Marsh & Mclennan Companies, Inc. (MRSH) Q2 2020 Earnings Call Transcript

Welcome to the Marsh & McLennan Companies Conference Call. Today's call is being recorded. Second quarter 2020 financial results and supplemental information were issued earlier this morning. They are available on the company's website at www.mmc.com. Please note that remarks made today may include forward-looking statements, including certain expectations related to COVID-19 and other matters. Forward-looking statements are subject to risks and uncertainties and a variety of factors may cause actual results to differ materially from those contemplated by such statements. For a more detailed discussion of those factors, please refer to our Earnings Release for this quarter and to our most recent SEC filings, including our most recent Form 10-K, all of which are available on the MMC website. During the call today, we may also discuss certain non-GAAP financial measures. For a reconciliation of these measures to the most closely comparable GAAP measures, please refer to the schedule in today's earnings release. I'll now turn this over to Dan Glaser, President and CEO of Marsh & McLennan Companies.

Thank you, operator. Good morning and thank you for joining us to discuss our second quarter results reported earlier today. I'm Dan Glaser, President and CEO of Marsh & McLennan. Joining me on the call today is Mark McGivney, our CFO and the CEOs of our businesses, John Doyle of Marsh; Peter Hearn of Guy Carpenter; Martine Ferland of Mercer; and Scott McDonald of Oliver Wyman. Also with us this morning is Sarah DeWitt, Head of Investor Relations. I am pleased with our second quarter results which demonstrate Marsh & McLennan's strength and resiliency as we navigate the current global health crisis and economic recession. The world is experiencing two dramatic and uncertain, unforeseen events at the same time. First, the global pandemic and second, the global economic crisis driven by an unprecedented simultaneous lockdown in almost every part of the world. In addition, society reached the breaking point on racial inequalities which have persisted for far too long. In the face of this extraordinary combination of events, Marsh & McLennan colleagues rose to the occasion and continued to serve our clients with excellence and distinction. I want to thank our 76,000 colleagues globally and our leadership team for their dedication and outstanding execution in these challenging times. While the impact to our business from the economic downturn and health crisis so far has been manageable, we live in troubled times and the conditions in many parts of the world remain extremely difficult and uncertain. The world may have avoided the worst case health and economic scenarios, but this downturn may be longer than many initially expected, with waves of virus resurgence in certain geographies. While in most parts of the world we are through the initial phase of peak fear and uncertainty around health outcomes, we are now in a period of dealing with the economic fallout and living with the continuing health implications. These economic and health uncertainties could last a year or longer, challenging companies well into 2021. Regardless of the shape of the recovery, we have proven our business resilience, we have strong control over our expense base and the need for our advice and solutions is now more critical than ever. Our management team has made a number of tough calls and I believe the right ones as we navigated through these first months of the crisis. We continue to take actions that balance the short-term with a focus on positioning for the long-term. These include maintaining jobs in the thick of the pandemic, as well as proceeding with our annual salary increases, avoiding a hiring freeze and continuing to make strategic hires in the face of industry dislocation, and moving forward with several acquisitions so far this year in M&A as we continue to pursue inorganic growth. We've cut back significantly on discretionary expenses and have set a high bar for what is deemed essential spending, which has driven costs down while we preserve jobs and salaries. We also enhanced our liquidity by establishing a new credit facility and issuing additional long-term debt. Looking beyond the current crisis, I believe we will emerge as a stronger firm. Our organization has never been flatter, faster and better connected than it is today. I want to pause and comment on racial inequality. The racial inequality in our society is a pervasive issue that recently came to a breaking point with the tragic death of George Floyd. Systemic racism has caused inequities and injustices in healthcare, education, careers, wealth creation and freedom. The recent events have been shocking to me and all too familiar to others. Our executive committee has been fully engaged, listening to our Black colleagues and others, speaking up alongside them and implementing concrete actions to make a difference. We are determined to seize this moment to create a more diverse and inclusive company. In these dynamic times, we are pressing to develop new solutions to address rising and evolving risk globally. Our businesses are collaborating more than ever to bring the power of our firm to clients. For example, Guy Carpenter is leading the industry to create a new market for pandemic insurance. We initiated a dialogue in Congress in late March to create a public-private partnership for pandemic risk, which would facilitate future economic recovery and enhance resiliency among companies going forward. We are also developing public-private pandemic solutions in multiple countries. We developed a leading disease progression model, Pandemic Navigator, which is being used by governments and companies to predict virus spread and guide decisions. Both Oliver Wyman and Mercer are advising clients across a number of industries utilizing Pandemic Navigator to make return-to-office plans, understand future demand recovery patterns, manage supply chains, model credit losses and assess early warning signals. Mercer and Marsh's consulting have also joined forces to work with employers on their new normal strategies, helping clients use this time as an opportunity to adapt, reinvent and become more resilient. In summary, I am proud of how our company continues to innovate while responding to the immediate pressures caused by the crisis. Let me spend a moment on current P&C insurance market conditions. P&C insurance pricing continues to accelerate. The Marsh Global Insurance Market Index increased 19% year-over-year versus 14% in the first quarter and 11% in the fourth quarter of 2019. Global property insurance was up 19% and global financial and professional lines were up 37%, while global casualty rates are up 7% on average. Keep in mind our index uses a large account business where we typically earn fees. However, U.S. small and middle market insurance pricing is up meaningfully as well, although not to the same magnitude as large complex accounts. Overall, underwriters continue to push for higher levels of rate increases as a result of social inflation pressures, persistently low yields and a number of large underwriting losses including COVID-19. This is before the peak of the hurricane season. While capital remains adequate, the risk appetite of insurers is reduced as they are increasingly cautious in an uncertain environment. Turning to reinsurance, the mid-year renewals which are largely focused on southeast U.S. wind exposure saw meaningful rate increases. Florida peak zone property catastrophe reinsurance programs were up 25% to 35%. These are some of the highest rate increases seen since 2012. Non-Florida mid-year renewals were typically up 15%. Reinsurers are being cautious regarding the amount of capital they are currently willing to expose in an environment of great uncertainty. Overall, global P&C insurance and reinsurance markets remain challenging with accelerating price increases and narrowing terms and conditions. It is in times like these where our experienced advice and solutions are even more critical. Now, let me turn to our second quarter financial performance. We delivered excellent adjusted EPS growth of 12%, despite the global impact of COVID-19. Our strong EPS growth in the quarter reflects great execution on the part of our colleagues, the immediate benefit of expense management actions and the delayed impact of the COVID-19 crisis on our revenue. Total revenue was $4.2 billion, down 4% or down 2% on an underlying basis. Underlying revenue grew 2% in our RIS and declined 6% in consulting. In risk and insurance services, second quarter revenue was $2.6 billion, an increase of 1%. Underlying revenue growth was up 2% in the quarter reflecting strong 9% growth at Guy Carpenter and 1% at Marsh; excluding a reduction in revenue we booked in the quarter related to estimated exposure declines, underlying revenue in both RIS and Marsh was up 3% in the quarter, which is a strong result in the face of the economic downturn. RIS adjusted operating income increased 19% to $752 million and the adjusted operating margin expanded 430 basis points versus a year ago. In consulting, second quarter revenue was $1.6 billion, underlying revenue declined by 6% for the quarter. Oliver Wyman and Mercer's career business saw the greatest impact from the lockdown as expected. Consulting adjusted operating income declined by 13% and the adjusted margin declined by 70 basis points versus a year ago. Overall adjusted operating income increased 10% versus a year ago to $984 million. Our adjusted operating margin increased 270 basis points to 25.5%. Adjusted earnings per share increased 12% versus a year ago to $1.32 reflecting expense tightening and strong execution. Even though COVID-19 will impact our results for the remainder of the year, our strong second quarter performance is evidence that our business is resilient and that we are able to manage through challenging environments. While our year-to-date results are strong, the economic outlook is weak and uncertainty is still very high. For the full year 2020, we continue to expect a modest decline in underlying revenue. However, given our strong second quarter performance, we now expect to generate modest growth in adjusted EPS for the full year, despite the decline in underlying revenue. With that, let me turn it over to Mark for a more detailed review of our results.

