Over the past three years, the United States and the world have experienced catastrophes ranging from severe hurricanes to devastating earthquakes. Extraordinarily high losses associated with these events appear to have had a generally limited impact on the insurance industry. Turmoil continues at Lloyd's of London raising doubt about its long-term viability. In the past year, there have been substantial mergers and a consolidation within the insurance industry. Rates for workers compensation coverage have generally been reduced. In recent years, low interest rates have reduced interest income earned on invested funds. Throughout all of this, there has generally been little change in property/casualty rates. Excess capacity remains and the competitive environment continues. It is management's view that for the foreseeable future, insurance pricing will not change significantly.
Commission revenues increased by $19.4 million or 9% in 1995. This increase is the result of new business production of $30.4 million, partially offset by lost business. Commission revenues increased by $23.0 million or 12% in 1994. This increase is the result of new business production of $30.1 million, and to a lesser extent, modest renewal rate increases partially offset by lost business.
Fee revenues increased by $18.6 million or 13% in 1995. This increase, generated primarily by Gallagher Bassett Services, Inc., resulted from strong new business production of $26.3 million and increases in existing business partially offset by lost business. Fee revenues increased by $12.7 million or 10% in 1994. This
Other operating expenses increased by $12.6 million or 11% in 1995. This increase is due primarily to additional office facilities (rent and utilities, miscellaneous office and supply expenses) resulting from leasing new office space and expanding and upgrading existing office facilities and significantly higher business insurance costs. Other operating expenses increased by $1.6 million or 1% in 1994. This increase was due primarily to additional office facilities (rent and utilities, miscellaneous office and supply expenses) resulting from leasing new office space and expanding and upgrading existing facilities, and higher business insurance costs. Travel and entertainment costs also increased in 1994 due to an increase in both the number of employees and the Company's sales volume. This increase was partially offset by the non- recurring write-off in 1993 of $2.0 million by a 1994 acquisition of certain intangible assets and by a reduction in professional fees related to claims processing, investment management and acquisition costs.
The Company's foreign operations recorded earnings before income taxes of $2.6 million, $1.3 million, and $7.1 million in 1995, 1994, and 1993, respectively. The 1995 increase is due primarily to stronger investment income. The 1994 decrease is due primarily to the 1993 non-recurring foreign benefit plan gain mentioned above and a reduction in investment income. See Notes 13 and 14 of the Notes to Consolidated Financial Statements.
The Company's total revenues vary from quarter to quarter as a result of the timing of policy renewals and net new/lost business production, whereas expenses are fairly uniform throughout the year. See Note 15 of the Notes to Consolidated Financial Statements.
The insurance brokerage industry is not capital intensive. The Company has historically been profitable with a positive cash flow from operations and has consequently been able to finance its operations and capital expenditures from internally generated funds. Funds restricted as to the Company's use (primarily premiums held as fiduciary funds) have not been included in determining the Company's liquidity.
In February, 1993, the Company entered into a $20 million unsecured revolving credit agreement (the "Credit Agreement") with two banks. Loans under the Credit Agreement are repayable no later than February, 1998, and bear floating interest rates over the term of the loan. In February, 1993, a loan was funded for $20 million. The Company simultaneously entered into interest rate exchange agreements which fixed the rate of interest payable on the loan. The Company retired the $20 million loan in the fourth quarter of 1994 and has fully satisfied all obligations associated with the loan. The Company also recognized a gain of $656,000 in closing out the interest rate exchange agreements. The Credit Agreement remains in effect and as of December 31, 1995, there are no borrowings currently existing under this agreement.
Net capital expenditures for fixed assets amounted to $9.4 million, $7.5 million and $7.8 million in 1995, 1994 and 1993, respectively. In 1996, the Company intends to make additional capital improvements of approximately $10.5 million to upgrade and modernize existing space, furniture and equipment.
In 1988, the Company adopted a plan, which has been extended through June 30, 1996, to repurchase its common stock. Under the plan, the Company repurchased 437,000 shares at a cost of $15.1 million, 1.4 million shares at a cost of $43.8 million and 225,000 shares at a cost of $7.0 million in 1995, 1994 and 1993, respectively. The 1994 common stock repurchases, in part, caused the weighted average shares outstanding to decrease by 590,000 shares from 1993 to 1994. The repurchases were funded entirely by internally generated funds and are held for reissuance in connection with exercises of options under its stock option plans. Under the provisions of the plan, the Company is authorized to repurchase approximately 360,000 additional shares through June 30, 1996. The Company is under no commitment or obligation to repurchase any particular amount of common stock and at its discretion may suspend the repurchase plan at any time.
The Company believes that internally generated funds will continue to be sufficient to meet the Company's foreseeable cash needs, including non- operating cash disbursements such as anticipated dividends, capital expenditures and repayment of borrowings under its loan agreements if the Company so determines.
Arthur J. Gallagher & Co. (the Company) provides insurance broker and risk management services to a wide variety of commercial, industrial, institutional and governmental organizations. Commission revenue is principally generated through the negotiation and placement of insurance for its clients. Fee revenue is generated by providing other risk management services including claims management, information management, risk control services and appraisals in either the property/casualty market or human resource, employee benefit market. The Company operates through approximately 140 offices throughout the United States and five offices abroad.
