Revenue up, but first-half profits undermined by soft market, regulatory costs
Despite a slight increase in revenues for the second quarter and first half of 2005, Marsh & McLennan Companies saw net income plummet 64 percent for the first six months of this year, impacted by soft market rates, charges for restructuring and employee retention, as well as regulatory and compliance expenses.
MMC–the New York-based parent of the world's largest insurance broker, Marsh–reported that second-quarter net income dropped 57 percent, or $223 million, from $389 million (73 cents a share) in 2004 to $166 million (31 cents a share) this year. Revenues were up more than 2 percent, rising $68 million to $3.09 billion.
For the first half of the year, net income dropped 64 percent ($535 million) from $835 million ($1.56 a share in 2004) to $300 million (56 cents a share). Revenues were up less than 1 percent, rising $54 million to $6.28 billion.
One portion of the business that was particularly hard hit by the soft market was Marsh's reinsurance broker, Guy Carpenter, which saw a 9 percent decline in revenues to $192 million, MMC said.
In an analyst's conference call, Michael G. Cherkasky, MMC's president and chief executive officer, said the insurance brokerage business at Marsh–which accounts for the bulk of revenue at the company–has been impacted by lower commissions due to soft market pricing, along with the loss of contingency commissions following regulatory probes.
Marsh agreed to forego contingency fees last year after New York Attorney General Eliot Spitzer brought a civil action, since settled, that alleged the bonus payments were part of a kickback scheme to fix prices with cooperating insurers. (A fourth Marsh executive pleaded guilty last week to fraud charges related to the Spitzer probe. See accompanying story.)
Mr. Cherkasky said Marsh is operating in a "two-tier" market, where some brokers take contingent commissions while others, such as Marsh, do not, affecting broker charges to clients.
The company, he said, will still be in for some rough sailing, as he predicted Marsh will be in the headlines once more with executives going on trial over the contingent fee kickback scandal that has rocked the industry.
As part of the settlement agreement with Mr. Spitzer this year, the company agreed to pay $850 million into a restitution fund for policyholders and give up contingent commissions. In 2004, contingency fees accounted for more than $800 million in revenue at the company.
Life without contingency fees is uncharted territory for Marsh, Mr. Cherkasky noted, adding that the company is learning how to deal with the new operating realities. He said the broker is charging fair market value for services and increasing retentions as the year progresses. He predicted the company would see further improvements throughout the year and begin its turnaround by the beginning of 2006.
Speaking about higher charges facing clients for services, he said buyers are "not happy about them, but they are accepting them."
He said the company's producers have done "an outstanding job implementing" the new business model. "Our clients will be better off because of our compliance. This gives us a competitive edge."
Eventually, he said, brokers will give up contingency commissions as clients show they are not willing to deal with brokers who take them. However, he distinguished broker contingent payments from agent contingency fees, which he said were more commodity-driven and would not have to go away.
While retentions are up, Mr. Cherkasky noted that the firm is struggling to write new business. As producers adjust, he said, they will begin to be able to refocus their attention on the writing of new business, and that will be part of the turnaround in 2006.
Mr. Cherkasky–who signed a deal last week to keep heading up MMC for at least another three years (see related story)–said Marsh has lost "substantial pieces" of business to regional brokers, but he believed this was short-term because customers would soon discover these brokers cannot do what they promised.
Flag: The Skinny
Head: Key Numbers For MMC
o Revenue–up 2 percent for the second quarter and less than 1 percent for the first half.
o Net income–fell 57 percent for the second quarter and 64 percent for the first half.
Flag: Other Results
Head: MMC Is More Than Brokerage
In financial news from MMC's other divisions:
o Kroll, its security consulting and technology business, saw revenues increase 927 percent, from $26 million to $267 million in the quarter.
o Mercer, its management consulting arm, saw revenues increase 6 percent, from $911 million to $963 million.
o Putnam, its investment subsidiary, saw revenue drop 13 percent, from $434 million to $377 million.
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