Thank you, Dan, and good morning. We're pleased with our second quarter results, despite a modest decline in revenues driven by the current crisis; we delivered strong earnings and continue to enhance our balance sheet and liquidity position. Overall, revenue declined 4% in the second quarter to $4.2 billion or down 2% on an underlying basis. Operating income in the quarter was $885 million, an increase of 30% over last year. Adjusted operating income increased 10% to $984 million and our adjusted margin increased 270 basis points to 25.5%. GAAP EPS was $1.12 in the quarter and adjusted EPS increased 12% to $1.32. For the first six months of 2020, underlying revenue growth was 2%, our adjusted operating income grew 13% to $2.2 billion, our adjusted margin increased 190 basis points and our adjusted EPS increased 10% to $2.96. Before I go deeper into our results, I want to discuss a $36 million reduction to previously recorded revenue we booked in the quarter. This adjustment reflects the estimated impact of the economic downturn on exposure units. It primarily impacted Marsh, but there was also a reduction in Mercer in health. A significant portion of brokerage revenue is recognized at policy inception including in some cases where ultimate revenue is uncertain. In these cases, premiums and commissions are recorded based on estimates of ultimate exposure. These estimates are typically not updated until the end of the policy term as variability in most cases is modest. However, due to the impact of COVID-19 and the economic downturn, exposures in many lines of business will likely be lower than originally anticipated, requiring that we update our estimates sooner. It is important to note that this charge is included in underlying growth and adjusted earnings. Returning to results in risk and insurance services, second quarter revenue was $2.6 billion with underlying growth of 2% or 3% excluding the revenue adjustment. A decline in fiduciary interest income was also a 70 basis point drag on underlying revenue. Operating income increased 34% to $696 million. Adjusted operating income increased 19% to $762 million and the adjusted margin expanded 430 basis points to 32.1%. For the first six months of the year revenue was $5.5 billion with underlying growth of 4%. Adjusted operating income for the first half of the year increased 20% to $1.7 billion, with a margin of 33.4% up 280 basis points from the same period a year ago. In Marsh, revenue in the quarter was $2.2 billion, an increase of 1% on an underlying basis, or 3% excluding the impact of the revenue adjustment, a strong result in the current environment. In U.S. and Canada, underlying growth was 3% in the quarter. In the international division, underlying growth was flat with EMEA down 3%, Asia Pacific up 4% and Latin America up 4%. For the first six months of the year Marsh's revenue was $4.2 billion with underlying growth of 3%. U.S. and Canada underlying growth was 4% and international was up 2%. Guy Carpenter had another great quarter; revenue was $433 million reflecting underlying growth of 9%. Growth was driven by solid retention, strong demand driving new business and a tailwind from the current pricing environment. For the first six months of the year, Guy Carpenter generated $1.3 billion of revenue and 8% underlying growth. In the consulting segment, underlying revenue declined 6% in the quarter reflecting the impact of the current crisis, operating income decreased 8% to $255 million. Adjusted operating income decreased 13% to $265 million and the adjusted margin decreased 78 basis points to 17.3%. Consulting generated revenue of $3.4 billion for the first six months of 2020 representing an underlying decline of 1%. Adjusted operating income for the first half of the year was down 7% to $554 million. Mercer's revenue was $1.1 billion in the quarter down 3% on an underlying basis. Wealth underlying revenue declined 2% reflecting modest growth in defined benefits offset by a decline in investment management solutions. Our assets under management were approximately $306 billion at the end of the second quarter, up 8% year-over-year. Health increased 1% on an underlying basis in the quarter or 2%, excluding the impact of the revenue adjustments. In career, underlying revenue declined 16%; careers is more discretionary project business which drove the revenue decline. The first six months of the year revenue at Mercer was $2.4 billion with 1% underlying growth. Oliver Wyman's revenue was $467 million in the quarter, a decline of 13% on an underlying basis, which was better than we expected coming into the quarter. For the first six months of the year revenue at Oliver Wyman was $978 million, a decline of 7% on an underlying basis. Adjusted corporate expense was $43 million in the quarter. Based on our current outlook, we expect approximately $96 million in total for the second half of the year. On investment income, on an adjusted basis, we had an investment loss of $7 million in the quarter. On a GAAP basis, we reported an investment loss of $31 