Good afternoon. Welcome to Arthur J. Gallagher & Company's Third Quarter 2022 Earnings Conference Call. Participants have been placed on a listen-only mode; your lines will be open for questions following the presentation. Today’s call is being recorded. If you have any objections, you may disconnect at this time. Some of the comments made during this conference call, including answers given in response to questions, may constitute forward-looking statements within the meaning of the securities laws. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the cautionary statements and risk factors contained in the company's 10-K, 10-Q, and 8-K filings for more details on its forward-looking statements. In addition, for reconciliations of the non-GAAP measures discussed on this call as well as other information regarding these measures, please refer to the earnings release and other materials in the Investor Relations section of the company's website. It is now my pleasure to introduce J. Patrick Gallagher, Chairman, President, and CEO of Arthur J. Gallagher & Co. Mr. Gallagher, you may begin.

Thank you, operator, and good afternoon, everyone. Thank you for joining us for our third quarter 2022 earnings call. On the call for today is Doug Howell, our CFO; as well as the heads of our operating divisions. Before I get to my comments about our financial results, I'd like to acknowledge the damage of devastation caused by Hurricane Ian. Our professionals are working diligently to help our clients sort through their coverages, file claims, and ultimately get losses paid. At the same time, many of our own colleagues are doing the same for themselves. Our hearts go out to all of those impacted by the storm. In the aftermath of events such as these, the insurance industry's role and response is paramount to help families, businesses, and communities restore their lives. I'm really honored to be part of an industry with such important responsibility. Okay, on to my comments regarding our third quarter financial performance. For our combined Brokerage and Risk Management segments, we posted 15% growth in revenue, 8.4% organic growth, net earnings growth of 12%, adjusted EBITDAC growth of 15%, and we completed or signed 7 mergers in the quarter totaling about $60 million of annualized revenues. Another fantastic quarter by our team. Let me give you some more detail on our third quarter performance, starting with our Brokerage segment. During the quarter, reported revenue growth was 16%. Of that, 7.8% was organic. That's right in line with our September Investor Relations Day expectation when we previewed there would be about a full point of headwind related to timing from a tough '21 comparison within our benefits business. Acquisition rollover revenues were $162 million. Net earnings growth was 11%, and we posted adjusted EBITDAC margins of 32.3%, a bit better than our Investor Relations Day guidance. Another excellent quarter for our brokerage team. Focusing on brokerage segment organic, it continues to be broad-based by both business and geography. Let me walk you around the world and provide some more detailed commentary, starting with our P/C operations. Our U.S. retail business posted 9% organic growth with strong new business and solid client retention, both consistent with last year's third quarter. Risk Placement Services, our U.S. wholesale operations, also posted organic growth of 9%. This includes more than 20% organic in open brokerage and about 5% organic in our MGA programs and binding businesses. New business was strong at more than 27% of prior year revenue, and retention was consistent with last year's third quarter. Shifting outside the U.S., our U.K. businesses posted organic growth of 15% with excellent new business production and retention. Australia and New Zealand combined organic growth was 9%. New business production remained very strong and retention improved relative to last year's third quarter. Canada was up 13% organically and continues to benefit from renewal premium increases, robust new business, and consistent retention. Moving to our Employee Benefit Brokerage and Consulting business. As I mentioned earlier, as we signaled last quarter and again at our September Investor Relations Day, our benefits business faced a tough organic comparison this quarter. Recall that due to last year's upward development in covered lives as employers resumed hiring coming out of the depths of the pandemic. Leveling for that, our benefits business organic growth was about 3%. And that's consistent with our Investor Relations Day expectations and includes strong growth with our HR benefits consulting units and solid growth in our international businesses. And before I conclude my organic comments, let me give you a quick update on our December 21 reinsurance acquisition. Third quarter revenues were right in line with our expectations and while not included in our Brokerage segment organic yet, after controlling for breakage prior to closing, organic was around 8%. That's just outstanding. With expected revenues and EBITDAC for the full year unchanged, reinsurance continues to be a fantastic story. So headline Brokerage segment all-in organic of 7.8% and around 9% after controlling for the benefits comparison, either way, an outstanding organic quarter. Next, let me give you some thoughts on our current P/C market environment, starting in the primary insurance market. Overall, global third quarter renewal premiums, that's both rate and exposure combined, were up 10.5%. That's a bit higher than the renewal premium change in the first half of '22. As for rate, most lines of business and geographies saw increases in the third quarter, similar to the first half with only one exception being D&O, where rates are now closer to flat, but our customers are buying more limits. Additionally, our customers' third quarter business