Wednesday, February 19, 2014

(No.258) Insurance company demutualization in Canada

"Demutualization in Canada: some of the real story behind 
Mutual Life, Sun Life, Manulife and Canada Life
becoming stock companies"

by Alastair Rickard

Over time I have devoted a number of columns on to the proposed demutualization of the Economical Mutual Insurance Co. of Waterloo, Ontario, a large federally regulated Canadian property and casualty (p & c) insurance company and to the matter of the regime to be developed by Ottawa to govern the demutualization of such companies.

In various columns including the one immediately preceding this one ("Some reflections on 'what if' history & an insurance business odyssey" -- No. 257) I have also indicated my view that the demutualization of the Mutual Life of Canada was unnecessary, unwise, unfortunate and undesirable. I have received emails from others formerly associated with Mutual Life who hold views similar to mine and have published excerpts from several of them.

The regime developed by Ottawa to govern the demutualization of Canadian life insurance companies is a parallel to the still awaited demutualization regime to be developed by the federal Department of Finance because of the request to demutualize by Economical Insurance.

The process to develop a p & c company demutualization regime was kicked off in June 2011 by the announcement of public consultation by Minister of Finance Jim Flaherty who solicited views about what the regime governing the demutualization of p & 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 but not all submissions were posted by Finance to its website. My submission was heavily censored before it was posted.

Claude Gingras, LL.L., LL.B., LL.M., is a lawyer and was until 1995 Vice-President & General Counsel of The Mutual Life of Canada when he moved on to assume other roles outside the company, He is now retired. He made a particularly substantive and well-informed submission to Finance on p & c demutualization: "Submission to the Consultation on a Demutualization Framework for Federal Property and Casualty Insurance Companies".

His submission also dealt with several little noted and understood aspects of the previous demutualization regime developed by Ottawa for mutual life insurance companies, one ultimately used by four major Canadian life insurance companies: Mutual Life, Manulife, Sun Life and Canada Life.

The Dept of Finance would not post Mr. Gingras' submission unless he agreed to a number of deletions from his text. He refused. However his submission was published in its entirety on (No. 209, posted July 31, 2011). The passages Finance insisted had to be deleted are underlined in the text of the submission as it appeared on RickardsRead.

Prompted by views presented in RickardsRead about Ottawa's life company demutualization regime Claude Gingras sent me some comments about it and its use by the four companies. His comments appear below. Any editiorial insertions by me appear as [italics within square brackets].


From Claude Gingras:

Your blog reproduced the rather negative views of some of your readers toward demutualization [of Canadian mutual life insurance companies], especially that of Mutual Life of Canada. This led me to ponder two questions:

(1) How did the right to demutualize come about?, and
(2) Was the demutualization regime established by Ottawa for life insurance companies the best that could have been?

Heavy stuff in respect of which a long chapter could be written; I will try to keep it short.

1.  The right to demutualize

Prior to the revision of the federal legislation on insurance companies in 1992, there was only a right to mutualize in the Canadian and British Insurance Companies Act, the predecessor of the Insurance Companies Act (ICA).  That right was put there in the 1950s to allow major stock life insurance companies to convert themselves into mutuals in order to avoid being taken over by American interests. It was a defensive nationalistic measure, not one to give policyholders a better corporate governance system.

At that time protection of policyholders’ interests was taken care of by the strong office of the [federal] Superintendent of Insurance. That office was merged in 1987 with the office of the Inspector General of  Banks to form the Office of the Superintendent of Financial Institutions (OSFI) and soon after came the in-depth revision of the insurance legislation, and the bankruptcy of the mutual Confederation Life in 1992, a victim of the real estate crisis at that time.

This is how the right to demutualize came about in the new Insurance Companies Act of 1992: as an unsuccessful attempt to provide Confederation Life with means to replenish its vanishing surplus by a share issue. Here again, not much thought was given to the corporate rights of policyholders and, I suspect, to the implications of a possible massive wave of demutualization in the Canadian life insurance industry.

Some countries did not allow demutualization, just merger with another mutual entity if deemed desirable, France for instance.  But in Canada the right was seen as  a nice thing to have, just in case of capital need.  As a safeguard, policyholders were precluded from making proposals requesting conversion into a stock company; demutualization could only be initiated by management.

In fact the companies that demutualized at the turn of the century (Mutual Life, Manulife, Sun Life and Canada Life) would be incapable, I am sure, of producing any substantial evidence of policyholders requesting demutualization, even if the CEO of the first company [The Mutual Life Assurance Co. of Canada] to announce its intention to convert into a stock company was saying to everyone who would listen that this was the right thing to do, meaning, presumably, giving the ownership of the company to the current generation of its voting policyholders who were already in absolute control of the company.

