a detailed discussion of the nature of these investments. See Note 7 to our 2017 consolidated financial statements for a summary of our debt at December 31, 2017 and 2016.
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 of the related plants, including those that are currently not operating. When we relinquish control in connection with the sale of majority ownership interests in our investments, we deconsolidate these operations.
Compensation expense - Compensation expense for 2017, 2016 and 2015, respectively, was $88.2 million, $72.6 million and $62.0 million.
The $10.6 million increase in 2016 compared to 2015 was primarily due to an increase in retention agreement compensation related to the litigation settlement, an increase in incentive compensation due to clean energy performance and an increase in benefits expense.
Operating expense for 2015 includes banking and related fees of $2.7 million, external professional fees and other due diligence costs related to 2015 acquisitions of $3.7 million, other corporate and clean energy related expenses of $9.9 million, $3.8 million for a biennial corporate-wide meeting and $1.7 million related to the litigation settlement.
Interest expense - The increase in interest expense in 2017 compared to 2016 and 2016 compared to 2015 was due to the following:
The capitalization of interest costs related to the purchase and development of our new corporate headquarters building that was completed in early 2017.
Deferred Income Taxes: We have determined that our net deferred tax asset will require revaluation as a result of the Tax Act. We have recognized a provisional $1.0 million net benefit to the provision for income taxes for the years ended December 31, 2017 as a result of the restatement of our net deferred tax assets.
Repatriation Tax: All U.S. shareholders of foreign corporations that own at least 10% must include in their income a one-time inclusion of all accumulated post 1986 undistributed earnings as of December 31, 2017. We have recognized a provisional income tax expense of $40.0 million as a result of this repatriation tax. The earnings and profits calculations of our foreign subsidiaries are subject to further refinement as additional information becomes available.
Global Intangible Low Taxed Income: The Tax Act requires U.S. shareholders to include in income certain “global intangible low-taxes income” (which we refer to as GILTI) beginning in 2018. We have adopted a policy to include the GILTI income in the future period when the tax arises.
Interest Expense Limitation: 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 are evaluating the potential impact of this provision.
Executive Compensation: The Tax Act contains provisions that may limit deductions for executive compensation. We are evaluating the potential impact of this provision.
During the year ended December 31, 2017, we incurred $8.9 million of pre-tax costs related to implementing a new accounting standard related to how companies recognize revenue, which was effective beginning in January 2018. We expect to incur costs related to implementing this new accounting standard through first quarter 2018. These charges are included in the corporate segment. A new accounting pronouncement, ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting, was effective January 1, 2017. It requires that the income tax effects of awards be recognized in the income statement (in the Income Tax Benefit column above) when the awards vest or are settled, rather than recognizing the tax benefits in excess of compensation costs through stockholders’ equity. The income tax benefit of stock based awards that vested or were settled in the year ended December 31, 2017 was $15.1 million and is included in the table above in the Corporate line. The income tax benefit of stock based awards that vested or were settled in the years ended December 31, 2016 and 2015 was $6.5 million and $5.3 million, respectively, and is not included in the Income Tax Benefit column above.
Tax Adjustments - In the fourth quarter of 2017, the Tax Act was enacted in the U.S., which lowered the U.S. corporate tax rate from 35.0% to 21.0% effective January 1, 2018. Accordingly, based on reasonable estimates, we adjusted our U.S. deferred tax asset and liability balances in 2017 to reflect this rate change and we also incurred a one-time provisional repatriation tax on untaxed accumulated foreign earnings. These items, plus the impact of some permanent tax differences, resulted in a net charge of approximately $27.0 million in the aggregate in the fourth quarter of 2017. Pretax costs incurred related to tax reform were $2.5 million in the fourth quarter of 2017. The ultimate impact of the Tax Act may differ from these estimated provisions, as we continue to assemble and analyze all the information required to prepare and analyze these effects and await additional guidance from the U.S. Treasury Department, Internal Revenue Service or other standard-setting bodies.
The estimated earnings information in the table reflects management’s current best estimate of the 2018 low and high ranges of after-tax earnings based on early production estimates from the host utilities and other operating assumptions, including current U.S. Federal income tax laws. However, coal-fired power plants may not ultimately produce refined fuel at estimated levels due to seasonal electricity demand, production costs, natural gas prices, weather conditions, as well as many other operational, regulatory and environmental compliance reasons. Future changes in EPA regulations or U.S. Federal income tax laws might materially impact these estimates.
We may sell ownership interests in some or all of the plants to co-investors and relinquish control of the plants, thereby becoming a non-controlling, minority investor. In any limited liability company where we are a non-controlling, 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 non-controlling, minority investor, we would deconsolidate the entity and subsequently account for the investment using equity method accounting.
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 13 to our 2017 consolidated financial statements for more information regarding risks and uncertainties related to these investments.
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 2017, 2016 and 2015, 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.
Capital Expenditures - Capital expenditures were $129.2 million, $217.8 million and $99.0 million for 2017, 2016 and 2015, respectively, of which $11.8 million, $112.1 million and $13.3 million, respectively, related to expenditures on our new corporate headquarters building. In addition, 2017 capital expenditures include amounts incurred related to investments made in information technology and software development projects. In 2018, we expect total expenditures for capital improvements to be approximately $125.0 million, part of which is related to expenditures on office moves and expansions and updating computer systems and equipment. Relating to the development of our new corporate headquarters, we received property tax related credits under a tax-increment 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 $80.0 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. The net capital expenditures in 2016 and 2015 primarily related to capitalized costs associated with expenditures on our new corporate headquarters building in 2016 and 2015 and the implementation of new accounting and financial reporting systems and several other system initiatives that occurred in 2016 and 2015.
