Federal demutualization regulations now in effect, Economical Insurance to consider options

Canada’s Department of Finance has issued the long-awaited final rules governing federally regulated mutual property and casualty insurance companies, a move welcomed by Economical Insurance, which has been readying its business for the demutalization option over the last few years.

The Mutual Property and Casualty Insurance Company with Non-mutual Policyholders Conversion Regulations were finalized and published in the Part II of the Canada Gazette July 1, 2015. The draft regulations were published in the Canada Gazette, Part I Feb. 28, and were subject to a 30-day comment period.

“If the directors of a mutual property and casualty insurance company wish to pursue its conversion, they must pass a resolution recommending conversion,” the final regulations state.

The key factors in determining eligibility remain unchanged in the final regulations, notes a statement Tuesday from Economical Insurance. Subject to specific exceptions, an eligible policyholder is a person who holds a mutual policy of the demutualizing company on the date the board decides to proceed with demutualization (eligible mutual policyholder), or a person who holds a non-mutual policy of the demutualizing company and has done so for the 12-month period ending on the date the board decides to proceed with demutualization (eligible non-mutual policyholder), the company reports.

The enactment of the new rules has proved a lengthy and complex regulation development process. Economical Insurance announced its intention to pursue demutualization more than four years ago.

With the final regulations in place, p&c mutual companies that choose to demutualize can use the federal framework to convert into companies with share capital, notes the Economical Insurance statement.

“Economical’s special committee and Board of Directors (BoD) are carefully reviewing the final regulations in order to determine whether demutualization within the final regulatory framework is in the best interests of the company and how to proceed,” says John Bowey, BoD vice-chair and head of the committee.

Related: Draft P&C demutualization rules aim to treat non-mutual policyholders fairly: Economical

The four-phase demutualization process is as follows:

• board resolution recommending demutualization;

• first vote of eligible mutual policyholders (eligible mutual policyholders vote on whether or not to proceed to the next stage of the demutualization), which needs to be approved by the Office of the Superintendent of Financial Institutions);

• the policyholder committee negotiates the conversion proposal; and

• second vote to amend bylaws and third vote to approve demutualization (the second vote is by eligible mutual policyholders to approve bylaw amendments to permit eligible non-mutual policyholders to vote on the conversion proposal, and the third vote is by all eligible policyholders to approve the conversion proposal and to authorize the company to seek final approval from the federal Minister of Finance).

Should board members decide to proceed, it is anticipated a special meeting will be held in early fall to allow eligible mutual policyholders to vote on whether or not to open negotiations with eligible non-mutual policyholders, Economical Insurance reports. If so, the company “will prepare and send a notice to all eligible policyholders to inform them of the demutualization.”

The many involved steps – assuming each is successful – means the process will take at least an estimated two years to complete. To obtain authorization, the regulations note that the company in question must submit to the Superintendent of Insurance information related to, among other things:

• the conversion proposal;

• an opinion prepared by the actuary of the converting company and an opinion prepared by an independent actuary;

• if other benefits are to be provided in lieu of shares;

• the annual statement for the most recently completed financial year of the converting company;

• pro forma financial statements of the future converted company showing the effect of the conversion and any other significant transactions contemplated in relation to the conversion, including any proposed initial public offering of common shares; and

• the notice of the special meeting.

Assignment of responsibilities for the conversion proposal – which contains the detailed terms for the company’s demutualization – is one of the most significant changes in the final regulations, Economical Insurance reports.

“The mutual and non-mutual policyholder committees still have the important responsibility of negotiating the allocation of financial benefits, and the demutualizing company is required to include the negotiated allocation in the conversion proposal,” the company notes. “Economical believes this is a change that will help to promote the demutualizing company’s best interests.”

Economical currently conducts business as Economical Insurance, Economical, Western General, Economical Select, Perth Insurance, Family Insurance Solutions, Federation Insurance and Economical Financial.

Related: Draft regulations for demutualization of p&c companies released

With regard to eligibility, the demutualization backgrounder notes policies issued by subsidiaries of a demutualizing company would not be eligible policies.

