|My opinions relating to demutualization generally involve life insurance mutualities only. There are many other types of mutualities, some related to different types of insurance (automotive, health, home, etc.). Some mutual organizations do not offer insurance of any kind. I am not overly concerned about demutualization unless it involves stored-up wealth of its members.|
In any type of demutualization, existing policy contracts remain valid. That is, theoretically there will be no effect to death benefit, cash value, or policy earnings projections. Because demutualization is a recent phenomenon (more so for MHC's), there is no long-term validation of this theory.
Mutualities which have been attacked by such personages include Standard Life (®, UK), Scottish Provident (®, UK), Friends Provident (®, UK: Quakers for Heaven's sake -- they pillaged the Quakers!), and MassMutual (®, USA).
As best as I can
tell, the Amish & Brethren Beneficial Association
(USA) has been relatively unscathed.
The jerks probably realize if the A&BBA were to demutualize, a real,
live stock company would be formed.
Modern carpetbaggers would have little interest in the 3 sheep, 2 goats,
rooster, and 5 chickens they might strangle out of this organization.
Besides, it would be just too much hassle nowadays to rent the horse
and buggy necessary to acquire their ill-gotten gains.
Eliza gives her succinct opinion
concerning the carpetbaggers.
"Rich, I don't get it. What is wrong with any of this?"
I am not saying full demutualization is unethical. The owners of property should have the right to sell their property. You used the correct word; demutualization is generally "wrong". In the first place, there is the violation of trust. There are those (myself obviously included) that believe in the concept of mutuality, and they specifically chose to buy a policy from a company because it was "mutual". The trust those people had is violated by the greed of others. In the second place, there is the violation of integrity. Not so much "integrity" in the moral sense, but integrity in the sense of a solid, complete, unbreakable foundation. When a mutuality writes a permanent insurance policy, it is not simply a legal contract. It is also a solemn commitment to be there 50 years from now. Corporations do not think in terms of 50 years. Or 5 years. They think in terms of 3 months -- this quarter. How did we do this quarter? "OMG, we need to lay some people off to make the quarterly report look less bad!". This is no way to run a life insurance company, IM(not so humble)O.
Since I have included diagrams of a
simple mutual insurance company, a
complex mutual insurance company, and a
mutual holding company, here is one for a fully
demutualized insurance company. This one is "real life", adapted from
Prudential's Demutualization site. (It is no longer available.)
As I write, policyholders are voting to approve or disapprove the plan.
They have until 31 July 2001 to vote. To be approved, there
must be at least 1 million votes cast (of 11 million eligible voters), and
at least 2/3 of those voting must approve. I'm not
"picking on" Prudential; it is simply a convenient case study for full
demutualization because they have made all their documentation publicly
(I snooped around the MetLife ® site and have come
to the conclusion that the dog ate their demutualization info. They
fully demutualized in 2000.)
6 August 2001|
Results of Demutualization Vote
over 4 million votes cast
92% favored demutualization
(votes of true owners not reported separately)
Prudential ® shows its current (mutual) form as seen on the right.
In their demutualization, they plan to distribute the "total value" of the
mutual company to policyholders. Actually
only about 40.5% will be directly distributed in one form or another
(see Share Breakdown below).
The majority of shares will be owned indirectly by the former
policyholders. These are "treasury shares".
As they are sold or used directly to buy
other companies, policyholder ownership will decrease proportionately.
Theoretically, the total value of Prudential Financial, Inc. will increase
as these shares are depleted. (It's the old
"smaller piece of a bigger pie" theory.)||
Completely owned by PolicyHolders|
Get a Piece of the Rock ®
In this demutualization plan, the definition of "policyholders" is
extremely liberal. Participating policyholders (currently defined
as the true owners) and almost all non-participating policyholders,
term life insurance policyholders, health-insurance policyholders, annuity
owners, and even some former policyholders are all scheduled to get a piece
of the pie. As I understand it, almost everyone who had a policy by
15 Dec 2000 will get at least 8 shares, or the cash or
policy-credit equivalent of 8 shares. (If you have ever had any
financial instrument from Prudential and have not received a package from
them, it would be extremely wise of you to contact them now.