million primarily driven by the sale of a portion of our equity ownership in Alexander Forbes. Foreign exchange was neutral to EPS in the quarter. Assuming exchange rates remain at current levels, we would expect FX to have a minimal impact on EPS for the remainder of the year. Our adjusted effective tax rate in the second quarter was 25%, compared with 25.9% in the second quarter last year. Excluding discrete items, our effective adjusted tax rate was approximately 25.5%. Through the first half of the year, our adjusted effective tax rate was 24% compared with 24.1% last year. Based on the current environment and outlook, we continue to expect a tax rate between 25% and 26% for 2020, excluding discrete items. The most challenging parts of the JLT integration are now well behind us as demonstrated by our strong first half results. We are on plan or ahead of schedule on all of our key milestones, including cost savings and restructuring actions. We incurred $57 million of JLT integration and restructuring costs in the second quarter, bringing the total to-date to $472 million. In total, we still expect to incur approximately $625 million of cash costs and $75 million of non-cash costs to generate at least $350 million of savings. We expect the majority of these costs will be incurred in 2020, with the savings achieved by the end of 2020. I want to take a minute and provide an update to our outlook for this year. Our revised view contemplates recessionary conditions persisting through at least the remainder of 2020. But it goes without saying that uncertainty remains very high and conditions could turn out materially different than our assumptions, which would affect our projections. For the full year 2020, as Dan mentioned, we now expect to generate modest EPS growth, despite our outlook for a modest decline in underlying revenue. We currently expect adjusted EPS to decline in the back half of the year reflecting the full impact of the pandemic on revenue as well as some rebound in spending in certain areas. At Marsh, we still see the potential for modest underlying revenue growth for the year although the back half will be challenging. For the full year 2020, we continue to expect mid-single digit growth at Guy Carpenter. Underlying revenue growth for the second half of the year will likely be more muted, but these are seasonally small quarters for Guy Carpenter. Also keep in mind that Guy Carpenter faces a difficult year-over-year comparison in the third quarter, which as we mentioned last year, benefited from a $17 million true-up of a multi-year contract. We continue to expect Mercer's underlying revenue will decline for the remainder of the year and be down modestly for the full year. Finally, revenue weakness in Oliver Wyman could persist through the back half of the year. Turning to the balance sheet, we ended the quarter with $1.7 billion of cash, a sequential reduction in outstanding debt and the entirety of our combined $2.8 billion of credit facilities available. Since the onset of the pandemic, we have taken prudent steps to enhance our financial resources and flexibility. In April, we secured a new $1 billion line of credit and in May issued $750 million of 10-year senior notes at a coupon of 2.25%. We remain committed to deleveraging and expect to reduce debt this year, although the ultimate amount will depend on our cash generation in the current environment. Total debt at the end of the second quarter was $13.2 billion down from $13.6 billion at the end of the first quarter, representing a reduction of $439 million. Our next scheduled debt maturity is in December 2020, when $700 million of senior notes mature. We also have a $500 million term loan due in January 2021. Interest expense in the second quarter was $132 million. Based on our current forecast, we expect approximately $131 million of interest expense in the third quarter. Although uncertainty in our outlook remains high, we feel comfortable that we have the resources and flexibility to manage through the crisis from a liquidity perspective. In line with our commentary on the first quarter call, we did not repurchase any shares in the second quarter. Given the ongoing uncertainty of the current environment, we do not plan to repurchase shares for the remainder of 2020. Earlier this month, we announced an increase to our quarterly dividend to $0.465 per share. This increase represents the 11th consecutive year of dividend increases at Marsh & McLennan. Uses of cash in the second quarter totaled $684 million and included $450 million for acquisitions and $234 million for dividends. For the first six months, uses of cash totaled $1.2 billion and included $694 million for acquisitions and $466 million for dividends. Overall, we are pleased with our performance in the first half of 2020. We've shown resiliency, the level of commitment and execution throughout the organization has been outstanding. And while the crisis is far from over, we believe we are positioned to continue to navigate it well. With that, I'm happy to turn it back to Dan.