Acquisitions - Cash paid for acquisitions, net of cash acquired, was $376.1 million, $243.4 million and $249.6 million in 2017, 2016 and 2015, respectively. The increased use of cash for acquisitions in 2017 compared to 2016 was primarily due to an increase in the number and size of acquisitions than occurred in 2016 and we used less of our common stock to fund acquisitions in 2017. The decreased use of cash for acquisitions in 2016 compared to 2015 was primarily due to a decrease in the number of acquisitions that occurred in 2016. In addition, during 2017, 2016 and 2015 we issued 1.0 million shares ($59.6 million), 2.0 million shares ($89.6 million) and 7.3 million shares ($338.9 million), respectively, of our common stock as payment for a portion of the total consideration paid for acquisitions and earnout payments. We completed 39, 37 and 44 acquisitions in 2017, 2016 and 2015, respectively. Annualized revenues of businesses acquired in 2017, 2016 and 2015 totaled approximately $172.3 million, $137.9 million and $230.8 million, respectively. In 2018, 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.
Dispositions - During 2017, 2016 and 2015, we sold several books of business and recognized one-time gains of $3.4 million, $6.6 million and $6.7 million, respectively. We received cash proceeds of $3.2 million, $7.8 million and $9.2 million, respectively, related to these transactions.
Clean Energy Investments - During the period from 2009 through 2017, we have made significant investments in clean energy operations capable of producing refined coal that we believe qualifies for tax credits under IRC Section 45. Our current estimate of the 2018 annual net after tax earnings, including IRC Section 45 tax credits, which will be produced from all of our clean energy investments in 2018, is $105.0 million to $115.0 million. The IRC Section 45 tax credits generate positive cash flow by reducing the amount of Federal income taxes we pay, which is offset by the operating expenses of the plants, by capital expenditures related to the redeployment, and in some cases the relocation of refined coal plants. We anticipate positive net cash flow related to IRC Section 45 activity in 2018. However, there are several variables that can impact net cash flow from clean energy investments in any given year. Therefore, accurately predicting positive or negative cash flow in particular future periods is not possible at this time. Nonetheless, if current ownership interests remain the same, if capital expenditures related to
On April 8, 2016, we entered into an amendment and restatement to our multicurrency credit agreement dated September 19, 2013 (which we refer to as the Credit Agreement) with a group of fifteen financial institutions. The amendment and restatement, among other things, extended the expiration date of the Credit Agreement from September 19, 2018 to April 8, 2021 and increased the revolving credit commitment from $600.0 million to $800.0 million, of which $75.0 million may be used for issuances of standby or commercial letters of credit and up to $75.0 million may be used for the making of swing loans, (as defined in the Credit Agreement). We may from time to time request, subject to certain conditions, an increase in the revolving credit commitment under the Credit Agreement up to a maximum aggregate revolving credit commitment of $1,100.0 million. There were $190.0 million of borrowings outstanding under the Credit Agreement at December 31, 2017. Due to the outstanding borrowing and letters of credit, $592.8 million remained available for potential borrowings under the Credit Agreement at December 31, 2017.
At December 31, 2017, we had $2,798.0 million of corporate-related borrowings outstanding under separate note purchase agreements entered into in the period 2007 to 2017 and a cash and cash equivalent balance of $681.2 million. See Note 7 to 2017 our consolidated financial statements for a discussion of the terms of the note purchase agreements and the Credit Agreement.
Consistent with past practice, we have entered into pre-issuance hedging transactions for $200.0 million related to each of the 2018 and 2019, $100.0 million note maturities.
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, 2017, we are unable to make reasonably reliable estimates of the period in which cash settlements may be made with the respective taxing authorities. Therefore, $10.9 million of unrecognized tax benefits have been excluded from the contractual obligations table above. See Note 17 to our 2017 consolidated financial statements for a discussion on income taxes.
Since commitments may expire unused, the amounts presented in the table above do not necessarily reflect our actual future cash funding requirements. See Note 15 to our 2017 consolidated financial statements for a discussion of our funding commitments related to our corporate segment and the Off-Balance 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 459 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 2013 to 2017 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- to three-year period subsequent to the acquisition date. The aggregate amount of the maximum earnout obligations related to these acquisitions was $567.9 million, of which $264.2 million was recorded in our consolidated balance sheet as of December 31, 2017, based on the estimated fair value of the expected future payments to be made.
Off-Balance Sheet Debt - Our unconsolidated investment portfolio includes investments in enterprises where our ownership interest is between 1% and 50%, in which management has determined that our level of influence and economic interest is not sufficient to require consolidation. As a result, these investments are accounted for under the equity method. None of these unconsolidated investments had any outstanding debt at December 31, 2017 and 2016 that was recourse to us.
ASC Topic 606 - ASU No. 2014-09, Revenue from Contracts with Customers.
We do not assume underwriting risk on a net basis, other than with respect to de minimis amounts necessary to provide minimum or regulatory capital amounts to organize captives, pools, specialized underwriters or risk-retention groups. Rather, capital necessary for events of loss coverages is provided by underwriting enterprises.
(i) Identifying, negotiating and placing all forms of insurance or reinsurance coverages, as well as providing risk-shifting, risk-sharing and risk-mitigation consulting services, principally related to property/casualty, life, health, welfare and disability insurance. We also provide these services through, or in conjunction with, other unrelated agents and brokers, consultants and management advisors.
(iv) Providing management and administrative services to captives, pools, risk-retention groups, healthcare exchanges, small underwriting enterprises, such as accounting, claims and loss processing assistance, feasibility studies, actuarial studies, data analytics and other administrative services.