activity was not reflective of any economic slowdown. In fact, revenue related to third quarter midterm policy endorsements, audits, and cancellations combined were above third quarter '21 levels. Looking ahead, thus far in October, midterm policy endorsements and audit adjustments remain higher than last year's level, and renewal premium increases are also consistent with the third quarter. But remember, our job is to help our clients mitigate that overall 10% increase in premiums by developing creative risk management solutions that fit their budgets. Let me move to the reinsurance market. Let me provide you with some broad observations regarding the upcoming '23 reinsurance renewal season. First, there is no question that rates, terms, and conditions will vary depending on geography, individual seed and loss history, risk characteristics, and line of business. Second, pricing on peak zone property catastrophe cover is moving higher. And tightening terms and conditions are highly likely. Third, while we haven't witnessed the impact of Hurricane Ian spill over to non-property lines yet, it is possible that this could happen if there's a broad shift in reinsurance risk appetite and capacity deployment strategies. Fourth and finally, the amount of property reinsurance capacity available is an open question. Some reinsurance providers had already planned to pull back their catastrophe capacity priority in, and now it is likely the significant level of ILS capital will be trapped into 1/1 renewals, further pressuring potential capacity. Ultimately, supply will depend on expected returns from changes in pricing, terms, and conditions, and perhaps expected returns will reach a level that will attract additional reinsurance capital. While we have yet to see any significant third-party capital entering the market, given ILS capital can move quickly, there is still time before the January renewal season. This will play out over the next two months. But at this point, it seems the stage is set for a hard or even harder renewals market as we enter the important 1/1 renewal season. Reinsurance conditions will no doubt influence primary markets in 2023, and carriers are already facing rising loss costs in property and casualty lines. We see good reason for our carrier partners to continue to underwrite retail and wholesale risks cautiously for the foreseeable future. Moving to our Employee Benefit Brokerage and Consulting business. U.S. labor market conditions remained tight but broadly favorable. During August, while U.S. employers reduced job openings by 1 million positions, there are still more than 10 million job openings according to the most recent data. And the level of open jobs remains well above the nearly 6 million people unemployed and looking for work as of the end of September. So we see tight U.S. labor market conditions lingering for some time and expect strong demand for our HR and benefits consulting services to continue as businesses prioritize attracting, retaining, and motivating their workforce. Let me wrap up my Brokerage segment organic comments with three terrific quarters in the books. Year-to-date, brokerage organic growth stands at 9.3%. And as I look to the fourth quarter, I see us posting another quarter above 9%, which would deliver a fantastic year. Moving on to mergers and acquisitions. During the third quarter, we completed 6 new tuck-in brokerage mergers representing about $20 million of estimated annualized revenues. We also signed another merger late in the third quarter, representing an additional $40 million of estimated annualized revenues. I'd like to thank all of our new partners for joining us and extend a very warm welcome to our growing Gallagher family of professionals. As I look at our tuck-in merger and acquisition pipeline, we have about 50 term sheets signed or being prepared, representing nearly $400 million of annualized revenue. We know not all of these will close; however, we believe we'll get our fair share. Next, I'd like to move to our Risk Management segment, Gallagher Bassett. Third quarter organic growth was 12.2%, a strong finish to the quarter that pushed organic a bit higher than our Investor Relations Day expectation. We also continue to benefit from increases in new arising claims across general liability and core workers' compensation during the quarter. That's both on an organic existing client basis and also due to some recent new client wins, including a significant insurance company client we added to our fast-growing insurance carrier practice. And profitability remains excellent. Third quarter adjusted EBITDAC margin was 18.2%, in line with our expectations. That would have been closer to 19% without the impact from the new large client ramp-up that we spoke about at our September Investor Relations meeting. Looking forward for the fourth quarter, we believe organic revenue growth will be about 10% and adjusted EBITDAC margins between 18.5% and 19%, closing out a great year for the Gallagher Bassett team. And I'll conclude my remarks with some thoughts on our bedrock culture. October 2 marked Gallagher's 95th anniversary. I took note on that day that our teams were hard at work helping our clients assess damage, file claims, and ultimately start the repairing and rebuilding process for Ian. And if not directly assisting individuals and communities impacted, many Gallagher colleagues around the world donated their own money to help those impacted by Ian. What a fitting way for us to solidly celebrate this incredible milestone. My grandfather would be proud of the company founded by employees that embody the culture he started in the industry in which we toil. It's our people's actions in challenging times that bring our unique Gallagher culture to the forefront, a culture that we believe will thrive for another 95 years. Okay. I'll stop now and turn it over to Doug.

