Fitch Drops Marsh & McLennan’s Senior Debt

October 28, 2004

Fitch Ratings has downgraded the senior debt and long-term ratings on Marsh & McLennan Companies Inc. (Marsh) to ‘BBB’ from ‘A-‘. The short-term ratings on Marsh remain at ‘F2’. All ratings remain on Rating Watch Negative.

Fitch has lowered Marsh’s senior debt rating four notches since the announced civil suit brought against the company by New York Attorney General Elliot Spitzer and allegations of collusion and price rigging. Regardless of the ultimate outcome of the suits, Fitch believes that Marsh will suffer a material decline in its franchise value as a result of the allegations, especially given recent reputation issues suffered in its Putnam mutual fund unit, tied to improper trading practices.

The rating action follows recent reports of potential penalties and settlement costs in addition to continued analysis on the potential long-term impacts from recent investigations on Marsh’s operating capabilities and balance sheet position. Fitch has considered various scenarios that will influence both future operating performance and financial leverage levels in the near future. Considerations in Fitch’s analysis include:

— Marsh will eliminate contingent commission revenue, which totaled $845 million in 2003. Contingent commissions provided less than 10% of total revenues in recent periods, but likely contributed 25-35% to total pre-tax earnings. Further, while Marsh may try to offset lost contingent commissions through increases in fees or traditional commission payments, Fitch believes that in the near term a majority of earnings generated by contingent commissions will not be recaptured;

— Fitch expects Marsh to experience some reduction in general profit margins within its insurance brokerage business, even excluding the impact of lost contingent commissions, on the thought that traditionally high margins in this business will no longer be tolerated by Marsh’s clients given recent controversies and need for Marsh to regain credibility and trust. Heightened disclosures of commission levels will further contribute to margin pressures;

— Fitch believes that Marsh will experience both revenue reductions, and related challenges in shedding fixed costs, due to a likely reduction in market share resulting from recent controversies. This risk could be lessened if other brokers, especially number two positioned Aon, are ultimately named in civil or criminal actions;

— The likely need to fund fines, penalties and litigation settlements could prove to be a significant cash drain, place near-term pressure on financial leverage ratios and cause one time earnings charges. Fitch also believes Marsh could be susceptible to cash-based restructuring charges, and non-cash goodwill write-downs;

— Fitch believes Marsh will experience an increase in borrowing costs due to the impact of recent downgrades and the need to ultimately term out short-term borrowings. Pressures on borrowing costs could be mitigated to the extent Marsh generates cash flow that can be used to reduce its sizeable short-term debt burden.

Given that there still exists significant uncertainties as to the ultimate magnitude of the above noted items, Fitch has constructed several scenarios to ‘stress’ the impact of the fall out from recent developments on key financial measurements at Marsh. In Fitch’s opinion, under a reasonable range of stress scenarios, Marsh’s cash flow coverage ratio – measured as pretax earnings before interest, depreciation and amortization expense (EBITDA) relative to total interest costs – will likely to drop to within a range of 4-8 times (x) in the foreseeable future. This is a meaningful deterioration from historical levels of approximately 15x.

Further, financial leverage, as measured by total debt relative to EBITDA, would increase to a range of between 2.0x and 3.5x under that same scenarios (barring debt pay-downs). This is a sharp unfavorable increase from approximately 1.1x at year-end 2003.

While coverage and financial leverage at the most favorable end of the noted range is still consistent with an ‘A-‘ long-term rating, coverage and leverage at the least favorable end of the range would no longer meet Fitch’s investment grade standards. The current rating action reflects the alignment of the rating with a current ‘best estimate’ within the noted range.

Fitch recognizes that Marsh has approximately $700 million of cash currently which should assist near term liquidity needs. However, Fitch believes that while current liquidity could potentially be used in the future to pay down bank debt, cash may also be needed to pay any fines or penalties.

Further, Fitch believes it is possible that fines and settlements could exhaust current cash balances. Marsh has the ability to free up significant amounts of cash over time even under very conservative stress scenarios if it chooses to take certain actions. The elimination of share buy-backs in the near-term certainly will assist cash generation to pay back bank debt. Further, approximately $600 million of annual cash flow is available if Marsh were to eliminate its shareholder dividend, which could be an ultimate course of action under a scenario of high fines and/or challenges in refinancing its bank debt.

Fitch believes the recently announced business plan that will create more transparency in commissions and eliminate insurer payments to Marsh is a strong course of action and perhaps the optimal route the company can take at this time. Over the long term, this plan may allow Marsh’s operating profile to most closely align with its recent brokerage earning performance.

However, Fitch contends that the likelihood of lost market share and reduced margins, above the lost contingent commission revenue, is a reasonable approach. Thus, Fitch believes that there is a fundamental change in Marsh’s operating profile in which the company will fade from a superb profit generator and that Marsh’s pretax brokerage margins could drop from 24-28% historically to as low as 12-15% over the next eighteen months.

Fitch considers the recently announced restructured bank line agreements and the diminished potential for criminal charges to be brought against Marsh to be favorable developments, since they have allowed Marsh to avert near-term situations that could have called ongoing viability into question.

Fitch also believes that changes in executive management will help Marsh in reaching a settlement with the Attorney General, but that there remains longer-term uncertainties related to new management’s abilities to effectively run an organization of Marsh’s size and complexity.

Fitch originally placed the ratings of Marsh & McLennan and Marsh USA on Rating Watch Negative on Oct. 14 following announcements that the New York State Attorney General had filed a lawsuit against Marsh & McLennan claiming it directed clients to unknowingly use insurers with whom Marsh & McLennan had lucrative contingent commission arrangements.

Additionally, the lawsuit claims Marsh & McLennan solicited predetermined ‘rigged’ bids for insurance contracts. This lawsuit stems from a broader investigation by the New York Attorney General of fraud and anticompetitive practices in the insurance industry.

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