Tuesday, July 15, 2014

(No.268) Economical Insurance's demutualization: what's next?


"Economical Insurance's demutualization: What's next?"

by Alastair Rickard


The annual meeting of Economical Mutual Insurance Company, the Waterloo Ontario based property and casualty insurance company, took place on June 24.

Readers of the columns appearing on RickardsRead.com in the past several years [most recently column nos. 251,253,255 & 260] concerning the relative handful who can vote among the 1 million+ Economical policyholders will be familiar with the fact that the small group (through their mouthpieces on the board of directors) proposed in Dec. of 2010 to demutualize the company, i.e., to convert it from a mutual company to a stock company.

It was and remains a calculated attempt by this group of fewer than 1000 policyholders whose policies carry the right to vote to realize the company's (currently) $1.6 billion in equity by demutualizing and distributing that value among themselves.

As for the rest of the company's policyholders, they were to get no share of the equity under the company's concept of demutualization even though the only justification for the claim by the 943 voting policyholders was that, somehow, they had been carrying a special burden of financial risk until just a few years ago because in theory they could have been called upon financially for assistance by the company if the company ever encountered financial difficulties.

 [Reality check: this never happened and in the modern era never would have; today's small group of insiders hold 'special' policies that carried no more financial risk to the holder than those of other policyholders. O.S.F.I., the federal financial regulator ref. solvency, requires a capital to debt ratio (MCT) of 150%. Economical Insurance's MCT was, at the end of 2013, twice the required level -- 295%.]

In the run-up to the company's annual meeting in June, through a "backgrounder" prepared for the media and at the Economical annual meeting, the company's board of directors and senior management continued to work hard at spinning their favourite arguments for why demutualization should take place and why it was essential to the company's well-being.

To anyone knowlegeable about the Canadian insurance business and its regulation the main arguments of this company 'spin' exercise range from the false through the unconvincing to the downright silly. Unfortunately too few journalists and media analysts are both able and willing to deal with that reality.

For example: Economical, a large 'Top 10' property and casualty company in the Canadian market, is (the company asserts) forced to demutualize in order to access capital to be able to buy other P & C companies to bulk up to enable the company to compete (note -- it is a company with more than $5 billion in assets as of the end of 2013).

Of course one needs to ignore the fact that demtualization is hardly the only option available to acquire money for a company whose equity has risen by more than 31% -- $370 million -- in the past 3 years. To call this and similar Economical arguments kleenex thin is to insult a useful personal product.

Or one might count the P & C companies in the Economical group (presumably their ownership by Economical was not brought to the company's front steps by the sugar plum fairy) as well as looking at the company's annual report to count the dollars available to support acquisitions.

As a former executive with the Mutual Life Assurance Co. of Canada, also of Waterloo, this argument for demutualization reminds me of a similar one used by the board and senior management of Mutual Life to try to add some substance to their weak case for demutualizing the oldest Canadian life insurance company thus guaranteeing its disappearance two years later. Disappearance into some corporate maw is not only a possible but likely consequence of a demutualization of Economical Insurance.

Studiously ignored at Mutual Life (as at Economical these days) were certain inconvenient truths. For example: the fact that Mutual Life had recently, as a mutual company, easily found the 'capital' to buy the very substantial Canadian operations of both Metropolitan Life and Prudential Assurance.

The reality was that Mutual Life, a company that could have carried on as a mutual being a major competitor in Canada, was unnecessarily and unwisely demutualized.  So could Economical continue as a mutual in its markets, although another core purpose of the demutualization initiative may turn out to have been to turn Economical into a shareholder company so it can be acquired by a buyer willing to pay through the nose as was the case with Mutual Life's purchase by Sun Life.

So what can one usefully deduce from recent comments by Economical Insurance's chair of its special demtualization committee and its CEO? In terms of a firm grasp on the reality of things, not too much.

