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ARTHUR J. GALLAGHER & CO. – 10-K – Management's Discussion and Analysis of Financial Condition and Results of Operations.
Introduction
The following discussion and analysis should be read in conjunction with our consolidated financial statements and the related notes included in Item 8 of this annual report. In addition, please see "Information Regarding Non-GAAP Measures and Other" beginning on page 35 for a reconciliation of the non-GAAP measures for adjusted total revenues, organic commission, fee and supplemental revenues and adjusted EBITDAC to the comparable GAAP measures, as well as other important information regarding these measures. We are engaged in providing insurance brokerage and consulting services, and third-party property/casualty claims settlement and administration services to entities in theU.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 inRolling Meadows, Illinois , have operations in 68 countries and offer client-service capabilities in more than 150 countries globally through a network of correspondent brokers and consultants. In 2021, we expanded, and expect to continue to expand, our international operations through both acquisitions and organic growth. We generate approximately 67% of our revenues for the combined brokerage and risk management segments domestically, with the remaining 33% generated internationally, primarily in theU.K. ,Australia ,Canada ,New Zealand andBermuda (based on 2021 revenues). We expect that our international revenue as a percentage of our total revenues in 2022 will increase compared to 2021, in part due to our acquisition of the Willis Towers Watson plc treaty reinsurance brokerage operations (see further below). We have three reportable segments: brokerage, risk management and corporate, which contributed approximately 73%, 13% and 14%, respectively, to 2021 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. Our ability to generate additional tax credits from our Section 45 clean energy investments ended inDecember 2021 . UnlessCongress reinstates the law allowing for such tax credits, we do not expect to generate any revenue or earnings from such investments in 2022. This Management's Discussion and Analysis of Financial Condition and Results of Operations contains certain statements relating to future results which are forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995. Please see "Information Concerning Forward-Looking Statements" at the beginning of this annual report, for certain cautionary information regarding forward-looking statements and a list of factors that could cause our actual results to differ materially from those predicted in the forward-looking statements.
Prior Year Discussion of Results and Comparisons
For information on fiscal 2020 results and similar comparisons, see "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations" of our Form 10-K for the fiscal year ended
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Summary of Financial Results - Year Ended
See the reconciliations of non-GAAP measures on page 33.
Year 2021 Year 2020 Change
Reported Adjusted Reported Adjusted Reported Adjusted
GAAP Non-GAAP GAAP Non-GAAP GAAP Non-GAAP
(In millions, except per share data)
Brokerage Segment
Revenues $ 5,967.5 $ 5,948.7 $ 5,167.1 $ 5,283.0 16 % 13 %
Organic revenues $ 5,603.6 $ 5,188.4 8.0 %
Net earnings $ 1,016.6 $ 866.0 17 %
Net earnings margin 17.0 % 16.8 % +28 bpts
Adjusted EBITDAC $ 2,018.1 $ 1,727.6 17 %
Adjusted EBITDAC
margin 33.9 % 32.7 % +123 bpts
Diluted net earnings
per share $ 4.86 $ 5.47 $ 4.42 $ 5.00 10 % 9 %
Risk Management
Segment
Revenues before
reimbursements $ 967.6 $ 967.5 $ 821.7 $ 833.1 18 % 16 %
Organic revenues $ 933.9 $ 832.4 12.2 %
Net earnings $ 89.5 $ 66.9 34 %
Net earnings margin
(before
reimbursements) 9.3 % 8.1 % +111 bpts
Adjusted EBITDAC $ 184.5 $ 151.5 22 %
Adjusted EBITDAC
margin
(before
reimbursements) 19.1 % 18.2 % +88 bpts
Diluted net earnings
per share $ 0.43 $ 0.47 $ 0.34 $ 0.38 26 % 24 %
Corporate Segment
Diluted net loss per
share $ (0.92 ) $ (0.46 ) $ (0.56 ) $ (0.57 )
Total Company
Diluted net earnings
per share $ 4.37 $ 5.48 $ 4.20 $ 4.81 4 % 14 %
Total Brokerage and
Risk
Management Segment
Diluted net earnings
per share $ 5.29 $ 5.94 $ 4.76 $ 5.38 11 % 10 %
In our corporate segment, net after-tax earnings from our clean energy
investments was
respectively. At this time, we do not anticipate our clean energy investments
will produce after-tax earnings in 2022.
The following provides information that management believes is helpful when
comparing revenues before reimbursements, net earnings, EBITDAC and diluted net
earnings per share for 2021 and 2020. In addition, these tables provide
reconciliations to the most
31 -------------------------------------------------------------------------------- comparable GAAP measures for adjusted revenues, adjusted EBITDAC and adjusted diluted net earnings per share. Reconciliations of EBITDAC for the brokerage and risk management segments are provided on pages 39 and 45 of this filing. Year EndedDecember 31 Reported GAAP to Adjusted Non-GAAP Reconciliation: Revenues Before Net Earnings Diluted Net Earnings (Loss) Reimbursements (Loss) EBITDAC Per Share Segment 2021 2020 2021 2020 2021 2020 2021 2020 Chg (In millions, except per share data) Brokerage, as reported$ 5,967.5 $ 5,167.1 $ 1,016.6
10 % Net (gains) loss on divestitures (18.8 ) 5.8 (15.0 ) 4.7 (18.8 ) 5.8 (0.07 ) 0.02 Acquisition integration - - 25.2 19.3 31.7 25.1 0.12 0.10 Workforce and lease termination - - 18.0 34.0 20.6 43.9 0.09 0.17 Acquisition related adjustments - - 98.3 39.7 27.4 19.2 0.47 0.20 Levelized foreign currency translation - 110.1 - 17.4 - 36.2 - 0.09 Brokerage, as adjusted * 5,948.7 5,283.0 1,143.1 981.1 2,018.1 1,727.6 5.47 5.00 9 % Risk Management, as reported 967.6 821.7 89.5 66.9 177.1 141.6$ 0.43 $ 0.34 26 % Net gains on divestures (0.1 ) - (0.1 ) - (0.1 ) - - - Workforce and lease termination - - 6.0 6.0 7.1 7.9 0.03 0.04 Acquisition related adjustments - - 2.1 0.4 0.4 - 0.01 - Levelized foreign currency translation - 11.4 - 0.7 - 2.0 - -
Risk Management, as adjusted * 967.5 833.1 97.5
74.0 184.5 151.5 0.47 0.38 24 % Corporate, as reported 1,141.3 863.1 (151.1 )
(74.8 ) (231.0 ) (142.2 )
Loss on extinguishment of debt
- - 12.2 - - - 0.06 - Transaction-related costs - - 38.5 - 47.9 - 0.19 - Legal and income tax related - - 43.6 (1.1 ) 9.5 - 0.21 (0.01 ) Corporate, as adjusted * 1,141.3 863.1 (56.8 ) (75.9 ) (173.6 ) (142.2 ) (0.46 ) (0.57 )
4 %
14 % Total Brokerage and Risk Management, as reported$ 6,935.1 $ 5,988.8 $ 1,106.1
11 % Total Brokerage and Risk Management, as adjusted *$ 6,916.2 $ 6,116.1 $ 1,240.6 $ 1,055.1 $ 2,202.6 $ 1,879.1 $ 5.94 $ 5.38 10 %
* For the year ended
segment adjustments totals
the provision for income taxes of
the year ended
segment adjustments totals
the provision for income taxes of
the year ended
adjustments totals
benefit for income taxes of
tax items noted on page 50. For the corporate segment, the clean energy
related adjustments are described on page 50.
For the year ended December 31, 2020 , the pretax impact of the brokerage segment
adjustments totals $148.5 million , with a corresponding adjustment to the
provision for income taxes of $33.4 million relating to these items. For the
year ended December 31, 2021 , the pretax impact of the risk management segment
adjustments totals $9.5 million , with a corresponding adjustment to the
provision for income taxes of $2.4 million relating to these items. For the year
ended December 31, 2021 , there is no pretax impact of the corporate segment
adjustments, but there is an adjustment to the provision for income taxes of
$1.1 million . For the corporate segment, the clean energy related adjustments
are described on page 50.
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Reconciliation of Non-GAAP Measures - Pre-tax Earnings and Diluted Net Earnings
per Share
(In millions except share
and per share data)
Earnings Provision Net Earnings
(Loss) (Benefit) Net Earnings (Loss) Diluted Net
Before for Net Attributable to Attributable to Earnings
Income Income Earnings Noncontrolling Controlling (Loss) per
Taxes Taxes (Loss) Interests Interests Share
Year EndedDec 31, 2021 Brokerage, as reported$ 1,345.5 $ 328.9 $ 1,016.6 $ 8.4 $ 1,008.2$ 4.86 Net gains on divestitures (18.8 ) (3.8 ) (15.0 ) - (15.0 ) (0.07 ) Acquisition integration 31.7 6.5 25.2 - 25.2 0.12 Workforce and lease termination 22.8 4.8 18.0 - 18.0 0.09 Acquisition related adjustments 123.5 25.2 98.3 - 98.3 0.47 Brokerage, as adjusted$ 1,504.7 $ 361.6 $ 1,143.1 $ 8.4 $ 1,134.7$ 5.47 Risk Management, as reported$ 120.1 $ 30.6 $ 89.5 $ - $ 89.5$ 0.43 Net gains on divestitures (0.1 ) - (0.1 ) - (0.1 ) - Workforce and lease termination 8.0 2.0 6.0 - 6.0 0.03 Acquisition related adjustments 2.7 0.6 2.1 - 2.1 0.01 Risk Management, as adjusted$ 130.7 $ 33.2 $ 97.5 $ - $ 97.5$ 0.47 Corporate, as reported$ (490.5 ) $ (339.4 ) $ (151.1 ) $ 39.8 $ (190.9 )$ (0.92 ) Loss on extinguishment of debt 16.2 4.0 12.2 - 12.2 0.06 Transaction-related costs 47.9 9.4 38.5 - 38.5 0.19 Legal and income tax related 9.5 (34.1 ) 43.6 - 43.6 0.21 Corporate, as adjusted$ (416.9 ) $ (360.1 ) $ (56.8 ) $ 39.8 $ (96.6 )$ (0.47 ) Year EndedDec 31, 2020 Brokerage, as reported$ 1,142.3 $ 276.3 $ 866.0 $ 4.9 $ 861.1$ 4.42 Net loss on divestitures 5.8 1.1 4.7 - 4.7 0.02 Acquisition integration 25.1 5.8 19.3 - 19.3 0.10 Workforce and lease termination 43.9 9.9 34.0 - 34.0 0.17 Acquisition related adjustments 51.0 11.3 39.7 - 39.7 0.20 Levelized foreign currency translation 22.7 5.3 17.4 - 17.4 0.09 Brokerage, as adjusted$ 1,290.8 $ 309.7 $ 981.1 $ 4.9 $ 976.2$ 5.00 Risk Management, as reported$ 89.4 $ 22.5 $ 66.9 $ - $ 66.9$ 0.34 Workforce and lease termination 7.9 1.9 6.0 - 6.0 0.04 Acquisition related adjustments 0.6 0.2 0.4 - 0.4 - Levelized foreign currency translation 1.0 0.3 0.7 - 0.7 - Risk Management, as adjusted$ 98.9 $ 24.9 $ 74.0 $ - $ 74.0$ 0.38 Corporate, as reported$ (360.8 ) $ (286.0 ) $ (74.8 ) $ 34.4 $ (109.2 )$ (0.56 ) Income tax related - 1.1 (1.1 ) - (1.1 ) (0.01 ) Corporate, as adjusted$ (360.8 ) $ (284.9 ) $ (75.9 ) $ 34.4 $ (110.3 )$ (0.57 )
Acquisition of the Willis Towers Watson plc Treaty Reinsurance Brokerage
Operations
OnDecember 1, 2021 , we acquired substantially all of the Willis Towers Watson's plc treaty reinsurance brokerage operations for an initial gross consideration of$3.25 billion , and potential additional consideration of$750 million subject to certain third-year revenue targets. There are twelve remaining international operations with deferred closings that comprise approximately$180 million of the initial purchase consideration that are subject to local regulatory approval and are expected to close in the first and second quarters of 2022. We funded the transaction using cash on hand, including the$1.4 billion of net cash raised in ourMay 17, 2021 follow-on common stock offering,$850 million of net cash borrowed in ourMay 20, 2021 30-year senior note issuance,$750 million of net cash borrowed in ourNovember 9, 2021 10-year ($400 million ) and 30-year ($350 million ) senior note issuances and shortterm borrowings. 33 --------------------------------------------------------------------------------
Significant Developments and Trends
Impact of COVID 19 Pandemic Recovery
Relative to fourth quarter 2020, during fourth quarter 2021;
• Nearly all of our brokerage segment operations' revenue benefited from our
clients' improving business conditions which increases insured exposure
units (i.e., insured values, payrolls, employees, miles driven, gross
receipts, etc.) and covered lives;
• Our risk management segment operations' revenue benefited from our clients'
improving business conditions, which increases new arising workers'
compensation and general liability claims; and
• Our clean energy investments benefited from higher electricity production
due to increased demand for electricity from improving business conditions,
somewhat offset by the sunset of our 2011 Era Plants in November and
December of 2021.