Thanks, Pat, and hello, everyone. Today, I'll touch on organic and margins using our earnings release. Then I'll move to the CFO commentary document that we post to our website and make some comments on our corporate segment. I'll conclude my prepared remarks with some thoughts on M&A, debt, and cash. During my comments today, I'll also provide some thoughts on our fourth quarter and some first thinking around how we are seeing 2023 now that we have started our budget process. Okay. Starting with the earnings release in the Brokerage segment organic table on Page 3. Headline all-in brokerage organic of 7.8%. That's over 9% when controlling for the tough benefits compare, bringing us to a strong 9.3% year-to-date organic growth. When I look at our organic quarter-to-quarter, it's fairly consistent in that 9% range. We boast 9.6% organic growth in the first quarter, about the same in the second quarter when you exclude that infrequent large live sale we discussed last quarter. Now we're at about 9% here in the third quarter when adjusting for the benefits headwind. It's looking like over 9% in the fourth quarter. That would deliver a full year 2022 organic growth above 9%, a little noisy on the quarters, but very consistent and actually a fantastic performance by our sales team. As for 2023, early feel is in that 7% to 9% organic range for our Brokerage segment. Next turning to Page 5, to the Brokerage segment adjusted EBITDAC margin table. Recall, this is a year of quarterly margin change volatility due to the roll-in impact of the acquired reinsurance operations, expenses returning as we come out of the pandemic, and the impact of a stronger dollar. Specifically, we've been saying to expect year-over-year margins to be up 50 basis points in the first quarter, down 100 in the second quarter, down 125 basis points in the third quarter, and up about 125 basis points in the fourth quarter. While that was about right for our third quarter, we posted 32.3%, which was in line with our Investor Relations Day guidance, and we are still comfortable with our fourth quarter outlook of around 125 basis points of margin expansion relative to the FX adjusted fourth quarter 2021 EBITDAC margin. That would suggest a fourth quarter margin of around 32% at today's FX rates. In the end, since early '22, we've been targeting around 10 to 20 basis points of full year '22 margin expansion. And we're on track to deliver that. More importantly, that would mean we improved margins around 570 basis points since 2019. As we look ahead to '23, we continue to expect margin expansion next year starting around 4% or better organic growth, call it maybe 50 basis points at 6%. Moving on to the Risk Management segment on Pages 5 and 6. As Pat said, 12.2% organic and 18.2% adjusted margins, both pretty close to our September Investor Relations Day expectations. Looking forward, we see these excellent results continuing in the fourth quarter. Organic revenue growth of about 10% and margins in the mid- to upper 18% range. That would be a full year organic growth of about 12% and full-year margins around 18.5%. Looking to '23, we will see the roll in of the new large carrier client, and we have already had a nice new business win in Australia that will end up mid-year. Add continued strong new business production, combined with continued growth in newer arising claims, we see organic at least in the high single digits and margins around 19% in '23. All right. Let's shift now to the CFO commentary document. Starting with Page 3, which shows our typical brokerage and risk management modeling helpers. A few things to highlight. First, the continued strengthening of the U.S. dollar since our September Investor Relations Day. Please take a look at our updated FX guidance for the fourth quarter of '22. As for 2023, perhaps the best start is just to assume what we are projecting for full year '22 repeats in '23, but most of that will be seen in the first half. Second, you'll see our current estimate for fourth quarter integration costs; most of this relates to the reinsurance acquisition. The team is making really excellent progress on this and is executing at a faster pace than our original plan. It was terrific to see our new reinsurance colleagues located with our other brokerage operations when I was in London a couple of weeks ago. As for technology and system rebuilds, we still see being done by the end of '23 or early '24. Turning to the Corporate segment on Page 4. Relative to our September outlook, interest in banking, clean energy, and M&A costs after adjusting for the large transaction-related expenses, those three lines totaled to about the midpoint of our outlook. Within the corporate line, most of the upside was due to some favorable tax items and a favorable FX remeasurement gain. Looking towards the fourth quarter, moving down that page, only one significant change to our outlook. As you'll see in the fourth quarter corporate line and read in Footnote 7 on Page 4, here in October, we settled a litigation resulting in Gallagher receiving $55 million in cash. Net of litigation costs and taxes, we will record a gain of approximately $35 million, and you'll see a few lines down that we'll adjust that gain out of our GAAP results. As for the cash proceeds, which because of our tax credits is actually closer to $40 million, we'll put that to good work over the next couple of years to fund incremental production hires and make incremental investments in technology. I'll break down our thinking a little more during our December Investor Relations Day. Moving now to Page 5, Clean Energy. This page should be familiar to everyone by now. It highlights that we have close to $1 billion of tax credit carryforwards. The pink column shows that we expect a $125 million to $150 million of cash flows here in '22, and the peach column shows that we could be even greater in '23 and beyond. And as a reminder, that would come through our cash flow statement, not our P&L. Turning to Page 6. The top of the page is the rollover revenue table. Third quarter revenues of $162 million are right in line with our expectations six weeks ago. Shifting to the lower half of the page, this table is an update on our December '21 reinsurance acquisition. Third quarter revenue of $120 million is consistent with our September Investor Relations Day estimate. As for EBITDAC, a tightening difference between third and fourth quarter. Punchline is full-year revenue and EBITDAC should come in very close to our pro forma. That's a really terrific story, and great credit to the team. Okay. As to cash and capital management and future M&A. At September 30, available cash on hand was about $500 million, and we've been saying that we might have around $4 billion of M&A capacity in '22 and '23 combined without using stock. That still seems about right to us today. Okay. Those are my comments. Another fantastic quarter, and 9 months are in the books, another strong outlook for the fourth quarter, and it's looking like we're well positioned for a terrific year in 2023. Back to you, Pat.

