Tuesday, July 31, 2012

(No.209) Policyholder issues raised by Economical Mutual Insurance

"More views censored by the Department of Finance in Ottawa on demutualization, Economical Mutual Insurance and related issues"


Alastair Rickard

Over time I have devoted a number of columns on RickardsRead.com (q.v., Nos. 159, 166, 179, 206 and 208) to the issue of the proposed demutualization of Economical Mutual Insurance, a large Canadian federally regulated property and casualty insurance company (p and c) and to the ongoing discussion of  the regime that should be put in place by Ottawa to regulate the demutualization of all such companies.

The proposed demutualizaion of Economical Mutual prompted federal Finance Minister Jim Flaherty to begin a process of public consultation in June 2011 by publicly soliciting views about what the regime governing the demutualization of p and c companies should embrace.

A number of submissions from various stakeholders and interested parties were made to the Department of Finance, including one from me. Most although not all submissions have been posted by Finance on its website ( for posted submissions, go to www.fin.gc.ca/consultresp/dffpcic-cdsamf-eng.asp). The gatekeepers at Finance did not want to share publicly some of the views they received on this subject.

For example: my submission to Finance was heavily 'redacted' (i.e., censored) before it was posted to the Department's website, so heavily that I decided to share with readers exactly what Finance had removed from my submission before posting it (see "Economical Mutual's demutualization and public consultation" on RickardsRead.com, column No. 208, posted July 23, 2012). My object was to allow readers to draw their own conclusions about the actual views I expressed that Finance mandarins apparently found to be so sensitive and/or objectionable.

That brings us to an even more interesting exercise in Finance Department censorship on this issue, and the reason for this particular column on RickardsRead.com

Claude Gingras, a leading Canadian expert on demutualization and a former special advisor on the subject to the Department of Finance in Ottawa, made a particularly important, well-informed and thoughtful submission on p and c demutualization as well as about several little noted and understood aspects relevant to par policyholders about the previous demutualization of four major Canadian life insurance companies ( the submission was dated July 28, 2011). I published excerpts from Mr. Gingras' submission to Finance on RickardsRead.com (column No. 179, posted Nov. 28, 2011)

When the time came for Finance to fish or cut bait on whether or not to post Mr. Gingras's submission he was informed that Finance wanted certain statements removed from the submission before it could be posted. No agreement on this matter was reached with Mr. Gingras and his seminal work on this topic has not been posted along with other submissions.

For that reason this column of RickardsRead presents (below) the entire submission by Claude Gingras including those passages which Finance gatekeepers wanted removed as a condition of its posting to the public discussion the Minister said he wanted.

The passages Finance wanted removed are underlined in the text of the submission reprinted below.   Many readers will find, as I did, the reasons for the removal of certain passages desired by Finance gatekeepers both self-evident and revelatory of Finance Department defensiveness involving previous deficiencies.


Submission to the Consultation on a Demutualization Framework
for Federal Property and Casualty Insurance Companies


Claude Gingras, LL.L, LL.B., LL.M.


I am responding to your invitation of June 30, 2011, to submit comments on the establishment of a demutualization framework for federal P and C insurance companies. I was General Counsel for Mutual Life of Canada from 1977 to 1995 and, thereafter, Special Advisor to the Department of Finance of Canada until mid-2003. In this latter capacity, I assisted the Government in establishing a demutualization regime for life insurance companies that was used by four major mutual companies (ManuLife, Sun Life, Canada Life and Mutual Life of Canada) to convert to stock companies. I consent that my submission be posted on the Department of Finance website with the inclusion of my name.

My comments will focus primarily on the broad policy objectives that should guide the Government in establishing a P and C demutualization regime, with emphasis on the need for “fair and equitable treatment of policyholders.” However, I will first address the matter of governance that the invitational message raises.

The Issue of Governance in some P and C Companies

The message asks: “Independent from the demutualization issue, the Government is seeking views on how mutual P and 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, and in these terms, is somewhat intriguing. The fact is that at least half of the mutual P and 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 of Canada (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 and C mutual is therefore free to determine to whom they will issue a voting policy. A number of mutual P and C companies have granted voting rights to all their policyholders by by-law, including, for instance, Wawanesa, a major company. 

However Economical, another major P and C company, which announced its intention to demutualize last December, 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 January 2003, entitled “Corporate Governance of Financial Institutions,” that is worth citing in its entirety here:

1. Right of Policyholders to Vote in Mutual P&C Companies

Some federally-regulated mutual property and casualty (P&C) companies have a very small voting base because they sell very few policies that entitle their holders to vote. In contrast, voting policies, particularly par policies, are prevalent in mutual life companies for historical and economic reasons.

A narrow voting base may reduce the effectiveness and fairness of governance because the management of such companies is accountable to only a few policyholders. Moreover, one of the objectives of a mutual structure is to allocate the risks and benefits of ownership to a broad group of people.  As a consequence, it may be advantageous to increase the voting base of policyholders in mutual insurance companies in the P&C sector.

Proposal: To extend [by legislation] the right to vote to all policyholders of P and 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.” 

This 2003 proposal, together with others intended to protect and strengthen the rights and interests of policyholders following the massive demutualization movement that had occurred in the life sector, was never implemented as the Government chose to give in to the powerful lobbies of the insurance industry (including by agents, life and P&C company associations and even the Canadian Association of Mutual Insurance Companies) 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.

For precisely the reasons mentioned by the Department of Finance in 2003, I submit that the Government should implement the above proposal in the ICA before even attempting to establish a P and 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
Indeed, those few privileged policyholders who have voting policies, who have been told repeatedly that each of their policies may be worth in excess of $1 million, may support demutualization for the wrong 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 policyholders may approve, or incite, demutualization without having the future well-being of their company in mind. 