If economic conditions continue to improve, we believe we may continue to see favorable revenue benefits in our brokerage and risk management segments in the first quarter of 2022 relative to the same quarter in 2021. However, if the economic recovery slows, due to the Omicron variant or other factors, we could see less revenue benefits than we experienced in second, third and fourth quarters of 2021. During the second, third and fourth quarters of 2020 and first quarter of 2021, we realized significant expense savings (totaling approximately$60 million to$75 million per quarter relative to the prior year same quarters, adjusted for pro forma fullquarter costs related to acquisitions) as a result of reduced travel, entertainment and advertising expenses, reduced costs from lower employee medical plan utilization, a reduction in workforce, wage controls, and reduced use of external consultants. During the second, third and fourth quarters of 2021, as we increased our business activities relative to the second, third and fourth quarters of 2020, we experienced increases in travel and entertainment, full restoration of advertising and more normalized usage of our employee medical plan, resumption of annual support-layer wage increases, increased use of external consultants, further investment in support of our hybrid employee environment, continued investment in cyber security and an increase in incentive compensation. These incremental costs totaled approximately$15 million ,$25 million and$30 million in our brokerage segment relative to the second, third and fourth quarters of 2020, respectively. Looking forward to 2022, we believe we will see incrementally higher brokerage segment costs relative to 2021, and if the pace of economic recovery accelerates beyond our expectations, we could see expense increases higher than our current estimates.
For a discussion of risk and uncertainties relating to COVID19 for our
business, results of operations and financial condition, see Part I, Item 1A.
Risk Factors in our Form 10-K pages 13-14.
Insurance Market Overview
Fluctuations in premiums charged by property/casualty underwriting enterprises
have a direct and potentially material impact on the insurance brokerage
industry. Commission revenues are generally based on a percentage of the
premiums paid by insureds and normally follow premium levels. Insurance premiums
are cyclical in nature and may vary widely based on market conditions. Various
factors, including competition for market share among underwriting enterprises,
increased underwriting capacity and improved economies of scale following
consolidations, can result in flat or reduced property/casualty premium rates (a
"soft" market). A soft market tends to put downward pressure on commission
revenues. Various countervailing factors, such as greater than anticipated loss
experience, unexpected loss exposure and capital shortages, can result in
increasing property/casualty premium rates (a "hard" market). A hard market
tends to favorably impact commission revenues. Hard and soft markets may be
broad-based or more narrowly focused across individual product lines or
geographic areas. As markets 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. 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.
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We typically cite the Council of Insurance Agents & Brokers (which we refer to
as the CIAB) insurance pricing quarterly survey at this time as an indicator of
the current insurance rate environment. The fourth quarter 2021 survey had not
been published as of the filing date of this report. The first three 2021
quarterly surveys indicated that U.S. commercial property/casualty rates
increased by 10.0%, 8.3%, and 8.9% on average, for the first, second and third
quarters of 2021, respectively. We expect a similar trend to be noted when the
CIAB fourth quarter 2021 survey report is issued, which would signal overall
continued price firming and hardening in some items. The CIAB represents the
leading domestic and international insurance brokers, who write approximately
85% of the commercial property/casualty premiums in the U.S.
We believe increases in property/casualty rates, will continue in 2022 due to
rising loss costs resulting from replacement cost inflation, increased frequency
of catastrophe losses and social inflation, and continued low fixed income
investment returns. The economies of the U.S. and other countries around the
world contracted during 2020 as a result of COVID-19. Global economic conditions
in many geographies improved during 2021, and have resumed growth despite supply
chain disruptions and new COVID-19 variants. Global economic growth is expected
to continue in 2022 and is likely to lead to higher exposure units, inflation, a
tight labor market and lower unemployment. Additionally, we expect that our
history of strong new business generation, solid retentions and enhanced
value-added services for our carrier partners should all result in further
organic growth opportunities around the world. Overall, we believe that in a
positive rate environment with growing exposure units, our professionals can
demonstrate their expertise and high-quality, value-added capabilities by
strengthening our clients' insurance portfolios and delivering insurance and
risk management solutions within our clients' budget. Based on our experience,
there is adequate capacity in the insurance market for most lines of coverage,
terms and conditions are tightening, most insurance carriers appear to be making
rational pricing decisions and clients can broadly still obtain coverage.
Clean energy investments - We have investments in limited liability companies
that own 29 clean coal production plants developed by us and six clean coal
production plants we purchased from a third party. All 35 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 plants which were placed in
service prior to December 31, 2009 (which we refer to as the 2009 Era Plants)
received tax credits through 2019 and the 21 plants which were placed in service
prior to December 31, 2011 (which we refer to as the 2011 Era Plants) received
tax credits through 2021. All twenty-one of the 2011 Era Plants were under
longterm production contracts with several utilities. Those agreements ended
December 31, 2021 due to the expiration of the IRC Section 45 program.
We also own a 46.5% controlling interest in Chem-Mod, which has been marketing
The ChemMod™ Solution proprietary technologies principally to refined fuel
plants that sell refined fuel to coal-fired power plants owned by utility
companies, including those plants in which we hold interests. Currently,
Chem-Mod is not anticipated to generate after-tax earnings after 2021.
All estimates set forth above regarding the future results of our clean energy
investments are subject to significant risks, including those set forth in the
risk factors regarding our IRC Section 45 investments under Item 1A, "Risk
Factors."
Business Combinations and Dispositions
See Note 3 to our 2021 consolidated financial statements for a discussion of our
2021 business combinations.
Results of Operations
Information Regarding Non-GAAP Measures and Other
In the discussion and analysis of our results of operations that follows, in
addition to reporting financial results in accordance with GAAP, we provide
information regarding EBITDAC, EBITDAC margin, adjusted EBITDAC, adjusted
EBITDAC margin, diluted net earnings per share, as adjusted (adjusted EPS),
adjusted revenues, adjusted compensation and operating expenses, adjusted
compensation expense ratio, adjusted operating expense ratio and organic
revenue. These measures are not in accordance with, or an alternative to, the
GAAP information provided in this report. We believe that these presentations
provide useful information to management, analysts and investors regarding
financial and business trends relating to our results of operations and
financial condition because they provide investors with measures that our chief
operating decision maker uses when reviewing the company's performance, and for
the other reasons described below. Our industry peers may provide similar
supplemental non-GAAP information with respect to one or more of these measures,
although they may not use the same or comparable terminology and may not make
identical adjustments. The non-GAAP information we provide should be used in
addition to, but not as a substitute for, the GAAP information provided. We
make determinations regarding certain elements of executive officer incentive
compensation, performance share awards and annual cash incentive awards, partly
on the basis of measures related to adjusted EBITDAC.
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Adjusted Non-GAAP presentation - We believe that the adjusted non-GAAP
presentation of our 2021 and 2020 information, presented on the following pages,
provides stockholders and other interested persons with useful information
regarding certain financial metrics that may assist such persons in analyzing
our operating results as they develop a future earnings outlook for us. The
after-tax amounts related to the adjustments were computed using the normalized
effective tax rate for each respective period.
• Adjusted measures - We define these measures as revenues (for the
brokerage segment), revenues before reimbursements (for the risk
management segment), net earnings, compensation expense and operating
expense, respectively, each adjusted to exclude the following, as
applicable:
o Net losses or gains on divestitures, which are primarily net losses or
proceeds received related to sales of books of business and other
divestiture transactions, such as the disposal of a business through
sale or closure.
o Costs related to divestitures, which include legal and other costs
related to certain operations that are being exited by us.
o Acquisition integration costs, which include costs related to certain
large acquisitions, outside the scope of our usual tuck-in strategy,
not expected to occur on an ongoing basis in the future once we fully
assimilate the applicable acquisition. These costs are typically
associated with redundant workforce, extra lease space, duplicate
services and external costs incurred to assimilate the
acquisition
with our IT related systems.
o Transaction-related costs associated with due diligence and
integration for its acquisition of the Willis Towers Watson plc treaty
reinsurance brokerage operations and the previous terminated
agreement
to acquire certain Willis Towers Watson reinsurance and other
brokerage operations. These include costs related to regulatory
filings, legal, accounting services, insurance and incentive
compensation.
o Workforce related charges, which primarily include severance costs
(either accrued or paid) related to employee terminations and other
costs associated with redundant workforce.
o Lease termination related charges, which primarily include costs
related to terminations of real estate leases and abandonment of
leased space.
o Acquisition related adjustments, which include change in estimated
acquisition earnout payables adjustments, impairment charges
and
acquisition related compensation charges. For 2021, this
adjustment
also includes the impact of an acquisition valuation analysis and
corresponding adjustments.
o 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
period in
the prior year.
o Legal and income tax related, which represents the impact in second
quarter 2021 of one-time income tax expense associated with the
change
in the U.K. effective income tax rate from 19% to 25% that is
effective in 2023. It also includes the impact of additional
U.S. income tax expense related to the non-deductibility of some acquisition related adjustments made and costs incurred related to a legal settlement. o Loss on extinguishment of debt represents costs incurred on the early redemption of the$650 million of 2031 Senior Notes, which
included
the redemption price premium, the unamortized discount amount
on the
debt issuance and the write-off of all the debt acquisition
costs.
• Adjusted ratios - Adjusted compensation expense and adjusted operating
expense, respectively, each divided by adjusted revenues.
Non-GAAP Earnings Measures
We believe that the presentation of EBITDAC, EBITDAC margin, adjusted EBITDAC, adjusted EBITDAC margin and adjusted EPS for the brokerage and risk management segment, each as defined below, provides a meaningful representation of our operating performance. Adjusted EPS is a performance measure and should not be used as a measure of our liquidity. We also consider EBITDAC and EBITDAC margin as ways to measure financial performance on an ongoing basis. In addition, adjusted EBITDAC, adjusted EBITDAC margin and adjusted EPS for the brokerage and risk management segments are presented to improve the comparability of our results between periods by eliminating the impact of the items that have a high degree of variability.
• EBITDAC and EBITDAC Margin - EBITDAC is net earnings before interest,
income taxes, depreciation, amortization and the change in estimated
acquisition earnout payables and EBITDAC margin is EBITDAC divided by
total revenues (for the brokerage segment) and revenues before
reimbursements (for the risk management segment). These measures for the
brokerage and risk management segments provide a meaningful representation
of our operating performance for the overall business and provide a
meaningful way to measure its financial performance on an ongoing basis.
36
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• Adjusted EBITDAC and Adjusted EBITDAC Margin - Adjusted EBITDAC is EBITDAC
adjusted to exclude net losses or gains on divestitures, acquisition
integration costs, workforce related charges, lease termination related
charges, acquisition related adjustments, transaction related costs, legal
and income tax related costs, loss on extinguishment of debt and the
period-over-period impact of foreign currency translation, as applicable
and Adjusted EBITDAC margin is Adjusted EBITDAC divided by total adjusted
revenues (defined above). These measures for the brokerage and risk
management segments provide a meaningful representation of our operating
performance, and are also presented to improve the comparability of our
results between periods by eliminating the impact of the items that have a
high degree of variability.
• Adjusted EPS and Adjusted Net Earnings - Adjusted net earnings have been
adjusted to exclude the after-tax impact of net losses or gains on
divestitures, acquisition integration costs, workforce related charges,
lease termination related charges, acquisition related adjustments, the
impact of foreign currency translation, as applicable. Adjusted EPS is
Adjusted Net Earnings divided by diluted weighted average shares
outstanding. This measure provides a meaningful representation of our
operating performance (and as such should not be used as a measure of our
liquidity), and for the overall business is also presented to improve the
comparability of our results between periods by eliminating the impact of
the items that have a high degree of variability.
Organic Revenues (a non-GAAP measure) - For the brokerage segment, organic change in base commission and fee revenues, supplemental revenues and contingent revenues excludes the first twelve months of such revenues generated from acquisitions and such revenues related to divested operations in each year presented. These revenues are excluded from organic revenues in order to help interested persons analyze the revenue growth associated with the operations that were a part of our business in both the current and prior year. In addition, organic change in base commission and fee revenues, supplemental revenues and contingent revenues exclude the period-over-period impact of foreign currency translation to improve the comparability of our results between periods by eliminating the impact of the items that have a high degree of variability. For the risk management segment, organic change in fee revenues excludes the first twelve months of fee revenues generated from acquisitions in each year presented. In addition, change in organic growth excludes the period-over-period impact of foreign currency translation to improve the comparability of our results between periods by eliminating the impact of the items that have a high degree of variability. These revenue items are excluded from organic revenues in order to determine a comparable, but non-GAAP, measurement of revenue growth that is associated with the revenue sources that are expected to continue in 2022 and beyond. We have historically viewed organic revenue growth as an important indicator when assessing and evaluating the performance of our brokerage and risk management segments. We also believe that using this non-GAAP measure allows readers of our financial statements to measure, analyze and compare the growth from our brokerage and risk management segments in a meaningful and consistent manner. Reconciliation of Non-GAAP Information Presented to GAAP Measures - This report includes tabular reconciliations to the most comparable GAAP measures for adjusted revenues, adjusted compensation expense and adjusted operating expense, EBITDAC, EBITDAC margin, adjusted EBITDAC, adjusted EBITDAC margin, adjusted EBITDAC (before acquisitions), diluted net earnings per share (as adjusted) and organic revenue measures. Brokerage The brokerage segment accounted for 73% of our revenue in 2021. Our brokerage segment is primarily comprised of retail and wholesale brokerage operations. Our brokerage segment generates revenues by:
(i) Identifying, negotiating and placing all forms of insurance or reinsurance
coverage, 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;
(ii) Acting as an agent or broker for multiple underwriting enterprises by
providing services such as sales, marketing, selecting, negotiating,
underwriting, servicing and placing insurance coverage on their behalf;
(iii) Providing consulting services related to health and welfare benefits,
voluntary benefits, executive benefits, compensation, retirement
planning, institutional investment and fiduciary, actuarial, compliance,
private insurance exchange, human resource technology, communications
and benefits administration; and
(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.
37
-------------------------------------------------------------------------------- The primary source of revenues for our brokerage services is commissions from underwriting enterprises, based on a percentage of premiums paid by our clients, or fees received from clients based on an agreed level of service 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 headcount 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. Rather than being tied to the amount of premiums, fees are most often based on an expected level of effort to provide our services. In addition, under certain circumstances, both retail brokerage and wholesale brokerage services receive supplemental and contingent revenues. Supplemental revenue is revenue paid by an underwriting enterprise that is above the base commission paid, is determined by the underwriting enterprise and is established annually in advance of the contractual period based on historical performance criteria. Contingent revenue is revenue paid by an underwriting enterprise based on the overall profit and/or volume of the business placed with that underwriting enterprise during a particular calendar year and is determined after the contractual period.