There may finally be a lukewarm acknowledgement of sorts from within Economical that in the real world of Canadian law and politics the fewer than 1000 'members' of the Economical insider group -- although chafing at the delay in the delivery to each them of what they want and to which they believe they are entitled: i.e., $1 million+ of the company's equity value on demutualization -- may have to share at least some ot the company's value with the company's hundreds of thousands of other policyholders. Doubtless the majority if not most of the insiders still firmly believe that they both deserve and should receive "preferred" financial treatment.

Considerable attention also seems to have been given within the company to a 'choice' between Economical demutualizing and becoming a publicly traded company or very soon after demutualizating being acquired (q.v., Mutual Life) by a buyer with deep pockets, Canadian or more likely foreign.

Outside the cloud-cuckoo-land in which the preponderance of those in the Economical insider group seem to have been dwelling since at least December 2010, in the here and now of Canadian federal politics, legislation and regulation, there are some relevant facts and informed speculation most readers are unlikely to have come across involving the development of a demutualization regime to which the Economical insider group is so anxious to gain access.

For example: take note of the detail in the federal government's recent omnibus budget bill C-31 into which the Harper government again dumped a variety of things having nothing to do with the government of Canada's annual budget. Specifically: consider the actual wording in the amendments to Canada's Insurance Companies Act which empower the federal government to create regulations necessary for the demutualization of any federally regulated property & casualty insurance company.

It is obvious that the group within Economical wanting demutualization (i.e., the board of directors, the senior management and the 'voting' policyholders) are expecting that these regulations will appear in draft form for public comment before the end of this year.  I am not so sure.

For one thing the departure from the federal cabinet of the politically seasoned Finance Minister Jim Flaherty introduces some uncertainty. He was in no hurry to act on this file, one forced on the government in Dec. 2010 by the Economical's unexpected proposal to demutualize.

Flaherty's replacement Joe Oliver, while perhaps less inclined than Flaherty to look askance at an attempt by the few to arrogate to themselves what equity indicates should be shared among the many, may well realize that the political math (943 votes vs 1 million+ votes) is something deserving of caution and extended consideration.

There are also some potential new complications which could interfere with the smooth sailing and speedy passage of the good ship PC Demutualization, a voyage so ardently desired for so long by the Economical Insurance bunch.

I wonder, for example, about the fact that in bill C-31 the federal government not only gave itself the power to make regulations for a demutualization process for P & C companies, it also gave itself the power to create regulations that "may provide for court intervention in the process, including the circumstances in which the court is to be seized of any matter in relation to that process, and may govern the court's powers and procedures in that regard" (Section 211 of C-31).

Might the federal government be going to delegate to the courts a role in the job of sorting out what is equitable vis-a-vis the demutualization  of a P & C insurance company?

OR, might the government be going to try to restrict the courts' jurisdiction and limit court powers vis-a-vis P & C company demutualization?

OR, ...?

If the first, then it would inter alia seem likely to open P & C demutualization to endless litigation while -- if the second -- it would absolutely beg for, indeed virtually guarantee a challenge ending before the Supreme Court of Canada, one likely to be successful.

Finally, what if anything might the eventual federal regulations governing P & C insurance company demutualization have to embrace or restrict if they were to anticipate and address the potential for even more egregious financial double dipping by (to use the immediate example) Economical's 943 'voting policyholders'?  This is not merely a theoretical question.

This issue could require regulatory consideration in this context if, having received some "preferred" share of Economical's equity on a demutalization, the insider group then decide to sell the now shareholder-controlled company (or control of it) to a buyer, thus realizing a second financial windfall for themselves? Might the feds decide to draft P & C regulations that would anticipate this possibility?

This is not an idle question. The regulatory powers with which the federal government endowed itself allow the feds to create regulations about "the ownership of shares" in a P & C company that is converted to a stock company.

There is more that could be said but that is sufficient to be getting on with. Stay tuned.

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email: Alastair. Rickard@sympatico.ca

blog: www.RickardsRead.com

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