The primary source of brokerage segment revenues are commissions from underwriting enterprises, which are based on a percentage of premiums paid by our clients, or fees received from clients, which are based on an agreed level of service with our clients, usually in lieu of commissions.
Commissions are fixed at the contract effective date and generally are based on a percentage of premiums for insurance coverage or employee head count for employer sponsored benefit plans. Commissions depend upon a large number of factors, including the type of risk being placed, the particular underwriting enterprise’s demand, the expected loss experience of the particular risk of coverage, and historical benchmarks surrounding the level of effort necessary for us to place and service the insurance contract. Fees are rarely tied to the amount of premiums; instead, they are based on an expected level of effort to provide our services.
Certain underwriting enterprises may pay us additional revenues based on the volume of premium we place with them and for insights into our sales pipeline, our sales capabilities or our risk selection knowledge. These amounts are in excess of the commission and fee revenues discussed above, and not all business we place with underwriting enterprises is eligible for supplemental revenues. Unlike contingent revenues, discussed below, these revenues are a fixed amount or fixed percent of premium of the underlying eligible insurance contracts. We recognize supplemental revenues using internal data and information received from underwriting enterprises that allows us to reasonably estimate the supplemental revenues earned in the period.
Certain underwriting enterprises may pay us additional revenues for our sales capabilities, our risk selection knowledge, or our administrative efficiencies. These amounts are in excess of the commission revenues discussed above, and not all business we place with participating underwriting enterprises is eligible for contingent revenues. Unlike supplemental revenues, discussed above, these revenues are variable, generally based on growth, the loss experience of the underlying insurance contracts, and/or our efficiency in processing the business. We generally operate under calendar year contracts, but we do not receive these contingent revenues from the underwriting enterprises until the following calendar year, generally in the first and second quarters, after verification of the performance indicators outlined in the contracts. We recognize contingent revenues as revenue when we have obtained the data necessary to reasonably determine such amounts. Historically we have not been able to reasonably determine these types of revenues until we have received the cash or the related policy detail or other underwriting enterprise specific information from the underwriting enterprise.
Where we operate under a contract where our fee is established on a per-claim basis, our obligation is to process claims for a term specified within the contract, which we provide over a period of time. We recognize these fee revenues ratably as the services are rendered, and record the income effects of subsequent fee adjustments when the adjustments become known.
Where we provide services and generate revenues on a cost-plus basis, we recognize revenue over the contract period.
Investment income primarily includes interest and dividend income (including interest income from our premium financing operations), which is accrued as it is earned. Gains on books of business sales represent one-time gains related to sales of brokerage related businesses, which are primarily recognized on a cash received basis. Revenues from clean coal activities include revenues from consolidated clean coal production plants, royalty income from clean coal licenses and income (loss) related to unconsolidated clean coal production plants, all of which are recognized as earned. Revenues from consolidated clean coal production plants represent sales of refined coal. Royalty income from clean coal licenses represents fee income related to the use of clean coal technologies. Income (loss) from unconsolidated clean coal production plants includes losses related to our equity portion of the pretax results of the clean coal production plants.
We are obligated under certain circumstances to provide future claims handling and certain administrative services for our former global risks brokerage clients in the U.K. Our obligation is the result of following the industry practice of insurance brokers providing future claims handling and administrative services to former clients. In addition, under certain circumstances, our risk management segment operations are contractually obligated to provide contract claim settlement and administration services to our former clients. Accordingly, we record a liability for these deferred run-off obligations based on the estimated costs to provide these future services to former clients. This liability is based on estimates and assumptions using historical data to project future experience. Such estimates and assumptions could change in the future as more information becomes known which could impact the amounts reported and disclosed herein. We periodically review (at least annually) the adequacy of this liability and will make adjustments as necessary.
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, 2017.
We are exposed to market risks, including changes in foreign currency exchange rates and interest rates. To manage the risk related to these exposures, we enter into various derivative instruments that reduce these risks by creating offsetting exposures In the normal course of business, we are exposed to the impact of foreign currency fluctuations that impact our results of operations and cash flows. We utilize a foreign currency risk management program involving foreign currency derivatives that consist of several monthly put/call options designed to hedge a portion of our future foreign currency disbursements through various future payment dates. To mitigate the counterparty credit risk we only enter into contracts with major financial institutions based upon their credit ratings and other factors. These derivative instrument contracts are cash flow hedges that qualify for hedge accounting and primarily hedge against fluctuations between changes in the GBP and Indian Rupee versus the U.S. dollar. Changes in fair value of the derivative instruments are reflected in other comprehensive earnings in the accompanying consolidated balance sheet. The impact of the hedge at maturity is recognized in the income statement as a component of investment income, compensation and operating expenses depending on the nature of the hedged item. We enter into various long term debt agreements. We use interest rate derivatives, typically swaps, to reduce our exposure to the effects of interest rate fluctuations on the forecasted interest rates for up to two years into the future. These derivative instrument contracts are periodically monitored for hedge ineffectiveness, the amount of which has not been material to the accompanying consolidated financial statements. We do not use derivatives for trading or speculative purposes.
Seven subsidiaries of the brokerage segment make short-term loans (generally with terms of twelve months or less) to our clients to finance premiums. These premium financing contracts are structured to minimize potential bad debt expense to us. Such receivables are generally considered delinquent after seven days of the payment due date. In normal course, insurance policies are cancelled within one month of the contractual payment due date if the payment remains delinquent. We recognize interest
Intangible assets represent the excess of cost over the estimated fair value of net tangible assets of acquired businesses. Our primary intangible assets are classified as either goodwill, expiration lists, non-compete agreements or trade names. Expiration lists, non-compete agreements and trade names are amortized using the straight-line method over their estimated useful lives (three to fifteen years for expiration lists, three to five years for non-compete agreements and five to fifteen years 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.