Financial information relating to our brokerage segment results for 2021 and
2020 (in millions, except per share, percentages and workforce data):
Statement of Earnings 2021 2020 Change Commissions$ 4,132.3 $ 3,591.9 $ 540.4 Fees 1,296.9 1,136.9 160.0 Supplemental revenues 248.7 221.9 26.8 Contingent revenues 188.0 147.0 41.0 Investment income 82.8 75.2 7.6 Net gains (losses) on divestitures 18.8 (5.8 ) 24.6 Total revenues 5,967.5 5,167.1 800.4 Compensation 3,252.4 2,882.5 369.9 Operating 757.9 687.2 70.7 Depreciation 87.8 73.5 14.3 Amortization 407.6 411.3 (3.7 ) Change in estimated acquisition earnout payables 116.3 (29.7 ) 146.0 Total expenses 4,622.0 4,024.8 597.2 Earnings before income taxes 1,345.5 1,142.3 203.2 Provision for income taxes 328.9 276.3 52.6 Net earnings 1,016.6 866.0 150.6 Net earnings attributable to noncontrolling interests 8.4 4.9 3.5
Net earnings attributable to controlling
$ 147.1 interests Diluted net earnings per share$ 4.86 $ 4.42 $ 0.44 Other Information Change in diluted net earnings per share 10 % 20 % Growth in revenues 15 % 5 % Organic change in commissions and fees 8 % 3 % Compensation expense ratio 55 % 56 % Operating expense ratio 13 % 13 % Effective income tax rate 24 % 24 %
Workforce at end of period (includes
acquisitions) 29,869 24,717 Identifiable assets at December 31$ 29,821.0 $ 19,185.3 38 --------------------------------------------------------------------------------
The following provides information that management believes is helpful when
comparing EBITDAC and adjusted EBITDAC for 2021 and 2020 (in millions):
2021 2020 Change
Net earnings, as reported $ 1,016.6 $ 866.0 17.4 %
Provision for income taxes 328.9 276.3
Depreciation 87.8 73.5
Amortization 407.6 411.3
Change in estimated acquisition earnout
payables 116.3 (29.7 ) EBITDAC 1,957.2 1,597.4 22.5 % Net (gains) loss on divestitures (18.8 ) 5.8 Acquisition integration 31.7 25.1 Acquisition related adjustments 27.4 19.2
Workforce and lease termination related charges 20.6 43.9
Levelized foreign currency translation
- 36.2 EBITDAC, as adjusted$ 2,018.1 $ 1,727.6 16.8 % Net earnings margin, as reported 17.0 % 16.8 % +28 bpts EBITDAC margin, as adjusted 33.9 % 32.7 % +123 bpts Reported revenues$ 5,967.5 $ 5,167.1 Adjusted revenues - see page 32$ 5,948.7 $ 5,283.0 Commissions and fees - The aggregate increase in base commissions and fees for 2021 was due to revenues associated with acquisitions that were made during 2021 and 2020 ($255.9 million ) and organic revenue growth. Commission revenues increased 15% and fee revenues increased 14% in 2021 compared to 2020, respectively. The organic change in base commission and fee revenues was 8% in 2021 and 3% in 2020. In our property/casualty brokerage operations, during the three-month period endedDecember 31, 2021 , we saw continued strong customer retention and new business generation, improving renewal exposure units (i.e., insured values, payrolls, employees, miles driven, gross receipts, etc.) and continued increases in premium rates across most geographies and lines of coverage. In our employee benefits brokerage operations, during the three-month period endedDecember 31, 2021 we saw continued improvement in covered lives on renewal business and new consulting and special project work. We believe these favorable trends should continue in 2022; however, if the economic recovery slows or reverses course, we could see our revenue growth soften from first half levels of 2021. 39 --------------------------------------------------------------------------------
Items excluded from organic revenue computations yet impacting revenue
comparisons for 2021 and 2020 include the following (in millions):
2021 Organic Revenues
2021 2020 Change
Base Commissions and Fees
Commission and fees, as reported $ 5,429.2 $ 4,728.8 14.8 %
Less commission and fee revenues from acquisitions (255.9 )
-
Less divested operations - (13.7 ) Levelized foreign currency translation -
97.3
Organic base commission and fees$ 5,173.3 $ 4,812.4 7.5 % Supplemental revenues Supplemental revenues, as reported$ 248.7 $ 221.9 12.1 % Less supplemental revenues from acquisitions (3.1 )
-
Levelized foreign currency translation -
5.5
Organic supplemental revenues$ 245.6 $ 227.4 8.0 % Contingent revenues Contingent revenues, as reported$ 188.0 $ 147.0 27.9 % Less contingent revenues from acquisitions (3.3 )
-
Levelized foreign currency translation -
1.6
Organic contingent revenues$ 184.7 $ 148.6 24.3 %
Total reported commissions, fees, supplemental
revenues and contingent revenues$ 5,865.9 $ 5,097.7 15.1 %
Less commissions, fees, supplemental revenues
and contingent revenues from acquisitions (262.3 )
-
Less divested operations and program repricing - (13.7 ) Levelized foreign currency translation -
104.4
Total organic commissions, fees supplemental
revenues and contingent revenues$ 5,603.6 $ 5,188.4 8.0 % Acquisition Activity 2021 2020 Number of acquisitions closed 36 27
Estimated annualized revenues acquired (in millions)
For 2021 and 2020, we issued 1,423,000 and 1,857,000 shares, respectively, of our common stock at the request of sellers and/or in connection with tax-free exchange acquisitions. In addition, onMay 17, 2021 we completed a follow-on common stock offering in which we issued 10.3 million shares of our common stock, the net proceeds of which were used to fund a portion of the acquisition of the Willis Towers Watson plc treaty reinsurance brokerage operations. OnDecember 1, 2021 , we acquired substantially all of the Willis Towers Watson's plc treaty reinsurance brokerage operations for an initial gross consideration of$3.25 billion , and potential additional consideration of$750 million subject to certain third-year revenue targets. There are twelve remaining international operations with deferred closings that comprise approximately$180 million of the initial purchase consideration that are subject to local regulatory approval and are expected to close in first and second quarters of 2022. We funded the transaction using cash on hand, including the$1.4 billion of net cash raised in ourMay 17, 2021 follow-on common stock offering, the$850 million of net cash borrowed in ourMay 20, 2021 30-year senior note issuance,$750 million of net cash borrowed in ourNovember 9, 2021 10-year ($400 million ) and 30-year ($350 million ) senior note issuances and shortterm borrowings. Following the completion of the acquisition of the reinsurance brokerage operations discussed above, we and Willis Towers Watson (which we refer to as WTW) entered into transition service agreements (which we refer to asTSA ). Under the agreement, WTW will provide certain specified back office support services globally on a transitional basis for a period of up to two years fromDecember 1, 2021 , based on the specific location and type of services being provided by WTW. Such services include among other things, client related billings, collections and carrier remittances, payroll and other human resource services, information systems, real estate as well as accounting support. The charges for the transition services are generally intended to allow the providing company to fully recover the allocated direct costs of providing the services, plus all out-of-pocket costs and expenses. Under theTSA , there is the option at our request for two extension periods for each service provided for up to six months each. If we do exercise the extensions there is a profit margin markup added in each period. 40 -------------------------------------------------------------------------------- OnNovember 9, 2021 , we closed and funded an offering of$750.0 million of unsecured senior notes in two tranches. The$400.0 million aggregate principal amount of 2.40% Senior Notes are due 2031 (which we refer to as the 2031 November Notes) and$350.0 million aggregate principal amount of 3.05% Senior Notes are due 2052 (which we refer to as the 2052 November Notes and together with the 2031 November Notes, the November Notes). The weighted average interest rate is 2.80% per annum after giving effect to underwriting costs. We used the net proceeds of the November Notes to fund a portion of the cash consideration payable in connection with theWillis Tower Watson plc treaty reinsurance transaction. OnMay 20, 2021 , we closed and funded an offering of$1,500.0 million of unsecured senior notes in two tranches. The$650.0 million aggregate principal amount of 2.50% Senior Notes were due 2031 (which we refer to as the 2031 Notes) and the$850.0 million aggregate principal amount of 3.50% Senior Notes are due 2051 (which we refer to as the 2051 Notes). The weighted average interest rate was 3.31% per annum after giving effect to underwriting costs and the net hedge loss. In conjunction with the termination of theWillis Tower Watson plc treaty reinsurance transaction, onJuly 29, 2021 , we exercised the special option redemption feature for the 2031 Senior Notes. These notes were redeemed onAugust 13, 2021 , which resulted in a loss on extinguishment of debt of$16.2 million . We used the net proceeds of this offering related to the 2051 Notes to fund a portion of the cash consideration payable in connection with the Willis Towers Watson plc treaty reinsurance transaction. OnMay 17, 2021 , we closed on a follow-on public offering of our common stock whereby 10.3 million shares of our stock were issued for net proceeds, after underwriting discounts and other expenses related to this offering, of$1,437.9 million . We used the net proceeds of the offering to fund the acquisition of the Willis Towers Watson plc treaty reinsurance brokerage operations.
Supplemental and contingent revenues - Reported supplemental and contingent
revenues recognized in 2021 and 2020 by quarter are as follows (in millions):
Q1 Q2 Q3 Q4 Full Year
2021
Reported supplemental revenues $ 66.8 $ 55.2 $ 61.0 $ 65.7 $ 248.7
Reported contingent revenues 63.3 43.3 43.7 37.7 188.0
Reported supplemental and
contingent revenues $ 130.1 $ 98.5 $ 104.7 $ 103.4 $ 436.7
2020
Reported supplemental revenues $ 59.0 $ 50.3 $ 54.7 $ 57.9 $ 221.9
Reported contingent revenues 45.1 37.4 34.5 30.0 147.0
Reported supplemental and
contingent revenues $ 104.1 $ 87.7 $ 89.2 $ 87.9 $ 368.9
Investment income and net gains on divestitures - This primarily represents (1)
interest income earned on cash, cash equivalents and restricted funds and
interest income from premium financing and (2) net gains (losses) related to
divestitures and sales of books of business, which were $18.8 million and $(5.8)
million in 2021 and 2020, respectively. Also included in net gains in 2021 is a
$8.7 million gain we recognized related to our acquisition of an additional 70%
equity interest in Edelweiss Gallagher Insurance Brokers Limited (which we refer
to as Edelweiss), which increased our ownership in Edelweiss to 100%. The gain
represents the increase in fair value of our initial 30.0% equity interest in
Edelweiss based on the purchase price paid to acquire the additional 70% equity
interest. On December 16, 2020 , we completed the sale of a U.K. wealth
management business we purchased over four years ago, that no longer
strategically fit in our benefits operations. In fourth quarter 2020, we
recognized a net pretax non-cash loss on the sale of approximately $12.0
million , primarily due to the writeoff of the remaining net book value of the
amortizable intangible assets.
Investment income in 2021 increased compared to 2020 primarily due to increases
in interest income from our U.S. operations primarily due to increases in
interest income related to premium funding operations and increases in income
from our partially owned entities accounted for using the equity method,
partially offset by decreases in interest income due to decreases in interest
rates earned on our funds.
41
--------------------------------------------------------------------------------
Compensation expense - The following provides non-GAAP information that
management believes is helpful when comparing 2021 and 2020 compensation expense
(in millions):
2021 2020
Compensation expense, as reported
Acquisition integration
(22.3 ) (14.9 ) Workforce related charges (16.2 ) (35.7 ) Acquisition related adjustments (27.4 ) (19.2 ) Levelized foreign currency translation - 61.6
Compensation expense, as adjusted
Reported compensation expense ratios 54.5 % 55.8 %
Adjusted compensation expense ratios 53.6 % 54.4 %
Reported revenues
$ 5,967.5 $ 5,167.1
Adjusted revenues - see page 32
The$369.9 million increase in compensation expense in 2021 compared to 2020 was primarily due to compensation associated with the acquisitions completed in the twelve month period endedDecember 31, 2021 -$102.9 million , producer compensation and other incentive compensation linked to operating results -$266.0 million in the aggregate and an increase in temporary-staffing -$1.0 million . During 2021, relative to 2020, as we increased our business activities, we saw more normalized usage of our employee medical plan and resumption of annual support-layer wage increases.