Thanks, Doug. Operator, if you would, let's open it up for questions, please.

Our first question is from Weston Bloomer with UBS. Please proceed.

Hi, thanks for taking my question. My first inquiry is about the 7% to 9% organic growth you expect next year. Could you elaborate on the type of environment you anticipate in terms of a potential recession? Can you achieve that target in a recessionary setting? Additionally, could you comment on the level of growth you're experiencing in your P&C operations compared to wholesale or international? I'm trying to understand how you arrive at that 7% to 9% estimate in more detail.

Weston, I'll address the recession question. Doug can examine the numbers, as we detailed them by division earlier. We believe they will remain fairly consistent next year. Our prepared remarks provide clarity on that issue. The recession aspect is intriguing because one reason we mention endorsements is that we can daily assess the performance of our clients' underlying businesses. Additionally, we monitor renewal exposure units as they are submitted to the market for renewal. When renewing a client, it’s essential to estimate future sales and payrolls. Clients are savvy and prefer not to overpay and then wait for a premium return through an audit months later. There’s a balance between the broker, the underwriter, and the client in determining the appropriate payroll figures we should offer. We are not witnessing any substantial decline in sales and payrolls; renewals reflect a perception that their businesses are doing well, which is confirmed by midterm audits and endorsements. I read the Wall Street Journal daily; yesterday the left-hand column suggested the world was ending, and I wasn’t aware of it.

We are not currently experiencing issues in our underlying business, and we are considering the possibility of a recession in 2023. We believe it would resemble the mild recessions of the early 1990s or the early 2000s, rather than the severe subprime financial crisis of 2007-2008 or the brief pandemic recession in 2020. Typically, these milder recessions last about two to three quarters. Historically, we have performed well during such downturns. If a recession were to occur next year, we expect it would create excess demand rather than reduce supply, and we are focused on ensuring our supply. Our outlook for next year is similar to this year, with stable exposure units and increasing rates as we have observed this year. I don't anticipate any significant changes come January 1 that would dramatically shift our situation from what it has been over the past three to six months. This is our baseline scenario, and it informs our budget preparations, leading us to project a range of 7% to 9%.

But we'll give you more reflection on that in December.

Got it. And just one follow-up there is kind of like a high single, low double-digit growth for reinsurance brokerage kind of the right range as well? And can you remind us how much of that business is more property versus long tail binds?

In response to your question, we anticipate reinsurance will be in the high single-digit range next year. Currently, the best estimate we have for pure property is 28%. When considering the package, it might be closer to 40% of our overall business. Additionally, some of our high-risk casualty lines may face a challenging renewal season, with about 60% of that book experiencing difficulties.

Great. And then just one more. On the commentary around 50 bps of margin based on 6% organic, does that contemplate a potential pickup in discretionary spending inflation maybe offset by higher fiduciary income? Or is that just core expansion net of any items?

Yes. For 2023, I anticipate an increase in investment income, although not all of it will contribute to the bottom line due to some potential inflation in our figures. We believe that around 80% of our business is not significantly impacted by headline inflation. As mentioned during our Investor Relations Day and previous calls, approximately 20% of our expenses are facing inflationary pressures. However, we expect a positive impact from the additional investment income next year. I still need to finalize the calculations in the coming months.

I am working through it too.

Our next question is from Mike Zaremski with BMO Capital Markets. Please proceed.

I just wanted to follow up on the investment income levels. Is the guidance you're providing based on the current interest rates or the curve? Does that make sense?

You're talking about the '23?

Yes, '23. Sorry, Doug.

Yes. I think that when we look at 6% organic growth with possibly 50 basis points of margin expansion, that does not include a possible upside from incremental investment income. But not all that incremental investment income will likely hit the EBITDA line. It could go to some inflationary pressures on some of our cost base or it could go to some discretionary spend, but it would be upside to that 6 points, 50 basis points outlook.

Okay, got it. Thanks for the clarification. I'm shifting topics a bit. I'm curious why there hasn't been any mention of potential impacts to contingents or shops due to the hurricane. I know the new accounting rules were implemented a few years back. Should we be considering anything that might affect Gallagher in the upcoming year or even influence the programs business if there's limited capacity? I'm just trying to understand, as one of your peers caught us off guard a bit, so I’m checking to see if there's anything relevant to discuss.

Our outlook on the impact of Ian to our contingent commissions is a $465,000 effect on our revenues. This has all been fully accounted for in the numbers you see today. We do not anticipate any changes to this assessment. We are simply not exposed to contingent commissions on operating placements within our business.

Okay. Great. And lastly, any change in the competitive environment on the M&A side, given there's kind of now a consensus that interest rates may stay higher for longer? Or is it still just very competitive?

No, it's still very, very competitive. And there's a lot of interest out there in our industry still; we're watching that very carefully to see if some of that falls off. You'll see some write-ups recently about the number of deals done coming down a bit. I don't know if that's an early sign that maybe some of the people want to sit on the sideline a bit. But for the deals that we're after right now, the competition is very strong.

I was trying to be clear. So you don't expect multiples to decrease, and you're not observing that?

I hope they do, but we're not yet.

Our next question is from Greg Peters with Raymond James. Please proceed.

