Mutual Life Insurance Company Reorganizations: An Overview

  1. Table of contents
  2. What is this all about, and why should I care?
  3. What is a mutual company?
  4. What are the advantages and disadvantages of the mutual form oforganization?
  5. Why do mutual companies want to reorganize?
  6. How can a mutual company reorganize?
  7. What is a full demutualization?
  8. What are the advantages of a full demutualization?
  9. What are the disadvantages of a full demutualization?
  10. What is a mutual holding company conversion?
  11. What are the advantages and disadvantages of a MHC conversion?
  12. What are the advantages and disadvantages of a closed block?
  13. Why are consumer advocates so angry about MHC conversions?
  14. What is the relationship between MHC conversions and IMSA?
  15. Are all MHC conversions bad?
  16. Are all full demutualizations good?
  17. My company has announced that it will demutualize.
       What should I do?
  18. My company has announced that it will convert to a MHC.
       What should I do?
  19. My company has already converted to a MHC.
       What should I do?
  20. My company has not made any announcement about reorganization.
       What should I do?
  21. I own a policy issued by a mutual company.
       What should I do?
  22. I used to own a policy issued by a mutual company.
       What should I do?
  23. I'm thinking of buying a policy from a mutual company.
       What should I do?
  24. A personal case study

What is this all about, and why should I care?

Many mutual life insurance companies want to stop being purely mutual. Some have already changed to a different form of organization, some have proposed a reorganization plan, and some are exploring their options.

Reorganizations can affect existing and future policyholders. It is particularly important to be aware of a company's plans if you are thinking of replacing a policy that you already own, because you could miss out on significant benefits.

In some cases, companies have not adequately disclosed the risks of their proposed plans or discussed alternatives. The fact that a reorganization plan must be approved by a company's directors, its policyholders, and state regulators should give you no comfort.

Directors have their own interests, although they will publicly insist that they always put policyholders' interests first. Most policyholders don't bother to vote, and those who do may not understand the issues. State regulators have multiple objectives, such as promoting commerce in their state and obtaining future employment in the insurance industry. Most state laws do not require reorganization plans to be in the best interests of policyholders; regulators can approve them if they meet the weaker standard of being "fair and equitable."

There is only one person who can reliably put your interests first: you. Especially a well-informed you.

Although there are fewer than 100 mutual life insurance companies in the U.S. (compared with over 1,400 stock companies), mutuals account for over one-quarter of the industry's assets, insurance in force, premiums, and benefits paid. Many people are therefore affected by reorganizations.

What is a mutual company?

A mutual company is a corporation that has no shareholders. The policy- holders are the members of the corporation, and they have membership rights. These rights derive from the insurance contract, the corporation's bylaws and charter or articles of incorporation, state laws, and case law.

Membership rights include (1) the right to contractual benefits, including dividends declared by the board of directors; (2) the right to participate in corporate governance, usually by electing directors to oversee the operation of the company; (3) the right to receive any remaining value if the corporation is liquidated or demutualized; (4) the right to expect that the corporation will be run primarily for the benefit of the members; and (5) the right to bring legal action against the directors and officers for violating their fiduciary duties.

These rights are enjoyed collectively; individual members cannot sell their rights to someone else. Membership rights terminate when a member cancels the policy or dies.

In contrast, a stock company is a corporation that has shareholders, who may or may not be policyholders. Each shareholder's ownership interest is represented by shares of stock, which can usually be sold. The corporation is run primarily for the benefit of the shareholders, although its relationship with its customers must respect commercial laws and the need to compete in the marketplace.

A stock company is owned by its shareholders. Is a mutual company owned by its members? That question has been discussed for decades, and there are multiple points of view. In current conversations on this subject, one person often tries to avoid using the word "own," while the other person tries to force its use. Everyone acknowledges that policyholders have membership rights, but there is disagreement about the specific rights and what they mean.

Many insurance executives believe that policyholders think of themselves as customers rather than owners, and they may be right. Policyholders' membership rights do not become an issue in the normal course of business, except possibly when dividends fall short of expectations. Membership rights have now become a topic of heated discussion because there is real money at stake in reorganization plans.

What are the advantages and disadvantages of the mutual form of organization?

Because a mutual company has no shareholders, there is no conflict of interest between shareholders and policyholders. This makes it possible to fulfill the company's primary mission: to provide insurance at cost. That doesn't mean that mutuals are nonprofit organizations. They price their products to make a profit, because profits are needed to maintain financial strength and to support future growth. Mutuals generally have a lower profit goal than stock companies, however, because they don't have to satisfy the demands of outside investors. They can also take a long-term view in running their business, because they don't have pay attention to daily fluctuations of a stock price.

