Tuesday, February 24, 2009

(No.15) Demutualization: Does a fish need a bicycle?

By way of preface and in the interests of disclosure: I began my career in the life insurance business when I joined the Mutual Life Assurance Company of Canada in the field as a financial planner in the 1970s, later moving to its head office in Waterloo, Ontario where -- at the time its demutualization was announced on Dec 8,1997 -- I was an officer of the company. I was also among many Mutual Life staff at the time who still believed that mutuality was a superior form of organization, one  that best served the interests of the company's par policyholder owners (and virtually all of the company's hundreds of thousands of policyholders held policies designated by Mutual Life as participating, even its univeral life policies). 

Notwithstanding my status as an officer of the company I refused to speak in support of the company's demutualization either within or without the company, believing as I did then -- and still do -- that 
1. the demutualization was unnecessary and undesirable,
2. mutuality is a superior form of organization for policyholders,
3. Mutual Life had a culture and record of mutuality from its founding in 1870 that made it a model of how a life insurance company ought to be operated, and
4. a life insurance policyholder needs the company issuing that policy to be run with shareholder interests as the priority like a fish needs a bicycle.

It should be obvious to even the most ardent cheerleaders for stock life insurance companies that their senior managements tend to become so much the captives of a quarterly results perspective and the servants of rating agency 'group think' that they often preclude and frequently seem incompatible with an intelligent, longer term approach to (among other things) building, renewing and investing in that core activity for life insurance companies: distributing their products or, expressed somewhat less elegantly but more realistically, 'selling stuff'.

This reality, this generally ignored elephant in the corner of the life insurance industry conference room, was nicely underlined by the CEO of New York Life, a mutual company with one of the top agency systems in the world. In an interview with the New York Times (July 5, 2008) Theodore Mathas said that "if someone came in [to see me] with a proposal and said 'I'm going to cost you some money this year but it's the right thing to do in the long run', I was able to say, 'Do it. It's the right thing.' I didn't say, go calculate earnings per share and tell me how my share price might drop and tell me what analysts are going to get on our case. I didn't have to do that. It made it possible to do the right thing. Our business model permits us to do the things that are in the best long term interests of our policyholders. It doesn't mean we aren't issuing quarterly profits. Of course we are. But it means it doesn't take an undue importance in our calculations."

In another interview (New York Times, Oct 3, 2008) Edward Zore, the CEO of that great mutual company (and the one to which Mutual Life was most often likened) Northwestern Mutual, the largest direct provider of individual life insurance in the US, observed that "We're a triple-A-rated company. I don't have to worry about meeting the ideals of a Wall Street analyst or some hedge fund manager who has a 60 day time horizon. I don't have to worry about short-sellers. Our investment portfolio is very well balanced, very well diversified. It's a portfolio I could not have as a stock company. The earnings effect of what we have would be less predictable than what would be required by stockholders. So we couldn't do what we do. We have no intention to become a stock company." 

To which I say 'amen', even more so in light of the meltdown on Wall Street and events which reinforce the cogency of what these 2 CEOs said last year. One need look no further for an example of what can happen when a stock life insurance company succumbs to a frantic pursuit of ever greater profits and increasing share price to impress investors than AIG (American International Group) and its life insurance operations. AIG has already received $150 billion or so of US government 'bailout' money and, as I write this, is expected to announce soon a 4th quarter 2008 loss of perhaps $60 billion.

If, dear readers, you had to pick a large North American life insurance company on the books of which you wanted to have your life insurance coverage, which would you pick: New York Life, Northwestern Mutual or AIG?   QED

Alastair Rickard,