In connection with the hiring and retention of both new talent and experienced personnel, including our senior management, brokers and other key personnel, we have entered into various agreements with key employees setting up the conditions for the cash payment of certain retention bonuses. These bonuses are an incentive for these employees to remain with the company, for a fixed period of time, to allow us to capitalize on their knowledge and experience. We have various forms of retention bonus arrangements; some are paid up front and some are paid at the end of the term, but all are contingent upon successfully completing a minimum period of employment. A retention bonus that is paid to an employee upfront that is contingent on a certain minimum period of employment, will be initially classified as a prepaid asset and amortized to compensation expense as the future services are rendered over the duration of the stay period. A retention bonus that is paid to an employee at the end of the term that is contingent on a certain minimum period of employment, will be accrued as a liability through compensation expense as the future services are rendered over the duration of the stay period. If an employee leaves prior to the required time frame to earn the retention bonus outright, then all or any portion that is ultimately unearned or refundable, and recovered by the company if prepaid, is forfeited and reversed through compensation expense.
applied prospectively. The new guidance is effective for annual periods beginning after December 15, 2018, including interim periods within those periods. Early adoption is permitted in any interim period or annual year before the effective date. If the guidance is early adopted in an interim period, any adjustments would be reflected as of the beginning of the fiscal year that includes that interim period. We are currently assessing the impact that adopting this new guidance will have on our consolidated financial statements.
In March 2017, the FASB issued ASU No. 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. The new guidance requires that an employer report the service cost component in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period. It also requires the other components of net periodic pension cost and net periodic postretirement benefit cost to be presented in the income statement separately from the service cost component and outside a subtotal of income from operations, if one is presented. An entity will apply the new guidance retrospectively for the presentation of the service cost component and the other components of net periodic pension cost and net periodic postretirement benefit cost in the consolidated statement of earnings. The new guidance allows a practical expedient that permits an employer to use the amounts disclosed in its pension and other postretirement benefit plan note for the prior comparative periods as the estimation basis for applying the retrospective presentation requirements. The new guidance is effective in the first quarter of 2018. The adoption of this guidance will have no impact on our consolidated net earnings. The presentation in our consolidated statement of earnings will reflect a change in compensation expense offset by an equal change in operating expense for each period presented. See Note 12 to these 2017 consolidated financial statements for details on our net periodic pension benefit cost.
In January 2017, the FASB issued ASU No. 2017-01, 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 is effective for annual periods beginning after December 15, 2017, including interim periods within those periods. Management does not anticipate that this new guidance will have a material impact on our consolidated financial statements upon adoption.
In January 2017, the FASB issued ASU No. 2017-04, 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 impairment charge for the amount by which the carrying value exceeds the reporting unit’s fair value with the loss not exceeding the total amount of goodwill allocated to that reporting unit. The new guidance is effective beginning January 1, 2020, with early adoption permitted, and will be applied on a prospective basis. The new guidance currently has no impact on our consolidated financial statements; however, we will evaluate the impact of this updated guidance on future annual or interim goodwill impairment tests performed.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). Under this new accounting guidance, an entity is required to recognize right-of-use assets and lease liabilities on its balance sheet and disclose key information about leasing arrangements. 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, with early adoption permitted. Under the modified retrospective approach, lessees are required to recognize and measure leases at the beginning of the earliest period presented. In addition, the modified retrospective approach includes a number of optional practical expedients that entities may elect to apply. These practical expedients relate to the identification and classification of leases that commenced before the effective date, initial direct costs for leases that commenced before the effective date and the ability to use hindsight in evaluating lessee options to extend or terminate a lease or to purchase the underlying asset.
In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, (ASU 2016-15). The amendments in ASU 2016-15 address eight specific cash flow issues and apply to all entities that are required to present a statement of cash flows under ASC 230, Statement of Cash Flows. This new guidance is effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years, with early adoption permitted. We early adopted this guidance in first quarter 2017.
The adoption of this guidance resulted in a change to our classification whereby contingent payments on acquisitions that are up to the acquisition date fair value have been presented in financing activities and those payments in excess of the acquisition date fair value have been presented in operating activities. Historically these payments have all been included in investing activities. Accordingly, in our 2016 consolidated statement of cash flows, we reclassified $22.8 million and $45.5 million of payments from investing activities to operating activities and financing activities, respectively, to conform to the current year presentation. In our 2015 consolidated statement of cash flows, we reclassified $12.1 million and $21.8 million of payments from investing activities to operating activities and financing activities, respectively, to conform to the current year presentation. The modifications can be seen in our statement of cash flows.
In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash. This new accounting guidance addresses the classification and presentation of changes in restricted cash on the statement of cash flows under Topic 230, Statement of Cash Flows. This guidance is effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted for all entities. We early adopted this guidance in fourth quarter 2017. The adoption of this new guidance changed the presentation in our consolidated statement of cash flows as we now show the changes in the total of cash, cash equivalents and restricted cash in the statement of cash flows. Previously, the net change in restricted cash was reported as an operating activity and cash paid for acquisitions, net of cash was not presented net of restricted cash. In our 2016 consolidated statement of cash flows, the adoption of ASU 2016-18 resulted in an increase to net cash provided by operating activities of $50.3 million and a decrease to cash paid for acquisitions, net of cash and restricted cash of $15.6 million. These changes resulted in a change of $85.9 million to the effect of changes in foreign exchange rates on cash, cash equivalents and restricted cash. In our 2015 consolidated statement of cash flows, the adoption of ASU 2016-18 resulted in an increase to net cash provided by operating activities of $45.6 million and a decrease to cash paid for acquisitions, net of cash and restricted cash of $58.8 million. These changes resulted in a change of $59.9 million to the effect of changes in foreign exchange rates on cash, cash equivalents and restricted cash. The modifications can be seen in our statement of cash flows.
