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.




to set a 'Google alert' in order to receive automatic notice of
new columns as they are posted to, go to

previous columns and the blog archive: to access columns and the blog
archive, the links to which are listed chronologically in the margin
beside each column as it appears on the
website, go to a recent column and use the links