A by-product of the move towards financial services deregulation in the United States could cause chaos in the insurance industry, both on the life side and on the property/casualty side, as mutual insurance companies try to work out how to keep up with the big boys, says Phil Zinkewicz.

The announcement earlier this year of the merger by Citicorp and Travelers only served to drive home even further the message that the large financial services players are not going to wait around while Congress and state regulators fiddle with the "hows" and "wherefores" of removing the boundary lines that, under the Glass Steagal Act, have kept banks out of insurance, insurers out of banking and investments, and securities firms out of both.

It is all up for grabs right now, and mutual insurance companies - giants such as John Hancock, Prudential and Metropolitan Life - are anxious to get into the game. But they are not having an easy time of it. Because they exist under the "mutual insurance company" concept, they find it hard to raise the additional capital they need for acquisitions, and acquisitions are essential for them to play in the same league as the major banks and securities firms.

Their only answer is to "demutualise," - that is to cease being mutual insurance companies owned by the policyholders where the chance for raising additional capital is minimal, and to "go public". By becoming a stock company, they can raise additional capital by public offerings, and that is exactly what p/c and life insurance companies now stuck under the "mutual" umbrella want to do. The question is: how?

Demutualising how?

There are several reasons why the demutualisation process in the US is a thorny one. The idea of demutualising is not new. It has been done in the past. But the increasing number of mutual insurance companies taking this route and concerns by regulators and consumer activists as to the treatment of policyholders under demutualisation mean a great deal of attention has been focused on the "how".

It should be remembered that, under a stock insurance company situation, the company is owned by its shareholders who may or may not be policyholders. Traditionally, under the mutual company approach, policyholders have been the "owners" of the company. Therefore, what do they get when demutualisation occurs?

The issue began festering late last year, and then came to a boil this year over the consequences of the demutualisation a decade ago of a Des Moines, Iowa, company called Allied Mutual. A lone man, David Schiff, whose background is in the insurance business but who is now the editor and publisher of a New York based newsletter, has been leading a fight on behalf of its policyholders, whom he argues have been put at a serious disadvantage by the actions of the company management.

Allied Mutual elected to demutualise under a holding company approach, one which was approved at the time by the Iowa Department of Insurance, rather than just "demutualising and paying off the policyholders either in cash or in stock ownership," says Mr Schiff. A holding company, called Allied Group was formed, which became a publicly traded company. Allied Mutual was then spun off as a sister company.

At first, Mr Schiff's allegations were dismissed by executives of Allied Group. Questioned by the Wall Street Journal, one executive said: "What does he know? He's just a writer from New York." But Mr Schiff persisted and now the current Iowa Insurance Department and the Center For Insurance Research have entered the controversy. The Iowa Department has initiated an investigation into Allied Mutual's demutualisation, and the Center for Insurance Research has instituted a class action lawsuit against Allied Group for $500 million on behalf of policyholders.

In addition, Mr Schiff has become a crusader of sorts, testifying before various state insurance departments in the US which are considering legislation similar to the Iowa law that allowed Allied Group to demutualise under the holding company concept.

Complicating the situation even further is the fact that Nationwide Mutual recently offered a considerable amount of money to absorb both the Allied Group and the mutual. Mr Schiff was not impressed. He says Nationwide is offering $110 million to take over a mutual that has about $300 million in surplus plus other assets. "Nationwide can have the stock company for the price it is offering, but it should not be allowed to suck up the mutual for $110 million when policyholders are owed so much more."

However, in mid-July, an Iowa District Court judge denied a request from an Allied Mutual policyholder, backed by the Center for Insurance Research, to halt the takeover on the grounds that it was not in the best interest of policyholders. The company president and ceo Douglas Andersen expressed his pleasure with the ruling. "We believe that Allied Mutual's board of directors acted appropriately in negotiating a merger agreement with Nationwide that the board believes is in the best interest of policyholders," Bestwire quotes him saying afterwards.