We adopted ASC Topic 606 as of January 1, 2018, using the full retrospective method to restate each prior reporting period presented. An assessment to determine the impacts of the new accounting standard has been performed. We implemented new accounting and operational processes which were a result of the new guidance and analyzed the impact of these changes. We anticipate the cumulative effect of the adoption to be recognized will be an increase to retained earnings of between $100.0 million and $180.0 million on January 1, 2016. At the time of this filing we are completing our final review of the amount. Our final review includes steps related to our international locations, our acquired companies and ensuring these multiple systems have complied with the processes that we have established. We anticipate this standard will have a material impact on individual lines in our consolidated financial statements, but we do not expect it will have as much of an impact on our results of operations on an annual basis. The primary impacts of the new standard to our product and service lines are anticipated to be as follows:
Expense - The assets recognized for the costs to obtain and/or fulfill a contract will be amortized on a systematic basis that is consistent with the transfer of the services to which the asset relates. For the vast majority of our contracts, the renewal period is one year or less and renewal costs are commensurate with the initial contract. As a result, we plan to apply a practical expedient and recognize the costs of obtaining a contract as an expense when incurred. We are quantifying and analyzing the impact of the costs to fulfill a contract. We do not expect the net impact of deferring and amortizing these costs to be material on an annual basis, but it will have an impact on the timing of expenses recognized in the interim periods.
We expect that the timing related to recognition of revenue in our corporate segment will remain substantially unchanged. We do not expect a material impact on our annual after tax earnings, but we do expect a material change in the emergence of our after tax earnings in the interim quarterly periods as income tax credits are recognized based on our quarterly consolidated pretax earnings patterns.
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- to three-year period subsequent to the acquisition date, are measured at fair value as of the acquisition date and are included on that basis in the recorded purchase price consideration in the foregoing table. We will record subsequent changes in these estimated earnout obligations, including the accretion of discount, in our consolidated statement of earnings when incurred.
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 5.0% to 17.0% for our 2017 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 rates of return that reflect the ability of the acquired entity to achieve the targets. These discount rates generally ranged from 7.5% to 9.0% for our 2017 acquisitions. 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.
During 2017, 2016 and 2015, we recognized $20.2 million, $16.9 million and $16.2 million, respectively, of expense in our consolidated statement of earnings related to the accretion of the discount recorded for earnout obligations in connection with our acquisitions. In addition, during 2017, 2016 and 2015, we recognized $10.7 million, $15.2 million and $24.4 million of expense, respectively, related to net adjustments in the estimated fair value of the liability for earnout obligations in connection with revised projections of future performance for 108, 101 and 105 acquisitions, respectively. The aggregate amount of maximum earnout obligations related to acquisitions made in 2014 and subsequent years was $567.9 million as of December 31, 2017, of which $264.2 million was recorded in the consolidated balance sheet as of that date based on the estimated fair value of the expected future payments to be made. The aggregate amount of maximum earnout obligations related to acquisitions made in 2013 and subsequent years was $527.2 million as of December 31, 2016, of which $242.3 million was recorded in the consolidated balance sheet as of that date based on the estimated fair value of the expected future payments to be made.
Our consolidated financial statements for the year ended December 31, 2017 include the operations of the acquired entities from their respective acquisition dates. The following is a summary of the unaudited pro forma historical results, as if these entities had been acquired at January 1, 2016 (in millions, except per share data):
The carrying amount of goodwill at December 31, 2017 and 2016 allocated by domestic and foreign operations is as follows (in millions):
The changes in the carrying amount of goodwill for 2017 and 2016 are as follows (in millions):
The terms of the Credit Agreement 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, 2017. The Credit Agreement 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.
At December 31, 2017, $17.2 million of letters of credit (for which we had $13.5 million of liabilities recorded at December 31, 2017) were outstanding under the Credit Agreement. See Note 15 to these consolidated financial statements for a discussion of the letters of credit. There were $190.0 million of borrowings outstanding under the Credit Agreement at December 31, 2017. Accordingly, at December 31, 2017, $592.8 million remained available for potential borrowings, of which $57.8 million was available for additional letters of credit.
The interest rates on Facility B are Interbank rates, which vary by tranche, duration and currency, plus a margin of 1.05%. The interest rates on Facilities C and D are 30 day Interbank rates, plus a margin of 0.55%. The annual fee for Facility B is 0.4725% of the undrawn commitments for the two tranches of the facility. The annual fee for Facilities C and D is 0.50% of the total commitments of the facilities.
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, 2017. 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.
See Note 15 to these 2017 consolidated financial statements for additional discussion on our contractual obligations and commitments as of December 31, 2017.
The aggregate estimated fair value of the $2,798.0 million in debt under the note purchase agreements at December 31, 2017 was $2,920.7 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 based on our current estimated credit rating. The estimated fair value of the $190.0 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 $151.1 million of borrowings outstanding under our Premium Financing Debt Facility approximates their carrying value due to their short-term duration and variable interest rates.
Options to purchase 1.3 million, 5.9 million and 3.5 million shares of our common stock were outstanding at December 31, 2017, 2016 and 2015, respectively, but were not included in the computation of the dilutive effect of stock options for the year then ended. These stock options were excluded from the computation because the options’ exercise prices 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.
During 2017, 2016 and 2015, we recognized $17.3 million, $14.7 million and $11.2 million, respectively, of compensation expense related to our stock option grants.
