!
Charters a new mutual holding company;
!
Reorganizes into the stock form of organization;
and
!
Issues all of its shares of capital stock to
the mutual holding company.
Recent
hearings in New York drew standing-room-only crowds and forced additional
hearings. Advocates and opponents
of mutual holding companies have faced off in Massachusetts, Wisconsin,
Illinois and other states. At
the national level, the National Association of Insurance Commissioners
is considering model legislation that would address how to allow and
regulate the relatively new form of ownership.
Mutual
holding companies are not unique to insurance.
They made their appearance first in banking when thrifts began
converting from mutual to hybrid forms of stock ownership. Insurance companies have been demutualizing
for at least a decade.
What=s driving the new surge of
interest is companies scrambling to position themselves in the current
wave of consolidation and shakeouts.
The bottom line: Companies
must find new ways to raise money or face becoming aquired--or less
able to compete.
Plaintiff=s attorneys have been eyeing
the mutual holding company controversy.
Ralph Nader, who frequently spotlights areas that become fertile
ground for the lawsuit industry, has targeted the form as unfair to
policyholders. Attorney Melvin Weiss, who built a formidable
practice suing insurers for alleged market misconduct, has been making
the rounds of insurance conferences to decry mutual holding companies.
Some
of the nation=s
leading insurers, including New York Life Insurance Co. and Metropolitan
Life Insurance Co., have been actively guiding proposed new legislation
in New York state to allow mutual holding companies in that state. Mutual of New York--commonly known as AMONY@--has announced it will become a stock company
and has chosen to undertake a full demutualization, in which the company
becomes a true stock company, with policyholders then eligible to become
shareholders.
Meanwhile, a steady groundswell of companies based in states that
already allow mutual holding companies have been announcing they are
converting to that form, including:
!
AmerUs Life Holdings Inc.;
!
General American Life Insurance Co.;
!
Acacia Mutual Life Insurance Co.; and
!
Pacific Life Insurance Co. (formerly Pacific
Mutual Life)
To
examine both sides of the controversy over mutual holding companies,
we invited two leading advocates to debate the merits of that form of
organization. Both are attorneys, but that=s where the similarities end.
Until
recently, Jason B. Adkins was director of the Center for Insurance Research,
Cambridge, Mass. The center
has been a regular at the NAIC=s
quarterly meetings and recently became certified by the association,
which gives the group access to funding and a place in association discussions. Adkins has formed a new firm in Boston.
Jeffrey
A. Koeppel is a partner with the law firm of Elias, Matz, Tiernan &
Herrick, L.L.P., Washington, D.C. His
practice focuses on private and public equity and debt offerings, mutual-to-stock
conversions, corporate reorganizations and mergers and acquisitions.
MUTUAL HOLDING COMPANIES:
THEY
SMELL ROTTEN AND APPEAR UNCONSTITUTIONAL
by Jason B. Adkins
Recently,
mutual insurers have been lobbying relentlessly in the hallways of state
capitols nationwide for legislation permitting a new type of insurance
company. The age-old distinction
between mutual insurers magically disappears under mutual holding company
laws, which have been slipped through in 15 states and the District
of Columbia, and are under consideration in several others.
Executives
at the gigantic mutuals argue that efforts to eradicate the well-tested
mutual structures, which policyholders relied on for over 100 years,
are done with the best of intent. Ostensibly,
the mutuals seek to access capital to compete and gain flexibility. In reality these goals are obtainable under
current law without stripping policyholders of rights and protections.
Like
scandalous savings-and-loan industry conversions before them, this process
is fueled by investment bankers and corporate law firms seeking windfall
profits. We question the very
viability of the mutual holding company schemes.
Under
the new legislation, a mutual converts fully to stock, but a parent
mutual holding company is created that owns at least 51% of the converted
insurer=s voting stock. Policyholders receive none of the stock, unlike
in a traditional demutualization in which policyholders are given all
of it before additional stock is sold to raise capital. Essentially, for policyholders it is like owning a set of keys to
a car someone else is driving away.
