Brown & Brown 1Q17 Earnings Call Notes

Powell Brown – President and Chief Executive Officer

Optimism has slowed, companies are more skeptical

“I am now on Slide 5. The first quarter was an interesting one, as we entered it with a lot of optimism about what the new administration might do to further improve the economy. As the quarter continued, some of this optimism has slowed and now companies are more cautious or skeptical about what shape some of the programs, including tax reform, infrastructure projects and ACA reform will take and when they might actually take effect, if at all. With that said, we did see the economy continue to expand across most communities in the past quarter. There are number of geographies that are doing well as evidenced by construction starts, while communities that are tied to oil and gas have leveled out”

Biggest topic has been ACA reform

“One of the biggest – or one of the bigger topics during the quarter was what the impacts would be if there was any reform of the Affordable Care Act. This was in addition to the continual topic of cost containment for healthcare plans. With the material increases to premium rates for most state exchanges or decreases in the number of providers or both, we did see customers continue to manage plan design. Creativity around plan options is at the forefront. We continue to believe that this uncertainty and need for creativity is a positive for Brown & Brown as it positions us well as a trusted advisor to bring alternative options to customers that best address the needs of their company and their employee base.”

If we don’t find opportunities then we’ll stockpile cash

“I have been asked that what happens if in fact acquisitions were very, very expensive going forward for a protracted period of time and if we evaluated our stock price and we thought the stock price was fully valued at the time. And the answer to the question is that we are going to stockpile cash on our balance sheet. And so if anybody wants to criticize somebody at Brown & Brown, you can criticize me. But we are not going – we do not have a whole burning in our pocket and I know you know that and we look very, very closely at our acquisitions and how we deploy that capital and we will continue to do so. It’s interesting, because as I alluded to in my prepared remarks, some of the acquisitions that we see out there, we know that the numbers don’t make sense, but we are a forever company and those companies are going to be flipped in 3 to 5 to 7 years and they don’t build cultures in that period of time. We have only been doing this for 77 years and we think we really have a strong culture and we will continue to maintain that. So, I anticipate that we will have opportunities to deploy our capital fine over the intermediate to longer term, but it’s very possible we could continue to stockpile cash on the balance sheet.”

Brown and Brown 4Q16 Earnings Call Notes

Brown & Brown’s (BRO) CEO Powell Brown on Q4 2016 Results

cat property rates will remain under pressure in 2017

” Now that the 2016 hurricane season is behind us and insured losses were not material, we believe cat property rates will remain under pressure in 2017. Insureds continuing to evaluate the hurricane deductibles, flood coverage, and flood excess of the NFIP.”

When everything is overvalued we stockpile cash

“We have also been asked what happens if our stock price is fully valued and the acquisition marketplace continues to be fully priced or even goes up. And the answer to that is we stockpile cash on our balance sheet. So we constantly evaluate share repurchase as one of the investment options for the cash that we buildup. But as you know we don’t have a stated amount that we’re going to purchase on a quarterly basis, we’re going to look at it opportunistically just like acquisitions and we’re going to do it when we think it makes sense for the company.”

Conversations with clients haven’t changed dramatically post election

“I think the discussions with our client has not dramatically changed prior to the election versus postelection of our new President. And the reason I say that is the conversation typically is focused around managing cost. Obviously some people talk about bending the cost curve and all these other things. I just make it simple, I just basically say how do you manage your cost in a thoughtful manner over the next several years it’s not a one-year window. And so in doing that changes in ACA everybody is, doing a lot of speculating right now. Do we think there is going to be changes? Yes. Do we think it’s going to be totally repealed? I don’t know about that and that may be semantics in terms of how you define total repealed.”

Uncertainty creates opportunity to talk to clients

“, is it creates more uncertainty which actually creates an opportunity for us to talk with our clients about options and how they can think about it and attack it going forward particularly based on whatever is the outcome of the changes.”

Marketplace is fully priced and expectations of some sellers are unrealistic

“As it relates to tax rate, I think there is two parts to think about, yes, I do think you have corporate tax rate and then you have the potential for capital gains changes as well. And as we said earlier we believe that the marketplace is fully priced and so expectations of some sellers are unrealistic and with a tax cut either in one or both, I believe that those expectations would probably go up because the bankers will facilitate that. That said, at the end of the day, remember, Kai, we are focused on looking for acquisitions that fit culturally and make sense financially. And so therefore as you’ve heard we’ve only done $55 million of acquisition for the last two years and I would tell you that I’m comfortable with that because we didn’t find ones that fit culturally and made sense financially. We found a couple that fit culturally last year but financially would not have made sense and that’s not our plan. ”

Brown and Brown 2Q16 Earnings Call Notes

Brown & Brown’s (BRO) CEO Powell Brown on Q2 2016 Results

We continue to see a tremendous amount of capital in the market and risk bearers want to put it to work

” we would characterize the second quarter as another quarter that is moderating upward, but inconsistency in the middle market does remain. These inconsistencies can be seen in certain geographies or industries or a combination of both. During the quarter, our customers continue with modest hiring and exposure units are increasing. As a general comment, we continue to see a tremendous amount of capital in the market and risk bearers want to put it to work with some being more aggressive than others either with their pricing or terms and conditions or both.”