Over the years, mutual companies have spent a lot of time thinking about how to treat policyholders equitably; that's one of the core values of their corporate culture. Some mutuals are more dedicated to fair treatment than others, but the cash value life insurance policies issued by most mutual companies have probably provided better value to policyholders than those issued by most stock companies.

These advantages are offset by several disadvantages.

  • Mutual companies have limited flexibility to raise capital and to merge with or acquire other companies, because they can't issue stock.
  • Financial reporting is less flexible, because all transactions are reflected on the parent's books.
  • Non-insurance subsidiaries may receive a valuation penalty for being associated with a heavily-regulated parent.
  • A mutual company's identification as a life insurance company may hinders efforts to provide comprehensive financial services.
  • Management performance is not subject to the same level of scrutiny that it is at stock companies, because there are no outside investors. In fact, corporate governance at mutual companies can be a farcical affair. It is virtually impossible for unhappy policyholders to replace directors who are not fulfilling their duties. Policyholders have to rely on rating agencies to place constraints on management actions.
  • Mutual companies may also have a higher tax burden than stock companies, although this has been a subject of debate.

There is a clear legal distinction between mutual and stock forms of organization, but mutual companies now resemble stock companies in many ways. There is a convergence in products (level premium term, universal and variable universal life, annuities, health insurance), corporate form (some mutuals issue policies from stock subsidiaries), financial reporting methods (GAAP for mutuals, economic value added), compensation methods (some mutual company CEOs have an equity stake in stock subsidiaries), and corporate mission (global competition across multiple product lines).

Pure mutuality now exists only in small pockets. "Why We Need Mutual Life Insurers" is a timely reminder of what we're losing.

Why do mutual companies want to reorganize?

Mutual companies believe that the purely mutual form of organization hinders their ability to adapt to the changes taking place in the financial services industry. They cannot raise capital by selling stock, and they cannot use stock as a convenient currency to acquire or merge with other companies. They believe that these obstacles may affect their ability to deliver attractive products and services to customers and to remain financially strong.

Some observers believe that there is a second motive for reorganizations: mutual company executives want to receive higher compensation, particularly in the form of stock and stock options. The top executives at mutual companies are generally not as highly paid as their counterparts at stock companies, and reorganizations offer some hope of achieving parity. The deal-making that follows reorganizations also provides an opportunity to get greater power and prestige by managing a larger organization.

Reorganizations also benefit the investment bankers, attorneys, accountants, and consulting actuaries whose professional services are required to prepare and implement a reorganization plan. State regulators may gain increased oversight responsibilities.

Ironically, some of today's largest mutuals converted from stock companies earlier in this century. At that time, they wanted to eliminate the conflict of interest between policyholders and shareholders, and they wanted to eliminate takeover threats.

How can a mutual company reorganize?

The most common ways of reorganizing are through a full demutualization and a mutual holding company (MHC) conversion, which is also called a mutual insurance holding company (MIHC) conversion. Both approaches have variations, reflecting differences in state laws.

What is a full demutualization?

In a full demutualization, the company becomes a stock company. The mutual company's net worth (its "surplus") is usually distributed to policyholders as stock, cash, and policy enhancements. Each policyholder's share of the total distribution is determined according to some accepted method of allocation, which must be reviewed by state regulators.

The policyholders' membership rights are extinguished, but their contractual rights remain unchanged. The company may concurrently issue additional stock in an initial public offering (IPO), in order to replenish its capital, raise more capital, and establish a market value and liquidity for the stock.

Here's a numerical example to show what happens. Let's assume that the company's book value (that is, its net worth according to accounting statements) is $1 billion and that it has one million identical policyholders. An established, well-managed stock company might have a market value of $2 billion, but a demutualizing company will usually enter the market at a discount. Let's say that its fair market value is $800 million; i.e., 80% of its book value. Let's also assume that it wants to raise an additional $250 million in an IPO, which is priced at the same 20% discount.

The total book value, including the IPO proceeds, will be $801.25 billion, and the total initial market value will be $801.0 billion. To obtain the desired pricing, the IPO investors must wind up with a 25% stake in the post-IPO company. They pay $1050 million for stock that has an immediate market value of $1050 million and a book value of $1112.5 million, so the stock is priced at 80% of book value, as assumed.