Hearings before the Iowa state insurance commissioner were due to begin later in the month, and Allied Mutual had also scheduled a meeting for its policyholders.

Quandary for regulators

Whether or not Mr Schiff's allegations of conflict of interest on the part of management hold true, the Allied situation stands as a case in point. The fact of the matter is that mutual insurance companies are anxious to go public, and regulators are apparently wondering how to proceed.

For example, in New York this year, Governor George Pataki and the New York Insurance Department were backing proposed legislation that would have allowed mutual insurance companies to "demutualise" by creating holding companies as "umbrellas" for the existing mutual and a newly created stock company, along the lines of the Allied approach. Similar laws already have been adopted in 18 states and are being considered by other states.

In New York, however, Alexander Grannis, chairman of the state assembly's insurance committee, put a stop to the movement and, in a special report, detailed a host of concerns about the bill, most particularly how it would affect policyholders of the mutual. He says that, with the proposed legislation, policyholders would give up control of their companies and be exposed to added risk.

Almost immediately after Mr Grannis' action, John Hancock Mutual Life Insurance Co, which had, along with Met Life, been a staunch supporter of the bill, announced that it would demutualise, but not in the holding company fashion. Instead it would effect complete demutualisation in the fashion of Prudential and MONY (Mutual of New York).

The announcement by Hancock was a surprise to the proponents of the holding company approach to demutualisation, because it had been so solidly in Met's camp. Many believed that the controversy over Allied and the overall criticism of the holding company concept were, in part, responsible for Hancock's decision. Stephen Brown, ceo of Hancock, however, said that such criticism was not a "significant factor" in the company's decision to abandon the holding company approach.

Met Life continued its campaign to have the Pataki bill passed, taking out ads in major New York daily newspapers saying that the approach was beneficial to policyholders. Despite those efforts, however, the bill was defeated.

Canada

That defeat notwithstanding, the move towards insurance company demutualisation is bound to continue and, not just in the US. In Canada, for example, during the last year four leading insurers have converted from private to publicly traded companies.

On 10 December 1997, Mutual Life Of Canada, Waterloo, Ontario, was the first of the four to announce its intention to demutualise. Manufacturers Life Insurance Co, also known as Manulife Financial, followed suit in January. Sun Life Assurance Co of Canada announced its intention to demutualise that same month, and Canada Life Assurance Co made a similar announcement in April.

Citing competition from other parts of the financial services industry as a key reason for the trend, Donald Guloien, senior vice president for business development for Manulife Financial, told a New York conference on mutual restructuring, that demutualisation will "reinvigorate ourselves, our policyholders and the industry as a whole."

Canada Life's president and chief executive officer, David Nield, was quoted at a recent company meeting as saying that demutualisation would accomplish the goal of broader access to capital markets, which in turn would foster internal growth and an expansion of the company's existing acquisition strategy.

US regulatory babel

However, demutualisation in the US may be a good deal more difficult than in Canada where the insurance industry is regulated at the federal level. In the US, there are 50 state insurance departments, with myriad, often conflicting regulations, despite the efforts of National Association Insurance Commissioners (NAIC) to establish uniformity.

Moreover, on the subject of free and open markets for all financial service industries, there is a veritable regulatory and legislative "tower of Babel" to overcome. States regulate insurance, but the federal government has a hand in certain areas. National banks are under federal control, but state-chartered banks fall under state banking authorities. The securities industry is regulated by the Securities and Exchange Commission (SEC) and also falls under the purview of various other securities regulatory authorities. Then there is the Office of the Comptroller of the Currency which has taken a dictatorial approach to regulating bank involvement in insurance.

Add to all that the questions raised about demutualisation and whether policyholders may be being ripped off by insurance company management and the situation becomes even more complex. As the trend continues, US courts may have to determine whether policyholders actually own mutuals, as mutual insurers have touted in the past, or whether insurance company management can call the shots in the demutualisation process.

Phil Zinkewicz is an insurance writer based in New York and a regular contributor to Global Reinsurance.