You might be eligible and not even know it.)
The true owners' value will be diluted by about 11.8% of what they would
otherwise get if they were the only ones eligible.
(I.e. an owner who would have gotten 1000
shares will only get 882 shares.)
Prudential wrote pages and pages documenting what the considerations were in dividing the shares among policyholders, but apparently never states what the actual formulas were which utilized these considerations (per Appendix F of their demutualization documentation). The considerations seem to favor new policyholders, in my opinion. Apparently someone with a 3 year-old $100,000 policy and $1200 in total cash value will be treated almost (or even exactly -- it's hard to tell) the same as the owner of a 9 year-old $100,000 policy with $15,000 in cash value. Whether this seems "fair" to an individual voter or not depends a lot on how much cash value his policy has accumulated.
Reserves will be reduced from $11.7 billion to $7.0 billion (a 40% reduction), with anywhere from $360 million to $2.5 billion going directly to the new parent corporation. A block of shares will be reserved for distribution to directors, executives, and employees as stock options. However, everyone is specifically denied a bonus for making the "deal" go through. The options are to be distributed over a long period of time.
There will be from 89 million to 102.35 million shares available for sale at the time of the Initial Public Offering (IPO). These shares are actually part of the 40.5% total granted to policyholders. But many policyholders will receive cash instead of stock as their only option, and many more will choose to accept cash instead of stock when given the option. This cash (or in some cases "policy credit") is where a lot of the reserves will be going, and the shares freed up are those that may be sold at the IPO.
Historical Updatewith the IPO occurring between 13 and 17 December. 126.5 million shares were sold during the IPO by Prudential. 16.5 million of those shares were actually released on 21 December, when the underwriters for the IPO exercised an option to purchase them.
18 Dec 2001 was the formal date of demutualization,
Between 13 and 21 December, the PRU stock price varied between $29.00 (low
on first day) and $30.99 (both high and close on the 21st —
numbers courtesy of
that 616.5 million shares were available for trade, the vast majority being
passed directly to policyholders.
Prudential is choosing not to convert participating policies to non-participating ones. No further participating polices will be written, however. Participation will be accomplished by reserving a special block of shares.
Total Share Breakdown:
The income associated with the Class B ("closed block") of stock,
aided by other complex factors including a tightly coupled conservative
investment portfolio, will determine the future dividends paid to participating
policyholders. To gain necessary wisdom, the actuaries broke out their
calculators and incense. This enabled them to design an infrastructure
which will provide equivalent dividends to what the policies would
have received as a "Piece of the Rock".
In general I have great respect for actuaries, but when they render complex judgments about market factors 20 or 40 years in the future, it is a bit of a stretch. This is especially true when they choose to compare "what will be" to "what might have been". Hopefully some of them backed up their findings with I Ching meditation. If not, let me render my illiterate prognostication: "The participating policyholders might do the same as they would have, they might do worse, and they might do better." There. (It was harsh, but it had to be said. Now who are you going to believe -- me, or senior actuaries who could spend my weekly salary during brunch?)
Converting participating policies to non-participating ones would require a separate vote, this time of just the pre-existing owners. It might prove embarrassing to Prudential to have any sort of undiluted vote of the owners, and such a vote is avoided. Having such a large voter pool is not completely Prudential's idea, though. Apparently New Jersey law requires that non-participating policyholders be given a significant voice in the issue of demutualization. Still, I must note that since all policyholders get one vote per policy, regardless of whether they will be entitled to 8 shares or 8000, it is easy to drown-out the feelings of the pre-existing owners.
I have no financial interest in Prudential, and will be neutral on whether this is an overall fair plan or not. If I sound biased against it, that is true, but not because of the plan itself. As stated above, I strongly feel that the mutuals should remain mutual. "Fairness" is basically a subjective concept, different for every voter. I suspect some will be induced to vote in favor of the plan because they realize the shares they will receive are actually more than they "should" get. It is likely also that many will vote for the plan feeling it is unfair to them, but wanting to have the shares and\or cash now as opposed to mutuality ownership rights. Such rights are, quite honestly, a bit difficult to use in buying that Harley ®.