The policyholders initially have a 100% interest in the pre-IPO company, which has an appraised value of $1912 million and a potential long-term market value of $1114 billion. After the IPO, they have a 75% interest in a company that has a book value of $1113.25 billion, an appraised value of $1113 billion, and a potential long-term value of $1114.5 billion.

Each policyholder initially has a one-millionth interest in a company that has a long-term value of $1914 billion, so that interest might be worth $1914,000 over time (ignoring any future increase in book value). After the demutualization, however, each policyholder's stock is worth only $2662.

There are two reasons for the shortfall. First, the long-term market value cannot be realized immediately; it takes years to establish a track record that will support a higher valuation. Second, the policyholders' interest is diluted by the IPO. Before the IPO, the long-term value of each policy- holder's stock is $2664,000; after the IPO, it is only $2663,875. The $2787 difference is equal to the book value that is shifted from policyholders to IPO investors ($2724.50) times the long-term multiple (2).

Of course, in the real world the policyholders are not identical, and the company has to allocate the book value in some acceptable manner. Most policyholders will receive stock, but some will receive cash or policy enhancements that have an equivalent value. Cash may be the preferred choice for very small amounts. Policy enhancements may be the preferred choice when cash or stock would produce adverse tax consequences; for example, for policies in qualified retirement plans.

What are the advantages of a full demutualization?

It provides financial flexibility. The reorganized company can issue stock, debt, and hybrid securities, and it can get bank credit facilities. It provides maximum access to capital to finance future growth, and it creates a currency that the company can use for mergers and acquisitions.

Financial flexibility may improve the company's creditworthiness. Stock issuance leads to more disclosure and greater scrutiny of management's performance. Bank credit facilities may carry restrictions on some transactions and require the maintenance of good financial strength ratings.

It provides organizational flexibility. Business entities can become subsidiaries of a holding company rather than the life insurance company, thereby simplifying regulation, improving risk-based capital ratios, normalizing the financial statements of the life company, and providing marketing and investment advantages. Employees can be shifted so that GAAP rather than statutory accounting principles govern their cost accounting.

Talented employees can be attracted and retained by offering stock options.

The company's Federal income tax liability may be reduced.

Full demutualization is a well-established process that has been implemented successfully for many years.

Policyholders receive full compensation for giving up their membership rights. In most cases, they become shareholders in the reorganized company, so they can participate in the company's success both as policyholders and as shareholders.

What are the disadvantages of a full demutualization?

It is expensive. A large company can easily spend tens (or even hundreds) of millions of dollars on the professional services needed to go through the process. One costly task is figuring out how to allocate the company's surplus among the individual policyholders. Ongoing administration is also expensive, because the company is likely to have many small shareholders.

It is time consuming. It can take 18 to 24 months from start to finish. During this time, management's attention is distracted from other operational duties.

It may lead to litigation or at least to perceptions of unfairness. Some groups of policyholders may object to the company's allocation method. For example, the owners of nonparticipating cash value policies, such as universal life, may wonder why they receive less than the owners of participating whole life policies. Policyholders who receive cash or policy enhancements may object to a valuation that is based on a below-book-value IPO price. Litigation can be costly and time consuming, and it can also damage a company's reputation.

It may hurt the performance of existing policies, through lower dividends, interest rates, and other factors. Although every demutualization plan tries to address this risk, there is no assurance that the solutions will work. Shareholders want their stock to perform well, and policyholders want their policies to perform well, and that inherent conflict can't be avoided. Based on unconfirmed anecdotes, it appears that the risk of dividend cuts is much greater for small policies.

It may hurt a company's financial strength, because managers may take greater risks to improve profitability. Some companies may find that the cultural leap from mutual to stock was too sudden, like jumping into a pool before you have learned how to swim. The mistakes they make as they try to build a competitive organization may be costly. Early missteps may also depress the company's stock and create long-term credibility problems with the investment community.

It usually forces management to issue stock to policyholders even if conditions are temporarily unfavorable, although some state laws may provide more flexibility. An immediate IPO is usually needed to recover the costs incurred in the demutualization process. There may also be selling pressure immediately after issue if many small shareholders choose to unload their shares.

It creates the opportunity for the company to be taken over. A takeover may or may not benefit policyholders, but it is likely to be unsettling until more information is known.

It eliminates any flicker of mutuality. The company becomes a stock company, managed for the primary benefit of shareholders. In the past, most policyholders have sold their stock to institutional shareholders within the first year after demutualization.

To some observers, it is morally offensive. Philosophers have struggled with this question: do the citizens of a democracy have the right to vote for a dictatorship, and thereby permanently abolish the democracy? Similarly, you can ask: does one generation of policyholders have the right to give itself a windfall, and permanently change the nature of the enterprise? It's not obvious why today's policyholders should be entitled to a pot of money built up over many decades, even if the law says they are.

