Life Insurance GlossPinion
Demutualization Annex

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Prudential's Proposed Post-Demutualization Structure
Growing and Protecting Your Wealth ®

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 to policyholders (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
Prudential's Pre-Demutualized Structure
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.

Note that stock options are not actually "free"; they are offered at a certain price (usually but not always less than the market price), and the person offered the option has a certain amount of time to choose to buy it.  This is typically one to three years.  Some companies require the actual purchase, and some allow an immediate purchase at option price followed by sale at market price, generating a net cash gain.  In this second sort of transaction, the optionee will never see the shares he bought and sold, only the cash (and of course the taxes).  In the first sort, the company requires a holding period after purchase, which in my opinion adds a bit more legitimacy, especially to purchases made by executives and directors.  They have a bit more incentive to keep the company on track and profitable.  I cannot tell what methodology will be used by Prudential.  This may be a decision left for the new Board of Directors to decide.

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 Update
18 Dec 2001 was the formal date of demutualization,
with 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.

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 Yahoo!).  Note 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".

Reality Check
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?)
'I Ching' hexagram index
I Ching

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]


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