Option valuation models require the input of highly subjective assumptions including the expected stock price volatility. The Black-Scholes option pricing model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. Because our 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 our employee and non-employee director stock options. The weighted average fair value per option for all options granted during 2017, 2016 and 2015, as determined on the grant date using the Black-Scholes option pricing model, was $11.42, $8.45 and $9.25, respectively.
Options with respect to 16.2 million shares (less any shares of restricted stock issued under the LTIP-see Note 11 to these consolidated financial statements) were available for grant under the LTIP at December 31, 2017.
Other information regarding stock options outstanding and exercisable at December 31, 2017 is summarized as follows (in millions, except exercise price and year data):
Our common stock that is issued to or purchased by the rabbi trust as a contribution under DEPP is valued at historical cost, which equals its fair market value at the date of grant or date of purchase. When common stock is issued, we record an unearned deferred compensation obligation as a reduction of capital in excess of par value in the accompanying consolidated balance sheet, which is amortized to compensation expense ratably over the vesting period of the participants. Future changes in the fair market value of our common stock owed to the participants do not have any impact on the amounts recorded in our consolidated financial statements.
At December 31, 2017 and 2016, we recorded $54.7 million (related to 2.6 million shares) and $46.8 million (related to 2.4 million shares), respectively, of unearned deferred compensation as an reduction of capital in excess of par value in the accompanying consolidated balance sheet. The total intrinsic value of our unvested equity based awards under the plan at December 31, 2017 and 2016 was $166.0 million and $125.5 million, respectively. During 2017, 2016 and 2015, cash and equity awards with an aggregate fair value of $8.4 million, $7.6 million and $2.3 million, respectively, were vested and distributed to executives under the DEPP.
We have a Deferred Cash Participation Plan (which we refer to as the DCPP), which is a non-qualified deferred compensation plan for certain key employees, other than executive officers, that generally provides for vesting and/or distributions no sooner than five years from the date of awards. Under the provisions of the DCPP, we typically contribute cash in an amount approved by the compensation committee to the rabbi trust on behalf of the executives participating in the DCPP, 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. In the first quarter of each of 2017, 2016 and 2015, the compensation committee approved $5.1 million, $3.1 million and $2.7 million, respectively, of awards in the aggregate to certain key executives under the DCPP that were contributed to the rabbi trust in second quarter 2017, 2016 and 2015, respectively. During 2017, 2016 and 2015 we charged $2.5 million, $1.5 million and $1.1 million to compensation expense related to these awards. There were no distributions from the DCPP during 2017, 2016 and 2015.
As discussed in Note 9 to these consolidated financial statements, on May 16, 2017, our stockholders approved the LTIP, which replaced our previous stockholder-approved 2014 LTIP. The LTIP provides for the grant of a stock award either as restricted stock or as restricted stock units. In either case, the compensation committee may determine that the award will be subject to the attainment of performance measures over an established performance period. Stock awards and the related dividend equivalents are non-transferable and subject to forfeiture if the holder does not remain continuously employed with us during the applicable restriction period or, in the case of a performance-based award, if applicable performance measures are not attained. The compensation committee will determine all of the terms relating to the satisfaction of performance measures and the termination of a restriction period, or the forfeiture and cancellation of a restricted stock award upon a termination of employment, whether by reason of disability, retirement, death or any other reason.
In 2017, 2016 and 2015, we granted 476,350, 479,167 and 394,975 restricted stock units, respectively, to employees under the LTIP and 2014 LTIP, with an aggregate fair value of $26.8 million, $20.4 million and $16.7 million, respectively, at the date of grant.
The 2017, 2016 and 2015 restricted stock units vest as follows: 477,500 units granted in first quarter 2017, 466,600 units granted in first quarter 2016 and 362,600 units granted in first quarter 2015, vest in full based on continued employment through March 19, 2022, March 17, 2021 and March 11, 2020, respectively, while the other 2017, 2016 and 2015 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 2017, 2016 and 2015 are not subject to forfeiture upon such officers’ departure from the company after two years from the date of grant.
We account for restricted stock awards at historical cost, which equals its fair market value at the date of grant, which is amortized to compensation expense ratably over the vesting period of the participants. Future changes in the fair value of our common stock that is owed to the participants do not have any impact on the amounts recorded in our consolidated financial statements. During 2017, 2016 and 2015, we charged $19.6 million, $18.2 million and $14.4 million, respectively, to compensation expense related to restricted stock awards granted in 2007 through 2017. The total intrinsic value of unvested restricted stock at December 31, 2017 and 2016 was $109.3 million and $80.0 million, respectively. During 2017 and 2016, equity awards (including accrued dividends) with an aggregate fair value of $23.3 million and $14.2 million were vested and distributed to employees under this plan.
On March 16, 2017, pursuant to our Performance Unit Program (which we refer to as 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 award was approved. The Program consists of a one-year performance period based on our financial performance and a two-year vesting period. At the discretion of the compensation committee and determined based on our performance, the eligible officer or key employee will be granted a percentage of the provisional cash award units that equates to the EBITDAC (in 2017) or EBITAC (prior to 2017) 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 2017 provisional award will fully vest based on continuous employment through January 1, 2020. The ultimate award value will be equal to the trailing twelve-month price of our common stock on December 31, 2019, multiplied by the number of units subject to the award, but limited to between 0.5 and 1.5 times the original value of the units determined as of the grant date. The fair value of the awarded units will be paid out in cash as soon as practicable in 2020. If an eligible employee leaves us prior to the vesting date, the entire award will be forfeited. We did not recognize any compensation expense during the year ended December 31, 2017 related to the 2017 provisional award under the Program. Based on company performance for 2017, we expect to grant 242,000 units under the Program in first quarter 2018 that will fully vest on January 1, 2020.