What is a mutual holding company conversion?

In a mutual holding company conversion, the original mutual insurance company becomes a stock insurance company that is wholly owned by a mutual holding company. In most cases, a stock holding company is interposed between the mutual holding company and the insurance company to provide greater flexibility. Other subsidiaries can be owned directly by the mutual holding company or, more often, by the stock holding company or the insurance company.

The resulting structure looks like this:

Before conversion After conversion
Mutual life insurance company
Mutual holding company
Stock holding company
Stock life insurance company and subisidiaries

The policyholders' contractual rights remain with the stock life insurance company, and their other membership rights are transferred to the mutual holding company. In contrast to a full demutualization, policyholders do not receive stock, cash, or policy enhancements, because the surplus of the insurance company is not distributed. The mutual holding company may choose to proceed with a full demutualization at a later date, so this option is not precluded by the MHC conversion.

After the conversion, the mutual holding company may decide to sell part of the stock holding company, the insurance company, or the subsidiaries, but it must always retain a majority of the voting stock of the life insurance company.

This flexibility to sell a piece of the insurance company to outside investors has led to many confusing exchanges between advocates and critics of MHC conversions. Critics say that policyholders are worse off, because they lose part of their company without compensation. Advocates say that policyholders are no worse off or even better off, because they have a proportionate interest in a larger pie.

The arithmetic of stock issuance for MHC conversions is the same as for full demutualizations. The impact on the policyholders depends on the selling price of the stock in relation to the book value of the company. If the stock is sold for less than book value, as it usually is, the policyholders' interest will be diluted. Even in that case, however, the policyholders will benefit if the additional capital can be used to achieve a higher valuation for the company in the future.

In the earlier numerical example, suppose the long-term valuation of the company would be 175% of book value without more capital and 200% with more capital. Let's also assume, as before, that the IPO is priced at a 20% discount to book value, even though a higher discount might be justified for a MHC conversion, due to the policyholder/shareholder conflict. The policyholders' 100% interest before the MHC conversion might have a long-term value of $1.75 billion, but their 75% interest after the conversion and IPO might have a long-term value of $1.875 billion (i.e., 75% x $1.25 billion x 2). If the valuation multiple stays at 175%, however, the 75% interest will be worth only $1.641 billion (i.e., 75% x $1.25 billion x 1.75). It's also possible that the company's officers, directors, and employees would receive stock prior to an IPO, so that would siphon off some money that would otherwise be available for policyholders.

You can't say if policyholders gain or lose in a MHC conversion without looking at specific numbers. Also, a MHC conversion could be better than remaining a pure mutual but worse than full demutualization.

What are the advantages and disadvantages of a MHC conversion?

Because the proponents and opponents strongly disagree about the pros and cons of mutual holding companies, it's helpful to summarize the arguments in a table. Some details may depend on state laws and specific company plans.