In the positive, Prudential is somewhat a special case in that it began as a stock company and mutualized later. So its tradition is not the same as a company founded as a mutual, solely for the benefit of the policyholders. There appears to be no outright theft going on -- the plan does compensate policyholders for their loss of ownership. Let me quote Prudential concerning the alternative reorganization as a Mutual Holding Company. This is directly from their demutualization FAQ.
Why is Prudential choosing full demutualization instead of creating a
mutual insurance holding company?|
Prudential believes that a full demutualization will be most beneficial to Prudential's policyholders. The value of the company will be distributed to eligible policyholders in the form of shares of stock, cash or policy credits, while existing policy provisions remain the same. These benefits would not be available to policyholders in a mutual holding company conversion.
[emphasis is mine, not Prudential's]
Here's an example of a fictional Mutual Holding Company formed from a large mutual company.
If you did not already "click here" in the above table, you will not have seen where all the reserves went. Ah, now you have checked it out. Good. And I'll bet you still don't know where all the reserves went. Which, when you think about it, is probably a major motive behind either full demutualization or formation of the Mutual Holding Company.
The policyholder equity box is basically an illusion to make the MHC conversion seem less of a cheat. In theory, the participating policyholders will still "own" part of the entire entity (typically 51% of voting shares). But consider the Prudential full demutualization above. They are keeping about 60% of the potential value as "treasury" shares, owned by the corporation as a whole. By contrast, the MHC keeps 51% plus some outside the MHC box -- i.e. they are keeping the same percentage of the company as Prudential, but not returning a dime to the policyholders. (Prudential is returning billions.) Consider that policyholders of the MHC will still only get one vote per policy, while stockholders will get one vote per share. And if a full demutualization does ever happen, the policyholders have already sacrificed much of their property without compensation. And they lost a lot of the reserves in the initial reorganization. And they are likely to lose more of the reserves in a full demutualization. And "51% of voting shares" -- what a crock of hooey. Since voting shares include neither preferred shares nor treasury shares, the pre-existing owners are essentially lied to. They are told that under no circumstances will their ownership interest go less than that, but what sounds like "majority ownership" is not. ... And, hmmm, well golly!
The MHC pictorial is intentionally inverted to reveal the illusion. The legal state is that the MHC is the outer, overall, organization. But the practical state, and the very reason for transforming to MHC form, is to isolate the mutuality. Let the overall company act as a normal corporation, but pretend it is still preserving the rights of the original owners and remaining true to its mutual heritage.
I am about to go "over the edge", so let me say first that some companies have formed or want to form an MHC as a transitional step to full demutualization. In those cases, where there is a sincere intent and practical goal of eventually transferring fair value back to the original owners, conversion to an MHC might well be legitimate and ethical. [For the other cases, well, listen to my shouting as I fall...]
The first company (or few companies) that wants to do this in any given state has to convince the legislature that this is a nifty-kean idea. Their case is something like this:
And they donate lots and lots of policyholder's money to the campaign chests of the governor and legislators. Some lawmakers are clueless; they don't know what a mutual insurance company is in the first place, so eliminating such a strange entity will be one less thing to have to seem knowledgeable about. Other lawmakers are simply, um, appreciative of the donations.
A few states have already fallen. A law is passed that says, essentially,
"this entity which was owned by no one can be sold to the public at large".
I'm sure there are lots of pretty words and noble-sounding phrases too, but
in the end, the executives of the company can sell it. The company still
needs to get a majority of voting policyholders to vote for this transition,
but since most policyholders never vote anyway, this step has been one of
the easiest and cheapest ones to accomplish. It is quite
interesting that the participating policyholders don't have sufficient
owneriety to fully own the company in the "real" sense, but it
is sufficient to give them the authority to sell it. I bet that
after the first six-pack (or the sixth toke),
it all would make a lot more sense.
Afterwards, the companies which have already converted to mutual holding corporations might say, "Rich Franzen and others of his ilk are ignorant trouble-makers; our policyholders realized the importance of making this transition and voted to do so." Yeah, right. Whatever. How's your yacht?
[... climbs back up canyon wall] Let me be partially fair.