Thanks, Mark. Operator, we are ready to begin the Q&A.

Certainly. And our first question comes from the line of Phil Stefano with Deutsche Bank.

Dan, in your opening remarks, you talked about the immediate benefit of expense action with the delayed impact on revenue from COVID. And it feels like in the second quarter results, it was most clearly seen on the margin in brokerage. Could you dig a little more into that and maybe help us understand what drove the expansion in the second quarter and then as we think about the next couple quarters, or even year or two, can the hard decisions be dialed back? How do you think about managing the expenses versus maybe what your revenue expectations are at this point?

Sure, sure. So it's a good question. I'd start by saying let's look at the overall macro environment a bit. I mean, it may not feel like it, but so far the world has avoided the worst case health and economic scenarios. I mean, we're still in the early days, the economic downturn may last longer, since there will likely be waves of virus resurgence. So, when we were doing all of our scenario planning and stress testing in the very early stages of the health elements of the crisis, you could imagine a lot of very forward scenarios, right? And it's certainly not a rosy picture from here. But some of the worst case scenarios appear to have been avoided. And so we pulled back our expenses very quickly. We're a company that believes in distributed leadership; we put a lot of authority out in the field with our leaders in countries and in specialty divisions, et cetera. But there are times where you need to pull that authority back and I have to say the executive committee and I moved very quickly to essentially control the expense base of the company, set a very high bar for what essential expenses were, and then pulled back heavily on other items. Not only the things that naturally fall away like T&E, but over time contractors slowed down hiring—not a hiring freeze, but slowing down the pace of our hiring and focusing it on revenue-producing types of positions. I'm very proud of the notion that the team decided not only to preserve jobs in the thick of the pandemic, but also we did not cut salaries. Now you may notice that our overall compensation number is down a bit. And that's because the broad category of compensation also includes some things like overtime and sales plans and some contractors and some of our variable plans, et cetera. I feel pretty good about how quickly we were able to dial back expenses. And there is a bit of a lag in terms of how the revenue headwind actually turns off. Clearly, we had some good pipeline; you looked at our first quarter results, 5% underlying growth overall. So we had nice momentum and some of that momentum carried into the early parts of the second quarter and that goes away. And so we'll have a little bit more revenue pressure. Also because the worst case scenarios did not occur on either health or economy, we will ease up a bit on some of the restraints, but we will become a little bit more open to other levels of investment that we could make. And so when we look at the second half of the year, there's still a great deal of uncertainty. We think that delivering reasonable financial results in the context of the crisis, while continuing to invest in future growth is the right position for us to be in.

