Demutualization is never an easy process. From investments in systems to consolidate and organize policyholder data, to communicating the steps of transition to support staff, agents, policyholders, and the general public, to dealing with state regulators and the SEC, demutualization is a rigorous, time-consuming and ultimately expensive exercise.
Yet the benefits demutualization brings to an organization are well worth the effort. Improved access to the capital necessary for growing the business, the ability to compete on a level footing against ever larger competitors, and the creation of reward structures that attract, retain and motivate talented human capital can all result when an insurer moves from a mutual to a stock company.
Thus far, life and health companies are leading the demutualization trend. Realizing the opportunities and challenges presented by legislative and regulatory reforms, changing economic conditions and increasing global competition, such US giants as Prudential Life Insurance Company of America, John Hancock Mutual Life Insurance and Metropolitan Life Insurance Company, have all embraced demutualization as a means of revitalizing their organizations.
While property/casualty companies have been slower to demutualize, indications are that many are considering the move to shareholder ownership structures. In the medical malpractice arena for instance, a growing number of retiring policyholders are driving the change in order to extract the accrued value in those companies that their initially astronomical annual premiums have helped to create.
What's more, shorter product lifecycles can make demutualization an arguably less complicated undertaking for property/casualty companies. But the process is still a significant undertaking.
Whatever their stripes, mutual insurers must overcome a number of hurdles on the road to demutualization. From developing the parameters for policyholder eligibility and consideration, to opening their operations to the critical eyes of Wall Street analysts, the issues to be considered are many and varied.
To be sure, miss-steps can add costs to an already expensive process. One large company spent some $300 million on outside consultants when it recently demutualized. Those expenses were over and above the charges for systems upgrades and regular communication with staff, agents, policyholders and regulators.
Other insurers have found themselves with mounting bills for facing down legal challenges from irate policyholders who feel either that they are wrongly being left out or not being fairly compensated for the level of their contributions to the company's accrued wealth.
The key to making the journey a smoother, more economical one lies in careful preparation. And that is where the experience of trailblazing life and health insurers lends the most value to their property/casualty counterparts that plan to demutualize.
An ounce of prevention
Not surprisingly, most life and health insurers have found that much of the initial groundwork in the demutualization process begins well in advance of notifying policyholders, regulators and the market at large of their intentions. What's more, the bulk of these efforts are focused in-house, on such issues as boosting returns, modernizing systems and improving process efficiencies, as well as developing mechanisms to compensate policyholders for their loss of ownership interests in the mutual company.
Preparing for life as a stock company starts with the development of an action plan for demutualization, as well as laying out the goals and objectives for the company once the conversion to the new ownership structure is complete. These steps are vital for guiding the company through a difficult and time-consuming process, as well as preparing for the scrutiny of analysts and shareholders. For instance, many life and health companies have changed the format and accelerated the timeframe in which they report earnings to meet the demands of the more intense analyses to which stock companies are subjected.
Indeed, performance issues should be addressed well in advance of conversion. Because insurance companies tend to have higher levels of capitalization, return on equity often is lower than for other financial services firms. Performance improvement is especially important for insurance companies that do decide to conduct an initial public offering (IPO) of shares as part of the demutualization process because their performance will be compared against non-insurance financial services companies.
Insurance companies also must clearly articulate their plans for the capital to be raised in an IPO. Failure to deploy those funds quickly and achieve effective results could reduce investor interest and make competing with other stock insurers more difficult.
But internal preparation does not stop there. Life and health companies have found mining data on policyholders a time-consuming task and one that exposes weaknesses in their IT systems. In one recent demutualization, the company relied on a state database to obtain policyholder address information for several policyholders they initially could not locate. This took place so late in the policyholder voting process that they incurred further expenses to communicate with those groups and individuals, resulting in a delay in the voting process.
Because policyholders often own more than one policy, culling this data and coordinating it accurately are imperative for keeping down the cost of communicating the changes, as well as for reducing information fatigue for the policyholders that must approve the changes. Thus, investment in systems upgrades that are aimed at creating new policyholder databases represents money well spent for demutualizing insurers.
Life and health carriers have found that this is especially true when it comes to the mission-critical issue of determining policyholder consideration. While insurance companies are required to compensate policyholders fairly in return for extinguishing their ownership rights, consideration has become an explosive issue in many life and health conversions.
For property/casualty mutuals, there are equally pressing issues. For example, in the case of medical malpractice insurers, policyholders who contributed to a company's early capitalization tend to expect more policyholder consideration because of the initial risks they have taken. Equitable allocation of consideration among different classes of policyholders is difficult to achieve.
What's more, the treatment of policyholders that have purchased their policies from subsidiary stock companies needs to be addressed to avoid potential conflicts. Policyholders may view their policy as one issued by the parent company, rather than the subsidiary, based on a common company name and representations made by the company and/or its agents. Often, this necessitates review of sales practices at both the parent and subsidiary organizations.