Mutual
insurers continue to push this Astealth
legislation,@
as Ralph Nader termed it, behind the scenes as they seek to evade public
scrutiny. Regulators, legislators and mutual directors
should critically question mutual holding companies through the lens
of their representative and fiduciary duties to the public and policyholders. Some of the more egregious defects to consider
are:
Policyholder ownership dividends are terminated.
Part of the dividends policyholders receive on policies are Aequity
dividends,@
as recognized by Congress. Mutual
life insurers pay federal taxes on these Aownership@ dividends under Section 809
of the tax code. Yet mutual
life insurers must agree with the Securities and Exchange Commission
as part of the conversion process not
to pay dividends from the new mutual holding company.
So, under the new laws, policyholders no longer receive all dividends
declared by their insurer on all its profits.
No limits on the total sale of stock to outside
investors. Management of
reorganized insurers can sell 99% of the economic value of the company
to outside investors because there are no limits on the sale of blank-check
preferred stock or other equity instruments that pay dividends on the
insurers= profits. While new state statutes limit the amount of
voting stock that can be purchased
by shareholders to 49%, unlimited amounts of a converted mutual=s equity can be sold without
compensation to policyholders. That
couldn=t be
done to General Motors=
investors.
No limits on total stock to directors and executives. Most mutual holding company legislation purports to limit executives and directors to owning no more than 18% to 35% of the converted mutual=s voting stock. However, nothing limits the amount of preferred stock or other dividend paying instruments that management can receive. Because executives control the policyholders= 51% vote, none of the checks and balances pertaining to normal stock companies will apply. Indeed the mutual holding company scheme is management nirvana: stockholders have only a minority vote and management can exercise the votes of the disenfranchised policyholders to serve their own ends. These blank-check provisions contradict the accountability reforms proposed by major institutional investors. Even so-called limits on voting stock are suspect, since they appear to be preempted by the National Securities Markets Improvement Act of 1996. Unaccountable self-enrichment schemes are not fair or equitable to policyholders.
It will
create fewer insurers and less competition. Permitting mutual holding company conversions will only fuel the
current consolidation frenzy as management, corporate lawyers and investment
bankers drive a flood of initial public offerings and takeovers. All this activity will certainly provoke a
response from stock insurers who are just waking up to the reduced competition
that will result.
States lose control of bankruptcy proceedings.
Mutual holding companies are Ashells@ that will not issue policies,
pay dividends or engage in the insurance business. Under the McCarran-Ferguson Act of 1945, federal
jurisdiction applies--except where states are regulating the Abusiness of insurance.@ As one state regulator recently observed, federal bankruptcy and
securities laws could apply to the disadvantage of policyholders and
the mutual holding company may elude important state consumer protections.
It puts policyholders at financial risk. Of the four converted mutual insurers, one
issued stock, AmerUs in Iowa; another, General American in Missouri,
issued debt. Both companies
have been downgraded or placed on credit watches with negative implications
by rating agencies. This supports
the premonitions of Brian Atchinson, the former president of the National
Association of Insurance Commissioners who wrote: A[t]he potential exists for the policyholders
to shoulder all losses while the profits go to the [shareholders in
the] intermediate holding company.@
Shareholders could challenge demutualizations.
Mutual policyholders have exclusive rights to the assets
of the mutual insurer upon a formal demutualization under traditional
law. However, for the first
time, outside shareholders in a mutual holding company could seek to
limit payments to policyholders.
Shareholders could challenge demutualizations. Mutual policyholders have exclusive rights
to the assets of the mutual insurer upon a formal demutualization under
traditional law. However, for
the first time, outside shareholders in a mutual holding company could
seek to limit payments to policyholders.
Mutuals seek a billion-dollar federal tax
loophole. Section 809 of
the tax code, adopted in 1984, taxes the Aownership@ dividends paid to mutual
policyholders. Following mutual
holding company conversions, billions of dollars in these federal taxes
could be avoided by the new mutual
holding companies that will not pay any dividends to policyholders. This could result in a backlash when Congress,
the Internal Revenue Service and stock companies discover the loophole.
These
fundamental flaws are arguably unconstitutional, and go unresolved by
proponents of the mutual holding companies.
If the laws are so good for policyholders, why are they all passed
in the dead of night, without debate, as was attempted Nov. 13 in Illinois
with five days notice because of a so-called "emergency?"
