Monday, November 28, 2011

(No.179) Economical Mutual & demutualization rules

In two previous columns (Nos. 159 & 166) I wrote about the demutualization of Economical Mutual Insurance, a large federally regulated property and casualty (P & C) insurance company based in Waterloo, Ontario. Its demutalization was proposed by the company board and senior management who are among the relative handful of people who hold less than 1000 voting ('ownership') policies in the company. Some of them apparently believe that the surplus/'equity' in the company can -- on demutualization -- be shared among the few to the disadvantage of the company's tens of thousands of non-voting policyholders.

This prospect was apparently such a stench in the nostrils of those who value fairness that the federal government, in the person of Finance Minister Jim Flaherty, announced at the end of June that it was launching a public consultation on what ought to be the framework for the demutualization of federal P & C insurance companies. This would be a regime that would apply to all such companies looking to demutualize, not just to Economical Mutual.

I urged those interested in the issues involved to write to the Minister of Finance. A number of people, including both insurance brokers and non-voting Economical Mutual policyholders, have since indicated to me that they have done so.

One person who made a submission needed no urging to do so. I refer to a former colleague of mine Claude Gingras, LL.L.,LL.B.,LL.M. who in my view is Canada's leading expert on the subject of insurance company demutualization. He was General Counsel for the Mutual Life of Canada from 1977 to 1995 and, thereafter, Special Advisor to Canada's Dept. of Finance until mid-2003. In this latter capacity he assisted the federal government in establishing a demutualization regime for life insurance companies that was used by the four major mutual life insurance companies (Manulife, Sun Life, Canada Life and Mutual Life of Canada) to convert to stock companies.

I agree with and endorse the points in Mr. Gingras' submission. Their cogency should make them irresistible to all but those most financially or politically self-interested in the proposed Economical Mutual Insurance demutualization.

For those who have followed this issue on here are key excerpts from Claude Gingras' July 28 submission to Ottawa.


He notes that the June 30, 2011 announcement from the federal government asks: "Independent from the demutualization issue, the Government is seeking views on how mutual P & C companies can ensure that they continue to have an effective governance structure and whether measures need to be taken to increase the number of voting policyholders."

That the Department of Finance asks this question [Gingras states] and in these terms, is somewhat intriguing. The fact is that at least half of the mutual P & C companies under federal jurisdiction currently have a seriously defective governance structure that does not deserve to be "continued" at all, and this situation has been well known to the Government for a long time.

While the Insurance Companies Act (ICA) determines who has voting rights in a mutual life company, it is silent on this crucial governance matter for P & C mutual companies. Each P & C mutual is therefore free to determine to whom they will issue a voting policy. A number of mutual P & C companies have granted voting rights to all their policyholders by by-law, including for instance Wawanesa, a major company. However Economical [Mutual Insurance], another major P & C company, ... and a few smaller ones have reserved their voting policies mostly for directors, officers, staff and friends of the company, thus ensuring a very convenient and cosy entrenchment of management.

Aware of this disturbing situation, the Department of Finance put forward a proposal for legislation in its Consultation Paper of Jan. 2003 entitled "Corporate Governance of Financial Institutions" .... [It proposed] to "extend by legislation the right to vote to all policyholders of P & C mutual companies, subject to certain exclusions (e.g., policies of short duration or that fall below a certain premium value). One practical approach would be to extend the right to vote to policyholders upon purchase of a policy or renewal of an existing policy."

[Mr. Gingras then notes that] this 2003 proposal, together with others intended to protect and strengthen the rights and interests of policyholders following the massive demutualization movement that occurred in the life sector, was never implemented as the Government chose to give in to the powerful lobbies of the insurance industry ... which opposed all these measures. The industry even opposed a proposal, also abandoned, that companies be required either to consider the interests of participating policyholders in managing their participating funds or to act in a manner that is fair and equitable when managing these funds.

... I submit that the Government should implement the [2003] proposal in the ICA before even attempting to establish a P & C demutualization regime. Such a provision would not only facilitate the drafting of a P & C demutualization regime but would also ensure that the decision to demutualize is taken solely for the right reasons.