Of course, the implementation of this proposal will also strengthen the governance of those mutual companies that decide to retain their current mutual structure.

I now turn briefly to the first three broad policy objectives that supported the development of the demutualization regime for life companies, to see how they could apply to the establishment of an appropriate P and C regime. In my comments, I assume that the Government would implement its 2003 proposal stated above, before approving any P and C demutualization.
Fair and Equitable Treatment of P and C Policyholders upon Demutualization

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 sale of the entity) upon 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 and C demutualization, taking into account that P and C policies are mostly short-term contracts, while life insurance policies generally have much longer duration.
Of the four large mutual life insurers that demutualized in the latter part of the 1990s, I believe that only Mutual Life of Canada had non-participating policyholders with voting rights. Upon demutualization of this company, only a small portion of its value was allocated to these policyholders in compensation for the loss of their voting rights. This could be used as a model to compensate the current voting P and C policyholders for loss of their present voting rights, with the rest of the value going to all policyholders as stated above, although one could very well refuse to reward, in any way, bad governance.

Each of these four life insurance companies had hundreds of thousands of participating policyholders who received all or, in the case of Mutual Life, the vast majority of the demutualization benefits. P and C companies have no participating policyholder as this expression is defined in the ICA. 

P and C policyholders entitled to vote carry exactly the same risk – insolvency of the company – as those without that right. They have no additional risk over the other policyholders, as the right of the company to make a call on premium notes, where it still exists, will never be exercised because doing so would be useless and counter-productive to a company in serious financial difficulties.  

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.
The demutualization regime for life insurance companies allowed senior officers to acquire shares or receive options, free of charge, only one year after demutualization, resulting in a possible substantial windfall upon the exercise of these options or the sale of these shares at a later date. 

Here again, in order to ensure that the management decision to demutualize the company is made with a view only to the best interests of the company, other jurisdictions preclude the granting of options to, or share purchase by, management for a period of 3 to 5 years following demutualization. This longer period is thought to be required for the company to completely settle into its new structure and for its shares to reflect a value determined by a mature market. 

The Canadian government should adopt this approach in order to reduce the possibility of manipulation by management of the value of the company during the first few years after its conversion.
Maintaining Safety and Soundness

Since 1997, a Canadian mutual insurance company has been allowed to issue equity instruments in the form of participating shares (sections 83.01 to 83.03 of the ICA) with certain restrictions. Therefore, a mutual insurance company is not forced to resort to demutualization if it needs to access share capital for expansion or safety and 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 and 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. It should be noted that, in at least one large European country where mutuality is well-established, demutualization is prohibited and the only choice is to amalgamate with another mutual insurance company.

Fostering a Competitive and Efficient Sector

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 set them. This was well understood in the countries that experienced a wave of demutualization in the life insurance sector, as did Canada in the late 1990s. 

The United Kingdom and Australia, for instance, moved quickly after demutualization to enhance the protection of policyholders’ interests and rights, and to increase the flow of information that life insurers must provide in respect of the administration of their funds. Sadly, Canada, after making more lenient proposals in that direction in 2003, abandoned them all in the face of the fierce opposition of the industry and its representatives. 

What will happen to the P and C mutual companies under federal supervision, now that one has announced its intention to demutualize, is anyone’s guess. Surely, if the current voting policyholders of the company, 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 and C sector in Canada is already dominated by foreign companies. It is reasonable to assume that most Canadian P and C demutualized companies would then pass into foreign hands. This would further reduce the market share of the Canadian companies in the P and C sector with the attendant consequences: loss of jobs, lack of the ability to ordain the manner in which the internal affairs of the companies are carried out, lack of control over their governance, etc. 

It is therefore the responsibility of the federal government 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 and C demutualization regime that will be fair and equitable to all policyholders and that would not permit demutualization for the wrong reasons.


Each time our courts were asked, they clearly stated that, under the Canadian constitution,jurisdiction over insurance belongs to the provinces. However, in the first part of the 20th century, Ottawa fought very hard to acquire control over the insurance business. It finally succeeded, with the support of the main life insurance companies, to obtain this control through the use of its incorporation power. This gives the federal government control over the internal management of all federally incorporated insurance companies, including the manner in which they handle policyholders’ funds.
It is not sufficient for Ottawa to limit to solvency its responsibility to protect the rights and interests of the Canadian insuring public. Currently millions of Canadians hold participating life insurance policies. When they bought these policies, they were told that they would share in the profits of their companies, and, for this right, they agreed to pay a higher premium. But they are currently kept in the dark as to how their participating funds are managed; they are told precious little about how policy dividends are determined and even less about what share of the expenses of the company they are supporting. 

Bill 57, enacted in 2005, gave Ottawa the power to make regulations in order to require companies to provide more meaningful information to participating policyholders about the management of their funds. Unfortunately, to date, almost six years later, the Government has yet to exercise this power for the benefit of these millions of Canadians.

By appropriating jurisdiction through the power of incorporation over most of the industry, the federal government has greatly curtailed and weakened provincial supervision over insurance. The seemingly callous indifference of Ottawa toward the need of Canadians to know how their funds are managed, and toward the need to protect their interests beyond solvency in the insurance sector, does not bode well for the protection of investors should Ottawa succeed in taking control over the securities industry. 

In a recent decision reversing corporate transactions involving policyholders’ funds, which had been approved by Ottawa, an Ontario judge 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.
July 28, 2011


email: Alastair.Rickard@sympatico.ca

blog: www.RickardsRead.com

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