What the proponents say What the opponents say
A MHC conversion is faster and cheaper than a full demutualization. In some cases, it can take just a few months and cost just a few million dollars. Sometimes, yes. But the required time varies, and the cost could actually be higher if the company eventually demutualizes after the conversion, or if there is litigation and bad publicity.
It provides financial flexibility. (1) The holding company can issue stock, debt, and hybrids, and it can get bank credit facilities. The MHC structure permits mergers with other mutuals as well as the acquisition of stock companies using cash or stock. (2) The MHC doesn't have to issue stock immediately; it can wait until conditions are favorable. (1) A full demutualization provides more flexibility (except for mergers with mutuals). The MHC structure is inferior for raising capital, because the voting control requirement limits the amount of stock that can be offered and depresses the valuation. (2) Existing laws already allow companies to wait to issue stock, and more flexibility could be added.
Financial flexibility will improve the company's creditworthiness. Stock issuance leads to more disclosure and greater scrutiny. Bank credit facilities may carry restrictions on some transactions and require the maintenance of good financial strength ratings. Financial flexibility can be valuable but it can also be abused, so policyholders could be put at greater risk than with a purely mutual company. When the MHC issues stock, managers may become focused on improving profitability for equity investors, and creditworthiness could suffer.
It provides organizational flexibility. Business entities can become subsidiaries of the holding company rather than the life insurance company, thereby simplifying regulation, improving risk-based capital ratios, normalizing the financial statements of the life company, and providing marketing and investment advantages. Employees can be shifted so that GAAP rather than statutory accounting principles govern ir cost accounting. A full demutualization provides all of these benefits, too.
If the reorganized insurer is taxed as a stock company rather than a mutual, the conversion costs could be offset by tax savings within a few years. The practical effect of this favorable treatment remains to be seen. The same treatment applies to a full demutualization, too.
It gives the company more flexibility to continue to issue both participating and nonparticipating policies.
It gives managers a chance to get used to operating as a stock company, while they choose an appropriate time to fully demutualize. Unless there is a definite plan to fully demutualize, a MHC conversion permits management entrenchment.
It enables companies to offer stock and stock options to attract and retain talented employees. Executives' desire for stock and stock options may be the driving force behind the push for MHCs. This type of compensation creates a conflict of interest with policyholders, and it's unfair for executives and directors to get a tangible, immediate benefit from the conversion while policyholders receive nothing but vague assurances.
Dividends may go up, as the company uses its increased flexibility to benefit policyholders. Dividends may go down, because policyholders in a closed block may not benefit from future growth and some dividends may be retained by the mutual holding company.
If the company issues stock, policyholders will receive valuable subscription rights. The subscription rights are nontransferable, so this only benefits people who want and can afford to invest in the stock.
It preserves mutuality. Policyholders are protected in four ways: If this is preservation, what would destruction be?
#1: Policyholder control of the insurance company is maintained, because the holding company must always own a majority of the voting interest. There are also restrictions on stock ownership by insiders. #1: Policyholder control is a fiction. Management has effective control of the company, because policyholders don't have a practical way to replace management. Also, limitations on stock ownership may be in conflict with, and therefore pre-empted by, various Federal laws. Existing laws may already allow some restrictions on ownership.
#2: Important decisions must be approved by outside directors and state regulators. #2: The proponents' faith in these formal mechanisms is naive or, more likely, disingenuous. Outside directors may have an economic interest in going along with management's wishes. In the past, regulators have approved questionable transactions.
#3: A closed block can be set up to maintain the current dividend scale. #3: A closed block is not necessarily a good solution.
#4: Policyholders' membership rights remain unchanged; the rights are just transferred to the holding company. #4: As defined by some companies, membership rights are essentially worthless. Policyholders lose the most valuable feature of a mutual company: no conflicts of interest between policyholders and shareholders. If a company issues multiple classes of stock, a majority economic interest could wind up in the hands of outsiders and executives.
Some questions about MHCs remain unanswered. If dividends are paid to shareholders, will the MHC's members also receive dividends? Could regulatory control over an insolvent company be affected by Federal bankruptcy laws? Could restrictions on stock ownership be pre-empted by Federal laws? Do directors have a fiduciary duty to consider offers to buy the company and proceed wth a full demutualization?
MHC conversions will further erode trust in the life insurance industry. Mutual company managements may get their way by manipulating uninformed policyholders, but they will pay a price in the marketplace by tarnishing their companies' reputations.
Summary: The mutual holding company structure is the best of both worlds. Policyholders benefit from the financial and organizational flexibility of a stock company without giving up the advantages of a mutual company. Summary: The mutual holding company structure is the worst of both worlds. Management gets the benefit of a stock company (stock options) and a mutual company (protection from takeovers, less outside scrutiny), but policyholders lose the benefit of a mutual company (no conflicts of interest between policyholders and shareholders) and don't get the benefit of a stock company (demutualization proceeds).

What are the advantages and disadvantages of a closed block?

When insurers reorganize, they often segregate the existing participating policies from other business; in insurance jargon, they set up a "closed block." Based on actuarial calculations, the company sets aside a pool of assets to support the current dividend scale and to prevent arbitrary reductions that would not be justified by actual experience factors. This does not mean that the current scale is guaranteed; it is simply a mechanism to ensure that existing policyholders are treated fairly.

The closed block approach was endorsed by a Society of Actuaries Task Force in 1987, and it is a standard provision in state laws.

Recently, some actuaries and other observers have expressed doubts about this feature of reorganization plans. It may be a well-intentioned device, they argue, but it may actually hurt its intended beneficiaries over the long run. Can the block really be administered fairly as economic conditions change? If the company grows and prospers, will the closed block benefit, or will it languish as the company moves on to other ventures? If the company adopts a more conservative investment strategy in its closed block (for example, by eliminating any allocation to equities), isn't that likely to produce lower dividends over the long run?

Why are consumer advocates so angry about MHC conversions?

