AJG

Arthur J. Gallagher & Co. 2008 10-K Summary

Business Context and Reporting Period

This Form 10-K covers the fiscal year ended December 31, 2008. Arthur J. Gallagher & Co. (Gallagher) is the world's fourth-largest insurance broker and the largest third-party property/casualty (P/C) claims administrator. The company operates three segments: Brokerage (72% of revenue), Risk Management (28% of revenue), and Financial Services and Corporate (<1% of revenue). Approximately 87% of revenues are generated domestically, with the remainder primarily from Canada, the U.K., Australia, and Bermuda.

Key Financial Metrics

Segment Performance: Brokerage revenues grew 7% to $1,187.8 million, while Risk Management revenues grew 5% to $464.9 million. The Financial Services segment reported a loss of $7.7 million in revenues due to the expiration of IRC Section 29 tax credits and investment losses.

Material Changes vs. Prior Period

• Discontinued Operations: The company exited its global reinsurance and Irish wholesale brokerage operations. These were reclassified as discontinued operations, resulting in a net loss of $34.1 million in 2008 (compared to $15.8 million in 2007).
• Tax Rate Impact: The expiration of IRC Section 29 tax credits on December 31, 2007, caused the effective tax rate to rise from 22.7% in 2007 to 31.9% in 2008. Management expects the rate to range between 39.0% and 41.0% in future years.
• Investment Losses: The Financial Services segment incurred a net investment loss of $8.5 million in 2008, driven by a $5.8 million impairment charge on its investment in Asset Alliance Corporation (AAC) and losses from clean energy ventures.
• Acquisitions: Gallagher completed 37 acquisitions in 2008, contributing $101.6 million to commission and fee revenues. Organic growth in commissions and fees was flat (0%) in 2008.

Guidance, Outlook, and Risks

Outlook: Management anticipates continued growth through acquisitions and organic expansion in niche markets. However, the company faces a "soft" insurance market with declining premium rates, which pressures commission revenues. The company expects to maintain its dividend policy, having declared $1.28 per share in 2008.

Key Risks and Contingencies:

• Credit Market Disruption: The global credit crisis could limit access to capital, increase financing costs, or cause liquidity issues for insurance carriers, potentially leading to payment defaults to Gallagher.
• Contingent Commission Litigation: Gallagher is subject to a Multi-District Litigation (MDL) settlement requiring a $28.0 million distribution to clients. An appeal of the settlement approval is pending, with a hearing scheduled for April 2009.
• Regulatory Changes: Restrictions on accepting contingent commissions in retail brokerage may place Gallagher at a competitive disadvantage relative to firms not subject to similar restrictions.
• Pension Plan: Negative asset returns and increased discount rates in 2008 resulted in a $56.1 million underfunded status for the defined benefit pension plan, reducing stockholders' equity by $42.2 million.

Investor Verification Checklist

• Tax Rate Sustainability: Verify the projected 39-41% effective tax rate for 2009 and the potential impact of IRS audits on prior IRC Section 29 credits.
• Discontinued Operations: Confirm the final settlement terms and remaining liabilities associated with the reinsurance and Irish wholesale brokerage exits.
• Acquisition Integration: Assess the performance of the 37 acquisitions completed in 2008 and the $291.5 million in unrecorded earnout payables.
• Credit Exposure: Review the concentration of trade receivables from insurance carriers and the status of the $450 million credit facility.
• Investment Portfolio: Monitor the valuation of the Asset Alliance Corporation (AAC) investment and clean energy ventures (Chem-Mod, C-Quest) for further impairments.