I understand. My follow up would be based on the actions you've seen and how the world has unfolded—at least as far as I appreciate, it's early days. Last quarter, we were talking about maybe the sustainability of some of these things. Do you have any thoughts you can put around the actions you took that were hard at first, but maybe feel like the benefit could be something that, once COVID is comfortably in the rear view, could persist?

Yes. I mean, there are certainly certain things. We've been able to demonstrate that we can do placement activity and manage client deliverables on a remote basis now. It's not ideal in all circumstances, but it is pretty effective in many circumstances. So I'm not sure we'll go running back to hopping on an airplane to go to Singapore for a $100,000 opportunity. Maybe we will be a little bit more cautious about T&E type of spending; some of it will come back, it may not return to previous levels for a long time, and maybe never. Flexible work arrangements are another item; we won't see a benefit to our real estate footprint or our real estate costs for a while because of social distancing requirements. But over time, could we envision more of a hybrid type of operation where colleagues come to the office and also work from home sometimes during the week and so we can move to much more of an agile workplace in many locations? Yes, that's likely. I also think that there'll be more digital. It's important to know while we slowed down our CapEx a little bit in the second quarter, actually through six months CapEx is higher than it was last year because we're continuing to invest in our business. And I think those investments are things that would persist. I also can't underestimate how this crisis has brought the firm together. Crisis can bring out the worst in you or the best in you. Marsh & McLennan has risen and we have never been more collaborative and connected than we are today.

And our next question comes from the line of Mike Zaremski with Credit Suisse.

First question, maybe focusing more on the consulting segment, I think investors are asking the most questions about. Dan, you said you guys have fortunately, I think maybe we all fortunately have avoided the worst case scenarios so far. Does that hold true for kind of what you all were thinking might happen to organic revenues in the overall consulting segment? Clearly they were down but maybe not down as much as at least the consensus expected and maybe you can kind of give us some updates on what you're seeing and hearing in the consulting segments relative to your thoughts last quarter?

Sure. I mean, we were pleased with consulting's overall performance on organic growth. We clearly expected a decline in revenue and pressure, particularly in the project-related businesses. Oliver Wyman is almost purely a project business and some parts of Mercer, like the career business, are very project oriented and projects tend to be discretionary in the eyes of clients. So I think overall a minus 6% is a good result in the circumstances within our consulting business. Both of our main businesses in consulting—Mercer and Oliver Wyman—have done a nice job protecting shareholders by really focusing on discretionary expenses within our own shops and pulling that back. Every crisis is different; in a lot of ways this crisis is more concerning than the global financial crisis. But when you look at the global financial crisis, Mercer was down 4% in 2009; Oliver Wyman was actually down a bit in 2008 and more significantly in 2009 and had six quarters in a row of contraction. We're a resilient firm; we can operate on that basis. The bounce back in 2010 for Mercer and Oliver Wyman was quite good. We would expect something similar. If there is a lack of discretionary projects at companies, it doesn't mean that they don't need those projects and that they don't want to focus on their future growth and ways to be more efficient; we're a go-to firm for them across people issues and strategy issues. We feel good about the consulting business. It could have been worse. And when we looked at it, I think we're in decent shape. I don't know what the second half brings. At the end, we've indicated that we think Mercer will be modestly down for the year. They had a very nice first quarter, but overall for the year, we expect them to be modestly down. Oliver Wyman, as I said many times before, has a little bit more volatility to quarterly results than any of our other businesses. But we're well positioned and we feel pretty good about where we ended up on the bottom line in both of those areas of the company.

Okay, understood. That's helpful. Lastly, could you talk about FX and whether we should be thinking about it having an impact going forward?

Yes. The FX was not much of a story for EPS in the second quarter. As we look at the back half of the year, we don't expect much impact if rates stay where they are—much impact for the balance of the year to EPS.

And our next question comes from the line of Jimmy Bhullar with JPMorgan.