The critics of mutual holding companies point to actions that come close to

hypocrisy and deceit, and in some cases may cross the line. For example:

  • Mutual companies' sales materials have promoted the view that policyholders are the owners of the company, but some companies are now putting forth legalistic arguments to the contrary. In the critics' view, they have paid lawyers to create a phony debate. The "you are the owner" pitch was convenient to make a sale, but now it's more convenient to have customers rather than owners.
  • The Policyholder Information Statements distributed by companies usually give no indication that the proposed plans are controversial, and their descriptions of plan provisions are artfully incomplete. For example, they often stress that the mutual holding company must always have a majority voting interest in the insurance company, but they don't explain that the holding company could sell a majority economic interest by issuing multiple classes of stock. These statements certainly do not provide a basis for making an informed decision about the reorganization plans.
  • It is almost impossible for policyholders to exchange views and obtain truly independent guidance. When companies do try to provide a mechanism for communication, policyholders have just a few weeks to research, prepare, and submit their comments for distribution to fellow policyholders. It appears that companies are afraid to facilitate an honest discussion, because they know that many legitimate questions will be raised about the plans.
  • One New York company that is a strong advocate of MHCs often paints a rosy picture of the benefits for policyholders. But here's what one of their top actuaries said at a professional meeting in 1996: "The mutual holding company, in my opinion, has very limited possibilities...There are major conflicts of interest between the stake- holders, the policyholders and the shareholders, which have only begun to be explored...Whether those conflicts will cause problems later on will only be discovered as people actually start doing it."
  • Company executives argue that MHC conversions will allow the companies to grow and remain financially sound, so policyholders should happily support the conversions without asking for additional monetary benefits. But for some reason the executives forget to apply this reasoning to themselves. Financial strength enhances job security, so the executives shouldn't need additional monetary benefits (such as stock options) as an incentive to do their jobs. In fact, shouldn't they be proposing a pay cut? "More security, lower pay" — doesn't that sound like a fair and equitable deal?
  • One regulator has argued that full demutualization is unfair, because current policyholders don't deserve to get a windfall. Yet she has no problem with current executives getting stock options. When the executives sought employment at a mutual company, didn't they understand that mutual companies don't award stock options? Why is it fair to change the rules for executives now? And why is it the duty of regulators to prevent policyholders from getting windfalls?
  • In New York, company executives have tried to muster support for mutual holding companies by using contradictory scare tactics. On one hand, they raise the specter of a post-demutualization takeover by cold-hearted venture capitalists, and they portray themselves as the policyholders' defenders. But they've also threatened to leave New York if they don't get their way, even though that action could worry policyholders and employees.

Some proponents of MHCs have also made a public relations mistake by telling the critics that they just don't understand the advantages. The critics include an award-winning insurance professor and a Harvard Law School graduate. Telling smart people that they just don't understand something is like whacking a hornet's nest with a stick.

Here's a question to ponder: if a company's directors and officers can't lead it through a reorganization without causing an uproar, are they qualified to create a world-class financial services organization for the 21st century?

What is the relationship between MHC conversions and IMSA?

That's a good question. The Insurance Marketplace Standards Association was formed by the life insurance industry in 1997 in response to widespread market conduct problems that resulted in litigation, fines, and a loss of consumer confidence. To become an IMSA member, a life insurance company must agree to follow six principles of ethical market conduct. It must also perform a self-assessment to ensure compliance and pay for a review by an independent assessor.

IMSA's first principle of ethical market conduct is "to conduct business according to high standards of honesty and fairness and to render that service to its customers which, in the same circumstances, it would apply to or demand for itself."

It's hard to believe that an insurance company's directors and officers would want to make important financial decisions with incomplete information. When a company obtains a "yes" vote on conversion through a rigged voting process, it does not seem worthy of IMSA accreditation, but IMSA may not agree.

IMSA's fourth principle of ethical market conduct is "to provide advertising and sales materials that are clear as to purpose and honest and fair as to content."

Some companies have promoted their products by saying that policyholders are the owners of the company, but now they say that the policyholders are not really the owners. That seems to be a violation of IMSA's fourth principle, but IMSA may not agree.

Are all MHC conversions bad?

No. It depends on the consumer protections provided by state law, the specific provisions of the conversion plan, and what the company is trying to accomplish by converting. What are its stated and unstated objectives?

If the goal is to reduce the corporate income tax and to provide a limited amount of organizational and financial flexibility, with no intention of issuing stock, the conversion's rewards probably outweigh the risks. That's also true if the conversion is just one step on the way to a full demutualization — as long as there is a definite commitment to demutualizing, rather than just a vague statement.