In the 1997 revision of the Insurance Companies Act, attentive to the possible desire of mutual companies to make acquisitions or increase their capital, Ottawa gave them the right to issue voting shares, called “participating shares,” not exceeding a minority interest.

Surprisingly, mutuals seeking approval to convert in order to become stock companies never explained in the material they provided to voting policyholders, when seeking approval of their conversion, why they could not use this 1997 right to access capital even though the demutualization regulations required them to provide “a description of the alternatives to the conversion of the company that the directors of the converting company have considered, and the reasons why, in their opinion, the conversion is in the best interests of the company and its policyholders as a whole.”

It’s a fact that, while the conversion regime [i.e., for mutual life insurance cos. to stock life cos.] was devised by the Dept. of Finance, the Office of the Superintendent of Financial Institutions was in charge of supervising compliance with the regime for each converting company.   It is also a fact that a court of law recently reminded OSFI of its duty under its constituting legislation to protect the rights and interests of policyholders when discharging its functions (i.e., a duty extending  beyond company solvency only).

The life insurance companies’ demutualization regime was almost prepared under duress.  Indeed Ottawa must have been taken by surprise when, of all mutual life insurance companies, The Mutual Life of Canada first announced  its intention to demutualize in 1998, a year after the ICA revision of 1997.  Except for the 1992 right to demutualize, no process was in place in the law; everything had to be done quickly.

Mutual Life was a prosperous, successful and well capitalized company that had always been a mutual company from inception [in 1868]. The other large mutual life insurance companies followed suit almost immediately.

2. Thus the relevance of this question:  was the regime for the conversion of mutual life insurance companies that was put in place the best that could have been?

In my opinion, the answer is no, even if the worst was avoided.

It should be remembered that, at that time,  the management of the majority of large Canadian mutual life insurance companies were of the view that policyholders did not own their mutual companies but rather that management was in charge of a trust for the benefit of society at large.  (They never explained how “society at large” could hold them to account, however!)

In that perspective, the value of a company could be used on demutualization to attract outside investors rather than being all allocated to policyholders.  An industry meeting even contemplated a Michigan conversion scheme where up to 35% of the value of the converting company could be allocated to management, disregarding the fact that such a regime was put in place in that state for the benefit of P&C companies in need of capital!

Fortunately the Canadian regime required the allocation of the entire value of a converting [mutual life insurance] company to the hundreds of thousands of participating policyholders who had the right to vote (with the addition of the non-participating policyholders of Mutual Life who also had a right to vote out of a compromise reached with the local authorities when the company started to carry on business in the British colony of Newfoundland at the beginning of the 20th century.) This was much better than giving the value of the company to outside investors or management!

But the regime put in place was not perfect for a number of reasons, including the following:

(a)  Why was senior management allowed to obtain shares and share options only one year after demutualization when the better foreign models provided for a waiting period of 3 to 5 years?  Some of the Annual Information Forms of the converted companies, filed with the SEC in respect of the second year after conversion, indicated very generous free allocations of share options to senior management, which were certainly not made in order to attract them to join the companies since they were already in position. This, and the fact that two of the companies [Mutual Life and Canada Life] did not ask for a widely held status after conversion (which would have precluded any take-over), might be relevant to answering the question of who benefited from demutualization in these companies.    

(b) Why did OSFI allow converting [mutual life insurance] companies to “lend” required surplus to the participating accounts from the non-par accounts? In order to maximize the value to policyholders on demutualization, we are told, with the result that still today there is no surplus in those participating accounts, referred to as closed blocks? This, policyholders are told, was made possible pursuant to “supplementary documents” filed with OSFI at conversion but not disclosed to policyholders, then or now.

Why is surplus not allowed to arise in a closed block? Do those supplementary documents provide that any surplus left after the smoothing of policy dividends is automatically transferred to the shareholder account as charge for the “loan?”

Do these “loans” stem from the view, dear to many actuaries in the business, that there is no difference between a participating and a non-participating policy except that the cost of the latter is determined prospectively while the cost of the former is determined retrospectively?  Yet millions of participating policyholders were told that their policies would participate in the surplus distributions of the company.  If the policy dividend mechanism is used only to mitigate the risks of the insurer,  who is misrepresenting the situation here?

(c)  The demutualization of four large [Canadian] life insurance companies, together with the appearance  in the 1980s of “adjustable policies” where premiums or other elements of the policy could be changed at the discretion of the company on renewals or “from time to time” - an excellent substitute for participating policies from the point of view of a company – deeply transformed the Canadian life insurance market.

Other jurisdictions that experienced a major wave of conversions [mutual to stock companies] in their life insurance market were quick to react by enhancing the rights and interests of policyholders in their corporate insurance legislation.  This is true in the UK and of Australia especially, but not exclusively.  In Australia, for instance, the Insurance Act was amended in 1996 to order management and directors  to give preference to the interests of policyholders over the interests of shareholders when the two might conflict (as this may happen often in the allocations of assets between accounts or the allocation of expenses to these accounts, for instance).