It smells rotten.
REFUTING
THE MYTHS ABOUT MUTUAL HOLDING COMPANIES
by Jeffrey A. Koeppel
In
recent months, the mutual holding company transaction has been criticized
by those who claim policyholders' interests are not protected, and that
policyholders lose economic value.
I'd like to address the following five frequently raised criticisms:
Mutual insurers don't need the mutual holding
company transaction. This
is typically directed at large mutual insurance companies like Metropolitan
Life or Prudential. In the United
States there are approximately 486 mutual insurers with admitted assets
of $1.116 trillion. Investment
in technology, entering new markets, offering new and attractive products
to an increasingly sophisticated customer base requires capital. Some large insurers may be able to obtain some
or all of the financing they might require, typically debt, at a price
which does not necessarily benefit policyholders. Smaller mutuals may not be able to access the capital markets at
all and will find themselves falling further behind the technology curve,
penalizing policyholders with inefficient service and higher costs. The mutual holding company transaction represents
an alternative approach to the ability of mutuals, currently constrained
by their structure, to obtain equity capital and maintain their competitive
position in the marketplace. Failing
to do so may hurt policyholders.
Policyholders immediately lose economic value
in a mutual holding company reorganization. A mutual holding company
reorganization (where shares of the stock insurer are not sold) does
not, in any way, diminish the policyholder=s
economic value. If one considers
the policyholder to be the Aowner@ of the mutual (this term
is used in the generic sense here), ownership interest does not changes
when the mutual insurer merely reorganizes to stock form. As a mutual policyholder, the policyholder Aowned@ a relative share of the whole
mutual insurer; as a mutual holding company member, he or she would
temporarily (because the member=s
interest terminates upon termination of the policy), but indirectly
Aown@ the same portion of the stock insurer through
a membership interest in the mutual holding company. The mutual holding company transaction in no way interferes with
a member=s
interest in the mutual entity (the mutual holding company) or with the
mutual holding company=s
ownership of the stock insurer--until shares are sold.
To a certain extent, it=s
like moving your wallet from your shirt pocket to your pants pocket.
For almost 100 years, courts have held that policyholders do not have a separate and vested interest in the surplus of a mutual insurer recoverable at law until the insurer makes a distribution. Policyholder interest is not legally comparable to an equity interest held by a stockholder. The courts have said policyholders do not have a legal expectation to share in the company=s profits and policyholder Adividends@ are not legally the same as dividends paid to stockholders.
Policyholders lose when the stock insurer
sells equity to the public. In
the real world, if you own a company that has 100 shares outstanding,
earns $1 per year and has a book value of $20, it is worth what a willing
buyer would pay, probably some multiple of earnings or book value. If you sold all or a portion of your ownership interest, you would
receive some form of consideration in exchange for you ownership interest.
In
a mutual holding company reorganization, the mutual holding company
would own 100% (100 shares) of the stock insurer.
Let=s
also assume that: the board of directors would like to grow internally
or acquire business for the stock insurer, both of which require working
capital; capital requirements are greater than the value of the surplus
($20); and the insurer=s annual earnings can=t provide working capital
on a timely basis. If we agree
that the mutual holding company members obtain the value of 100% of
the surplus of the stock insurer through membership interests in the
mutual holding companies, the value of such interest in the stock insurers=
stockholders=
equity is $20. The board has
three choices. It can forgo
growth because it cannot be funded internally; it can borrow and diminish
current earnings; or it can sell for cash up to 49% of the voting power
of the stock insurer.
The
market values stock insurers every day.
Recently the public valued the Equitable Cos. at a price-to-book value of 219.8%. Although simplistic--and certainly not typical--if you ascribe that
method of valuation to our stock insurer discussed above, then each
share of the stock insurer would have a market value of $.44, based
on its $.20-per-share stockholders=
equity. Based on this assessment,
the entire stock insurer would have a market value of $43.96 (the book
value of $20 times 219.8%). If
the mutual holding company holds 100 shares of the stock insurer and
desires to sell 49% (or 49 shares) to the public, it could raise $21.54
($43.96 times 49%). Added to the stockholders= equity of the stock insurer
($20), the resulting stockholders=
equity would be $41.54. Prior
to the offering of stock of the stock insurer, the aggregate value of
the mutual holding company members=
interest was $20; after the offering the members=
interest in the aggregate market value became $22.42.