Commission income is generally recognized as of the effective date of insurance policies except for commissions on installment premiums which are recognized periodically as billed. Contingent commissions are recognized when received. Fee income is recognized ratably as services are rendered. The income effects of subsequent premium and fee adjustments are recorded when the adjustments become known. Premiums and fees receivable are net of allowance for doubtful accounts of $709,000 and $846,000 at December 31, 1995 and 1994, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) the net unrealized holding gains on securities classified as available for sale previously carried at the lower of cost or fair value, or at amortized cost. There was no cumulative effect on net earnings as a result of the adoption of Statement 115 because the securities classified as trading were carried as a current asset and had a fair value below cost at January 1, 1994. Accordingly, such unrealized losses were recorded in prior period earnings.
Fixed assets are carried at cost. Furniture and equipment with a cost of $59,130,000 at December 31, 1995 ($53,576,000 at December 31, 1994) are depreciated using the straight-line method over the estimated useful lives of the assets. Leasehold improvements with a cost of $7,828,000 at December 31, 1995 ($7,200,000 at December 31, 1994) are amortized using the straight-line method over the shorter of the estimated useful lives of the assets or the lease terms.
The Company grants stock options for a fixed number of shares to employees with an exercise price equal to the fair value of the shares at the date of grant. The Company accounts for stock option grants in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees", and, accordingly, recognizes no compensation expense for the stock option grants.
In 1995, the Company acquired substantially all the net assets of nine insurance brokerage firms in exchange for 723,000 shares of its common stock. In 1994, the Company acquired substantially all the net assets of five insurance brokerage firms in exchange for 819,000 shares of its common stock. These acquisitions were accounted for as poolings of interests and, except for seven of the 1995 acquisitions and three of the 1994 acquisitions whose results were not significant, the financial statements for all periods prior to the acquisition dates have been restated to include the operations of these companies.
The gross realized gains on sales of marketable securities totaled $1,079,000, $2,004,000 and $1,719,000 for the years ended December 31, 1995, 1994, and 1993, respectively. The gross realized losses totaled $1,918,000, $312,000 and $929,000 for the years ended December 31, 1995, 1994, and 1993, respectively.
At December 31, 1995, securities sold under agreements to repurchase the identical securities are collateralized by government backed small business administration loans and government securities with a carrying value of $20,071,000 and a fair value of $20,253,000. The securities collateralizing the agreements were held by two primary dealers. At December 31, 1994, these securities had a carrying value of $19,152,000 and a fair value of $19,098,000.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Options with respect to 1,269,000 shares were available for grant at December 31, 1995.
The Company accounts for the defined benefit pension plan in accordance with Statement of Financial Accounting Standards No. 87 (SFAS 87), "Employers' Accounting for Pensions". The difference between the present value of the projected benefit obligation at the date of adoption of SFAS 87 and the fair value of plan assets at that date is being amortized on a straight-line basis over the average remaining service period of employees expected to receive benefits.
In 1993, the Company converted its foreign defined benefit plan to a defined contribution plan. The defined contribution plan provides for basic contributions by the Company and voluntary contributions by employees which are matched 100% by the Company, up to a maximum of 5% of salary, as defined.
Net expense for foreign retirement plans amounted to $999,000 in 1995, $1,041,000 in 1994 and ($3,951,000) in 1993.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The assumed healthcare cost trend rate used for the next two years is 9.5%, scaling down to 4.5% after 13 years. A 1% increase in the assumed healthcare cost trend rate would increase the accumulated postretirement benefit obligation by $1,426,000 at December 31, 1995 and would increase the net periodic postretirement benefit cost for 1995 by $97,000.
The Company is engaged in various legal actions incident to the nature of its business. Management is of the opinion that none of the litigation will have a material effect on the Company's financial position.
Minimum aggregate rental commitments at December 31, 1995 under noncancelable operating leases having an initial term of more than one year are as follows:
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax liabilities and assets as of December 31 are as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONCLUDED) The consolidated financial statements include liabilities of $62,349,000 at December 31, 1995 ($58,048,000 at December 31, 1994) after elimination of intercompany balances applicable to foreign operations.
Exchange gains (losses) were approximately $51,000 in 1995, $106,000 in 1994 and ($115,000) in 1993.
The Management of Arthur J. Gallagher & Co. is responsible for the preparation and integrity of the consolidated financial statements and the related financial comments appearing in this annual report. The financial statements were prepared in accordance with generally accepted accounting principles and include certain amounts based on management's best estimates and judgments. Other financial information presented in the annual report is consistent with the financial statements.
The Board of Directors and Stockholders Arthur J. Gallagher & Co.
We have audited the accompanying consolidated balance sheet of Arthur J. Gallagher & Co. as of December 31, 1995 and 1994, and the related consolidated statements of earnings, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Arthur J. Gallagher & Co. at December 31, 1995 and 1994, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.
As discussed in Note 1 to the consolidated financial statements, in 1994, the Company changed its method of accounting for certain investments in debt and equity securities.