I had a question on reinsurance, that's Guy Carpenter. I think you imply the slowdown in growth in the second half in your comments. How much of that is just comps getting more difficult versus maybe exposures declining? And what's the interplay with pricing getting better, if applicable? Are you being overly conservative or are you actually facing some headwinds to growth given comps and exposures?

Sure. I mean, at the end we're not trying to be overly conservative, but we also always want to be realistic and transparent with our investor base. A lot of this is Carpenter: the third and fourth quarters are much smaller and therefore the movement of a hard account or two could swing things in different directions. As we pointed out in our remarks, there was a one-off last year of $17 million that is a tough comparison to overcome. Peter, do you want to talk a little about where you see exposure, rates and whether this view is overly conservative or not?

Thank you, Dan. Jimmy, I would just reiterate what Dan says: Q3 and Q4 are historically small quarters and they're subject to volatility with the movement of business from one quarter to the next or timing. From a new business standpoint, our new business growth has been strong for the past three years and we anticipate the same thing in Q3 and Q4. But again, we have tough comparables from Q3 and Q4 of last year, but we've seen no diminution in buying habits. We've done several hundred stress tests on client balance sheets to anticipate what the rest of the year could look like from catastrophic events or an adverse situation with regard to COVID-19. So we're winning new mandates on a regular basis. I feel good about where we are for the year and as both Mark and Dan said, these are small, volatile quarters and subject to change, but there's been no overarching issue that we've seen with exposure bases in revenue.

Okay. And there's been some concern among investors about E&O exposure or negligence-related lawsuits against brokers. Do you have anything that you can share about what your exposure might be and any sort of quantification of what your retention would be if you were to see something, because I'm assuming you've got insurance on that as well?

We haven't publicly disclosed the details of our E&O insurance program, so I'm not going to do it here. Our goal and principal focus as a broker is to advocate forcefully for policyholders. We do that by obtaining coverage and in the event they have a claim, we do our best to assist with recoveries and we've got very strong risk management practices, high levels of professional standards and E&O training for thousands of colleagues. At the end, it's not something that we spend a lot of time worrying about. Obviously, there are some coverage disputes occurring between clients who may believe they have some coverage in their policies related to COVID. Some of those clients may end up suing, but that really hasn't occurred at scale yet. I'm not overly concerned with it. I think we have good systems and controls. Frankly, it would be impossible today—and this is why public-private partnerships are being discussed at broad scale—because pandemic insurance is not insurable at broad scale: it goes into the trillions of dollars of potential exposure. So it's not like every client could have gotten full-scale broad pandemic protection because there is not a market for it; it had to be targeted, limited in certain industries and very expensive.

And our next question comes from the line of Yaron Kinar with Goldman Sachs.

First question on free cash flows: they seemed to be very strong this quarter. I was curious what drove that? I think one of your competitors has talked about the CARES Act pushing tax payments back a little bit, but any color you can offer on that. And how should we think about cash flows for the rest of the year?

Yes. Cash generation in the quarter was strong as you said; we're obviously pleased with that. A number of factors contributed, the most important of which was just the strong earnings growth. That was a big factor in driving free cash flow. There are a number of other factors: less spending on JLT related items, and if you compare it with last year we got nicked a little bit more by FX than we did this year. In any given quarter there can be fluctuation in some balance sheet accounts and working capital that can affect cash flows and we had good results on that front. So quarter-to-date our cash generation was strong. For the remainder of the year, it really is going to be about how our earnings trend.

Okay. And then with regards to exposure or the impact of exposure declines, I just want to make sure I was thinking about it correctly. So in consulting fees, the impact tends to be more immediate. In RIS, it takes—there's a bit more of a lag. Is that a fair summation?

Most of the exposure adjustments were actually in Marsh. I'll hand it off to John and he can describe a little bit the types of areas where you would see exposure declines. It's more mild in consulting and generally around the health business if you're looking at employment as an example as a proxy for the lives covered under plans: if employment is down then the anticipated amount of premium would be down. John, you want to talk about exposure units within the large account world because that's where most of the adjustment took place?

Sure. As Mark talked about earlier on the call, a number of different products are adjustable and exposed to unit-driven measures. Some industry groups—marine, aviation, energy, for example—expect to make an adjustment to accrue for exposure units over the course of the policy period. Product lines that are more impacted include commercial auto, which has been calm, and transaction risk and those kinds of things. Historically our growth is correlated with economic growth; when construction flows down and other economic flows down there's a bit of a lag effect. That impacts our ability to write new business, but we also attempted to make an adjustment for prior-period adjustable policies.

Our next question comes from the line of Elyse Greenspan with Wells Fargo.

