Two biggest brokers face similar challenges, but Aon reboundsfaster

By michael ha

The world's two biggest insurance brokers reported theirrespective 2005 first-quarter earnings last week in the aftermathof the sector's equivalent of the perfect storm–heightenedregulatory scrutiny, resulting in the elimination of contingencyfees, topped off by softening premium rates.

However, while Marsh & McLennan Companies saw its quarterlyprofit fall 70 percent from the year before, its smaller rival,Aon, enjoyed an 18 percent rise in its income, helped by expensecontrols.

Both brokers suffered a decline in revenues, exacerbated by theelimination of controversial contingency deals–which hurt Marshmore than Aon. MMC also took substantial charges for regulatory andrestructuring costs, and announced plans to charge higher clientcommissions to partly make up for lost fee income.

MMC said its quarterly profit dropped to $134 million–down from$446 million a year ago.

Indeed, it was hard to imagine a “more adverse environment for acompany and its employees than we had in the 2005 first quarter atMarsh,” said Michael Cherkasky, chief executive at the world'slargest broker. “Our integrity has been questioned, employees wereuncertain if they still had jobs, there was new management, and anew business model was in development. Distractions were at everywater cooler.”

At MMC's risk management/insurance broking business, revenuefell to $1.172 billion, down 19 percent from $1.451 billion a yearago. Reinsurance broking and services revenue stayed essentiallythe same–down $1 million to $282 million.

The broker said Marsh's revenue decline was caused by lostcontingency fees as well as falling prices and a decline in newbusiness. Total revenues fell to $3.182 billion from $3.196billion. On the positive side, MMC's consulting business sawrevenue rise 4 percent to $834 million.

Marsh revenues from contingency fees fell to $32 million during2005's first quarter, down from $179 million a year ago. MMC hasabandoned its contingency fee arrangements–previously described asillegal kickbacks by regulators in certain transactions–but thebroker will continue to collect those fees that were owed prior tothe fees' formal elimination.

MMC's first-quarter results also included $225 million of pretaxcharges for restructuring, retaining employees, and regulatory andcompliance issues, as well as fund reimbursements at its PutnamInvestments unit. Specifically, MMC spent $96 million on severance,$43 million for regulatory and compliance expenses, and $15 millionto retain employees.

“We've been affected by loss of market-service revenue,softening of insurance markets, and the loss of new and retainedbusiness because of our regulatory crisis,” Mr. Cherkasky toldanalysts during a conference call last week. The decline was mostsignificant in the United States, with modest drops in the rest ofthe world consistent with rate softening, he said.

Mr. Cherkasky, however, remained optimistic about the firm'sprospects.

The firm has slashed some 5,250 jobs since New York AttorneyGeneral Eliot Spitzer targeted MMC in a civil suit last October,but Mr. Cherkasky assured analysts there were “no real surprises”in MMC's first-quarter performance and that, more importantly, theworst is now over.

“The signs of recovery at Marsh are there. You could see at the[Risk and Insurance Management Society meeting] in Philadelphiathat Marsh was coming back,” Mr. Cherkasky said. “Marsh hasembraced a more disciplined profit-loss-management businessorientation. Our staff reductions are essentially over.”

Perhaps most significant for Marsh customers, Mr. Cherkaskyannounced higher client commissions beginning in the third quarterto help offset up to 25 percent of revenues lost from eliminatingcontingency fees in the United States. Mr. Cherkasky said Marsh hasgotten a “very good response from the marketplace” about itsexpected commission hike. “Even in discussions with our clients,our clients are overwhelmingly understanding about what it meansfor them,” he said during the conference call.

At Aon Corp., the second-largest broker behind Marsh reported an18 percent boost in its quarterly profit, thanks to expense-cuttingefforts that more than made up for a fall in revenues hurt bysoftening prices and the ending of contingency fees. Aon's profitfor the 2005 first quarter was $200 million, up from $170 millionone year ago.

“It's well understood that our industry continues to face adifficult revenue environment, but despite this, my colleagues atAon are doing a terrific job of managing costs and those effortsled to our improved performance this quarter,” said Aon's recentlyappointed chief executive, Gregory Case. He told analysts during aconference call last week that reported expenses in the quarterfell $66 million from a year ago, “more than offsetting a $53million decline in reported revenue.”

“We are absolutely committed to remaining vigilant incontrolling costs while we work on enhancing profitable growth,” hesaid, acknowledging that growing revenue “continues to be achallenge.”

Total quarterly revenues for Aon fell 2 percent to $2.51billion. Revenues for the Risk and Insurance Brokerage Servicesunit dropped 4 percent to $1.4 billion, with organic revenuedeclining 5 percent. The lackluster revenue growth can be mainlyattributed to softening property-casualty insurance rates as wellas the elimination of controversial contingency fees, Aonnoted.

However, the impact of abandoning contingency fees was muchsmaller for Aon when compared with its bigger rival Marsh. Aonreceived $12 million in contingency fees for 2005's first quarter,down from $35 million a year ago, as the firm booked fees tricklingin from expiring contingency agreements. Aon abandoned all sucharrangements at the end of 2004.

Mr. Case noted that Aon cut its expenses by 5 percent to $2.19billion by selling its claims-services business, changing employeeincentive compensations–by aligning compensations more closely withperformance–and cutting staff. “During the quarter, we continuedour efforts to keep costs under control,” Mr. Case said. “Theorganic growth was a little disappointing, but the margins wereextremely good.”

Aon's other business units also performed well. The firm'sconsulting revenue rose 3 percent to $309 million, while insuranceunderwriting revenue (both life and health, and warranty, creditand p-c) rose 1 percent to $789 million, further bolstering Aon'sbottom line. Total investment income also improved, up 15 percentto $93 million.

Aon's results seemed to top many analysts' expectations. NickPirsos, an analyst at New York-based research firm Sandler O'Neill,said the firm's quarterly performance was good and “clearly betterthan expected from analysts' standards.”

“Revenues did decline in line with what we were expecting in thecurrent environment, but the expense reductions were greater thanexpected and they more than offset revenue decline,” he added.

Flag: A Tale Of Two Brokers

First-Quarter Earnings At A Glance

Marsh & McLennan

Profit: $134M, Down 70% From $446M Last Year

Contingent Fees: $32M, Down From $179M

Total Revenues: $3.18B, Down From $3.20B

Aon

Profit: $200M, Up 18% From $170M Last Year

Contingent Fees: $12M, Down From $35M

Total Revenues: $2.51B, Down From $2.56B

“Our clients are overwhelmingly understanding about what itmeans for them,” said Marsh CEO Michael Cherkasky, after announcingincreases in client commissions to offset the loss of contingencyfees.