Small employer healthcare costs have increased at 8-12%

“Similar to previous quarters management of healthcare cost remains front and center for our customers, as small employers are generally experiencing rate increases of 8% to 12% while larger employers are seeing rates, rates that are generally flat up slightly. While these rate increases in small employer groups do not have a direct impact on our revenues as many of those carriers have moved to a per employee, per month, compensation model it does drive planned design. Companies are focused on how to best manage health and pharmacy cost and have their employees proactively share in managing these costs.”

You see carriers do unusual things in an environment like this

” there is a lot of reasons why you lose business but most of the time it’s loss of relationship with the buyer both the economic buyer and/or the user buyer. Having said that there in a market like this where you can see carriers do some really squirrely things in terms of pricing sometimes you just see crazy things, they just — right they do pricing that just doesn’t make sense where they blow something out of the water and we don’t know how long that’s going to last or if its real or whatever the case may be but sometimes you lose a little bit of business like that.”

We’re seeing rates on hurricane coverage come down to head-scratching levels

“what I would tell you is we’re starting to see rates in the pre-Hurricane Andrew levels. That would be 1992 for those that may not remember the exact year. But remember you’ve had enormous and I wouldn’t — I don’t want to say Ryan that we’re surprised like all of a sudden we’re just surprised. That’s I think it has been we’ve continued to sort of scratch our head at the continued rate decrease or pressure. So it’s not like second quarter we woke up one day and said well we’re surprised wasn’t that kind of deal. It has been, if you look at it for the last three years and I’m just using Southeast Florida because I live here in Florida and know that areas well and you look at these very nice high rise condominiums and Dade, Broward, Palm Beach County and all of a sudden, the rates have come down let’s just say 20%, 20%, 25% those are big cuts.”

It’s tough to compare what could happen in a big loss event because Hurricane Andrew was a different time

” So let me back up I actually joined Brown & Brown in July of 1995. I worked for an insurance company then. And so I saw rates go up in admitted markets as much as were permissible by rate filings however here is what I would say remember in Hurricane Andrew it was much different because the modeling for insurance companies was not nearly as sophisticated, it was more like a map and there would be people in Kansas City riding hotels and in Miami Beach and the people in Florida with the same insurance company didn’t even know that they were riding the hotel in Miami Beach. So there was the aggregation of exposure units that was substantial which most insurance standard carriers realize that had it been a direct hit in Hurricane Andrew on Miami Beach that we might had some very significantly impaired insurance company because they didn’t realize how much they had.”

A Florida storm will create upward pressure on rate

“I think a better example would be to go to 2001 and 2002 and 2003. So you had a constricting in the property market. You had post 09/11 event, you had lots of other things and rates started going up and up and up and up. The amount that, I don’t think you can say, this is how much they are going up in the event of a loss because the loss, the size of the loss is going to be a significant impact. The number and the losses by individual carrier will impacted and it depends on if how opportunistic certain carriers will feel on the way in, if the market places bearing on making this up 25% increase and all of a sudden you have a capital provider which is not taken a bunch of losses and may be didn’t participate in that segment and says that this level we might do that. They might come in and right at 15% so there is not going to be a linear relationship. I can just tell you when you have a big event that goes into Florida which is not a question of if, it’s a question of when we have another storm hit Florida, there will be upward pressure on rate.”

Brown and Brown 1Q16 Earnings Call Notes

Brown & Brown’s (BRO) Powell Brown on Q1 2016 Results

ACA reporting remains the forefront

“ACA Reporting and Compliance remains the forefront for many of our customers and a concern for many of them was the completion of the first major ACA reporting requirement, which occurred at the end of the first quarter.”

At some point there is going to be a wind event in Florida

“it’s been 11-years since we have had the last hurricane hit landfall in the State of Florida. I’m 48-years old and I can tell you, I remember every hurricane that has hit the State of Florida in my life time and it usually is every 10 to 14-years. That is not saying that we think there is going to be a hurricane this year, but at a point in the future, there will be a wind event in Florida and that will intern modify or change the marketplace.”

Valuations are high but M&A activity is not slowing

“From an M&A perspective, the activity in the industry is not slowing. While valuations remain high, we continue to look for company that fit culturally and make sense financially.”

