June 24, 2014 by Canadian Underwriter
A successful demutualization would help Economical Mutual Insurance Company in its goal of becoming a leader in the property and casualty insurance industry, amidst consolidation that is seeing larger P&C companies gain market share, notes an Economical backgrounder issued in advance of the company’s 2014 annual general meeting Tuesday.
The largest P&C companies are acquiring smaller competitors and gaining market share and economies of scale, the backgrounder notes. Since announcing its intention to pursue demutualization in December 2010 – a move meant to increase Economical’s financial flexibility and long-term strength – there have been six major transactions involving the Top 10 participants in the industry, affecting more than 12% of total industry premiums, the information adds.
With a mutual company’s structure, however, Economical is restricted in its ability to access capital. A successful demutualization would allow the company to overcome limitations inherent in the mutual structure, principally by the following:
“In the longer term, this is a very real competitive disadvantage,” the backgrounder notes. “Economical would risk becoming increasingly marginalized in an increasingly competitive environment dominated by stock companies.”
But like any other P&C company considering demutualization, Economical will first need to take a good look at federal regulations (not yet developed) to determine if demutualization is in the best interests of the company. Since the beginning of 2011 – just after Economical announced its intention to pursue demutualization, subject to the approval of both its policyholders and federal regulators – the company has been pushing for regulations.
The regulations moved a step forward when Bill C-31, the federal budget implementation act, recently received Royal Assent, enacting amendments to, among other acts, the Insurance Companies Act (ICA). Those changes include broadening the Governor in Council’s regulation-making authority under the ICA, which supports the “eventual implementation of the regulations that will allow federally regulated mutual property and casualty insurance companies that choose to do so to demutualize,” notes a statement Monday from Economical.
“The amendments to the ICA indicate that the courts may play a formal role in the demutualization framework. However, the nature and scope of that role will not be known until draft regulations are released,” adds the backgrounder.
In demutualization, a regulated process, mutual policyholders’ ownership and voting rights of the mutual company are exchanged for common shares in the stock company, the backgrounder explains. The two main types of insurance companies are mutual, owned and governed by their mutual policyholders/members; and stock, owned and governed by shareholders who may or may not also be policyholders.
The ultimate choice of Economical’s board between an initial public offering (IPO) – which would convert Economical from a mutual company to a public corporation with shares traded on a stock exchange – or a sponsored demutualization – which would involve a transaction with one or more companies that invest in the company to acquire a significant ownership position, perhaps as much as 100% – “depends on the implications of the demutualization regulations, the economic environment and prevailing market conditions,” the backgrounder notes. If the decision is made to move forward, “the complex process of developing and approving an appropriate conversion proposal will begin,” the information adds.
“It is likely that enabling legislation would require non-mutual policyholders to participate in a demutualization by having their policies (sometimes referred to as ‘cash’ policies) converted as well. In the process of converting, the demutualizing company distributes to eligible policyholders the proceeds of the conversion in the form of cash, transferable shares or a combination of cash and shares,” the backgrounder explains.
“A demutualization does not involve the distribution of a company’s surplus. The financial benefits of demutualization derive from an ownership transition transaction accompanying the demutualization process. Through this transaction, some or all of the newly exchanged common shares are sold to one or more private investors (in a sponsored demutualization) or to broader capital markets by way of an initial public (secondary) offering and stock exchange listing. The valuation placed on a demutualizing property and casualty insurance company is generally determined with reference to a multiple of its book value.”
Once demutualization regulations are in place, “Economical’s Board of Directors will be in a position to determine whether demutualization within the final regulatory framework would be in the best interests of the company,” John Bowey, chair of the company’s special committee on demutualization, said Monday.
If found to be in the company’s best interest, the backgrounder notes, the board will submit a proposal for approval to the Office of the Superintendent of Financial Institutions (OSFI) and its eligible policyholders reflecting the form of demutualization transaction it has selected. The methodology for allocating benefits among eligible policyholders would be developed by the demutualizing company’s appointed actuary and validated by an independent actuarial opinion, both of which would be subject to review and approval by OSFI.
Demutualization has the potential to make a strong company stronger, the backgrounder states. Using the past several years to improve performance, Economical’s book value has grown by $350 million to more than $1.6 billion since it announced its intention to demutualize more than three years ago.
Although government is now in a position to publish draft regulations, Bowey told attendees at the AGM that it is not yet clear if the summer break will impact timing. Once board members have all the details of the new regulatory framework, they will be in a position to decide whether or not it is still in the best interests of Economical “to proceed with demutualization within that framework,” he said.
In principle, demutualization is in Economical’s and everyone¹s best interests, Bowey suggested. The company’s view is that “demutualization would also make the entire Canadian P&C industry more competitive and secure. And it would give other companies the choice to make the change if they wished, without forcing anyone¹s hand,” he added.