Operating expense - The following provides non-GAAP information that management
believes is helpful when comparing 2021 and 2020 operating expense
(in millions):
2021 2020
Operating expense, as reported $ 757.9 $ 687.2
Acquisition integration (9.4 ) (10.2 )
Workforce and lease termination related charges (4.4 ) (8.2 )
Levelized foreign currency translation
- 12.3 Operating expense, as adjusted$ 744.1 $ 681.1 Reported operating expense ratios 12.7 % 13.3 % Adjusted operating expense ratios 12.5 % 12.9 % Reported revenues$ 5,967.5 $ 5,167.1 Adjusted revenues - see page 32$ 5,948.7 $ 5,283.0 The$70.7 million increase in operating expense in 2021 compared to 2020, was due primarily due to expenses associated with the acquisitions completed in the twelve month period endedDecember 31, 2021 -$39.5 million and an increase in technology expenses -$33.9 million , partially offset by a decrease of$2.7 million in the aggregate due to continued operating control measures. During 2021, relative to 2020, as we increased our business activities, we saw increases in travel and entertainment, full restoration of advertising and increased use of external consultants. Depreciation - The increase in depreciation expense in 2021 compared to 2020 was due primarily to the impact of purchases of furniture, equipment and leasehold improvements related to office expansions and moves, and expenditures related to upgrading computer systems. Also contributing to the increases in depreciation expense in 2021 was the depreciation expense associated with acquisitions completed in 2021. Amortization - The decrease in amortization in 2021 compared to 2020 was due primarily to the write-off of amortizable assets in 2021 (see impairment discussion below), partially offset by the impact of amortization expense of intangible assets associated with acquisitions completed in 2021 and 2020. Expiration lists, noncompete agreements and trade names are amortized using the straight-line method over their estimated useful lives (two to fifteen years for expiration lists, two to six years for non-compete agreements and two to fifteen years for trade names). Based on the results of impairment reviews performed on amortizable intangible assets in 2021 and 2020, we wrote off$16.8 million and$51.5 million , respectively, of amortizable intangible assets related to the brokerage segment. We review all of our intangible assets for impairment periodically (at least annually for goodwill) and whenever events or changes in business circumstances indicate that the carrying value of the assets may not be recoverable. We perform such impairment reviews at the division (i.e., reporting unit) level with respect to goodwill and at the business unit level for amortizable intangible 42 -------------------------------------------------------------------------------- assets. In reviewing amortizable intangible assets, if the undiscounted future cash flows were less than the carrying amount of the respective (or underlying) asset, an indicator of impairment would exist and further analysis would be required to determine whether or not a loss would need to be charged against current period earnings as a component of amortization expense. We performed a qualitative impairment review on carrying value of our goodwill for all of our reporting units as ofDecember 31, 2021 and no indicators of impairment were noted. Change in estimated acquisition earnout payables - The change in the expense from the change in estimated acquisition earnout payables in 2021 compared to 2020 was due primarily to adjustments made to the estimated fair value of earnout obligations related to revised projections of future performance. During 2021 and 2020, we recognized$34.7 million and$32.0 million , respectively, of expense related to the accretion of the discount recorded for earnout obligations in connection with our acquisitions made from 2017 to 2021. During 2021 and 2020, we recognized$81.6 million of expense and$61.7 million of income, respectively, related to net adjustments in the estimated fair market values of earnout obligations in connection with revised projections of future performance for 95 and 131 acquisitions, respectively. The amounts initially recorded as earnout payables for our 2017 to 2021 acquisitions were measured at fair value as of the acquisition date and are primarily based upon the estimated future operating results of the acquired entities over a two- to threeyear period subsequent to the acquisition date. The fair value of these earnout obligations is based on the present value of the expected future payments to be made to the sellers of the acquired entities in accordance with the provisions outlined in the respective purchase agreements. In determining fair value, we estimate the acquired entity's future performance using financial projections developed by management for the acquired entity and market participant assumptions that were derived for revenue growth and/or profitability. We estimate future earnout payments using the earnout formula and performance targets specified in each purchase agreement and these financial projections. Subsequent changes in the underlying financial projections or assumptions will cause the estimated earnout obligations to change and such adjustments are recorded in our consolidated statement of earnings when incurred. Increases in the earnout payable obligations will result in the recognition of expense and decreases in the earnout payable obligations will result in the recognition of income. Provision for income taxes - The brokerage segment's effective tax rate in 2021 and 2020 was 24.4% and 24.2% respectively. We anticipate reporting an effective tax rate of approximately 23.0% to 25.0% in our brokerage segment for the foreseeable future. Net earnings attributable to noncontrolling interests - The amounts reported in this line for 2021 and 2020 include noncontrolling interest earnings of$8.4 million and$4.9 million , respectively.
Litigation, Regulatory and Taxation Matters
As previously disclosed, our IRC 831(b) (or "micro-captive") advisory services business has been under audit by theIRS since 2013. Among other matters, theIRS is investigating whether we have been acting as a tax shelter promoter in connection with these operations. Additionally, theIRS is conducting a criminal investigation related to IRC 831(b) micro-captive underwriting enterprises. We have been advised that we are not a target of the criminal investigation. We are fully cooperating with both matters. While we are not able to reasonably estimate the ultimate amount of any potential loss in connection with these investigations, we do not expect any loss to be material to our consolidated financial statements. 43 --------------------------------------------------------------------------------
Risk Management
The risk management segment accounted for 13% of our revenue in 2021. Our risk management segment operations provide contract claim settlement, claim administration, loss control services and risk management consulting for commercial, not for profit, captive and public entities, and various other organizations that choose to self-insure property/casualty coverages or choose to use a third-party claims management organization rather than the claim services provided by underwriting enterprises. Revenues for our risk management segment are comprised of fees generally negotiated (i) on a per-claim or per-service basis, (ii) on a cost-plus basis, or (iii) as performance-based fees. We also provide risk management consulting services that are recognized as the services are delivered.
Financial information relating to our risk management segment results for 2021
and 2020 (in millions, except per share, percentages and workforce data):
Statement of Earnings 2021 2020 Change Fees$ 967.2 $ 821.0 $ 146.2 Investment income 0.3 0.7 (0.4 ) Net gains on divestitures 0.1 - 0.1 Revenues before reimbursements 967.6 821.7 145.9 Reimbursements 133.0 151.7 (18.7 ) Total revenues 1,100.6 973.4 127.2 Compensation 580.7 517.5 63.2 Operating 209.8 162.6 47.2 Reimbursements 133.0 151.7 (18.7 ) Depreciation 46.2 49.4 (3.2 ) Amortization 7.5 6.0 1.5
Change in estimated acquisition earnout payables 3.3 (3.2 )
6.5 Total expenses 980.5 884.0 96.5 Earnings before income taxes 120.1 89.4 30.7 Provision for income taxes 30.6 22.5 8.1 Net earnings 89.5 66.9 22.6
Net earnings attributable to noncontrolling
interests - -
-
Net earnings attributable to controlling interests$ 89.5 $ 66.9 $ 22.6 Diluted earnings per share$ 0.43 $ 0.34 $ 0.09 Other information Change in diluted earnings per share 26 % (3 %) Growth in revenues (before reimbursements) 18 % (2 %) Organic change in fees (before reimbursements) 12 % (3 %)
Compensation expense ratio
(before reimbursements) 60 % 63 % Operating expense ratio (before reimbursements) 22 % 20 % Effective income tax rate 25 % 25 %
Workforce at end of period
(includes acquisitions) 7,308 6,378 Identifiable assets at December 31$ 1,034.4 $ 973.9 44 --------------------------------------------------------------------------------
The following provides non-GAAP information that management believes is helpful
when comparing 2021 and 2020 EBITDAC and adjusted EBITDAC in millions):
2021 2020 Change
Net earnings, as reported $ 89.5 $ 66.9 33.8 %
Provision for income taxes 30.6 22.5
Depreciation 46.2 49.4
Amortization 7.5 6.0
Change in estimated acquisition earnout
payables 3.3 (3.2 ) Total EBITDAC 177.1 141.6 25.1 % Net gains on divestitures (0.1 ) -
Workforce and lease termination related
charges 7.1 7.9 Acquisition related adjustments 0.4 - Levelized foreign currency translation - 2.0 EBITDAC, as adjusted$ 184.5 $ 151.5 21.8 % Net earnings margin, before reimbursements, as reported 9.3 % 8.1 % +111
bpts
EBITDAC margin, before reimbursements,
as adjusted 19.1 % 18.2 % +88
bpts
Reported revenues before
reimbursements$ 967.6 $ 821.7
Adjusted revenues - before reimbursements
- see page 32$ 967.5 $ 833.1 Fees - In 2021, our risk management operations, new workers' compensation and general liability claims arising improved due to our clients' improving business conditions and are well above second quarter 2020 pandemic lows. We believe these favorable trends should continue for 2022, however, a slower recovery, reversal in the number of workers employed, new COVID variants or surge in cases could cause fewer new workers' compensation claims to arise in future quarters. Organic change in fee revenues was 12% in 2021 and (3%) in 2020.
Items excluded from organic fee computations yet impacting revenue comparisons
in 2021 and 2020 include the following (in millions):
2019 Organic Revenue
2021 2020 Change
Fees $ 954.0 $ 815.3 17.0 %
International performance bonus fees 13.2 5.7
Fees as reported 967.2 821.0 17.8 %
Less fees from acquisitions (33.3 ) -
Levelized foreign currency translation - 11.4
Organic fees $ 933.9 $ 832.4 12.2 %
Reimbursements - Reimbursements represent amounts received from clients
reimbursing us for certain third-party costs associated with providing our
claims management services. In certain service partner relationships, we are
considered a principal because we direct the third party, control the specified
service and combine the services provided into an integrated solution. Given
this principal relationship, we are required to recognize revenue on a gross
basis and service partner vendor fees in the operating expense line in our
consolidated statement of earnings. The decrease in reimbursements in 2021
compared to 2020 was primarily due to a change in business mix that is processed
internally versus using outside service partners.
Investment income - Investment income primarily represents interest income
earned on our cash and cash equivalents. Investment income in 2021 decreased
compared to 2020 primarily due to decreases in interest income from our U.S.
operations due to decreases in interest rates earned on our funds.
45
--------------------------------------------------------------------------------
Compensation expense - The following provides non-GAAP information that
management believes is helpful when comparing 2021 and 2020 compensation expense
compensation expense (in millions):
2021 2020
Compensation expense, as reported $ 580.7 $
517.5
Workforce and lease termination related charges (2.3 ) (7.5 ) Acquisition related adjustments (0.4 ) - Levelized foreign currency translation -
7.7
Compensation expense, as adjusted$ 578.0 $
517.7
Reported compensation expense ratios
(before reimbursements) 60.0 % 63.0 % Adjusted compensation expense ratios (before reimbursements) 59.7 % 62.1 % Reported revenues (before reimbursements)$ 967.6 $
821.7
Adjusted revenues (before reimbursements) - see page 32
The$63.2 million increase in compensation expense in 2021 compared to 2020 was primarily due to compensation and other incentive compensation linked to operating results -$31.5 million in the aggregate, compensation associated with the acquisitions completed in the twelve month period endedDecember 31, 2021 -$23.9 million and an increase in temporarystaffing expense $7.8 million . Operating expense - The following provides non-GAAP information that management believes is helpful when comparing 2021 and 2020 operating expense operating expense (in millions): 2021 2020 Operating expense, as reported$ 209.8 $
162.6
Workforce and lease termination related charges (4.8 ) (0.4 ) Levelized foreign currency translation -
1.7
Operating expense, as adjusted 205.0 $
163.9
Reported operating expense ratios
(before reimbursements) 21.7 % 19.8 % Adjusted operating expense ratios (before reimbursements) 21.2 % 19.7 % Reported revenues (before reimbursements)$ 967.6 $
821.7
Adjusted revenues - (before reimbursements) see page 32
The$47.2 million increase in operating expense in 2021 compared to 2020 was primarily due to increases in professional fees associated with revenue growth in certain products $18.2 million , technology expense -$9.8 million , business insurance -$5.0 million , lease termination costs -$4.4 million , professional fees -$3.7 million and expenses associated with the acquisitions completed in the twelve month period endedDecember 31, 2021 -$5.9 million . Depreciation - Depreciation expense decreased in 2021 compared to 2020, which reflects the impact of office consolidations that occurred as leases expired in 2021 and 2020 (less depreciation associated with furniture, equipment and leasehold improvements), partially offset by expenditures related to upgrading computer systems. Amortization - Amortization expense increased in 2021 compared to 2020. The increase in amortization in 2021 compared to 2020 was primarily due to the impact of amortization expense of intangible assets associated with acquisitions completed in 2021 and to an intangible asset impairment in 2021. Based on the results of impairment reviews performed on amortizable intangible assets during 2021 and 2020, we wrote off$0.8 million and$0.2 million , respectively, of amortizable assets related to the risk management segment. Change in estimated acquisition earnout payables - The change in expense from the change in estimated acquisition earnout payables in 2021 compared to 2020, were due primarily to adjustments made in 2021 and 2020 to the estimated fair value of an earnout obligation related to revised projections of future performance. During 2021 and 2020, we recognized$1.0 million and$0.5 million , respectively, of expense related to the accretion of the discount recorded for earnout obligations in connection with our 2018 to 2021 acquisitions, respectively. During 2021, we recognized$2.3 million of expense related to net adjustments in the 46 -------------------------------------------------------------------------------- estimated fair value of earnout obligations related to revised projections of future performance for four acquisitions. During 2020, we recognized$3.7 million of income related to net adjustments in the estimated fair value of earnout obligations related to revised projections of future performance for four acquisitions. Provision for income taxes - We allocate the provision for income taxes to the risk management segment using local statutory rates. The risk management segment's effective tax rate in 2021 and 2020 was 25.5% and 25.2%, respectively. We anticipate reporting an effective tax rate on adjusted results of approximately 24.0% to 26.0% in our risk management segment for the foreseeable future.
Corporate
The corporate segment reports the financial information related to our clean energy and other investments, our debt, certain corporate and acquisition-related activities and the impact of foreign currency translation. See Note 14 to our 2021 consolidated financial statements for a summary of our investments atDecember 31, 2021 and 2020 and a detailed discussion of the nature of these investments. See Note 8 to our 2021 consolidated financial statements for a summary of our debt atDecember 31, 2021 and 2020.
