Demutualization and the Public Good

Canada’s federal government recently asked for public feedback on a proposed regulatory framework that would allow property and casual mutual insurers to demutualize. The initiative follows an announcement in December 2010 that The Economical Mutual Insurance Company planned to demutualize. From the insurance broker’s perspective, this is a timely discussion and one in which it is worthwhile for the industry and government to engage.

Insurance brokers have a rather special interest in this discussion. Unlike any mutuals in Canada, which have a direct interest in the consequences of how a demutualizing regulatory “regime” takes shape, a broker’s viewpoint is based on how these changes might affect their customers – the Canadian public.

Mutuals sell product mainly through the broker network, as do most stock-company insurers. Therefore, when looking for the most appropriate product for their customers, brokers represent a large gamut of mutual and stock organizations. This gives the insurance broker an objective view of how the different models (mutual or stock) are faring and which products they offer are the most appropriate for customers. Brokers also bear witness to trends taking hold of the marketplace in the short to medium term.

P&C Mutuals

It is important to underline one issue in any discussion regarding the Canadian financial services sector; that is, the fundamental difference between the wealth management industry and the risk management industry. The principal goal of wealth management (the core activity of banks and life insurers) is the maintenance and accrual of wealth through such instruments as investing, interest and dividends. Consumers lend their money so that this money grows in value, only to be withdrawn at some future point – ideally, at a significantly higher value than when the money was initially lent. The principal goal of risk management (the core activity of the property and casualty sector), however, is to provide service/protection in the event of an unforeseen event that creates an economic loss. The goal of that protection is to place people exactly in the same financial situation as they were prior to the loss event.

Seeing the very different relationship that exists between life policyholders versus property and casualty policyholders and the capital of their respective organizations, let’s now turn to a discussion on how P&C mutuals should approach the question of demutualizating.

The Insurance Brokers Association of Canada (IBAC) made a submission to the Government of Canada about demutualization, in which we note that mutual property and casualty insurers have, both in conception and execution, a different mandate than their non-mutual counterparts. In our view, the regulation of the demutualization of property and casualty insurers ought to be primarily concerned with maintaining the broad public policy objective of preserving and enhancing the quality, cost and continuity of financial services primarily (but not exclusively) outside of major urban areas. A mutual organization is generally well suited to meeting this policy objective.

If, however, the government finds demutualization to be warranted under certain circumstances, we would like those companies proposing demutualization to make a credible commitment to undertake the following:

• Provide a clear rationale as to why the transformation into a publicly held company is preferable.
• Provide demonstrable proof that the existing tools available to mutual insurers – such as amalgamations with other mutual property and casualty insurers, raising capital via outside loans etc. – is not sufficient to meet their requirements.
• Provide a clear indication of how the newly transformed mutual will provide the same level of quality, cost and continuity to the same diversity of constituents in the delivery of its services.

The demutualization of property and casualty insurers raises a series of conceptual and practical problems. Three will be identified here. All three relate to the relationship between policyholders and the mutual itself.

First, unlike in mutual life insurance, in mutual property and casualty insurance, no direct connection exists between present constituents (policyholders) and the assets of the mutual. The constituents of property and casualty mutual insurers subscribe to their policies on an annual basis; once their policy expires, so too does their membership in the mutual. During their subscription period, policyholders do not enjoy an individual claim to any of the mutual’s assets. They enjoy the “insurance” or “protection” of their personal assets that the mutual (pooling of capital) provides.

Second, and flowing from the first point, the assets of a mutual are essentially community assets built up over generations by those living in the community.

Hence third, present policyholders have no more right to claim the assets of the mutual than past policyholders. Or to put it another way, both present and past policy holders have built up, through capital accumulation, the ability of the mutual to be able to offer this “protection” – in essence, the sole purpose for the mutual’s existence.

In light of the above three points, it should be clear it is conceptually difficult – if not impossible – to determine a clear line of property rights flowing from policyholders to a property and casualty mutual’s assets. That is to say, deciding how to apportion the benefits of demutualization is a difficult task, both conceptually and practically.

Mutuals and Participation

In many respects, mutual insurers are facing the same problem as other public participatory institutions – namely, a declining interest of the relevant constituency in participating in the governance and development of their public institutions. The disciplines of political science and sociology have been studying the decline of public participation for over three decades now and no firm conclusions have been drawn.

Thankfully, more specific work has been done on the topic of mutuals and cooperatives. Research suggests the single biggest reason for the decline in participation among these societies is the lack of education offered to executives, managers and members about the nature of their relationship to their cooperative or mutual. A second reason is that mutual societies lose their focus and cease to deliver the services desired by their members. In our estimation, given the solid track record of mutual insurers in delivering quality, cost efficient and consistent services to their members, we think mutuals need to make more of an effort to address the first area of concern and not the second.

Based on the above analysis, we feel that if proposed regulations surrounding demutualization are too lax, those charged with the governance of a mutual insurer may be tempted to view demutualization as a quick fix to what in fact is a communications problem and not one of organizational form.  We would therefore encourage the department of finance to place demutualization within the broader social and economic context, and seriously consider the role mutual insurers play as a financial infrastructure in smaller communities and recognize the model they provide for democratic and voluntary organization of citizens in the furtherance of realizing their collective needs independent of direct state support. In other words, IBAC believes mutual insurers provide an excellent example of where organizational form can promote enlightened self-interest in the furtherance of economic development and a sense of financial security amongst citizens.