Here in Canada the federal government did nothing!  Yes, there was a set of proposals put forward in a Consultation Paper of the Department of Finance in 2003 that would have required directors and officers to consider the interest of policyholders in their management decisions, and that would also have required companies with participating policyholders to have meaningful disclosure of dividend policies for policyholders and disclosure also of the manner in which these companies manage their participating accounts.

There was even a bill (C.57) that went through the House of Commons and the Senate in late 2005, that provided authority to make regulations to specify that meaningful disclosure.  Bill C-57 was proclaimed on November 26, 2005, but these enabling provisions never came into force due to the failure of the Canadian Government to produce the needed regulations (the Executive frustrating the intent of the Legislative...)

In the absence of competition [in Canada] to shareholder-owned life insurance companies following the disappearance of these four major mutual life insurance companies, and in the absence of counterbalancing legislation to protect policyholders’ interests, one must conclude that it is impossible to say that the life insurance demutualization regime put in place at the time was the best that could have been.




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Sunday, February 9, 2014

(No.257) "Some reflections on 'what if?' history & an insurance business odyssey"

"Rickard of RickardsRead offers a few reflections on his odyssey  
in the life insurance business and its intersectiion with the 'what if?' school of history"

by Alastair Rickard

In my experience academic historians don't care all that much for what has been called the 'what if?' school of history. For example, what would have happened if Abraham Lincoln or John F. Kennedy or Archduke Franz Ferdinand had not been assassinated? Or if Hitler had not invaded Russia in June of 1941 or if either of the Quebec separatist referenda had succeeded?

While historical hypotheses based on 'what if?' speculation are unprovable, they can have an interesting relevance. Case in point: in 1931 two pedestrians were knocked down in the street by cars. Either or both could easily have been killed. One, visiting New York was Winston Churchill; the other, in Munich, was Adolph Hitler.

Years of studying history helped me gain some understanding of the importance of learning from the past as well as informing my understanding of the present and occasionally encouraging some personal 'what if?' speculation.

In terms of my education in the reality of the life insurance business, at root a business dependent upon 'selling stuff', the most valuable part came early on working in the field as a salaried financial planner with Mutual Life of Canada career agents and their clients. Indeed it was this formative experience which both created and propelled the growth of my unlikely interest in the business. I use the word "unlikely" deliberately.

As for the 'what if?' school and my personal history:  I well remember during drinks following my successful defence of the thesis for my second graduate degree (an event that occurred after I had joined Mutual Life) a couple of my erstwhile professors made clear to me that they thought I had lost my ability to make good judgements. For them the ultimate evidence of this was my having declined a Canada Council fellowship I had won (and had deferred taking up), thereby stepping off the path to a professorship in favour of pursuing my then budding interest in the life insurance business. I was not deterred by their scepticism.

Within a few years I had reason to reflect on the quality of my judgement compared with that of this duo who had shared their opinion with me over sherry that afternoon:  one ended up in prison while the other was murdered by a stranger he invited to his Mexican hotel room. 

The company I had joined from grad school, the Mutual Life of Canada founded 1868, was the first and the only significant Canadian mutual life insurance company founded as a mutual. The other big Canadian companies in this category (Sun, Manufacturers, Canada, Confederation) had all been stock companies that mutualized in the late 1950s and early 1960s as a means of avoiding foreign takeover.

For the life insurance companies it was an optional solution to their problem devised by then federal Supt. of Insurance K.R. MacGregor. He told me years later that the CEOs of a number of larger Canadian stock life insurance companies came to Ottawa begging for help to avoid the possibility of foreign, mainly U.S., takeover.

Later on he was invited to become the CEO of Mutual Life and accepted; he said it was the only Canadian life insurance company for which, becasue of its high standards, he would ever have agreed to become CEO. MacGregor was as fine a gentleman as I ever knew in the life insurance business and I have been fortunate enough to have known quite a few in Canada and the U.S.

By the time I joined the business these 'stock company mutuals' were chafing at the organizational restrictions imposed by mutuality, an approach to the life insurance business and to policyholder ownership and benefit in which their senior managements (it seemed clear to me, then and now) did not believe and to which they paid no more than lip service in any case -- and precious little of that. Only in Mutual Life had a fairly significant tradition and belief in and practise of mutuality survived down the years -- although it declined sharply latterly.

The tolling of the final bell for a fine, historic Canadian company, one owned by its participating policyholders in Canada, began on Dec.8,1997 when Mutual Life's senior management and board announced that the company would demutualize. It became a stock company renamed Clarica Life, a dumb name and one that was short-lived. 

The tolling of the bell concluded on Dec.17, 2001 with the announcement of the purchase of Clarica Life by Sun Life (also demutualized). However the disappearance of Mutual Life (like Canada Life) was inevitable once demutualization had occurred and Ottawa's short term post-demutualization protection from takeover applicable to these two new stock companies had expired.