Technology based insurance brokers may not understand the complexities of particular risks for larger customers

“what we found whether it would be in personal lines or in small commercial. There are certain complexities that come with risk particularly as you as an individual or as an business start to accumulate assets which they may not be familiar with the coverages that would be appropriate and so there is a possibility that they have what I call coverage is stripped down that maybe cheaper, cheaper, cheaper. But they maybe buying a Yugo as opposed to a Chevrolet or a Cadillac. And so and do they actually know the difference in the coverages and so I’m not aware of anything yet ”

Tech companies have done a good job of sizzle but not not in terms of executing on making money

“What we say so far though, so far is the technology companies that I’m aware of, they have done a good job of sizzle in terms of the marketing but I don’t think that they have done as well a job in the execution of the plan where they are able to make money over a period of time. “

Brown and Brown 2Q15 Earnings Call Notes

Seeing a soft market for insurance prices

“we, like the entire industry, continued to experience headwinds related to the rate declines. The downward pressure on rates continued to be driven by good overall loss experience, minimal weather related events and a significant amount of excess capital in the market chasing returns. We expect this trend to continue unless there is a material change in one or all of these factors.”

See slow but inconsistent hiring in middle market

“We continue to see slow economic improvement in some markets and certain areas in the country, but this is not consistent. We see exposure of unit growth in certain regions, but don’t see consistent hiring across the board in the middle market. We believe this is partially driven by a lack of qualified – possibly of lack of qualified candidates, but more specifically the implications of ACA adoption that many employers are facing.”

Declining property rates, higher auto, flat professional liability

“”We continue to see declining rates for our coastal properties and also seeing admitted property rates trending flat, down 5% in some cases. However, we are seeing commercial auto rates generally trending up, but it really depends on the specific loss experience, and professional liability rates are flat to up 5%.”

Employers are all over the map relative to ACA implementation

“relative to ACA, is I believe that many small employers are all over the board in terms of their preparation, some are behind and being – getting ready for next year, some are on their way and some are already there.’

Public exchanges will probably see rate increases because of unfavorable loss experiences

“a number of those exchanges are experiencing rate increases and they will continue to experience rate increases, we believe, because of the unfavorable loss experience many of them have had over the last year due to the number of people in those pools.”

Private exchange is an option for smaller businesses

” I would reiterate that the private exchange is an option, not the option. And so we believe that it is, one, a technology play; two, a coverage play; three, a compliance play. And you wrap all that up and that is appealing to some smaller businesses.”

INvesting in people rather than acquisitions with acquisition prices up

“There are a lot of acquirers out there, some of whom are paying what we might consider ridiculous prices in certain transactions. We are considering making investments in people, where there isn’t any so-called acquisition, but bringing those capabilities and talents on to our team that is a short-term margin hit until the revenue comes with them. And so, you are correct in saying that there will continue to be an ongoing expense. But I can assure you that there are components to these investments, which are opportunistic and we will continue to explore those when we’re in an environment, where acquisition pricing is up and we want to get more talent on our team in certain areas to serve our client base.”

Private equity has been a big buyer of insurance agencies

“I would say that the biggest participant in this is private equity. And so, Ken, if you go back to 2006, as an example, 29% of all transactions announced were done by financial institutions, banks. And only 4% were done by private equity firms. In there, you have a big group of the public buyers and you have some private buyers. But in 2013 and 2014, private equity was 44% and 43% of the announced transactions. And in that same period, banks were only 8% and 5% of the transactions, while the publicly-traded brokers, the percentage in the 20%s which has remained fairly confident over the entire period of time.”

“So we’re starting to see private equity buy private equity, which I think is many times an indication of a frothy environment. And so – but there are other publicly-traded firms that you know that are announcing transactions and there are some private firms, but it’s predominantly private equity. We are always talking to people out there always. And as I’ve said before, how and when or why and when they sell is different and unique to each one.”

“We would tell you and quite honestly, the reason that we did not make that comment at this time is because the pricing continues to be very competitive. It’s not that there aren’t a number of transactions out there. There are actually a lot of transactions and there’s a lot of activity because of the speculation of these high or higher multiples. But we are going to continue to stick to our knitting, which is we are trying to execute better every day. We want to sell more accounts and we want to retain the existing clients that we have. We want to work really closely with our carrier partners, which enable us to have additional success, investing in our teammates all along the way and driving long-term shareholder returns for our stockholders.”

People buy emotionally and justify intellectually

“I’ve had several people asked me that some people may be saying, they’re paying 7 times. And I say is that 7 times revenue, is that 7 times a pro forma of 2018 earnings, is it 7 times of what? So, I don’t think it’s so much the multiple number it is, what is – what are the earnings that they’re calculating and that’s where I think sometimes there is a divergence in that discussion.

So it’s very interesting, it sometimes is challenging, sometimes comical, but we keep going and different people are going to make – typically people buy emotionally and justify it intellectually, so they will go where they think that they will be best served unless the number is so unusual and if nobody else can get to it.””

At some point the PEs need to exit

“when we look at this space, lot of the really high multiples are – appears to be the really high multiples being paid by the private equity side, as Powell mentioned. There – their strategy is there is an exit to it, right, that means there is a liquidity event at some point in the future”