I wanted to revisit your comments about the reinsurance market and the reinsurance business to understand what's happening and get your insights. It seems like we are at a crucial point in that marketplace where we might be entering a hard market, particularly for cat-exposed property, and it appears this is affecting other lines as well. Reinsurers have not been able to achieve an adequate return on their business, and now primary companies will be required to take on higher retentions and pay more on rates online. My question is, if your two partners are experiencing profitability pressure, do you anticipate that you might also face pressure on commission rates as the market continues to evolve?

No, I don't think so, Greg. I think it's clear that we earned our money. And you see that in the market. I mean, the business has been very stable. I've had a chance to meet with a number of managements. They know exactly every dollar that we're making. There is no hidden factor here anywhere. And we have to do the work that justifies that income level every single day. Now in my experience as a retailer, I'm not a reinsurance person, but a hard market makes you incredibly more valuable. In a soft market in the retail business, some person with a shingle out to get a quote and beat you, when you're sitting with someone in a hard market, you are talking strategy, man. You are not talking about what's going to happen to my comp premium. You're talking about, am I going to get GL coverage? And that's going right down to personal lines. I've got tons of friends, as you can imagine, in South Florida. Am I going to get homeowners next year? I don't know. I mean, I think you will, but you're going to pay more, and they know it. Now that, I think, trusted adviser works its way all the way back to reinsurance, and this is not a time when these carriers are going to put a lot of emphasis on how much we get paid when they're looking at trying to get returns literally on hundreds of millions of dollars of ratings.

Yes, Greg, I will say this. It's been 20 years since I've been CFO of insurance companies, but right now, this is a time where my reinsurance brokers would be the most important people to have in my office with their skills, their capabilities, and this is a time where they really earn their money.

Fair enough. I'm sure there's an in-depth discussion taking place regarding this matter. I also wanted to shift the conversation to the brokerage business and the pipeline. If we are in or heading towards a recession, the conditions seem to be quite strong. Could you remind us about how you view the risk management aspects and how they might perform in the event of a soft landing? What kind of guidance can you provide us regarding that?

First of all, Greg, as you know, when prices are rising, one of the key skills that has helped us reach our current position is our ability to guide clients who should be self-insuring into that market, showing them how to handle higher retentions and involving Gallagher Bassett. The impact of a recession is similar, particularly in the upper middle market. A recession can influence companies, especially if it coincides with rising prices. They begin to seek alternatives. When I suggest that the alternative is to manage claims effectively and prevent them, clients tend to be more receptive than when prices are decreasing and private companies feel content. Larger accounts consist of sophisticated buyers who don’t typically shift based on recessions. However, if there is a recession that results in a reduction of our larger clients' workforce, we might see a decline in claim counts. Still, I don’t anticipate an immediate effect on that business, and we will be aware of any slowdown in advance as businesses begin cutting shifts. We will likely have more insights as we progress into the next quarters. Currently, we aren't observing that trend, which I find interesting. I follow the news daily and analyze the situation closely, and our primary business partners continue to perform strongly. Looking at Gallagher Bassett's results, claim counts are increasing rather than decreasing. I understand your concerns, but historically, we've performed well during recessions. Clients typically do not switch between self-insurance and traditional insurance frequently; deciding to take on a larger retention and manage claims is a significant commitment. While you may notice a decrease in claim counts if fewer hours are worked, clients are not leaving the market. Overall, we are in a solid position.

Got it. Thanks for the answer, and I read the journal too. It does seem like the end of the world is imminent, but you guys are posting good results. So congratulations.

Thanks, Greg.

Our next question is from Elyse Greenspan with Wells Fargo. Please proceed.

My first question, I'm going to head in the opposite direction of talking about a recession. I want to go to the flip side and talk about how good, I guess, 2023 could be. As you had said 6% to 9% organic in September. Today, you're saying 7% to 9% for next year. But we could have a really strong reinsurance market, and it sounds like you have really good exposure on the wholesale side where the market is really firming. So at 80% of your revenue is commission based. So could there be an environment next year where pricing is still firm that Gallagher could print double-digit organic revenue growth?

If we look back at our results in other challenging markets, that could happen. I'm not going to say it's impossible. If capacity decreases, smaller brokers may struggle to perform, and reinsurance will clearly step in. Depending on the availability of capital in the ILS market, if capacity is either present or lacking, there's definitely a possibility to present a positive outlook.

And then assuming, right, Doug, you said at 6% organic, we could see 50 basis points of margin improvement. So assuming that the base is 7%, right, and it sounds like it could be better than that, so is the base case that we'll see something margin improvement that's above that 50 basis point level next year?

I think the relationship isn't straightforward. If we report 9%, I don't believe it would result in 150 basis points of margin expansion, but it could potentially lead to around 75 basis points. Let's focus on getting through December and reviewing our budgets. Some of this may relate to discretionary spending that we would like to allocate towards investments in technologies and other strategies for organic growth. However, it is possible that such an outcome could occur.