Financial information relating to our corporate segment results for 2021 and
2020 (in millions, except per share and percentages):
Statement of Earnings 2021 2020 Change
Revenues from consolidated
clean coal facilities$ 1,075.4 $ 802.0 $ 273.4
Royalty income from clean coal
licenses 67.7 62.4 5.3 Loss from unconsolidated clean coal facilities (2.3 ) (0.9 ) (1.4 ) Other net revenues (losses) 0.5 (0.4 ) 0.9 Total revenues 1,141.3 863.1 278.2
Cost of revenues from consolidated
clean coal facilities 1,173.2 882.1 291.1 Compensation 94.4 66.5 27.9 Operating 104.7 56.7 48.0 Interest 226.1 196.4 29.7 Loss on extinguishment of debt 16.2 - 16.2 Depreciation 17.2 22.2 (5.0 ) Total expenses 1,631.8 1,223.9 407.9 Loss before income taxes (490.5 ) (360.8 ) (129.7 ) Benefit for income taxes (339.4 ) (286.0 ) (53.4 ) Net loss (151.1 ) (74.8 ) (76.3 ) Net earnings attributable to noncontrolling interests 39.8 34.4 5.4 Net loss attributable to controlling interests$ (190.9 ) $ (109.2 ) $ (81.7 ) Diluted net loss per share$ (0.92 ) $ (0.56 ) $ (0.36 )
Identifiable assets at
EBITDAC
Net loss
$ (151.1 ) $ (74.8 ) $ (76.3 ) Benefit for income taxes (339.4 ) (286.0 ) (53.4 ) Interest 226.1 196.4 29.7 Loss on extinguishment of debt 16.2 - 16.2 Depreciation 17.2 22.2 (5.0 ) EBITDAC$ (231.0 ) $ (142.2 ) $ (88.8 )
Revenues - Revenues in the corporate segment consist of the following:
• Revenues from consolidated clean coal production plants represents
revenues from the consolidated IRC Section 45 facilities in which we have
a majority ownership position and maintain control over the operations at
the related facilities.
47 --------------------------------------------------------------------------------
• The increase in revenue from consolidated clean coal production plants in
2021 compared to 2020, was due primarily to increased production of
refined coal related to higher electricity production as a result of
increased demand for electricity as businesses open up, hotter
temperatures, less energy produced from wind, rising natural gas prices
and more plants within our portfolio being operational during the period.
• Royalty income from clean coal licenses represents revenues related to
• The increase in royalty income in 2021 compared to 2020 was due to
increased production of refined coal by
increased demand for electricity as businesses open up and rising natural
gas prices.
Loss from unconsolidated clean coal production plants represents our equity
portion of the pretax operating results from the unconsolidated IRC Section 45
facilities. The production of refined coal generates pretax operating losses.
The losses from unconsolidated clean coal production plants were greater in 2021
compared to 2020 due to higher production levels in 2021.
Cost of revenues - Cost of revenues from consolidated clean coal production plants in 2021 and 2020 consists of the cost of coal, labor, equipment maintenance, chemicals, supplies, management fees and depreciation incurred by the clean coal production plants to generate the consolidated revenues discussed above. The increase in cost of revenues in 2021 compared to 2020, was primarily due to increased production of refined coal. Compensation expense - Compensation expense for 2021 and 2020 includes salary, incentive compensation, and associated benefit expenses of$94.4 million and$66.5 million , respectively. The$27.9 million increase in 2021 compensation expense compared to 2020 was primarily due to transaction-related costs as described on page 50 in note (2) as well as higher incentive compensation recognized in 2021 compared to 2020. Operating expense - Operating expense for 2021 includes banking and related fees of$3.6 million , external professional fees and other due diligence costs related to 2021 acquisitions of$40.8 million , which includes specific transaction-related costs as described on page 50 in note (2), other corporate and clean energy related expenses of$59.6 million , including legal fees, and costs associated with the idling of the Section 45 program, and a net unrealized foreign exchange remeasurement loss of$0.7 million . Operating expense for 2020 includes banking and related fees of$5.1 million , external professional fees and other due diligence costs related to 2020 acquisitions of$9.4 million , other corporate and clean energy related expenses of$41.9 million , including legal fees, and costs related to corporate data and branding initiatives, and a net unrealized foreign exchange remeasurement loss of$0.3 million .
Interest expense - The increase in interest expense in 2021 compared to 2020 was
due to the following (in millions):
Change in interest expense related to: 2021 / 2020 Interest on borrowings from our Credit Agreement $ (2.9 ) Interest on the maturity of the Series C notes (3.5 ) Interest on the maturity of the Series K and L notes (1.9 ) Interest on the$348.0 million notes funded on August 2 and 4, 2017 (1.1 ) Interest on the$500.0 million notes funded on June 13, 2018 (0.3 ) Interest on the$575.0 million notes funded onJanuary 30, 2020
1.8
Interest on the$100.0 million notes funded onFebruary 10, 2020
2.2
Interest on the$75.0 million notes funded onMay 5, 2021
2.1
Interest on the
22.6
Interest on the$750.0 million notes funded onNovember 9, 2021
3.0
Amortization of hedge gains
7.7
Net change in interest expense $ 29.7
Depreciation - Depreciation expense in 2021 decreased compared to 2020,
primarily due to the write-off of two of the 2011 Era Plants in 2020.
Net earnings attributable to noncontrolling interests - The amounts reported in this line for 2021 and 2020 primarily include noncontrolling interest earnings of$39.8 million and$34.4 million , respectively, related to our investment inChem-Mod LLC . As ofDecember 31, 2021 and 2020, we held a 46.5% controlling interest inChem-Mod LLC . Also, included in net earnings attributable to noncontrolling interests are offsetting amounts related to non-Gallagher owned interests in several clean energy investments. 48 -------------------------------------------------------------------------------- Benefit for income taxes - We allocate the provision for income taxes to the brokerage and risk management segments using local statutory rates. As a result, the provision for income taxes for the corporate segment reflects the entire benefit to us of the IRC Section 45 credits generated, because that is the segment which produced the credits. The law that provides for IRC Section 45 tax credits expired inDecember 2019 for our fourteen 2009 Era Plants and expired inDecember 2021 for our twenty-one 2011 Era Plants. Our consolidated effective tax rate was 2.1% and 1.5%, for 2021 and 2020, respectively. The tax rates for 2021 and 2020 were lower than the statutory rate primarily due to the amount of IRC Section 45 tax credits recognized during the year. There were$193.4 million and$148.6 million of IRC Section 45 tax credits generated and recognized in 2021 and 2020, respectively. The income tax benefit of stock based awards that vested or were settled in the years endedDecember 31, 2021 and 2020 was$40.0 million and$25.3 million , respectively.U.S. Federal Income Tax Law Changes - OnMarch 27, 2020 , the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was enacted in response to the COVID-19 pandemic. The CARES Act contains several significant business tax provisions that could affect a company's accounting for income taxes. See discussion of the various impact of the CARES Act below.
Alternative Minimum Tax Credit - The CARES Act amends Section 53(e) of the TCJA so that all prior year minimum tax credits are available for refund for the first taxable year of a corporation beginning in 2018. We have adjusted the classification of the remaining Alternative Minimum Tax (which we refer to as AMT) credits as a result of the AMT credit acceleration. All remaining AMT credits were utilized as part of our 2019 federal income tax return or refunded in 2020. Interest Expense Limitation - The CARES Act contains modifications on the limitations of business interest for tax years beginning in 2019 and 2020. The modifications to Section 163(j) increase the allowable business interest deduction from 30% of adjusted taxable income to 50% of adjusted taxable income. This modification would significantly increase the allowable interest expense deduction of the company. We have evaluated the impact and determined there is no limit on our interest deductibility for federal income tax purposes for the years endedDecember 31, 2021 and 2020. The following provides non-GAAP information that we believe is helpful when comparing 2021 and 2020 operating results for the corporate segment (in millions): 2021 2020 Net Earnings Net Earnings (Loss) (Loss) Income Attributable to Income Attributable to Pretax Tax Controlling Pretax Tax Controlling Loss Benefit Interests Loss Benefit Interests Components of Corporate Segment, as reported Interest and banking costs (2)$ (245.9 ) $ 61.4 $ (184.5 )$ (201.4 ) $ 50.4 $ (151.0 ) Clean energy related (1) (135.4 ) 232.8 97.4 (112.4 ) 182.2 69.8 Acquisition costs (2) (54.9 ) 9.5 (45.4 ) (9.9 ) 1.0 (8.9 ) Corporate (3) (4) (94.1 ) 35.7 (58.4 ) (71.5 ) 52.4 (19.1 ) Reported Year Ended (530.3 ) 339.4 (190.9 ) (395.2 ) 286.0 (109.2 ) Adjustments Loss on extinguishment of debt (2) 16.2 (4.0 ) 12.2 - - - Transaction-related costs (2) 47.9 (9.4 ) 38.5 - - - Legal and income tax related (3) 9.5 34.1 43.6 - (1.1 ) (1.1 ) Components of Corporate Segment, as adjusted Interest and banking costs (229.7 ) 57.4 (172.3 ) (201.4 ) 50.4 (151.0 ) Clean energy related (1) (135.4 ) 232.8 97.4 (112.4 ) 182.2 69.8 Acquisition costs (7.0 ) 0.1 (6.9 ) (9.9 ) 1.0 (8.9 ) Corporate (3) (4) (84.6 ) 69.8 (14.8 ) (71.5 ) 51.3 (20.2 ) Adjusted Year Ended$ (456.7 ) $ 360.1 $ (96.6 )
(1) Pretax losses for the years ended
net of amounts attributable to noncontrolling interests of
49 --------------------------------------------------------------------------------
(2) We incurred transaction-related costs, which include legal, consulting,
employee compensation and other professional fees associated with due
diligence and integration for its (a) acquisition of the Willis Towers Watson
plc treaty reinsurance brokerage operations; and (b) the previous terminated
agreement to acquire certain Willis Towers Watson reinsurance and other
brokerage operations. In connection with (b), in third quarter 2021, we
redeemed $650 million of 2031 Senior Notes and incurred a loss of $16.2
million related to the early extinguishment of such debt.
(3) In fourth quarter 2021, we incurred (a) additional
expense related to the non-deductibility of acquisition related adjustments
made in the quarter, (b) costs related to a legal settlement and (c) income
tax adjustments as we filed our 2020 tax returns in the fourth quarter and
finalized our 2021 income tax provisions within the
jurisdictions where we operate. In third quarter 2021, we incurred additional
related adjustments made in that quarter. In second quarter 2021, the
government enacted tax legislation that increases the corporate income tax
rate from 19% to 25% effective in 2023, in which we incurred additional
income tax expense during 2021 to adjust certain deferred income tax
liabilities to the higher income tax rate.
(4) Corporate pretax loss includes a net unrealized foreign exchange
remeasurement loss of
net unrealized foreign exchange remeasurement loss of
year endedDecember 31, 2020 .
Interest and banking costs and debt - Interest and banking costs includes
expenses related to our debt.
Clean energy related - Includes the operating results related to our investments
in clean coal production plants and
Acquisition costs - Consists mostly of external professional fees and other due diligence costs related to acquisitions. On occasion, we enter into forward currency hedges for the purchase price of committed, but not yet funded, acquisitions with funding requirements in currencies other than theU.S. dollar. The gains or losses, if any, associated with these hedge transactions is also included. Corporate - Consists of overhead allocations mostly related to corporate staff compensation, other corporate level activities, other corporate level activities and net unrealized foreign exchange remeasurement. In addition, includes the tax expense related to partial taxation of foreign earnings, nondeductible executive compensation and entertainment expenses and the tax benefit from vesting of employee equity awards. The income tax benefit of stock based awards that vested or were settled in the years endedDecember 31, 2021 and 2020 was$40.0 million and$25.3 million , respectively, and is included in the table above in the Corporate line. Impact ofU.K. Brexit Decision - During the third and fourth quarters of 2020, ourU.K. operations completed the transfer of its EEA books of business to our EU affiliate in connection with theU.K. exiting the EU onDecember 31, 2020 . The transfer related after-tax charges reported in 2020 were a net$1.1 million of income tax benefit, reflecting the amortization of those assets at the Swedish tax rate and utilization of historicalU.K. capital losses that previously had valuation allowances against them. Clean Energy Investments - We have investments in limited liability companies that own 29 clean coal production plants developed by us and six clean coal production plants we purchased from a third party. All 35 plants produced refined coal using propriety technologies owned byChem-Mod LLC . We believe that the production and sale of refined coal at these plants were qualified to receive refined coal tax credits under IRC Section 45. The 14 2009 Era Plants received tax credits through 2019 and the 21 2011 Era Plants received tax credits through 2021.
Our investment in
production plants owned by those limited liability companies in which we invest
as well as refined coal production plants owned by other unrelated parties.
See the risk factors regarding our IRC Section 45 investments under Item 1A, "Risk Factors." for a more detailed discussion of these and other factors could impact the information above. See Note 14 to our 2021 consolidated financial statements for more information regarding risks and uncertainties related to these investments.
Liquidity and Capital Resources
Liquidity describes the ability of a company to generate sufficient cash flows
to meet the cash requirements of its business operations. The insurance
brokerage industry is not capital intensive. Historically, our capital
requirements have primarily included dividend payments on our common stock,
repurchases of our common stock, funding of our investments, acquisitions of
brokerage and risk management operations and capital expenditures.
50
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In light of the economic uncertainty caused by COVID-19, subsequent to the first
quarter of 2020, we preserved liquidity during 2020 by reducing capital
expenditures for the remainder of 2020 and made working capital process changes
such as moved more cash into the U.S. from our international operations, pursued
collections on receivables from our customers and partners and renegotiated
longer payment terms on vendor payables. We also slowed down our acquisition
program in the second and third quarters of 2020. Some of these initiatives and
trends continued into 2021, however, as economic conditions continue to improve
our capital expenditures and acquisition activity have moved towards
pre-pandemic levels. We believe we have sufficient liquidity on hand to continue
business operations during this uncertain period. If we experience a significant
reduction in revenue in the future, we have additional alternatives to maintain
liquidity, including use of common stock to fund future acquisitions.