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 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 2015 provisional award were similar to the terms of the 2016 provisional awards. Based on our performance for 2015, we granted 294,000 units under the Program in first quarter 2016 that fully vested on January 1, 2018. During 2017 and 2016, we charged $9.3 million and $6.6 million to compensation expense related to these awards. We did not recognize any compensation expense during 2015 related to the 2015 awards.
On March 12, 2014, pursuant to the Program, the compensation committee approved the provisional cash awards of $10.8 million in the aggregate for future grants to our officers and key employees that are denominated in units (229,000 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 2014 provisional award were similar to the terms of the 2015 provisional awards. Based on our performance for 2014, we granted 220,000 units under the Program in first quarter 2015 that fully vested on January 1, 2017. During, 2016 and 2015, we charged $4.5 million and $4.9 million to compensation expense related to these awards. We did not recognize any compensation expense during 2014 related to the 2014 awards. During 2017, cash awards related to the 2014 provisional awards with an aggregate fair value of $9.3 million (199,000 units in the aggregate) were vested and distributed to employees under the Program.
We have a noncontributory defined benefit pension plan that, prior to July 1, 2005, covered substantially all of our domestic employees who had attained a specified age and one year of employment. Benefits under the plan were based on years of service and salary history. In 2005, we amended our defined benefit pension plan to freeze the accrual of future benefits for all U.S. employees, effective on July 1, 2005. Since the plan is frozen, there is no difference between the projected benefit obligation and accumulated benefit obligation at December 31, 2017 and 2016. In the table below, the service cost component represents plan administration costs that are incurred directly by the plan. A reconciliation of the beginning and ending balances of the pension benefit obligation and fair value of plan assets and the funded status of the plan is as follows (in millions):
The following is a summary of the plan’s weighted average asset allocations at December 31 by asset category:
Plan assets are invested in various pooled separate accounts under annuity contracts managed by two life underwriting enterprises. The plan’s investment policy provides that investments will be allocated in a manner designed to provide a long-term investment return greater than the actuarial assumptions, maximize investment return commensurate with risk and to comply with the Employee Income Retirement Security Act of 1974, as amended (which we refer to as ERISA), by investing the funds in a manner consistent with ERISA’s fiduciary standards. The weighted average expected long-term rate of return on plan assets assumption was determined based on a review of the asset allocation strategy of the plan using expected ten-year return assumptions for all of the asset classes in which the plan was invested at December 31, 2017 and 2016. The return assumptions used in the valuation were based on data provided by the plan’s external investment advisors.
We were not required under the IRC to make any minimum contributions to the plan for each of the 2017, 2016 and 2015 plan years. This level of required funding is based on the plan being frozen and the aggregate amount of our historical funding. During 2017, 2016 and 2015 we did not make discretionary contributions to the plan.
We also have a qualified contributory savings and thrift (401(k)) plan covering the majority of our domestic employees. For eligible employees who have met the plan’s age and service requirements to receive matching contributions, we match 100% of pre-tax and Roth elective deferrals up to a maximum of 5.0% of eligible compensation, subject to Federal limits on plan contributions and not in excess of the maximum amount deductible for Federal income tax purposes. Effective January 1, 2014, employees must be employed and eligible for the plan on the last day of the plan year to receive a matching contribution, subject to certain exceptions enumerated in the plan document. Matching contributions are subject to a five-year graduated vesting schedule. We expensed (net of plan forfeitures) $51.6 million, $47.7 million and $42.5 million related to the plan in 2017, 2016 and 2015, respectively.
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 $32.0 million, $30.6 million and $31.7 million in 2017, 2016 and 2015, 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 basis. The postretirement benefit obligation and the unfunded status of the plan as of December 31, 2017 and 2016 were $2.5 million and $2.7 million, respectively. The net periodic postretirement benefit (income) cost of the plan amounted to ($0.3 million), ($0.3 million) and ($0.3 million) in 2017, 2016 and 2015, respectively.
Chem-Mod International LLC - At December 31, 2017, we held a 31.5% non-controlling ownership interest in Chem-Mod International. Chem-Mod International has the rights to market The Chem-Mod™ Solution in countries other than the U.S. and Canada. Such marketing activity has been limited to date.
We enter into various long term debt agreements. We use interest rate derivatives, typically swaps, to reduce our exposure to the effects of interest rate fluctuations on the forecasted interest rates for up to two years into the future.
The notional and fair values of derivative instruments are as follows at December 31, 2017 and 2016 (in millions):
(3) Included within foreign exchange contracts at December 31, 2017 were $141.0 million of call options offset with $141.0 million of put options and $13.3 million of buy forwards offset with $31.0 million of sell forwards. Included within foreign exchange contracts at December 31, 2016 were $78.3 million of call options offset with $78.3 million of put options and $61.6 million of buy forwards offset with $57.5 million of sell forwards.
The amounts of derivative gains (losses) reclassified from accumulated other comprehensive loss into income (effective portion) were as follows (in millions):
We estimate that approximately $2.7 million of pretax gain currently included within accumulated other comprehensive loss will be reclassified into earnings in the next twelve months. The amount of gain (loss) recognized in earnings on the ineffective portion of derivatives for 2017, 2016 and 2015 was $(0.2) million, $1.6 million and $0.7 million, respectively.
Note Purchase Agreements, Credit Agreement and Premium Financing Debt Facility - See Note 7 to these consolidated financial statements for a summary the amounts outstanding under the note purchase agreements, the Credit Agreement and Premium Debt Facility.
Since commitments may expire unused, the amounts presented in the table above do not necessarily reflect our actual future cash funding requirements. See Note 13 to these consolidated financial statements for a discussion of our funding commitments related to our corporate segment and the Off-Balance 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.