And then on the M&A side, right, you guys obviously have a good amount of capital flexibility over the next couple of years. It does seem maybe it's because you guys have had such a strong track record of M&A. Deal flow has been a little light relative to historical levels this year. So I know the pipeline is still strong. At what point do you reach that level? Will you consider buying back your shares? Or is it something where deals just ebb and flow depending upon the time of year, and you guys will give it some time and then maybe consider buybacks?

If we have excess capital, our primary goal would be to ensure we maintain a strong investment-grade borrowing rating, especially with rising interest rates making this increasingly crucial. Additionally, our M&A pipeline remains strong. It's also important to consider the arbitrage benefits we gain from multiples. We're expanding our team to enhance our competitive edge and generate more organic growth. While stock buybacks are indeed an option for us and part of our overall strategy, I would prefer to see us engaging in more M&A activity daily to effectively utilize our cash in ways that add value for our shareholders. We are actively searching for opportunities, and while sometimes we succeed and sometimes we do not, we currently have many promising prospects in our pipeline.

Given the strength of the U.S. dollar, are you guys seeing more opportunities for international deals?

Well, listen, we've got some pretty good pipelines going on, especially in Canada, Australia, and the U.K. right now. So we'd be happy to continue to look at those acquisitions there. And yes, the dollar does have a little bit of an impact on that, but it's not what drives our investment choices.

Our next question is from Yaron Kinar with Jefferies. Please proceed.

My first question is about headcount. I noticed there was a significant increase in headcount, particularly in Brokerage, where it has risen 7% year-to-date. Could you provide some details about the roles you are hiring for? Additionally, I was quite impressed to see that the compensation and benefit ratio has improved year-over-year despite the increase in headcount. Should we anticipate any adjustments, or how are you managing to keep that ratio down?

Certainly. We have made a significant increase in our workforce at our offshore centers of excellence, a focus we've maintained for 15 years. We believe this is an excellent opportunity to enhance the quality of our insurance offerings. Consequently, we are significantly increasing our offshore operations to support this work, which accounts for the metric you're observing. Regarding the decrease in the comp ratio this quarter, part of it is related to the timing of bonuses. Last quarter, we noted that we were slightly ahead in our bonus accruals, allowing us to post less this quarter, which helped balance out some inflation in our rates pool. We distributed an additional $8 million in our raise pool this year. The timing of the bonuses has played a role in offsetting these changes.

Got it. And I'm curious what led to the increase in the organic growth estimate for '23, at least the bottom end of the range from 6% to 7%? What changed in the last 6 weeks?

I believe Ian has introduced a new perspective in the marketplace. We are observing reports of reserve strengthening across the board. The reinsurance outlook we've discussed indicates that we projected organic growth for 2023 to be between 6% and 9%. This is based on the comparison of 2023 to the years 2019 and 2022, with 2019 showing 6% organic growth. As we approach our budget process and closely analyze our renewal pipeline, we felt it was appropriate to narrow that range slightly.

Also, Yaron, I think that before Ian, it was clear that loss costs and verdicts were putting pressure on our carriers. Today, we look across the loss at the catastrophe level and wonder if they might affect the casualty lines. I’ve had some conversations with some of our reinsurance experts, and we believe that’s a strong possibility. If that occurs, it will be beneficial for us as well.

Got it. Maybe one last one, and following up on Greg's question. I guess, in what markets, what kind of environment do you typically see some pressure on commission rates or maybe clients trying to shift over to fees?

Primarily in the retail market as accounts go from being, say, upper middle, middle market, where typically you'll have about 85% to 90% of your clients. Probably, we're 100% transparent. This is their choice. We have an adult conversation. They know we collect contingents. Let's not go back to 2004 and get me all in trouble again for accepting convenience and supplemental. They're all disclosed. This is client choice. And so as they get a little bigger, if they bring in a risk manager, that type of thing, then there's usually a shift to fee, and we're happy with that.

Our next question is from David Motemaden with Evercore ISI.

Just had a question on the investment income side, the fiduciary income. Could you just quantify how much that generated this quarter? I think you've said in the past it's $40 million for every 100 basis points move in short-term rates. But just wanted to just to double check what the benefit was to revenues this quarter? And then maybe just talk about how that impacted margins? How much of it fell to the bottom line?

Okay. I'll address that in a few parts. This quarter, we had an additional $12.5 million in investment income due to rate changes. To understand the full-year impact, at the start of the year, we noted a margin expansion of about 550 basis points over the past two years. Looking ahead from January 2022, we projected a potential margin expansion of 10 to 20 basis points on organic growth from around 8% in 2022. In terms of our expectations, we still anticipate the same margin expansion, but organic growth is performing a point better. We estimate that investment income might increase by about $30 million this year, leading to around $80 million more in revenue. As for where that $80 million in revenue goes, one-third will contribute to the bottom line, leaving approximately $50 million to $53 million in additional revenue. We need to compensate our producers and support our field leadership, which typically accounts for about 45% of that $50 million, around $23 million. This means we need to explain the allocation of the remaining $30 million from organic growth and increased investment income compared to our early-year outlook. We spent around $10 million on additional hiring, raises, and incentive compensation this year, which is about a third of the additional revenue. We also incurred about $10 million in increased travel and entertainment expenses, primarily due to inflation and not because of an increase in trips beyond our original expectations. Lastly, we allocated an extra $10 million for IT improvement projects that we hadn't initially planned for, as we had the capacity to implement them. Overall, I believe this outcome is commendable, given our expectations at the beginning of the year. I'm proud of our team's performance; they have managed their travel wisely, been selective in their value-added initiatives for clients, and made prudent IT investments. Achieving a 10 to 20 basis points margin expansion this year amidst inflation, on top of 550 basis points over the previous two years, reflects a strong year in my view. It might be a lengthy response, but I hope it clarifies what you were seeking.