Policyholders may also benefit if the company uses a small amount of stock to make strategic acquisitions, as long as the stock receives a reasonable valuation in the deal. Many informed policyholders might even be willing to allow management to have a small amount of stock or stock options as an incentive to prepare the company for a successful demutualization and initial public offering in the near future. All policyholders would then benefit from a higher value for their shares.

A MHC conversion is much more troubling if it seems designed primarily to create a permanent structure for mergers and acquisitions through issuing stock and to increase management compensation, without providing any monetary benefits to policyholders. It's reasonable to be suspicious of a plan that provides directors and officers with real assets, while giving policyholders nothing more than assurances that something nice will happen in the future.

Are all full demutualizations good?

No. Some companies may move from the mutual to the stock worlds without the resources, planning, or skills necessary to be successful. Remaining a mutual or making a gradual transition by using a mutual holding company structure might benefit policyholders in the long run. Obviously, it's difficult to know in advance which companies are not good candidates for a full demutualization and which ones are. Also, the mutual holding company approach has its own set of risks for policyholders.

In the May 2000 issue of The Insurance Forum, editor and professor emeritus Joseph M. Belth listed these characteristics of an excellent demutualization plan: (1) adequate compensation for policyowners; (2) broad definition of eligibility; (3) disclosure of the allocation formula; (4) IPO subscription rights for policyowners; (5) a policyowners' committee to facilitate communication and independent review of the plan; and (6) a formal hearing with cross-examination of witnesses. (You can obtain a reprint of the article for $5 by calling 888-876-9590.)

My company has announced that it will demutualize. What should I do?

Be thankful that the company decided to do a full demutualization rather than a mutual holding company conversion. Unless you feel strongly about the end of mutuality, vote "yes" and wait for your shares or other benefits to arrive in the mail. You can then decide if you want to keep your policy or shares; that's a completely different question.

If you're not sure about your eligibility to participate in the distribution of benefits, get your policy number and then check with the company. If you feel that you are being unfairly excluded from participation, keep your eyes open for notices of class action lawsuits filed against the company.

My company has announced that it will convert to a MHC. What should I do?

You should read carefully the materials that the company sends you, and keep these questions in mind:

Has the company made an effort to present different points of view, to help me make an informed decision, or is it just giving me its point of view?

Has the company explained why it chose the MHC approach rather than an alternative such as full demutualization?

Is the MHC intended to be a permanent arrangement, or is it a step on the way to a full demutualization?

How does the company plan to distribute excess profits from the holding company to policyholders?

Will the officers and directors receive stock or stock options prior to any distributions to policyholders?

Is the company setting up a closed block, and if so, has it discussed the pros and cons of this feature?

Has the company arranged for a truly independent assessment of its proposed plan,

and is it providing a convenient forum for policyholders to discuss the pros and cons among themselves?

My company has already converted to a MHC. What should I do?

You should review the materials that the company sent you, while keeping in mind the additional information that you now have about the issues involved. If you voted "yes" or abstained and now believe that you would have voted "no" if you had known what you know now, you can send a brief complaint to the chief executive officer of the company, with copies to your state insurance commissioner and IMSA (1001 Pennsylvania Ave., N.W., Washington, D.C. 20004). This may not accomplish anything, but you will put the company on notice that it has a public relations problem that may ultimately affect its sales.

My company has not made any announcement about conversion. What should I do?

You can send a short letter to the chief executive officer of your company, stating that (1) you are following the company's actions closely; (2) you have made an effort to educate yourself about the advantages and disadvantages of various types of reorganization, including mutual holding companies; (3) you expect the directors and officers to make a good-faith effort to explain the advantages and disadvantages of any plan that they propose, as well as a discussion of alternatives; and (4) you want the company to provide a way for policyowners to communicate with one another about the merits of any proposed plan.

I own a policy issued by a mutual company. What should I do?

You should think twice before you drop a life insurance policy or an annuity issued by a mutual company, because you may be forfeiting your right to valuable benefits if the company reorganizes. It's difficult to estimate the potential value of these benefits. A participating whole life policy issued 20 years ago is likely to entitle you to a greater benefit than a nonparticipating term policy issued two years ago. But in both cases, if the company chooses to do a MHC conversion rather than a full demutualization, you might not see any benefits for many years.

If your company is in the process of fully demutualizing, it probably makes sense to keep the policy until the process is completed. If you own a cash value life insurance policy, you should also find out what date is being used for determining benefits. If the determination date has not yet occurred, you may be able to increase your benefits by using dividends to buy paid-up additions. Conversely, if the policy is performing poorly and the determination date has already occurred, you may use the reduced paid-up nonforfeiture option to improve the investment return.