On December 1, 2021 , we acquired substantially all of the Willis Towers Watson
plc treaty reinsurance brokerage operations for an initial gross consideration
of $3.25 billion , and potential additional consideration of $750 million subject
to certain third-year revenue targets. There are twelve remaining international
operations with deferred closings that comprise approximately $180 million of
the initial purchase consideration that are subject to local regulatory approval
and are expected to close in first and second quarters of 2022. We funded the
transaction using cash on hand, including the $1.4 billion of net cash raised in
our May 17, 2021 follow-on common stock offering, $850 million of net cash
borrowed in our May 20, 2021 30-year senior note issuance, $750 million of net
cash borrowed in our November 9, 2021 10-year ($400 million ) and 30-year ($350
million ) senior note issuances and shortterm borrowings.
Operating Cash Flows
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 2021 and 2020, 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 the follow-on common stock offering. Cash provided by operating activities was$1,704.1 million and$1,807.1 million for 2021 and 2020, respectively. See Note 20 to our 2021 consolidated financial statements for a discussion on reclassifications that were made to the 2020 and 2019 consolidated statement of cash flows in 2021. The decrease in cash provided by operating activities during 2021 compared to the same period in 2020 was primarily due to increases in the amount of net income taxes paid, payments on acquisition earnouts in excess of original estimates and interest on debt paid in 2021 and to timing differences between periods with cash receipts and disbursements related to other current assets compared to 2020. The 2020 income taxes paid amount was favorably impacted due to an AMT refund of$28.5 million and approximately$20.0 million from tax-payment deferrals and refunds as a result of the CARES Act and other similar temporary relief measures available globally. The 2021 income taxes paid amount was unfavorably impacted due to payment of the$20.0 million of 2020 tax-payments deferrals (as noted in the previous sentence) and also approximately$106.0 million of tax prepayments made in 2021 with regards to tax method changes filed with our 2020 tax returns in the fourth quarter of 2021. Those method changes also effected our 2021 estimated tax payments. These payments would have been made in future periods, and do not represent additional taxes due. During 2021, we managed our working capital in terms of receivables and payables as a cautionary step to protect liquidity during this uncertain period. During 2021, employee matching contributions to the 401(k) plan of$63.6 million relating to 2020 were funded using common stock. During 2020, employee matching contributions to the 401(k) plan of$59.4 million relating to 2019 were funded using cash. Our cash flows from operating activities are primarily derived from our earnings from operations, as adjusted, for our non-cash expenses, which include depreciation, amortization, change in estimated acquisition earnout payables, deferred compensation, restricted stock, and stock-based and other non-cash compensation expenses. Cash provided by operating activities can be unfavorably impacted if the amount of IRC Section 45 tax credits generated (which is the amount we recognize for financial reporting purposes) is greater than the amount of tax credits utilized to reduce our tax cash obligations. Excess tax credits produced during the period result in an increase to our deferred tax assets, which is a net use of cash related to operating activities. Please see "Clean energy investments" below for more information on their potential future impact on cash provided by operating activities. When assessing our overall liquidity, we believe that the focus should be on net earnings as reported in our consolidated statement of earnings, adjusted for non-cash items (i.e., EBITDAC), and cash provided by operating activities in our consolidated statement of cash flows. Consolidated EBITDAC was$1,903.3 million and$1,596.8 million for 2021 and 2020, respectively. Net earnings attributable to controlling interests were$906.8 million and$818.8 million for 2021 and 2020, respectively. We believe that EBITDAC items are indicators of trends in liquidity. From a balance sheet perspective, we believe the focus should not be on premium and fees receivable, premiums payable or restricted cash for trends in liquidity. Net cash flows provided by operations will vary substantially from quarter to quarter and year to year because of the variability in the timing of premiums and fees receivable and premiums payable. We believe that in order to consider these items in assessing our trends in liquidity, they should be looked at in a combined manner, because changes in these balances are interrelated and are based on the timing of premium payments, both to and from us. In addition, funds legally restricted as to our use relating to premiums and clients' claim funds held by us in a fiduciary capacity are presented in our consolidated balance sheet as "Restricted cash" and have not been included in determining our overall liquidity. 51 --------------------------------------------------------------------------------
Fiduciary Funds
In addition, cash provided by operating activities in 2021 was favorably
impacted by timing differences in the receipts and disbursements of client
fiduciary related balances in 2021 compared to 2020. The following table
summarizes two lines from our consolidated statement of cash flows and provides
information that management believes is helpful when comparing changes in client
fiduciary related balances for 2021 and 2020 (in millions):
2021
2020
Net change in premiums and fees receivable$ 132.9 $ (796.5 ) Net change in premiums payable to underwriting enterprises 35.5 1,154.2 Net cash provided by the above$ 168.4 $
357.7
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 andU.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. Related to our third party administration business and in certain of our brokerage operations, we are responsible for client claim funds that we hold in a fiduciary capacity. We do not earn any interest income on the funds held. These client funds have been included in restricted cash, along with a corresponding liability in premiums payable to underwriting enterprises in the accompanying consolidated balance sheet.
At
billion
Defined Benefit Pension Plan Our policy for funding our defined benefit pension plan is to contribute amounts at least sufficient to meet the minimum funding requirements under the IRC. The Employee Retirement Security Act of 1974, as amended (which we refer to as ERISA), could impose a minimum funding requirement for our plan. We were not required to make any minimum contributions to the plan for the 2021 and 2020 plan years. Funding requirements are based on the plan being frozen and the aggregate amount of our historical funding. The plan's actuaries determine contribution rates based on our funding practices and requirements. Funding amounts may be influenced by future asset performance, the level of discount rates and other variables impacting the assets and/or liabilities of the plan. In addition, amounts funded in the future, to the extent not due under regulatory requirements, may be affected by alternative uses of our cash flows, including dividends, acquisitions and common stock repurchases. During 2021 and 2020 we did not make discretionary contributions to the plan. See Note 13 to our 2021 consolidated financial statements for additional information required to be disclosed relating to our defined benefit pension plan. We are required to recognize an accrued benefit plan liability for our underfunded defined benefit pension plan (which we refer to together as the Plan). The offsetting adjustment to the liabilities required to be recognized for the Plan is recorded in "Accumulated Other Comprehensive Loss," net of tax, in our consolidated balance sheet. We will recognize subsequent changes in the funded status of the Plans through the income statement and as a component of comprehensive earnings, as appropriate, in the year in which they occur. Numerous items may lead to a change in funded status of the Plan, including actual results differing from prior estimates and assumptions, as well as changes in assumptions to reflect information available at the respective measurement dates. In 2021, the funded status of the Plan was favorably impacted by an increase in the discount rates used in the measurement of the pension liabilities atDecember 31, 2021 , the net impact of which was approximately$13.6 million . In addition, the funded status was favorably impacted by returns on the plan's assets being higher in 2021 than anticipated by approximately$17.1 million . The net change in the funded status of the Plan in 2021 resulted in a decrease in noncurrent liabilities in 2021 of$30.7 million . In 2020, the funded status of the Plan was unfavorably impacted by a decrease in the discount rates used in the measurement of the pension liabilities atDecember 31, 2020 , the net impact of which was approximately$15.0 million . However, the funded status was favorably impacted by returns on the plan's assets being higher in 2020 than anticipated by approximately$17.9 million . The net change in the funded status of the Plan in 2020 resulted in a decrease in noncurrent liabilities in 2020 of$2.9 million . While the change in the funded status of the Plan had no direct impact on our cash flows from operations in 2021 and 2020, potential changes in the pension regulatory environment and investment losses in our pension plan have an effect on our capital position and could require us to make significant contributions to our defined benefit pension plan and increase our pension expense in future periods. 52 --------------------------------------------------------------------------------
Investing Cash Flows
Capital Expenditures - Capital expenditures were$128.6 million and$99.3 million for 2021 and 2020, respectively. In 2021 and 2020 capital expenditures include amounts incurred related to investments made in information technology and software development projects. Relating to the development of our corporate headquarters, we received property tax related credits under a tax-increment financing note fromRolling Meadows, Illinois and anIllinois state EDGE tax credit. Incentives from these two programs could total between$60.0 million and$90.0 million over a fifteen-year period. In 2022, we expect total expenditures for capital improvements to be approximately$185.0 million , part of which is related to expenditures on office moves and investments being made in information technology and software development projects. Acquisitions - Cash paid for acquisitions, net of cash and restricted cash acquired, was$3,250.9 million and$324.3 million in 2021 and 2020, respectively. The increased use of cash for acquisitions in 2021 compared to 2020 was primarily due to our acquisition of the Willis Towers Watson plc reinsurance brokerage operations. In addition, during 2021 and 2020 we issued 1.7 million shares ($249.6 million ) and 3.0 million shares ($306.1 million ), respectively, of our common stock as payment for a portion of the total consideration paid for acquisitions and earnout payments. We completed 38 and 27 acquisitions in 2021 and 2020, respectively. Annualized revenues of businesses acquired in 2021 and 2020 totaled approximately$1,002.0 million and$251.4 million , respectively. In 2022, we expect to use new debt, our Credit Agreement, cash from operations and our common stock, or a combination thereof to fund all of the acquisitions we complete.
If liquidity concerns arise, we may be more likely to use common stock to fund
acquisitions.
Dispositions - During 2021 and 2020, we sold several books of business and recognized one-time gains (losses) of$18.9 million of gains and$(5.8) million of losses, respectively. OnDecember 16, 2020 , we completed the sale of aU.K. wealth management business that we purchased over four years ago that no longer strategically fit in our benefits operations. In fourth quarter 2020, we recognized a net pretax non-cash loss on sale of approximately$12.0 million , primarily due to the write-off of the remaining net book value of the amortizable intangible assets.
We received cash proceeds of
respectively, related to these transactions.
Clean Energy Investments - During the period from 2009 through 2020, 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. The IRC Section 45 tax credits generate positive cash flow by reducing the amount of federal income taxes we pay. We anticipate positive net cash flow related to IRC Section 45 activity in 2022. 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 in particular future periods is not possible at this time. However, if we continue to generate sufficient taxable income to use the tax credits produced by our IRC Section 45 investments, we anticipate that these investments will continue to generate positive net cash flows through at least 2027 due to the utilization of IRC Section 45 tax credits to offset taxable income in years after the program expired. While we cannot precisely forecast the cash flow impact in any particular period, we anticipate that the net cash flow impact of these investments will be positive overall. Please see "Clean energy investments" on page 50 for a more detailed description of these investments and their risks and uncertainties. Financing Cash Flows OnJune 7, 2019 , we entered into an amendment and restatement to our multicurrency credit agreement datedApril 8, 2016 (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 fromApril 8, 2021 toJune 7, 2024 and increased the revolving credit commitment from$800.0 million to$1,200.0 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$1,700.0 million . OnAugust 27, 2020 , we entered into an amendment to the Credit Agreement providing that the obligations of each subsidiary ofGallagher that was a borrower, guarantor and/or obligor under the Credit Agreement, ceased to apply and that each such subsidiary was released from all of its obligations under the Credit Agreement. The amendment also replaced the minimum asset covenant with a priority indebtedness covenant, substantially similar to other priority indebtedness covenants applicable to us under our private placement note purchase agreements. There were$45.0 million of borrowings outstanding under the Credit Agreement atDecember 31, 2021 . Due to the outstanding borrowing and letters of credit,$1,140.6 million remained available for potential borrowings under the Credit Agreement atDecember 31, 2021 . 53 -------------------------------------------------------------------------------- We use the Credit Agreement to post letters of credit and to borrow funds to supplement our operating cash flows from time to time. During 2021, we borrowed an aggregate of$1,280.0 million and repaid$1,235.0 million under our Credit Agreement. During 2020, we borrowed an aggregate of$2,630.0 million and repaid$3,150.0 million under our Credit Agreement. Principal uses of the 2021 and 2020 borrowings under the Credit Agreement were to fund acquisitions, earnout payments related to acquisitions and general corporate purposes. OnSeptember 14, 2021 , we entered into an amendment to our revolving loan facility (which we refer to as the Premium Financing Debt Facility) that provides funding for the three Australian (AU) andNew Zealand (NZ) premium finance subsidiaries. The amendment, among other things, extended the expiration date of the Premium Financing Debt Facility fromSeptember 15, 2022 toSeptember 15, 2023 , and increased the total commitment for the AU$ denominated tranche from AU$310.0 million to AU$360.0 million. The Premium Financing Debt Facility is comprised of: (i) Facility B is separated into AU$310.0 million and NZ$25.0 million tranches, (ii) Facility C, an AU$50.0 million equivalent multicurrency overdraft tranche and (iii) Facility D, a NZ$15.0 million equivalent multi-currency overdraft tranche. AtDecember 31, 2021 , AU$292.0 million and NZ$10.0 million of borrowings were outstanding under Facility B, AU$3.0 million of borrowings outstanding under Facility C and NZ$14.7 million of borrowings were outstanding under Facility D, which in aggregate amount toUS$228.4 million of borrowings outstanding under the Premium Financing Debt Facility. OnFebruary 10, 2021 , we closed a private placement of$100.0 million aggregate principal amount of unsecured senior notes. The unsecured senior notes were issued with an interest rate of 2.44% and are due in 2036. We used the proceeds of these offerings in part to fund the$75.0 million February 10, 2021 Series D note maturity, and for acquisitions and general corporate purposes. The weighted average interest rate is 3.97% after giving effect to a net hedging loss. In 2018, we entered into a pre-issuance interest rate hedging transaction related to this private placement. We realized a net cash loss of approximately$22.9 million on the hedging transactions that will be recognized on a pro rata basis as an increase in our reported interest expense over ten years of the total 15year notes. OnMay 5, 2021 , we closed and funded a private placement of$75.0 million aggregate principal amount of unsecured senior notes. The unsecured senior notes were issued with an interest rate of 2.46% and are due in 2036. We used the proceeds of this offering in part to fund acquisitions and general corporate purposes. The weighted average interest rate is 3.98% after giving effect to a net hedging loss. In 2018, we entered into a pre-issuance interest rate hedging transaction related to this private placement. We realized a net cash loss of approximately$17.2 million on the hedging transactions that will be recognized on a pro rata basis as an increase in our reported interest expense over ten years of the total 15year notes. OnJanuary 30, 2020 , we closed and funded an offering of$575.0 million aggregate principal amount of fixed rate private placement unsecured senior notes. The weighted average maturity of these notes is 11.7 years and the weighted average interest rate is 4.23% per annum after giving effect to underwriting costs and the net hedge loss. In 2017 and 2018, we entered into pre-issuance interest rate hedging transactions related to this private placement. We realized a net cash loss of approximately$8.9 million on the hedging transactions that will be recognized on a pro rata basis as an increase to our reported interest expense over ten years.