Yes, that was very helpful. Switching to the reinsurance deal, the organic growth accelerated to 8% this quarter from 7% in the second quarter. I feel that aiming for high single digits in 2023 may be somewhat conservative. Could you discuss the potential outcomes for that high single digit growth? Additionally, what factors are preventing it from being significantly higher, considering the current market conditions?

You are engaging with the most advanced buyers in the market. As Doug mentioned earlier, while he was purchasing reinsurance, he did not concern himself with what individuals were being paid. The core issue is centered on their capital, the returns, and how they will manage demand. There is a notable imbalance between supply and demand, which appears to be significantly increasing. These buyers aim to be responsible players; they want to capitalize on the situation and ensure they achieve favorable returns. Ultimately, these solid returns are expected to attract additional capacity. These buyers are very astute and are willing to pay us higher rates. The earlier question about whether they would continue paying their usual rates indicates they will pay us more, but this is not a straightforward trend. In contrast, when discussing poorer policies or the lower middle market, the price increases are linear. Prices there are up by 10%, and we can assist clients in managing that by adjusting deductibles or reducing umbrella limits. However, on a policy-by-policy basis, we expect to receive that commission. This is not the situation in reinsurance, though.

Yes. I think it's not perfectly symmetrical, but I would estimate it around 8%, maybe between 6% and 10%. So perhaps it's a 2-point range on either side, and likely leans more towards a favorable bull case than a bear case.

Got it. That's helpful. And then maybe just one more. You mentioned that you don't expect a recession. I don't want to be a Debbie Downer here, but if there is one like there was in the early '90s or early 2000s, have you guys given any thoughts on what organic growth would be in that type of scenario?

I think Doug did a great job of reflecting on our history. Our results have been public since 1984, and we perform well in both good and bad times. While recessions are challenging for brokers, as our premiums are driven by sales and payrolls, we will certainly feel any decline in those areas. However, during tough times, clients tend to pay more attention to how we can assist them with our professionalism and specialized capabilities, especially when local brokers are affected.

Yes. I would say, listen, if we get into a recession that you wanted to refer to as you being a downer on, that type of recession, we're still in an inflating rate environment, and we're not seeing a slowdown on that. When it comes to the contraction of exposure units, I'm not seeing trucks just come out of the fleet. They may not be running quite as much, and I know there's a mileage adjustment on it, but I'm not completely convinced that the stuff that we insure will just all of a sudden evaporate next year. They may take different covers on it. They may take some additional deductibles. When you're also looking at an environment, if you get into a recession, that will help us on our employee retention because they will stay with a good company, versus jumping for a new opportunity. So when those 3 or 4 things applied, rate increases, stable workforce, a flight to quality and what people are looking for in terms of their broker, I see us performing very well in that environment. If you want me to pick a number in there, if we have a downer, I'd be hard pressed to see how it would be less than 5% organic growth.

Our next question is from Rob Cox with Goldman Sachs. Please proceed.

I just had one question. I noticed open brokerage accelerated to 20% versus 15% last quarter. And I was just hoping you could talk about what inflected quarter-over-quarter and how you see open brokerage and the E&S market broadly trending from here?

The E&S market is on fire. And I think you're seeing more premiums move there, freedom of rate, freedom of form, clients need to cover everything from small accounts to large accounts. That's why we're seeing so much interest in terms of people investing in that market. The primary markets, quite honestly, are not as flexible as the E&S markets are able to move at the pace that they can move, and they are in a tough market sucking business out of the primaries. Did that answer your question, Rob?

Yes. Very helpful.

Our next question is from Mark Hughes with Truist Securities. Please proceed.

Thank you, good afternoon. Pat, you talked about the potential spillover to non-property lines from the hardness of the reinsurance market. Have you seen that in the past? I just wonder how much influence the cat property business is going to have on some of the other casualty lines, but I hear what you're saying. Just sort of curious to hear more about it.

Let me caution you since I've been a retailer my whole life. Over the past year, I've spent considerable time with our reinsurance team to understand that business better, which I discussed in detail last quarter. In the past, when faced with a capital situation where it becomes necessary to raise prices and incorporate catastrophe loads on other coverage lines, that can be done. However, I can't confirm whether this is exactly what Travelers or Hyper did this year or similar situations from the past like Andrew or Katrina. What I can share is that the team believes it’s highly probable that due to our limited capacity and the imbalance of supply and demand, there is a necessity for increased rates, which may also impact sales in other lines. I apologize for not being more specific; I'm learning alongside you.