... Human nature being what it is, faced with the prospect of receiving humongous windfalls in the form of demutualization benefits and becoming instant millionaires, these [few P & C voting] policyholders may approve, or incite, demutualization without having the future well-being of their company in mind. ...

Many generations of policyholders have contributed to the accumulated surplus of their company and, ideally, should receive their share of the value of the company in the form of shares or as a portion of the proceeds of the sale of the entity on demutualization. Obviously that is not feasible and, in practice, participation in the benefits of demutualization is limited by the availability of records.

In a number of foreign jurisdictions the regulations require that all policyholders of the last 3 to 5 years be included in the payout of benefits but only the current policyholders are entitled to vote on the conversion. Benefits representing the value of the company are allocated to all these policyholders in proportion to the premiums they have paid during the whole period chosen.

This appears to be the most fair and equitable way to treat policyholders upon a P & C demutualization [emphasis added], taking into account that P & C policies are mostly short term contracts, while life insurance policies generally have much longer duration. ...

P & C companies have no participating policyholders as this expression is defined in the ICA. P & C policyholders entitled to vote carry exactly the same risk -- insolvency of the company -- as those without that right. ... Thus those voting policyholders have no greater claim to "ownership" of the company than those without voting rights. Consequently, they should not receive a greater benefit upon demutualization by virtue of their voting rights than the other policyholders [emphasis added].

Since 1997 a Canadian mutual insurance company has been allowed to issue equity instruments in the form of participating shares .... Therefore a mutual insurance company is not forced to resort to demutualization if it needs to access share capital for expansion or safety or soundness purposes.

In the information material to be provided to policyholders by a company seeking their approval of its demutualization, management should explain in detail why demutualization is sought, beyond platitudes such as "this is the right thing to do" and "the need to give the company to its rightful owners". The other options of the company beyond demutualization, including issuance of participating shares, should not only be explained to policyholders but policyholders should be told why these options have been rejected by management.

For smaller P & C mutual companies unable to effect a successful initial public offering and maintain a presence in the stock market, but wishing to demutualize, merger or sale of all the assets of the company to another entity could be the only avenue. ...

There is no doubt that the disappearance of mutual companies in the insurance sector will greatly reduce competition. Indeed, the presence of entities in which policyholders do not have to pay rent to shareholders forces stock insurers to keep premiums at a lower level than they would otherwise have set them. This was well understood in the countries that experienced a wave of demutualization in the life sector, as did Canada in the late 1990s. ....

Surely, if the current voting policyholders of the company [i.e., Economical Mutual] that first announces its intention to demutualize are allowed by Ottawa to become instant millionaires for no valid reason, the pressure will be great for the other P & C mutuals, where also only a small minority of policyholders have the right to vote, to follow suit.

The P & C sector in Canada is already dominated by foreign companies. It is reasonable to assume that most Canadian P & C demutualized companies would then pass into foreign hands. This would further reduce the market share of the Canadian companies in the P & C sector.... [and] the responsibility of the federal government [is] to ensure that demutualization does not occur mainly for the unjust enrichment of few policyholders.

Let's hope that Ottawa will find the courage to resist the pressure and establish a P & C demutualization regime that will be fair and equitable to all policyholders and that would not permit demutualization for the wrong reasons. ...

In a recent decision reversing corporate transactions involving policyholders' funds, which had been approved by Ottawa, an Ontario judge [Johanne Morissette of Ontario Superior Court] felt the need to remind the Office of the Superintendent of Financial Institutions of its duty to protect the rights and interests of policyholders when carrying out its mandate. Let's hope someone in Ottawa has been paying attention.

[The reference above is to an Oct.10, 2010 Ontario Superior Court judgement involving a class action by London Life policyholders against Great-West Life led by former London Life executive Bill Rudd; on this subject see also column No.118 posted Oct.8, 2010 to "Great-West 0, par policyholders 1". The case was also the subject of an article by R.A. Rickard in the Dec., 2010 issue of Joseph Belth's periodical The Insurance Forum.]




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