Some of the arguments in favor of an MHC are not completely hollow.
In my case, I own a participating policy from New York Life. It owns
a stock subsidiary called NYLIAC (New York Life Insurance and Annuity
Corporation). How much "right" do I really have to ownership of
NYLIAC? Much of its value derives from policyholders who desired the
extra flexibility that Variable and Universal policies
provide. The money those policyholders have put into their policies
does not belong to me in any way, shape or form, nor do the reserves NYLIAC
has built up over time. I view "ownership" in this case as a trust.
Commitments were made to those policyholders, and
it is the duty of NYL to have NYLIAC fulfill those commitments.
(If a dime or two of NYLIAC profit is added to the
general earnings of the mutuality, this is still a better result than a dollar
or two going to stock holders of a fully corporate insurance company.)
Ok, let's go further: fairer than fair. Assume almost
every claim in favor of MHCs is true. Assume there is no self-serving
ulterior motive by the executives and directors of the Mutual Company.
Assume it is even not financially unbeneficial for me to abandon my ownership
rights without meaningful compensation. Besides the theft thing, is
there some other problem? Let us see: -- Now my policy is part
of the Mutual Holding Company owned by the bigger corporation. The
law which allowed the establishment of the MHC says it must continued
to be operated exclusively for the benefit of the policyholders.
My policy still participates in the earnings of the MHC, and the dividends
I receive are the profits of the MHC.
That is to say, there can be no financial return to the stockholders of the corporation. The current executives are happy with this situation. They know how hard the conversion was to accomplish, and, hey, maybe some of them really do have concern for my rights. But what about 22 years from now? The executives who drove this transition are gone. To the new executives, the MHC will not be viewed as a trust, but dead weight. It is not earning anything for the corporation as a whole. My policy (and I) are relics of a past that no longer matter -- a problem, not an opportunity. I have gone from being an owner to living in the corporate ghetto. So, yeah, I have a problem with the MHC concept even if the claims in favor of it were true.
|I might be wrong. Perhaps the MHC is not dead weight to the corporation. Perhaps the law allowing the creation of the MHC does more than "insure" that it will be operated exclusively for the benefit of its policyholders. Perhaps it also allows fees, considerations, and shared business expenses to be passed on to the corporation. Perhaps it allows pooling of reserves to insure not only the health of the Mutual Holding Company, but the health of the corporation as well. Perhaps I am an asset after all! Perhaps I not only got robbed in the very creation of the MHC, but have the distinct pleasure of being robbed annually thereafter.||
"Are you sure you have
never worked for the IRS?"
And, what do you want to bet? -- 33 years down the road, after attrition has significantly reduced the number of participating policyholders, the executives of the corporation will be arguing before regulators that such a small population of policyholders has no right to own such a large percentage. "It's just not fair", they will say. And you know what -- that's likely the first honest thing they will have said in the last 34 years.
|The terminology normally used by a commercial insurance company which is owned by its policyholders. I prefer mutuality, emphasizing the core nature of its existence. Many of the current managers of these companies would prefer to freely act like corporate executives, forgetting their historical roots, legal foundation, and duties and traditions of trust. In fairness, things do get fuzzy when the mutual company fully owns one or more stock companies. But it is not that fuzzy -- the money to establish or purchase the stock companies originally came from the policyholders of the mutuality.||
Here's an example of a fictional mutual company which has been around a long time. It has grown both large and complex.
The internal development pool is where most profits end up. This money would be used to grow the overall company. In Prudential's demutualization documentation, they state that for them it was a very rare event when profits were passed to participating policyholders. This is a bit disturbing from an ownership point of view. Since the wholly-owned subsidiaries were initially bought with policyholder's money, and since the entire mutual company is to be operated "for the benefit of the policyholders", it should be clear that the policyholders deserve some return from what they "wholly own". I don't expect as much as a stockholder would, and I don't mind a mutual company making itself bigger. Still, this doesn't excuse the executives and Board of Directors from their responsibility to those they say they benefit.
Prudential executives will be partially off the ethical
hook if their demutualization is approved. The profit initially
denied participating policyholders will be returned to many of
them as they become stockholders. (Ethical relief will not come
to those who died before receiving this compensation.)