No. No, that's interesting. Is there any difference you see between larger accounts, middle market, and smaller accounts in terms of exposure units and endorsements, considering that the economy is still looking good?

No. I keep looking at the Wall Street Journal and, after reading it, I discuss it with our data team who tell me they aren't seeing the same things. I can't point to specific areas like construction being down while retail is booming, or trucking facing issues. We have also examined our marine business. Cargo appears to be stable, and if there is any drop in cargo, cruise ships are thriving. It's a strange time based on our observations. These aren't just anecdotal examples; they are concrete data points that I can access daily. We are witnessing broad geographic, solid, and continuous business growth. I mean, maybe there is something significant happening that we aren't aware of, but we're just not seeing it.

Our next question is from Josh Shanker with Bank of America.

Yes. Some of the people asked about competition for deals. I just want to talk about debt. And when I think about private equity being one of your competitors, is the marketplace different for them if they have to borrow at higher costs? Is it still debt generally cheap in your mind? And so we're not at the market where that's a consideration. How do you think about their role in their appetite in a higher interest rate environment?

Yes, we kind of signaled that early on. Their appetite is still strong right now. But when you're adding an extra 300 basis points of debt cost into the structure, it does change return expectations. And I think that we're really not competing on price when we come to these deals, Josh, we're really competing on capabilities. And we win on every day. If somebody decides our prices aren't dissimilar to what they're offering, that may be a turn higher, but people just have chosen that they don't want to be in an organization with increased capabilities or resources. So this will cause a compression of pricing by the PEs; it will probably come down to where we're comfortable with pain. And I think we should excel in that then because now it isn't about price. It's entirely about capabilities.

Well, dream with me a little here, Josh. I mean, yes, I think what Doug meant is that our price is similar to our competitors. Yes, multiples over the last five years have expanded substantially. Prices are higher for these deals. But money was free. So now you start paying for that money, and I'm not hoping for a recession, and we don't see one, but show a little slowdown in there. And maybe that annuity isn't as strong as it was before. Our lever is about 2.3 times EBITDA. We've got competitors in the market that are happy to be at 9 times. I'm sorry, at some point, the music has got to stop, and all the chairs aren't going to be full.

Our final question is from Ryan Tunis with Autonomous Research. Please proceed.

I first just wanted to say that the $55 million good guy, that's a nice line. I can't remember the last time in broker land, you had a below-the-line item that is somehow went in the right direction. I think some of your competitors might even count that as organic.

Yes. Go ahead, Ryan.

But yes, Doug, take your time spending it. We don't need it to rely on margins in 2023. I have a broader question regarding margins. Organic growth has been quite weak over the last couple of years. However, if it hadn't been as strong, I believe your expense growth wouldn't have been as high as it is. It appears that the organic growth has allowed for an investment cycle. I'm interested to know if this is the correct perspective. Has the robust organic growth enabled you to expedite some needed investments? I'm also curious about the capabilities you have been able to enhance in the organization over the past couple of years that might not have been possible in an environment with over 4% organic growth.

Yes. I think you've got your notes right in it. And I think if you go back and you listen to our Investor Relations Days, these earnings calls, we get an hour to talk to you, but during our Investor Relations Days, you hear our 5 or 6 division leaders talk about all the investments you listen to the first 5 minutes or 6 minutes of their prepared remarks. They're talking about all the value-added features and client-centric enhancements that we're doing in our business. And we're spending a lot of money on that. We've talked about Gallagher Drive. We've talked about SmartMarket, we've talked about Gallagher Submit. We've talked about our niche resources. If you look at our content that's out there, all of that is investment and we're adding to it every year. So we are running a business right now that has a substantial amount of investment in it to make us better. I think it's showing up in our organic, to be honest. I think the reason why we perform well on organic is we continue to make investments into our production and our sales and niche capabilities in our service. 15 years ago, we didn't know how long it took us to turn around a set. Right now, we turn around 99.9% of them within one hour of request because of the investments that we've made to better the service. Those types of things are just in our blood at this point. And it's in our operating side, yet, we're still posting terrific margins on it.

So to add to that, I would say take a look at our internship; we're very proud of the fact that this summer, we had 500 young people look at our business. And these are paid interns. These aren't interns that come to work for free, and that's a U.S.-based number. If we take the people outside the U.S., it's probably closer to 600. I don't know another organization investing in the future of their people like that in our business or, frankly, in another business. So I'm very proud of that. Thanks, Ryan, and thank you, everybody, for joining us. We really appreciate this evening. We had an excellent third quarter. We're well on our way to delivering a fantastic year of financial performance. I need to thank more than 42,000 colleagues around the globe for their hard work and dedication to our clients. We look forward to speaking with you again in person in December at our Investment Day in New York. Thanks again, everybody. Have a great evening.

Thank you. This does conclude today's conference. You may disconnect your lines at this time, and thank you for your participation.