In the United States, accepted life insurance industry best practice dictates that policyholder consideration is determined via complicated actuarial calculations of how much each policy has contributed to the company's surplus and how much value they are expected to add in the future. Meanwhile, many mostly non-US companies have sought to simplify the process by basing consideration on policy characteristics, such as premium amounts and the length of time the policy has been in force. While this practice creates a more user-friendly allocation process, it's one that sacrifices fundamental actuarial principles and can result in a less equitable distribution of consideration and a summary rise in the risk of policyholder litigation.
Further, insurance companies must determine the form of consideration to be distributed and how they will compensate for exceptions. Generally, considerations are in the form of stock, cash or policy credits, yet special cases often arise that make this a far from straightforward choice. Thus, insurers also must decide how, and to what extent, policyholders will be given a choice as to the forms of consideration they receive.
Some US life and health companies have found that certain policyholders located outside the domestic market are not eligible to receive stock. A similar risk arises if companies decide to dissolve existing ownership rights by giving policyholders cash. If companies obtain the cash by offering shares via a public floatation, there is a risk that the stock won't trade at a price that is as high as expected and companies may end up raising less money from the IPO than they have paid out to policyholders. To mitigate these risks, life and health companies have linked the policyholder consideration and recapitalization processes by making shares of stock in the demutualized insurer the primary form of consideration.
The value of communication
Keeping constituent groups, from policyholders and regulators to in-house managers and independent agents, abreast of the steps and progress of demutualization via the use of early, frequent and coordinated communication is vital to ensuring that the conversion process runs at optimum efficiency. As mentioned earlier, failure to carefully describe information regarding the conversion and consideration to policyholders - or even to reach them - has driven up costs and delayed time to market for demutualizing life and health companies.
As with so much of the advance preparation for conversion, effective communication begins in-house. Informing managers not directly involved in the process, back office staff and client-facing professionals of both the drivers of demutualization and the company's plans for conversion can reduce problems down the line. Indeed, life and health companies have found that regularly briefing staff is as important as continually updating policyholders.
For insurers that distribute their products through independent agents and brokers, it is imperative that those groups are made aware of the progress of the demutualization at regular intervals so that they can address policyholders concerns effectively. If employees, brokers and agents do not understand why demutualization is a positive and important strategic move, it can lead to low morale, customer dissatisfaction and negative public perception.
What's more, it is important to initiate and maintain effective lines of communication among third-party consultants that are assisting in the conversion. Any duplication of efforts can drive up costs dramatically.
Once the internal communication strategy is in place, interaction with policyholders can begin. The company needs to communicate with policyholders regularly to let them know what is happening and why. At the same time, policyholders must communicate back to the company, typically through a voting process, whether they approve of the demutualization and the company's plans to compensate them for their loss of ownership rights.
Life and health companies increasingly have taken a multi-media approach to policyholder communication, combining dedicated Internet websites with traditional vehicles such as newspaper advertisements, press releases and direct mail. Consumer groups opposed to demutualization tend to be high profile, so it is critical for demutualizing companies to emphasize the positives to the public.
Communication with customers initially involves determining which policyholders are eligible to participate in various aspects of the demutualization (such as voting and receipt of consideration), what policies they own and where and how they can be reached. Again, this often becomes a systems issue. Insurance companies are expert at tracking policies, but often lack the infrastructure capabilities to track policyholders. And although individuals may hold several policies, they do not need (or want) more than one set of communication regarding the conversion process.
Data mining and manipulation has proved an arduous task at best for the largest life and health carriers. For multi-line property/casualty insurers, it is arguably more difficult.
No less laborious and time-consuming is the regulatory approvals process. No matter how tempered they are in their time-scale projections, life and health carriers invariably have found that they must contend with regulators who may need to comply with certain requirements that necessitate more time.
Regulatory approval from an insurer's state of domicile (and, in some cases, other states) is required for conversion. Demutualizing insurers also need to contact the SEC to comply with requirements for filing, prospectus and related matters. Further, tax implications may require coordination with the IRS.
Because regulatory reviews are exhaustively comprehensive, they are viewed as the critical path in demutualization. As guardians of policyholders' interests, regulators must exert considerable care in evaluating conversion plans. In some cases, irate policyholders have initiated lawsuits against them, making thorough due diligence all the more paramount.
Yet life and health companies have found that by exercising the same care in advance planning and communication, they can better manage the process of dealing with regulators. And this is indicative of the value of a comprehensive approach when converting from a mutual to a stock company.
Indeed, by taking into account all of the issues - from eligibility and consideration to the need for coordinated and clear communication - companies can reduce the risks and lower the costs inherent in the demutualization process. Drawing on the lessons learned by their life and health counterparts, property/casualty insurers can position themselves to deliver higher returns to their shareholders by unlocking the value accrued in their companies.
Based in Hartford, Connecticut, Patricia E. Matson is an experienced manager in Arthur Andersen's life & health actuarial services practice. Robert G. Palm is the managing partner of Arthur Andersen's property/casualty actuarial services practice, based in New York City. Eamonn Rice is the partner leading Arthur Andersen's Scottish financial services practice and is based in the Edinburgh office.