Mutuals need to let their participating
policyholders participate in all earnings.
There should be a legal firewall around NAL Joint Ventures, Inc. Whenever doing business in foreign countries, the assets of the mutual company as a whole need to be protected from potentially disastrous legal changes, coups, revolutions, nationalizations, etc. Similarly, if involved in a co-venture within the USA, it would be extremely unwise to have all assets of the mutual company at risk because your partner did something stupid.
The participating policyholders of New Amsterdam Life own it. Policyholders or investors in any of the subcorporations have the same rights as they would in a stock corporation, but this does not include ownership rights. It may not seem fair to someone who bought a permanent life policy from NALIAC. There is a basic tradeoff:
The expectation of profit is less than if they were stockholders of a stock insurance company, because stockholders are willing to expose themselves to higher risk. Plus, philosophically, mutuality means that assets are treated as a trust, not property to plunder. And realistically, competition with other insurance companies forces that NALIAC policyholders be treated well.
If Demutualization of NAL Were Controlled by Me
I would actively oppose its demutualization. But if NAL were going to be fully demutualized anyway, then I would allow non-participants a consideration in the distribution of the shares of stock. Here are some ideas which seem fair to me.
Other owners of NAL would justifiably argue that non-participants have no right to a single share. Now you might see the biggest problem with demutualization — its sheer complexity. There is no way to do it in a manner which seems "fair" to everyone. The issue of "ownership" is moot so long as the mutual structure is maintained.
Several Types of Financial Mutualities|
Building Society||These are organizations similar to Savings & Loans. The USA has had them, and still might have a few. They are more prevalent in the nations of the British Commonwealth. From what I can tell, there is a stronger emphasis on customer ownership than an S&L. But like S&L's, they are tending to demutualize. In the UK, they are a favorite target of the carpetbaggers, who can gain membership with a pittance, campaign for demutualization, and walk away with assets far in excess of their contribution. The Queen should really do something -- it's downright unBritish!|
Credit Union||In the USA, this is the probably the most well-recognized financial entity owned by its members. State regulation and their charters work together to keep them mutual. They drive large commercial banks crazy -- sure its great when the credit unions accept accounts for people without a lot of money. (These accounts are a bother to commercial banks, which pay pitiful interest on those deposits, then charge a monthly fee equal to 10 times the interest paid.) But when the credit unions have the audacity to offer mortgages to their members, or offer credit cards, or checking accounts, the banks yell "unfair! unfair!!". (They are right -- it's "unfair" to rob people just because they are poor.) I'm just glad low-income people have a place to put their money that doesn't charge them for the privilege of entering the building. If they stick with the credit union after acquiring a bit of wealth, that is justice, not unfairness.|
|Fraternal and religious organizations often have an associated company which sells insurance to members of that organization. They may provide some financial return to the sponsoring organization. Theoretically the goal is reasonably-priced policies for the membership as well as fundamental integrity of structure.|
or Savings Bank
|This kind of mutual organization has a state or federal banking charter. Some Savings & Loans evolved into mutual banks. There are not many left -- most of them in the USA have demutualized. In many cases the regulators have let them keep "mutual" in their name, even though there is nothing mutual about the corporate entity any more. ˇCaveat Emptor!|
Many who have money invested in a mutual fund do not realize that they
actually own it. It may be managed by Fidelity ® or
TRowePrice ®, but the assets are fully owned by the investors, not the
company. Fundamental decisions require a vote of those invested in the
fund. A charter change (e.g., converting from
a "large cap equity" to a "small cap value" fund) would require a vote,
as would a dissolution (usually to enable the assets to be managed by
another fund in the same family).|
The Vanguard Group ® deserves special mention. Not only are the funds owned by those investing in them, but Vanguard itself is a mutual, owned by its funds. This allows them to have the lowest fee structure of any of the major fund families. There are no stockholders demanding that Vanguard itself deliver profits quarter after quarter. This significantly reduces the need to siphon fund money to Vanguard, and fees remain low.