The notes consist of the following tranches:
•$30.0 million of 3.75% senior notes due in 2027; •$341.0 million of 3.99% senior notes due in 2030; •$69.0 million of 4.09% senior notes due in 2032; •$79.0 million of 4.24% senior notes due in 2035; and •$56.0 million of 4.49% senior notes due in 2040 OnFebruary 13, 2019 , we closed an offering of$600.0 million aggregate principal amount of fixed rate private placement senior unsecured notes. This offering was funded onFebruary 13, 2019 ($340.0 million ) andMarch 13, 2019 ($260.0 million ). The weighted average maturity of these notes is 10.1 years and the weighted average interest rate is 5.04% after giving effect to a net hedging loss. In 2017 and 2018, we entered into pre-issuance interest rate hedging transactions related to this private placement. We realized a net cash loss of approximately$1.2 million on the hedging transactions that will be recognized on a pro rata basis as an increase in our reported interest expense over the life of the debt.
The notes consist of the following tranches:
•$100.0 million of 4.72% senior notes due in 2024; •$140.0 million of 4.85% senior notes due in 2026; 54
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•$100.0 million of 5.04% senior notes due in 2029; •$180.0 million of 5.14% senior notes due in 2031; •$40.0 million of 5.29% senior notes due in 2034; and •$40.0 million of 5.45% senior notes due in 2039
We used the proceeds of these offerings to repay certain existing indebtedness
and fund acquisitions.
OnJune 12, 2019 , we closed a private placement of$175.0 million aggregate principal amount of unsecured senior notes. The unsecured senior notes were issued with an interest rate of 4.48% and are due in 2034. We used the proceeds of these offerings in part to fund the$50.0 million June 24, 2019 Series L note maturity, for acquisitions and general corporate purposes. The weighted average interest rate is 4.68% after giving effect to a net hedging loss. In 2017 and 2018, we entered into pre-issuance interest rate hedging transactions related to this private placement. We realized a net cash loss of approximately$5.2 million on the hedging transactions that will be recognized on a pro rata basis as an increase in our reported interest expense over ten years of the total 15year notes. OnDecember 2, 2019 we closed a private placement of$50.0 million aggregate principal amount of unsecured senior notes. The unsecured senior notes were issued with an interest rate and weighted average interest rate of 3.48% and are due in 2029. We used the proceeds of those offerings to fund the$50.0 million November 30, 2019 Series C note maturity.
We used these offerings to repay certain existing indebtedness and for general
corporate purposes, including to fund acquisitions.
OnMay 20, 2021 , we closed and funded an offering of$1,500.0 million of unsecured senior notes in two tranches. The$650.0 million aggregate principal amount of 2.50% Senior Notes were due 2031 (which we refer to as the 2031 May Notes) and$850.0 million aggregate principal amount of 3.50% Senior Notes are due 2051 (which we refer to as the 2051 May Notes and together with the 2031 May Notes, the May Notes). The weighted average interest rate is 3.13% per annum after giving effect to underwriting costs and the net hedge loss. In 2018 and 2019, we entered into a pre-issuance interest rate hedging transaction related to these notes. We realized a net cash loss of approximately$57.8 million on the hedging transactions that will be recognized on a pro rata basis as an increase to our reported interest expense over ten years. The offering of the May Notes was made pursuant to a shelf registration statement filed with theSEC . The relevant terms of the May Notes, the Indenture and the Officers' Certificate are further described under the caption "Description of Notes" in the prospectus supplement datedMay 13, 2021 , filed with theSEC onMay 17, 2021 . The 2031 May Notes had a special optional redemption whereby, we had the option to redeem the 2031 May Notes, in whole and not in part, by providing notice of such redemption to the holders of the 2031 May Notes within 30 days following aWillis Tower Watson plc transaction termination event, at a redemption price equal to 101% of the aggregate principal amount of the 2031 May Notes, plus any accrued and unpaid interest. These notes were redeemed onAugust 13, 2021 . As a result of the redemption of this debt, we incurred a loss on extinguishment of debt of$16.2 million , which included the redemption price premium of$6.5 million , which is presented in cash flows from financing activities, and the unamortized discount amount on the debt issuance and the write-off of all the debt acquisition costs of$9.7 million , which is presented in cash flows from operating activities. The 2051 May Notes are not subject to the special optional redemption. We used the net proceeds of the 2051 May Notes offering to fund a portion of the cash consideration payable in connection with theWillis Tower Watson plc treaty reinsurance transaction. OnNovember 9, 2021 , we closed and funded an offering of$750.0 million of unsecured senior notes in two tranches. The$400.0 million aggregate principal amount of 2.40% Senior Notes are due 2031 (which we refer to as the 2031 November Notes) and$350.0 million aggregate principal amount of 3.05% Senior Notes are due 2052 (which we refer to as the 2052 November Notes and together with the 2031 November Notes, the November Notes). The weighted average interest rate is 2.80% per annum after giving effect to underwriting costs. The November Notes were issued pursuant to an indenture, dated as ofMay 20, 2021 , as modified and supplemented in respect of the November Notes by an Officers' Certificate pursuant to the indenture, dated as ofNovember 9, 2021 . The relevant terms of the November Notes, the indenture and the Officers' Certificate are further described under the caption "Description of Notes" in the prospectus supplement filed with theSEC onNovember 3, 2021 . We used the net proceeds of the November Notes offering to fund a portion of the cash consideration payable in connection with theWillis Tower Watson plc treaty reinsurance transaction. 55 -------------------------------------------------------------------------------- AtDecember 31, 2021 , we had$1,600.0 million of Senior Notes,$4,448.0 million of corporaterelated borrowings outstanding under separate note purchase agreements entered into during the period from 2011 to 2021,$45.0 million of borrowings outstanding under our credit facility,$228.4 million outstanding under our Premium Financing Debt Facility and a cash and cash equivalent balance of$402.6 million . See Note 8 to our 2021 consolidated financial statements for a discussion of the terms of the Senior Notes, Note purchase agreements, the Credit Agreement and the Premium Financing Debt Facility.
Consistent with past practice, as of
hedges open for
million
The Senior Notes, Note Purchase Agreements, the Credit Agreement and the Premium Financing Debt Facility contain various financial covenants that require us to maintain specified financial ratios. We were in compliance with these covenants as ofDecember 31, 2021 . Dividends - Our board of directors determines our dividend policy. Our board of directors determines dividends on our common stock on a quarterly basis after considering our available cash from earnings, our anticipated cash needs and current conditions in the economy and financial markets. In 2021, we declared$396.2 million in cash dividends on our common stock, or$1.92 per common share. OnDecember 17, 2021 , we paid a fourth quarter dividend of$0.48 per common share to shareholders of record as ofDecember 3, 2021 . OnJanuary 26, 2022 , we announced a quarterly dividend for first quarter 2022 of$0.51 per common share. If the dividend is maintained at$0.51 per common share throughout 2022, this dividend level would result in an annualized net cash used by financing activities in 2022 of approximately$424.1 million (based on the outstanding shares as ofDecember 31, 2021 ), or an anticipated increase in cash used of approximately$32.1 million compared to 2021. We can make no assurances regarding the amount of any future dividend payments. Shelf Registration Statement - OnNovember 15, 2019 , we filed a shelf registration statement on Form S-3 with theSEC , registering the offer and sale from time to time, of an indeterminate amount of our common stock. The availability of the potential liquidity under this shelf registration statement depends on investor demand, market conditions and other factors. We make no assurances regarding when, or if, we will issue any shares under this registration statement. OnNovember 15, 2016 , we also filed a shelf registration statement on Form S-4 with theSEC , registering 10.0 million shares of our common stock that we may offer and issue from time to time in connection with future acquisitions of other businesses, assets or securities. AtDecember 31, 2021 , 2.5 million shares remained available for issuance under this registration statement. Common Stock Repurchases - We have in place a common stock repurchase plan, last amended by our board of directors inJuly 2021 , that authorizes the repurchase of up to$1.5 billion of common stock. During the years endedDecember 31, 2021 and 2020, we did not repurchase shares of our common stock. The plan authorizes the repurchase of our common stock at such times and prices, as we may deem advantageous, in transactions on the open market or in privately negotiated transactions. We are under no commitment or obligation to repurchase any particular number of shares, and the plan may be suspended at any time at our discretion. Funding for share repurchases may come from a variety of sources, including cash from operations, short-term or long-term borrowings under our Credit Agreement or other sources. Public Offering of Common Stock - OnMay 12, 2021 , we entered into an Underwriting Agreement withMorgan Stanley & Co. LLC to issue 9.0 million shares of our common stock in a public offering. OnMay 12 2021 , we agreed to price the offering of 9.0 million shares of our common stock at$142.00 and granted the underwriters in the offering a 30-day option to purchase up to an additional 1.3 million shares of our common stock at the same price. OnMay 12, 2021 , the underwriters exercised the option to purchase an additional 1.3 million shares. The offering closed onMay 17, 2021 and 10.3 million shares of our common stock were issued for net proceeds, after underwriting discounts and other expenses related to this offering, of$1,437.9 million . We used the net proceeds of this offering related to the 2051 Notes to fund a portion of the cash consideration payable in connection with the Willis Towers Watson plc treaty reinsurance transaction. Common Stock Issuances - Another source of liquidity to us is the issuance of our common stock pursuant to our stock option and employee stock purchase plans. Proceeds from the issuance of common stock under these plans were$108.7 million in 2021 and$111.9 million in 2020. OnMay 16, 2017 , our stockholders approved the 2017 Long-Term Incentive Plan (which we refer to as the LTIP), which replaced our previous stockholder-approved 2014 Long-Term Incentive Plan. All of our officers, employees and non-employee directors are eligible to receive awards under the LTIP. Awards which may be granted under the LTIP include non-qualified and incentive stock options, stock appreciation rights, restricted stock units and performance units, any or all of which may be made contingent upon the achievement of performance criteria. Stock options with respect to 9.5 million shares (less any shares of restricted stock issued under the LTIP - 1.8 million shares of our common stock were available for this purpose as ofDecember 31, 2021 ) were available for grant under the LTIP atDecember 31, 2021 . Our employee stock purchase plan allows our employees to purchase our common stock at 95% of its fair market value. Proceeds from the issuance of our common stock related to these plans have contributed favorably to net cash provided by financing activities in the years endedDecember 31, 2021 and 2020, and we believe this favorable trend will continue in the foreseeable future. 56 -------------------------------------------------------------------------------- We 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 historically have matched 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. Beginning with the match paid in 2021, the amount matched by the company will be discretionary and annually determined by management. 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 and can be funded in cash or company stock. We expensed (net of plan forfeitures)$65.7 million and$63.6 million related to the plan in 2021 and 2020, respectively. Our board of directors authorized the use of common stock to fund our 2020 employer matching contributions to the 401(k) plan, which we funded inFebruary 2021 . During, second quarter 2021, our board of directors authorized a 5.0% employer match on eligible compensation to the 401(k) plan for the 2021 plan year and the possible use of common stock to fund our 2021 employer matching contributions, which is expected to be funded inFebruary 2022 .
Other Liquidity Matters
Letters of Credit and Other Guarantees
We have entered into a number of arrangements whereby our performance on certain obligations is guaranteed by a third party through the issuance of a letter of credit. We had total letters of credit outstanding of$17.0 million atDecember 31, 2021 and$18.4 million atDecember 31, 2020 . These letters of credit secure our self-insurance deductibles on our own insurance programs, allow certain of our captive operations to meet minimum statutory surplus requirements, lease security deposits and collateral related to premium and claim funds held in a fiduciary capacity. See Note 17 to our 2021 consolidated financial statements for additional discussion of these obligations and commitments.
Earnout Obligations
Substantially all of the purchase agreements related to the acquisitions we do contain provisions for potential earnout obligations. For all of our acquisitions made in the period from 2017 to 2021 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$1,873.9 million , of which$988.5 million was recorded in our consolidated balance sheet as ofDecember 31, 2021 based on the estimated fair value of the expected future payments to be made, of which approximately$670.3 million can be settled in cash or stock at our option and$318.2 million must be settled in cash. Apart from commitments, guarantees, and contingencies, as disclosed herein and in Note 17 to our 2021 consolidated financial statements, we had no off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our financial condition, results of operations or liquidity. Our cash flows from operations, borrowing availability and overall liquidity are subject to risks and uncertainties. See "Information Concerning Forward-Looking Statements" at the beginning of this report.
Contractual Obligations
Our contractual obligations and commitments as of
comprised of principal payments on debt, interest payments on debt, operating
leases, pension benefit plan and purchase obligations.
Operating leases are primarily comprised of leased office space throughout the
world. As leases expire, we do not anticipate difficulty in negotiating
renewals or finding other satisfactory space if the premise becomes unavailable.
In certain circumstances, we may have unused space and may seek to sublet such
space to third parties, depending upon the demands for office space in the
locations involved. See Note 15 to our 2021 consolidated financial statements
for additional discussion of these operating lease obligations.
Defined benefit pension plan obligations include estimates of our minimum
funding requirements pursuant to the Employee Retirement Income Security Act and
other regulations. We may make additional discretionary contributions. See
Note 13 to our 2021 consolidated financial statements for additional information
required to be disclosed relating to our defined benefit pension plan.
