Commentary: Insurance Showdown: Who's Right?Andrew Osterland and Susan Jackson
Insurance may never be the same. Prudential Insurance Co.'s Feb. 12 announcement that it would convert from policyholder ownership to a stock company will likely accelerate the trend away from the traditional mutual form--largely to gain access to capital markets. But there is a hot debate over the best way to do it. Most insurers have transformed into stock companies. But under legislation passed in 15 states and the District of Columbia, mutuals could create holding companies and could sell as much as a 49% stake in their operating businesses to public shareholders. Big mutuals back the idea while some publicly owned insurers and consumer groups object. The outcome could have an enormous impact. Andrew Osterland and Susan Jackson debate the issue.
OSTERLAND: Holding companies are stronger and more flexible
Before the holding company legislation, an insurer who wanted to demutualize had to endure a costly and time-consuming process. Equitable Co. spent upwards of $40 million on its 1992 demutualization. Now, using state laws, mutuals can create holding companies much more quickly and inexpensively. Once established, the stock subsidiary can issue stock and buy other companies, as did Des Moines-based AmerUs Life Insurance Co. when it acquired AmVestors. "We see this as a way of preserving our mutual heritage and gaining access to the capital markets at the same time," says David Drury, CEO of Des Moines-based Principal Financial Group, the largest mutual insurer yet to seek approval for a holding-company structure.
A holding company can also be a better deal for policyholders, argues Salomon Smith Barney analyst Colin Devine. Fully demutualized companies tend to come to market at significant discounts to their book value. Since most policyholders usually sell immediately the shares they receive in return for their policyholder interests, they don't get a good price. "It can be a bad deal for policyholders," says Devine.
Devine thinks the holding company alternative gives poorly performing mutuals practice at being a profit-oriented company and allows management to pick the best time to go public. "If you use the holding company as a step on the way to full demutualization, you're not screwing policyholders," says Devine.
True, there are potential conflict-of-interest issues. Mutual managers will be compensated with options in the new stock subsidiary. Consumer advocates say if shareholders gain, policyholders will lose. But that's the case of any company with performance pay. "There's no more opportunity here to lie, cheat, and steal than there was before," says Scott Galenbeck, general counsel for the Iowa Department of Insurance office.
The book is still being written on how holding companies will be regulated. But given the need of the mutuals and the ordeal of demutualization, the holding company option makes a lot of sense.
JACKSON: Holding companies hurt policyholders
Under full demutualization, a major portion of the insurer's surplus is distributed to policyholders in cash or stock. Equitable's policyholders received hundreds of millions of dollars. But under most holding company laws, policyholders don't get any stock or cash. Indeed, to get a stake they would have to buy shares in the stock company. "It's like somebody walking up to your driveway, selling your car, and then giving you a chance to buy it back," says Betsy McCaughey Ross, lieutenant governor of New York and a foe of the plan. "What is to prevent the quiet confiscation of billions of dollars of accumulated profits that ordinary men and women were told they own as mutual policyholders?"
A mutual holding company also creates a conflict of interest since the structure has two sets of owners and a common management. The stock company wants quarterly earnings increases to push up the stock. That means lower policyholder dividends and claims payouts. The mutual company, by contrast, wants higher dividends and payouts. In the real world, though, policyholders are quiescent and management can do what it wants. "It's management nirvana," sniffs Jason B. Adkins, founder of the Center for Insurance Research in Cambridge, Mass.
One study suggests that since the mutual holding company would no longer be in the business of selling insurance directly, it might not be subject to state regulatory oversight. And some industry players also worry that holding companies will not have to abide by the same tax codes as stock companies. "We want to ensure a level playing field with all our competition," says Lon A. Smith, CEO of Hartford Life Inc. He and other stock-company execs are studying the holding company issues to see what kind of threat they pose.
Full demutualization may be expensive and time-consuming, but it's definitely the fairest way for mutual companies to enter the public equity market.