My first question is on the full year EPS side. You guys took that to modest growth, whereas before it was kind of maybe slightly negative to just about positive depending on what happened to organic for the full year. But if I think about that you guys printed just under 10% EPS growth in the first half of the year, which implies about a mid-single digit decline in the back half, which probably would have been where we would have been in your prior view just for the second half of the year. So I guess I'm trying to package all of the comments together: it does seem like the outlook is better although still cautious for the second half of the year. So I think that would come together in that EPS guide, or is it something to do with timing of JLT expenses that were more pronounced in the second quarter? Just trying to understand why that EPS outlook for the second half of the year isn't perhaps stronger than what you thought it was three months ago?

Sure. It's a fair question. Leading the business and as our business leaders within the company do every day is as much art as it is science. We can make the margin go up at any point in time by drawing back expenses, by being very tough on rehiring and by just pulling back a great deal. The art is figuring out what we should deliver today while we're investing for the future and positioning the company to emerge stronger. From that standpoint, yes, our second quarter performance was really terrific. But the reality is, we pulled the expense levers hard. We felt the immediate benefit of that lower spending and the revenue came in a bit higher since there's a lag in the full revenue headwind because activity from pre-COVID still benefited us in the second quarter. So you have to think the revenue headwind will be a bit stiffer in the second half of the year. It doesn't mean we're going to fall off a cliff. But it does mean that some of the benefits we had in the second quarter from momentum and expense tightening will moderate as we release some of those temporary pulls and as revenue pressure becomes more pronounced. Our focus is on delivering a reasonable result to shareholders in a year in which we expect modest revenue decline overall. You can see RIS will have a better margin outlook than consulting and we're not going to artificially do things in consulting to drive margin when the top line is under that kind of pressure.

Thanks. And then my second question is specific to Marsh. I know you pointed out last quarter that there would be a lag and that the third quarter would be worse than the second quarter. It sounds like from your comments that still holds. My question is more thinking further out than that: if there isn't a spike in cases and COVID is maintained at current levels, do you think within your business the fourth quarter should represent a bounce from the third quarter? Specifically to Marsh—how do you see that?

Okay. I'll hand off to John in a second. Obviously, we are thrilled with the positioning of Marsh. When we look at the future for Marsh, we couldn't be in a better position in terms of our risk advisory businesses, our placement capabilities and our scale. I couldn't be happier with the combination with JLT. Just as a reminder, that's all about growth—growth in capability, talent, scale, revenues and earnings—and within one year we came together as a single formidable team. The integration has gone well and we've been ahead of schedule on cost savings. Overall, well planned, well led, well executed. John, you want to talk a little bit about how you see Marsh in the back half of the year and as you look out to 2021 and beyond?

Sure, Dan. As we talked about, the second half is likely to be a bit more challenging given the economic consequences of the pandemic. I don't want to get into third quarter versus fourth quarter; obviously things are quite fluid with the pandemic and it's hard to predict the economic consequences. We've talked many times about the uncertain environment. Having said that, as Dan pointed out, I think we're extraordinarily well positioned. Our team is highly focused on our clients and getting the best outcome. It is a very, very difficult environment, but they've been there for one another and for our clients. I couldn't be more pleased with how the team has come together. There are some silver linings: while overall a human tragedy, what we've all been living through has accelerated cultural integration and collaboration. So I'm confident in our ability to perform well on a relative basis and when things improve, we'll continue to see improved performance in the business.

Our next question comes from the line of Meyer Shields with KBW.

One quick accounting question to start. Mark pointed out in the press release a $36 million revenue adjustment for exposure units. Does that all fall to the bottom line? Are there offsetting reductions to expenses?

It all falls to the bottom line, Meyer. I mean, it impacts our reported revenue and therefore the bottom-line. There could be an indirect effect on bonus formulas to the extent earnings grow or shrink for the year, but that specific adjustment is directed to revenue and the bottom-line.

Okay. Broader question for Dan. Back in prior hard markets we’ve seen rate increases that were very powerful. Marsh was very fee-focused, but the general takeaway was that you were able to negotiate higher fees because of incremental work that more or less matched revenue increases that would have come on a commission basis. Given the recessionary conditions, how does that play out in the current environment?

Marsh over a long period of time has become a much larger middle market firm, particularly in the U.S. and the U.K. With that, there's a bit more element of commission versus fee. I think previously we were roughly two-thirds commission and one-third fee in some parts. It's not easy out there; whether it's negotiating with a client or negotiating with an insurance company, each account is a negotiation about the level of work and the proper level of remuneration for the intermediary. So it's not a direct line that revenue or premium up immediately translates to fee revenue up. It's an account-by-account discussion and negotiation and trying to determine the value that we provide in the market—both as an advisor to clients and sometimes as a distributor for insurance companies.