In Economical Insurance’s case, eligible policies are those issued by the Economical Mutual Insurance Company, including those sold by Family Insurance Solutions and under the Western General brand. Policies issued by Perth Insurance Company, Waterloo Insurance Company, Missisquoi Insurance Company, and Federation Insurance Company of Canada would be excluded.

Economical Insurance has been undergoing substantial changes over the last couple of years. Senior officials have talked about enhanced flexibility is required to improve the company’s position to be able to grow and compete in consolidating p&c insurance market.

“Canada’s p&c insurance industry is consolidating and Economical wants to play a meaningful role in that consolidation,” the backgrounder states. “The big are getting bigger. The largest companies are acquiring smaller competitors and gaining market share and economies of scale.”

The mutual insurance company structure restricts the ability to access capital and, in the longer term, could become a competitive disadvantage, the backgrounder notes. Demutualization allows for improved financial stability and flexibility (no longer having to rely on retained earnings), as well as positioning for industry consolidation (the company cannot achieve its objective of being among the T
op 5 p&c insurers in Canada through organic growth alone. It needs access to capital for acquisition funding or to deploy as acquisition currency), it adds.

Over the last four years – since Economical Insurance began pursuing the demutualization option – “there have been eight major transactions involving the Top 10 participants in the industry, affecting more than 12% of total industry premiums,” including three significant examples of this consolidation (Intact acquisition of AXA Canada, Traveler’s purchase of The Dominion of Canada General Insurance Company by Travelers, and the acquisition of State Farm Canada by Desjardins Group).

The regulatory impact analysis statement notes the federally regulated mutual p&c sector is narrow and consists of seven companies: Wawanesa Mutual, Economical Insurance, Gore Mutual, Portage La Prairie Mutual, North Waterloo Farmers Mutual, Saskatchewan Mutual and The Kings Mutual.

“In general, these companies are relatively small, ranging from approximately $30 million to $270 million in equity, although Wawanesa Mutual and Economical Insurance rank among the top 10 largest p&c insurers in Canada, each having over $1 billion in equity as of December 2014.”

As of March 31, 2015, Economical Insurance had about $2.0 billion in annual premium volume and $5.2 billion in assets.

Gerry Hooper, chairman of Economical Insurance’s BoD, recently told attendees of the company’s annual general meeting that it is time for the company to unlock its “potential to compete on a level playing field with larger competitors and become a leading force in the Canadian property and casualty industry.”

“To compete on an equal footing with the leading Canadian and foreign-owned companies in our market, we are investing heavily in our long-term competitiveness (including completion of a major transformation of underwriting operations) and establishing a platform that will not only position us to deliver exceptional operating results, but to integrate future acquisitions, as well,” Hooper said at the time.

“To grow from being the eighth largest p&c insurance company to the fifth largest means that we have to grow our top line by 50% or $1 billion,” noted Karen Gavan, president and CEO of Economical Insurance. That means organic growth alone will not be sufficient, Gavan pointed out.

“Scale is critical to achieving long-term, sustainable competitive advantage.

In the face of these challenges, our industry has no choice but to focus on improving underwriting profitability,” she said during the AGM.

In the wake of the final regulations, Bowery notes that “the approach set out in the regulations is complex and will take time to complete. We estimate that, assuming each step of the process is successful, it will take at least two years before the demutualization is complete with final ministerial approval.”

During this time, “the board believes Economical will continue to strengthen its financial position, as it has over the past several years,” he adds.

“To give companies time to adjust to their new corporate structure and to limit the risk of takeover of recently demutualized companies,” the regulatory impact statement points out that regulations “require demutualized companies, subject to certain exceptions (e.g. if the converted company is in financial difficulty), to be widely held for two years following demutualization. The new corporate structure will foster competition by enabling companies which choose to demutualize to have access to capital which will allow them to grow and compete.”

The impact statement adds that with regard to a sponsored demutualization approach, it is not clear if the associated benefits of allowing this outweigh the benefits of the takeover protections. “The Department of Finance Canada will examine these issues in more detail, and if warranted, will come forward with a proposal on sponsored demutualization at a future date. In regard to extending the widely held requirements to five years, this could limit the flexibility of a converted company unduly, and so has not been included in the final regulations.”