Savings & Loan|
|An organization which exists primarily to offer housing loans (mortgages). They seem to be more focused on borrowers than on savers. In recent years there has been a tendency for them to demutualize and become commercial banks or sometimes even "Commercial Savings & Loans". Let the buyer beware!|
hypocrisy notice: I have stock in a large
regional bank. It was bought in self-defense --
I was being fee'd to death! I might still pay fee's, but I also
earn dividends from my shares. These dividends actually have
greater earnings than the interest they pay on savings accounts.
As the Church Lady would say, "Isn't that special?"
In my defense, I still do significant business with the
Great Lakes Credit Union, where I have been a satisfied
customer (and owner!) since 1974.|
Some of the nation's largest mutuals, including Prudential, MetLife and the
Equitable actually began as stock companies and converted into mutual form, at
least partially in response to the Armstrong Commission investigation in 1905.
The Commission, created by the Legislature and the Governor after a media storm
surrounding scandals at several life insurers, was named after its chairman,
Senator William Armstrong, and headed by Charles Evans Hughes, who later served
as Chief Justice of the U.S. Supreme Court from 1930-1941. The Commission found
evidence of a startling number of abuses within the industry, including illegal
loans, massive political contributions, fraudulent financial statements, self-dealing by officers and directors, lavish expenses and improper withholding of
dividends to policyholders. Many of the reform recommendations made by the
Commission were adopted and are in NYS law today.
The Feeling's Not Mutual
Report by the Assembly Committee on Insurance
Alexander B. Grannis, Chair -- March 1998
The three companies named above have apparently decided they can
"play nice" with the other children now. They have
already fully demutualized or are undergoing full demutualization.|
The Equitable (now a division of AXA) was first, in 1992.
Hmmm, am I the only one who won't be real surprised if newspaper headlines in 2005 are a lot like they were in 1905? I am not implying anything about the three named companies, but about stock insurance companies in general. Maybe even some mutuals this time around (since some of their executives are acting like corporate wanna-be's anyway ...).
Once their violations of duty and trust catch up to them, they have two options. Both involve rescue by another company. The better alternative is to do what some mutuals do from time to time anyway, which is merge with another mutual company. If they have so screwed up that no other mutual will have them, or if they never believed in mutuality to begin with, then they can try to find a publicly traded company to "buy" them.
they may have brought the mutuality so far down that neither is an
option, and the mutual company goes bankrupt. Bankruptcy is a rare
and unlikely result (life mutualities are very robust), but it can
happen. Creditors are paid, and the remaining assets are distributed
to the former policyholder-owners and annuitants.)
A sponsored demutualization is what must happen if they are to be bought. This is a form of full demutualization. The difference is that the policyholders receive stock in the sponsoring company rather than stock in a new company. The mutual company and sponsor agree on a price and a plan of conversion. Once state regulators approve the plan, it is presented for vote by the policyholders.
I doubt the policyholders would vote it down. State regulators should have assured that there is some degree of fairness to the deal, and the policyholders are likely anxious to get rid of the scoundrels who placed their assets at risk. The original bosses might get paid millions of dollars apiece just to go away once the deal is done.
During the transition process, a polite facade is established whereby the old senior executives and board members are thanked and praised for their diligence and hard work. (Cynics may view such talk as irony or downright sarcasm.) After the deal is done, the sponsor probably has very little use for those whose ineptness was proven by the very need to sell their life insurance mutuality.
It has happened that senior management from the failed mutual is kept on by the acquiring corporation. There is not a lot of actual respect, but you can bet rot knows rot. In this case, hundreds of those lower on the totem-pole, who strived to make the mutual company work like it should, are let go. It doesn't do to keep trouble makers around who might actually value policyholders over quarterly profit reports, raided reserves, and questionable business practices.
|When the scoundrels get bored, I think some of them run for Congress (or find some other job where bad work is highly regarded). Geez, I can hear one on TV now...|
|The Sound-Byte||The Poetic Reality|
|I know how to lead large organizations in times of complex change. As CEO of Lostbearing Mutual, I oversaw the transition of an out-dated 19th century organization into a modern 21st century corporation.||
I was an incompetent twit|
with neither the will nor the wit.
My mutuality died because of it.