Since January 1, 2002, we have acquired 459 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 2013 to 2017 that contain potential earnout obligations, such obligations are measured at fair value as of the acquisition date and are included on that basis in the recorded purchase price consideration for the respective acquisition. The amounts recorded as earnout payables are primarily based upon estimated future potential operating results of the acquired entities over a two- to three-year period subsequent to the acquisition date. The aggregate amount of the maximum earnout obligations related to these acquisitions was $567.9 million, of which $264.2 million was recorded in our consolidated balance sheet as of December 31, 2017 based on the estimated fair value of the expected future payments to be made.
(1) The guarantees are collateralized by shares in minority holdings of our Canadian operating companies.
Contingent Liabilities - We purchase insurance to provide protection from errors and omissions (which we refer to as E&O) claims that may arise during the ordinary course of business. We currently retain the first $5.0 million of each and every E&O claim. Our E&O insurance provides aggregate coverage for E&O losses up to $175.0 million in excess of our retained amounts. We have historically maintained self-insurance reserves for the portion of our E&O exposure that is not insured. We periodically determine a range of possible reserve levels using actuarial techniques that rely heavily on projecting historical claim data into the future. Our E&O reserve in the December 31, 2017 consolidated balance sheet is above the lower end of the most recently determined actuarial range by $1.7 million and below the upper end of the actuarial range by $7.6 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.
Due to the contingent nature of this exposure and our related assessment of its likelihood, no reserve has been recorded in our December 31, 2017 consolidated balance sheet related to this exposure.
Reconciliations of direct to net premiums, on a written and earned basis, for 2017, 2016 and 2015 related to the wholly-owned underwriting enterprise subsidiary discussed above are as follows (in millions):
At December 31, 2017 and 2016, our underwriting enterprise subsidiary had reinsurance recoverables of $59.8 million and $48.3 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.
On December 22, 2017, the U.S. enacted tax legislation commonly referred to as the Tax Cuts and Jobs Act (which we refer 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 deemed repatriated earnings of foreign subsidiaries. See discussion of repatriation tax 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 have determined that we are able to make reasonable estimates for certain effects of tax reform. In our 2017 consolidated financial statements, we have recognized provisional amounts for our deferred income taxes and repatriation tax based on reasonable estimates. However, as of the date of this Annual Report on Form 10-K, we are continuing to evaluate the accounting impactions of the Tax Act as we continue to assemble and analyze all the information required to prepare and analyze these effects and await additional guidance from the U.S. Treasury Department, IRS or other standard-setting bodies. We continue to assess information relating to these amounts, and with respect to the repatriation tax, we continue to assess its application in other jurisdictions. Additionally, we continue to analyze other information and regulatory guidance and accordingly we may record additional provisional amounts or adjustments to provisional amounts in future periods.
Cost Recovery: While we have not yet completed all of the computations necessary to determine the 2017 expenditures that qualify for immediate expensing, we have recorded an immaterial provisional benefit based on our current intent to fully expense all qualifying expenditures. This resulted in a decrease to our current income taxes payable and a corresponding increase in our deferred tax liability.
During 2017, 2016 and 2015, $5.0 million, $5.3 million and $6.2 million, respectively, of expense related to the pension liability was reclassified from accumulated other comprehensive earnings (loss) to compensation expense in the statement of earnings. During 2017, 2016 and 2015, $5.2 million of expense, $8.2 million of expense and $0.7 million of income, respectively, related to the fair value of derivative investments, was reclassified from accumulated other comprehensive earnings (loss) to the statement of earnings. During 2017, 2016 and 2015, no amounts related to foreign currency translation were reclassified from accumulated other comprehensive earnings (loss) to the statement of earnings.
We have three reportable operating segments: brokerage, risk management and corporate.
Our brokerage segment is primarily comprised of our retail and wholesale insurance brokerage operations. Our 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.
Our corporate segment manages our clean energy investments. In addition, our corporate segment reports the financial information related to our debt, and external acquisition-related expenses and other corporate costs.
Financial information relating to our segments for 2017, 2016 and 2015 is as follows (in millions):
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, 2017, 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 9, 2018 expressed an unqualified opinion thereon.
As discussed in Note 2 to the consolidated financial statements, in 2017 Gallagher retrospectively changed its method of presenting contingent payments related to past acquisitions and restricted cash in the consolidated statement of cash flows due to the adoption of Accounting Standards Updates 2016-15 and 2016-18.
Based on our assessment under the framework in Internal Control - Integrated Framework, management concluded that our internal control over financial reporting was effective as of December 31, 2017. In addition, the effectiveness of our internal control over financial reporting as of December 31, 2017 has been audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in their attestation report which is included herein.
We have audited Arthur J. Gallagher & Co.’s (Gallagher) internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework), (the COSO criteria). In our opinion, Gallagher maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on the COSO criteria.
As indicated in the accompanying management’s Report on Internal Control Over Financial Reporting, management’s assessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls of 15 of the 39 entities acquired in 2017, which are included in the 2017 consolidated financial statements of Gallagher and constituted approximately 0.2% of total assets as of December 31, 2017 and approximately 0.3% of total revenues and approximately 0.4% of net earnings for the year then ended. Our audit of internal control over financial reporting of Gallagher also did not include an evaluation of the internal control over financial reporting of these acquired entities.
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, 2017 and 2016, 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, 2017, and the related notes and financial statement schedule listed in the Index at Item 15(2)(a) (collectively referred to as the “financial statements”) of Gallagher and our report dated February 9, 2018 expressed an unqualified opinion thereon.
Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.