Our next question comes from the line of Paul Newsome with Piper Sandler.

Just one question. We're getting some questions from investors about the enormous amount of change we're having with your competitors—Aon and Willis, other combinations, and it seems like there's a private equity firm every day popping up as a competitor. What's happening with the hunt for talent—is it gotten easier or harder given all the changes we've seen in the market?

Yes. It's a really good point because we're in the talent business—that's what our business is. Do we have smarter, more creative, harder working, more dedicated-to-client-service colleagues than our competitors? Competition is good. Competition refreshes, it keeps you on your front foot and keeps you active and innovative. Clearly there's some private equity activity in the market largely on the middle market part of the business. You asked about Aon and Willis; I won't comment in depth on competitors' transactions. We do think there will be lots of opportunities. I like our strategic positioning. I wouldn't trade places with any of our competitors. On a personal note, as someone who's had almost 40 years in this business, I don't think the Aon-Willis combination is good for clients or for the market. But I do think it's good for Marsh & McLennan—if the big three becomes the big two, that could be a benefit to us.

Our next question comes from the line of Michael Phillips with Morgan Stanley.

I just have one as well. Dan, I'd love to hear your thoughts on how the pandemic has influenced valuations in the M&A space for brokers.

The M&A space for brokers has seen most activity in the upper middle market and below. There's a lot of private equity in that space and leverage levels are different for them. The ability to borrow at low interest rates means activity will remain. I don't think you'll see much change in multiples right now—multiples are high, probably too high in some areas in our opinion. With all the uncertainty out there, you probably see more earn-out components than you would have a year or two ago. You also have to be focused on what the EBITDA of the acquired business actually is and what it will do in your hands. We're still active. We generally don't compete head-to-head with PE in many of these deals because we're targeting different parts of the market, particularly with Marsh & McLennan Agency in the U.S., but we're committed to this part of the market. We think it's a great business and we will continue to be a buyer.

Our next question comes from the line of Josh Shanker with Bank of America.

Maybe Mark could give us a little detail on numbers. But can we talk a little about T&E? You said you'll be starting to do T&E again at least in some form. Can you put numbers behind this? How much was suppressed in the second quarter? And how much do you expect to resume?

We never give absolute numbers on T&E because once you do it, it's forever in guidance. T&E is not an immaterial number, but it's also not huge like double-digit percent of SG&A. In the second quarter, T&E was down dramatically—as in the mid-90% range—nobody was traveling or entertaining. So that's a huge downdraft. I may have misspoken earlier: I don't expect T&E to bounce back in any significant way in the second half of the year. So there won't be much travel or entertainment for the balance of the year. Over time, even looking into 2021 and 2022, I'm not sure T&E ever returns to pre-COVID levels. I don't think people will travel as much because it's often not necessary. So I do think over the long-term T&E may be one of those areas where we have a lasting expense benefit: T&E will obviously go up from near zero, but it won't go back to the level it had been pre-COVID.

So with that in mind, when I think about expenses in the back half of the year, I expect them still to be materially down from the second half of '19. But modest EPS increase for the full year sort of implies a material downturn in EPS in the back half, with expenses down. I know you're not giving explicit guidance, but it seems like expenses still persisting in the back half of the year—I'm not sure why we should expect a year-over-year decline in earnings even if revenues fall off a bit.

At the end, we're a revenue-based company. You looked at our second quarter where RIS margins were up 430 basis points with modest revenue changes; that obviously is not sustainable because we basically shut down large swathes of expenses given the great uncertainty about the top line. We now have more clarity around the top line, and we do believe the top line across the firm will feel a bit more pressure than in the second quarter. It doesn't mean we're going to fall off a cliff. But some of the benefits we had in the second quarter from rapid expense tightening and pre-COVID revenue momentum will moderate. We could cut expenses significantly from here and deliver margin improvement in the back half even if the top line is negative, but that would not be good for the company in the mid- to long-term. So we're not going to do that. We're going to continue to invest in the organization: the market dislocation gives us opportunities to recruit strategically, to accelerate digitization and technology modernization. All of that work continues.

I would now like to turn the call back over to Dan Glaser, President and CEO of Marsh & McLennan Companies for any closing remarks.

Thank you, operator. And thank you to all of you joining us on the call this morning. In closing, I want to thank our 76,000 colleagues for their hard work and dedication as well as their support of each other, clients and local communities. I am impressed and humbled by their response during these challenging times. I also want to thank our clients for their continued support. Thank you all very much and I look forward to speaking with you next quarter.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating and you may now disconnect.