While
the mutual holding company members Agave
up@ 49% of
their Aownership@ in the stock insurer, the
value of the stock insurer increased from $20 to $22.42; the earnings
strength of the stock insurer increased through its investment of the
stock sale proceeds; the board can pursue the company=s
business plan; and the policyholders control 51% of a stock insurer
that has successfully tapped the capital market and will be able to
reaccess the market.
If
the mutual holding company later undertakes a full demutualization in
which a surplus distribution is required, the mutual holding company
would be required to distribute the value of the Asurplus@ in the stock insurer--$41.54.
If the mutual insurer performed a demutualization without engaging
in the mutual holding company, it would distribute only the $20 surplus.
So, where=s
the loss of economic value to the policyholder?
If
a mutual holding company sells the stock of its stock insurer subsidiary
and give subscription rights to the policyholder, the policyholder will
buy something he or she already owns.
Subscription rights represent a non-transferable right to purchase
stock before the public may buy shares.
The stock insurer will generally be listed for trading on a stock
exchange or stock quotation system and will have a public market value
ascribed to it. The subscription right grants the policyholder a priority right
to obtain a security with value and a liquid market. Do policyholders recognize the value of such rights? In the most
recent demutualization under the new Pennsylvania law where subscription
rights were distributed to policyholders, policyholders subscribed for
$205 million worth of stock--even though only $39.5 million of subscriptions
were accepted (an oversubscription of 518%).
It appears policyholders understood the value of the subscription
rights offered.
The
sale of stock doesn=t
diminish the policyholders=
proportionate membership interest in the mutual holding company. Rather, it should increase the value of such
interest through the capture and retention of the proceeds form the
stock issuance--policyholders would have a smaller percentage of a larger
company. The subscription right
allows the policyholder the opportunity to participate in the public
valuation of the stock. In a
recent mutual holding company transaction involving American Mutual
Life Insurance Co., that is exactly what occurred.
In
a mutual holding company transaction, the board of directors will have
divided loyalties and must choose between policyholders and stockholders. In most instances after a mutual holding company
transaction, the interest of policyholders and stockholders will be
aligned. Both groups desire
a more efficient, cost-effective competitor.
Both want their company to remain profitable and increase profits. Increases profits increase stockholders= equity. This benefits stockholders (through a higher
stock price and higher dividends) and policyholders (who benefit via
an increase in the value of their membership interests and possibly
better rates or service). Policyholders
are the lifeblood of any insurer, mutual or stock.
Mistreated policyholders will eventually vote with their feet
and find a new home where their perceived treatment is better.
All
mutual insurers deal daily with the Apolicyholder
vs. stakeholder@
issue. The best companies treat
customers well to the benefit of their owners.
Having members of a mutual holding company who are policyholders
with insurance contract rights is little different from stockholders
of a stock insurer who also happen to be policyholders.
Do stock insurers take advantage of their policyholders to benefit
stockholders? It=s
a silly question.
In
many mutual holding company transactions it is unlikely (because of
securities law) that policyholders will receive dividends (over and
above their participating policies) while stockholders may receive cash
dividends from the stock insurer. That=s not fair, say the critics.
Dividends are paid on shares outstanding.
Even if the stock insurer had 49% of voting equity in public
hands, it would pay dividends to only those shareholders.
Cash for dividends to the other 51% would remain
in the stock insurer=s
stockholders= equity, accruing to the benefit
of all stockholders. The largest
stockholder, holding 51% of that is the mutual holding company. Perhaps if the critics view this as a form
of a Adividend
reinvestment,@
it wouldn=t
sound so bad.
Are mutual holding company transactions a panacea? Hardly, but they provide some access to the capital markets faster and cheaper than a full demutualization. Are they highly deleterious to policyholders? They should not be. If the mutual insurer takes the appropriate statutory procedural steps, clearly informs its policyholder base, participates in an open public hearing and gives policyholders the right and opportunity to vote, the mutual holding company transaction should help the mutual achieve its goal of raising capital while aiding the interest of the average policyholder.