If your company is converting to a mutual holding company or has not yet announced its plans, your decision is more difficult. You should at least take into account the possibility of receiving an additional benefit sometime in the future.

If an agent proposes that you replace your policy and doesn't mention the potential benefits that you might receive as a mutual policyowner, you can assume that you are dealing with a salesperson rather than a professional adviser. Just say no.

I used to own a policy issued by a mutual company. What should I do?

If you recently dropped a policy issued by a mutual company, you may want to investigate the possibility of getting it reinstated. You will probably have to provide evidence of good health and pay an interest charge, but it might be worth it, especially if the company has announced plans to demutualize. Be sure to verify that you will be eligible to participate in the distribution of benefits. According to proposed rules in Canada, for example, policies must be reinstated at least 90 days before the special meeting to consider the demutualization plan.

If your former insurer has settled a class-action lawsuit about misleading sales practices, you may be eligible to reinstate your policy on favorable terms.

I'm thinking of buying a policy from a mutual company. What should I do?

First, don't overreact. Yes, some of these companies are betraying the spirit of mutuality, and it's alarming to watch them defend their actions. (For example, at a June 1998 panel discussion sponsored by the Society of Financial Service Professionals, one company's chief actuary argued that the overwhelmingly favorable votes for MHCs at other companies were a good indicator of policyholder sentiment, because a 25% participation rate provides a valid statistical sample. He didn't mention that these policyholders might not have understood what they voted for, because the companies had given them only one point of view.)

Yes, it's reasonable to wonder why you should trust companies to be fair in setting premiums, dividends, interest rates, and mortality charges when they behave so shabbily in obtaining policyholder approval for their desired reorganization plans.

But mutual life insurance companies hardly have a monopoly on deceit. You can probably find other examples in today's newspaper. One attorney recently told The Economist that he expects to live to see a dictionary in which one of the definitions of "fiduciary" is "thief."

When money, power, and prestige are at stake, people are able to rationalize why an outcome that appears outrageous to other folks is really quite fair. So you could say that the dishonorable behavior on display in some mutual company reorganizations is just business as usual.

One reasonable response in some situations is to buy low-cost, guaranteed, convertible, level-premium term insurance, and wait to see how things develop before making a commitment to a cash value policy. For disability income and long term care insurance, you may have to buy on trust, because many products have non-guaranteed premiums that can be raised later.

A personal case study

I own two Massachusetts Mutual whole life policies, issued in 1964 and 1980. MassMutual has not yet announced a reorganization plan. If it fully demutualizes, my guess is that I would receive stock with a market value equal to at least 10% of my cash values. It's possible that my policies' dividends would be somewhat lower over time, despite whatever assurances I might receive. However, the value of my stock would provide a cushion against this. On balance, I'm willing to take my chances as a policyholder/shareholder of a stock company, owning the package of my two policies plus stock. (A friend of mine calls this a "synthetic mutual.")

If MassMutual proposes a mutual holding company conversion rather than a full demutualization, the burden of proof will be on the officers and directors to explain why I would be better off without the stock in my hands. That will be a difficult case to make, but I'll listen to their arguments. If I suspect that they feel that they deserve stock options and job security while I should be happy with membership rights, I'll vote against their proposed plan and encourage other MassMutual policyholders to do the same.

While I'm waiting for MassMutual to make an announcement, I'll certainly keep my policies in force. I already use dividends to buy paid-up additions, but if I didn't, I would change to that dividend option in order to maximize any demutualization benefits that I might receive.

A note on corporate governance

Critics of mutual holding companies have ridiculed the fiction that the policyholder-owners control the affairs of mutual companies. The critics claim that mutual companies are really controlled by the management, because it is virtually impossible for unhappy policyholders to nominate independent directors, communicate with other policyholders, or take other effective measures to exert control.

Here's an example: In March 1999, MassMutual mailed a proxy statement to its policyholders. The only matter listed for consideration at the April annual meeting is the election of four members to MassMutual's Board of Directors. By signing and returning a proxy card, policyholders can instruct MassMutual's management to vote for the four nominees. There is no place on the card for policyholders to instruct management to vote against the nominees. To do that, you apparently have to travel to Springfield, Massachusetts and cast your vote in person.


I gratefully acknowledge helpful comments from Richard G. Clemens, Sidley & Austin; Christian J. DesRochers, Avon Consulting Group LLP; and Richard W. Vautravers, Ameritas Life Insurance Corp. Of course, all opinions and errors are my own.