Purchase obligations are defined as agreements to purchase goods and services
that are enforceable and legally binding on us, and that specifies all
significant terms, including the goods to be purchased or services to be
rendered, the price at which the goods or services are to be rendered, and the
timing of the transactions. Most of our purchase obligations are related to
purchases of information technology services, marketing arrangements or other
service contracts. We had no other cash requirements from known contractual
57
-------------------------------------------------------------------------------- obligations and commitments that have, or are reasonably likely to have, a current or future material effect on the Company's financial condition, results of operations, or liquidity. See Note 17 to our 2021 consolidated financial statements for additional discussion of these contractual obligations.
Outlook - We believe that we have sufficient capital and access to additional
capital to meet our short- and long-term cash flow needs.
Critical Accounting Estimates
Our consolidated financial statements are prepared in accordance withU.S. GAAP, which require management to make estimates and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes. These accounting principles require us to make estimates and assumptions that affect the reported amounts of assets and liabilities and revenues and expenses, and the disclosure of contingent assets and liabilities at the date of our consolidated financial statements. We periodically evaluate our estimates and assumptions, including those relating to the valuation of goodwill and other intangible assets, right-of-use assets, investments (including our IRC Section 45 investments), income taxes, revenue recognition, deferred costs, stock-based compensation, claims handling obligations, retirement plans, litigation and contingencies. We base our estimates on historical experience and various assumptions that we believe to be reasonable based on specific circumstances. Such estimates and assumptions could change in the future as more information becomes known, which could impact the amounts reported and disclosed herein. We believe the following significant accounting estimates may involve a higher degree of judgment and complexity. See Note 1 to our 2021 consolidated financial statements for other significant accounting policies. Note 2 to our 2021 consolidated financial statements for a discussion of recently issued accounting pronouncements and their impact or potential future impact on the our financial results, if determinable.
Revenue Recognition
Description
The primary source of revenues for our brokerage services is commissions from underwriting enterprises, based on a percentage of premiums paid by our clients, or fees received from clients based on an agreed level of service usually in lieu of commissions. These commissions and fees revenues are substantially recognized at a point in time on the effective date of the associated policies when control of the policy transfers to the client, as well as deferring certain revenues to reflect delivery of services over the contract period. Whether we are paid a commission or a fee, the vast majority of our services are associated with the placement of an insurance (or insurance-like) contract. Accordingly, we recognize approximately 80% of our commission and fee revenues on the effective date of the underlying insurance contract. The amount of revenue we recognize is based on our costs to provide our services up and through that effective date, including an appropriate estimate of our profit margin on a portfolio basis. Based on the proportion of additional services we provide in each period after the effective date of the insurance contract, including an appropriate estimate of our profit margin, we recognize approximately 15% of our commission and fee revenues in the first three months, and the remaining 5% thereafter. For supplemental revenues certain underwriting enterprises may pay us additional revenues for the volume of premium placed 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 primarily a fixed amount or fixed percentage of premium of the underlying eligible insurance contracts. For supplemental revenue contracts based on a fixed percentage of premium, our obligation to the underwriting enterprise is substantially completed upon the effective date of the underlying insurance contract and revenue is fully earned at that time. For supplemental revenue contracts based on a fixed amount, revenue is recognized ratably over the contract period consistent with the performance of our obligations, almost always over an annual term. For contingent revenues 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 or fee revenues discussed above, and not all business we place with participating underwriting enterprises is eligible for contingent revenues. Unlike supplemental revenues, also 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 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. Accordingly, during each reporting period, we must make our best estimate of amounts we have earned using historical averages and other factors to project such revenues.
See Revenue Recognition and Contracts with Customers in Notes 1 and 4 to our
2021 consolidated financial statements.
58 -------------------------------------------------------------------------------- Judgments and Uncertainties For commissions and fees, these periods may be different than the underlying premium payment patterns of the insurance contracts, but the vast majority of our services are fully provided within one year of the insurance contract effective date. For supplemental and contingent commissions, we base our estimates each period on a contract-by-contract basis where available. In certain cases, it is impractical to assess a very large number of smaller contingent revenue contracts, so we use a historical portfolio estimate in aggregate. Because our expectation of the ultimate contingent revenue amounts to be earned can vary from period to period, especially in contracts sensitive to loss ratios, our estimates might change significantly from quarter to quarter. For example, in circumstances where our revenues are dependent on a full calendar year loss ratio, adverse loss experience in the fourth quarter could not only negate revenue earnings in the fourth quarter, but also trigger the need to reverse revenues previously recognized during the prior quarters. Variable consideration is recognized when we conclude, based on all the facts and information available at the reporting date, that it is probable that a significant revenue reversal will not occur in future periods. Effect if Actual Results Differ From Assumptions We do not believe there is a reasonable likelihood there will be a material change in the estimates or assumptions used to recognize revenue. As noted above, estimates are made based on historical experience and other factors. The vast majority of our brokerage contracts and service understandings are for a period of one year or less, and historically, the difference between actual experience compared to estimated performance has not been significant to the quarterly or annual financial statements. We have not made any material changes in the accounting methodology used to recognize revenue during the past three fiscal years. Income Taxes Description We estimate total income tax expense based on statutory tax rates and tax planning opportunities available to us in various jurisdictions in which we earn income. Income tax includes an estimate for withholding taxes on earnings of foreign subsidiaries expected to be remitted to theU.S. but does not include an estimate for taxes on earnings considered to be indefinitely invested in the foreign subsidiary. Deferred income taxes are recognized for the future tax effects of temporary differences between financial and income tax reporting using tax rates in effect for the years in which the differences are expected to reverse. Valuation allowances are recorded when it is likely a tax benefit will not be realized for a deferred tax asset. We record unrecognized tax benefit liabilities for known or anticipated tax issues based on our analysis of whether, and the extent to which, additional taxes will be due. See Income Taxes in Notes 1 and 19 to our 2021 consolidated financial statements. Judgments and Uncertainties Changes in projected future earnings could affect the recorded valuation allowances in the future. Our calculations related to income taxes contain uncertainties due to judgment used to calculate tax liabilities in the application of complex tax regulations across the tax jurisdictions where we operate. Our analysis of unrecognized tax benefits contains uncertainties based on judgment used to apply the more likely than not recognition and measurement thresholds. Effect if Actual Results Differ From Assumptions Changes in tax laws and rates could affect recorded deferred tax assets and liabilities in the future. Other than those potential impacts, we do not believe there is a reasonable likelihood there will be a material change in the tax related balances or valuation allowances. However, due to the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from the current estimate of the tax liabilities. To the extent we prevail in matters for which unrecognized tax benefit liabilities have been established, or are required to pay amounts in excess of our recorded unrecognized tax benefit liabilities, our effective tax rate in a given financial statement period could be materially affected. An unfavorable tax settlement would require use of our cash and generally result in an increase in our effective tax rate in the period of resolution. A favorable tax settlement would generally be recognized as a reduction in our effective tax rate in the period of resolution. Impairment ofGoodwill DescriptionGoodwill is evaluated for impairment by first performing a qualitative assessment to determine whether a quantitative goodwill test is necessary. If it is determined, based on qualitative factors, the fair value of the reporting unit may be more likely than not less than its carrying amount or if significant changes to macro-economic factors related to the reporting unit have occurred that could materially impact fair value, a quantitative goodwill impairment test would be required. The quantitative test compares the fair value of a reporting unit with its carrying amount. Additionally, we can elect to forgo the qualitative assessment and perform the quantitative test. Upon performing the quantitative test, if the carrying value of the reporting unit exceeds its fair value, an impairment loss is recognized in an amount equal to that excess, not to exceed the carrying amount of goodwill. 59 --------------------------------------------------------------------------------
We have elected to make the first day of the fourth quarter the annual
impairment assessment date for goodwill. However, we could be required to
evaluate the recoverability of goodwill outside of the required annual
assessment if, among other things, we experience disruptions to the business,
unexpected significant declines in operating results, divestiture of a
significant component of the business or a sustained decline in market
capitalization.
Judgments and Uncertainties We estimate the fair value of our reporting units considering the use of various valuation techniques, with the primary technique being an income approach (discounted cash flow method) and another technique being a market approach (guideline public company method), which use significant unobservable inputs, or Level 3 inputs, as defined by the fair value hierarchy. We include assumptions about revenue growth, operating margins, discount rates and valuation multiples which consider our budgets, business plans, economic projections and marketplace data, and are believed to reflect market participant views which would exist in an exit transaction. Assumptions are also made for varying perpetual growth rates for periods beyond the long-term business plan period. Generally, we utilize operating margin assumptions based on future expectations, operating margins historically realized in the reporting units' industries and industry marketplace valuation multiples. See Intangible Assets in Notes 1 and 7 to our 2021 consolidated financial statements.
Our impairment analysis contains uncertainties due to uncontrollable events that
could positively or negatively impact the anticipated future economic and
operating conditions.
Effect if Actual Results Differ From Assumptions We have not made material changes in the accounting methodology used to evaluate impairment of goodwill during the last three years. During fiscal 2021, 2020 and 2019, all of our material reporting units passed the impairment analysis. Some of the inherent estimates and assumptions used in determining fair value of the reporting units and indefinite life intangible assets are outside the control of management, including interest rates, cost of capital, tax rates, market EBITDAC comparables and credit ratings. While we believe we have made reasonable estimates and assumptions to calculate the fair value of the reporting units and indefinite life intangibles, it is possible a material change could occur. If our actual results are not consistent with our estimates and assumptions used to calculate fair value, it could result in material impairments of our goodwill.
Impairment of Amortizable Intangible Assets
Description
Amortizable intangible assets are evaluated for impairment whenever events or
changes in circumstances indicate the carrying value may not be
recoverable. Examples include a significant adverse change in the extent or
manner in which we use the asset, a change in its physical condition, or an
unexpected change in financial performance.
When evaluating amortizable intangible assets for impairment, we compare the carrying value of the asset to the asset's estimated undiscounted future cash flows. An impairment is indicated if the estimated future cash flows are less than the carrying value of the asset. The impairment is the excess of the carrying value over the fair value of the asset. We recorded impairment charges related to amortizable intangible assets of$17.6 million ,$51.7 million and$0.1 million 2021, 2020 and 2019, respectively. See Intangible Assets in Notes 1 and 7 to our 2021 consolidated financial statements. Judgments and Uncertainties Our impairment analysis contains uncertainties due to judgment in assumptions, including useful lives and intended use of assets, observable market valuations, forecasted revenue growth, operating margins and discount rates based on budgets, business plans, economic projections, anticipated future cash flows and marketplace data that reflects the risk inherent in future cash flows to determine fair value. Effect if Actual Results Differ From Assumptions We have not made any material changes in the accounting methodology used to evaluate the impairment of amortizable intangible assets during the last three fiscal years. We do not believe there is a reasonable likelihood there will be a material change in the estimates or assumptions used to calculate impairments or useful lives of amortizable intangible assets. However, if actual results are not consistent with our estimates and assumptions used to calculate estimated future cash flows, we may be exposed to impairment losses that could be material. 60 --------------------------------------------------------------------------------
Earnout Obligations
Description
Substantially all of the purchase agreements related to the acquisitions we do contain provisions for potential earnout obligations. The amounts recorded as earnout payables, which are primarily based upon the terms of the purchase agreements and 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. We will record subsequent changes in these estimated earnout obligations, including the accretion of discount, in our consolidated statement of earnings when incurred. Judgments and Uncertainties The fair value of these earnout obligations is based on the present value of the expected future payments to be made to the sellers of the acquired entities in accordance with the provisions outlined in the respective purchase agreements, which is a Level 3 fair value measurement. In determining fair value, we estimate the acquired entity's future performance using financial projections developed by management for the acquired entity and market participant assumptions that were derived for revenue growth and/or profitability. Revenue growth rates generally ranged from 2.5% to 15.0% for our 2021 acquisitions. We estimated future payments using the earnout formula and performance targets specified in each purchase agreement and the financial projections just described. 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. The discount rates generally ranged from 7.0% to 10.5% for our 2021 acquisitions. Effect if Actual Results Differ From Assumptions While management believes those expectations and assumptions are reasonable, they are inherently uncertain. Changes in financial projections, market participant assumptions for revenue growth and/or profitability, or the risk-adjusted discount rate, would result in a change in the fair value of recorded earnout obligations. See Note 3 to our 2021 consolidated financial statements for additional discussion on our 2021 business combinations.
Business Combinations
Description
We account for acquired businesses using the acquisition method of accounting, which requires that once control of a business is obtained, 100% of the assets acquired and liabilities assumed, including amounts attributed to noncontrolling interests, be recorded at the date of acquisition at their respective fair values. Any excess of the purchase price over the estimated fair values of the net assets acquired is recorded as goodwill.
We use various models to determine the value of assets acquired and liabilities
assumed such as discounted cash flow to value amortizable intangible assets.
For significant acquisitions we may use independent third-party valuation specialists to assist us in determining the fair value of assets acquired and liabilities assumed. See Note 3 to our 2021 consolidated financial statements for additional discussion on our 2021 business combinations. Judgments and Uncertainties Significant judgment is often required in estimating the fair value of assets acquired and liabilities assumed, particularly intangible assets. We make estimates and assumptions about projected future cash flows including sales growth, operating margins, attrition rates, and discount rates based on historical results, business plans, expected synergies, perceived risk and marketplace data considering the perspective of marketplace participants.
Determining the useful life of an intangible asset also requires judgment as
different types of intangible assets will have different useful lives.
Effect if Actual Results Differ From Assumptions While management believes those expectations and assumptions are reasonable, they are inherently uncertain. Unanticipated market or macroeconomic events and circumstances may occur, which could affect the accuracy or validity of the estimates and assumptions, which could result in subsequent impairments.
MARKEL CORP – 10-K – MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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