Neither Mutual Life nor Canada Life was the beneficiary of the sort of ongoing protection provided by required widely held status (which would have precluded any post-demutualization takeover), status enjoyed then and since by both Sun and Manulife. Why? The senior managements of Mutual Life and Canada Life did not ask for protection because they did not want it. 

The fact that only half of the quartet of big demutualized Canadian companies (Confederation Life having become insolvent) had protection of their independent status going forward is something for which the senior managements of Mutual Life and Canada Life, so eager to have their mutual companies become stock companies available for takeover, can share as much blame (more in my view)-- or credit, depending on one's point of view -- as can the federal government of the day.

Since these demutualizations of big Canadian life insurance companies more than a decade ago the interests of millions of par policyholders have run a distinct second to those of the companies' shareholders. Demutualization, perhaps most sadly for the Mutual Life of Canada, was both unnecessary and mistaken and not in the longer term interests of its par policyholder owners.

The same could also be said about a number of the other former mutual life insurance companies including in the U.S. On the flip side of that American coin are some larger mutual companies like New York Life and Northwestern Mutual which wisely remained as mutuals.

Those who argue that Canadian life insurance company growth -- especially via takeovers -- required demutualization and the raising of capital through a share structure are always happy to ignore inconvenient facts. For example: Mutual Life bought the Canadian operations of both Prudential Assurance and Metropolitan Life before it became a stock company.

In 1997 Canadian insurance legislation had been changed permitting mutual life insurance companies to issue voting shares which could not exceed a minority interest. This option was never used. In companies whose boards and senior managements were determined to demutualize, there was no interest in devices and approaches that would provide reasons not to demutualize thus negating the misleading message in their public song and dance about the need to demutualize in order to be able to access capital.

[The actual story behind regulatory and company aspects of Canadian life insurance company demutualization has not been told on the record. will attempt to fill in a few of the blanks in a future column.]

Nor should one forget that mutual company structure simply did not hold out the prospect of the sort of inflated levels and forms of executives' financial reward so readily available after a mutual becomes a stock company. Indeed as a key factor in propelling demutualization it should never be discounted.

Some of us who were associated with the Mutual Life of Canada will continue to remember job satisfaction derived from serving the company's par policyholder owners' best interests. It was a perspective that did not come from a quarterly results fixation.

It did not spring from decisions aimed at winning smiles of approval from institutional investors, financial media, rating agency analysts and various toads in the life insurance garden, nor from the priority routinely accorded in recent years to the financial aggrandizement of a financial services company's senior management group and board of directors [q.v., the pattern since ca. 2000 in senior executive compensation in the demualized companies].

During my years with Mutual Life, and entirely separate from my employment, I started in 1978 as a spare time activity -- and as what I thought of as my modest contribution to the Canadian life insurance industry's mental health -- the Canadian Journal of Life Insurance. It was a magazine that accepted no advertising and set out to publish material and opinions and focus on issues that trade magazines (dependent as they are on industry advertising) customarily choose to avoid.

Since CJLI was a spare time avocation of mine, and as the years passed more and more of that spare time was devoted by me to my employment, it was the Journal which eventually had to be put on the shelf after more than a decade.

Mutual Life's senior management had been most unhappy when (without consulting them) I started CJLI but I kept my job although I was told by the CEO that it was "hanging by a thread". It turned out to be a thread with rather remarkable tensile strength, one that did not break under the pressure of further threats of job termination or periodic threats of libel actions by several life company CEOs (among others who were particularly unhappy with what appeared in the pages of CJLI).

Nor did my departure from the company occur even when Sun Life bought Clarica although Sun had been a company I had criticized extensively in CJLI.

I was on several counts an unlikely corporate survivor throughout my odyssey in the life insurance industry. Indeed had anyone asked me in, say, 1980 how likely it was that I would ever find myself not only an employee of Sun Life but a survivor of its takeover of Mutual/Clarica, I would have put the odds of both events happening about the same as Don Cherry being chosen the national leader of the New Democratic Party.

After years as both an executive and (in my spare time) an editor, writer and industry critic, including latterly during my time with Sun Life, I did reach a point finally where I felt I had likely said or written, both to company management and publicly, everything I wanted to say about the business -- at least twice.

Some years prior ro my actual departure from Sun Life it had become as plain as a pikestaff to me that the time was approaching to remove myself.

It was time to put some distance between me and the tiresome combination of industry hypocrisy and executive cant, to separate my day-to-day existence from the industry's love affair with its brands of 'New Coke', from much of its current approach to the life insurance business including its ritual quarterly genuflection before investors under-informed about the business and from its handling and (mainly) mishandling of the various forms of agency distribution.
And so I departed.




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