No Doubts

• Lori Chordas
• September 2003
• 

The select number of property/casualty insurers that have shed their mutual status to form mutual holding companies say it's a decision they don't regret.

For United Heritage, forming a mutual holding company was a win-win situation. Not only did the conversion create greater flexibility for the Meridian, Idaho-based company, but it also strengthened United Heritage's ability to create long-term strategies and better serve its policyholders, said Dennis Johnson, chief executive officer.

Other mutual holding companies are finding similar value. And even though the potential of an improved equity market and economy could tempt some to demutualize, most mutual holding companies are comfortable where they are.

Making the Move

In a mutual-holding-company conversion, the original mutual insurer becomes a stock insurance company that is wholly owned by a mutual holding company. Creating future flexibility is a major advantage for companies to restructure into a mutual holding company, said Peter R. Porrino, global and Americas director of insurance for Ernst & Young LLP.

Also, mutual holding companies aren't answerable to the market on a quarterly basis to the same extent as stock companies.

Restructuring into a mutual holding company is an easier and quicker process than demutualizing, said Gregg Dykstra, vice president of internal operations and general counsel for the National Association of Mutual Insurance Companies. "It isn't a one-size-fits-all, however," he said. The decision to restructure depends ultimately on the circumstances facing a company, its strategic plan and objectives and what advantages and disadvantages may result.

Looking for Flexibility

After being a mutual life insurer since 1934, United Heritage converted to a mutual holding company last year. "We wanted to look at some flexibility in terms of adding other entities to our corporate structure and to have future access to capital if we need it," Johnson said.

On Aug. 23, 2002, United Heritage Mutual Life Insurance Co.'s policyholders voted a 97% approval for converting to a mutual holding company. As a result, the company took ownership of three companies--United Heritage Life Insurance Co. to handle life products; United Heritage Financial Services, a broker/dealer for financial products; and United Heritage Property & Casualty Co.

Since its restructuring, the company acquired another property/casualty company, Oregon-based Sublimity Insurance Co., through a merger earlier this year. Sublimity offers home, auto and umbrella coverages in Oregon and Idaho.

"Now their policyholders are also members of the United Heritage Mutual Holding Co. Sublimity Insurance kept its name but is now a downstream stock company owned as the fourth leg under the United Heritage Financial Group umbrella," said Johnson.

"The conversion gives what had traditionally been a mutual company the ability to access capital in ways they couldn't before and allows for more flexibility in mergers and acquisitions," said Johnson. Restructuring its life company into a stock company allows United Heritage to pay federal taxes at the rate of a stock company rather than a mutual company, he added.

In addition, the company is better able to serve its policyholders without the short-term demands of third-party shareholders, Johnson said. "Which allows us to more heavily concentrate on the needs of our policyholders."

"For us, the biggest challenge had to do with people," Johnson said. "We have technicians and actuaries that did a super job with this process, and the challenge for management is to do it well on the people side." United Heritage devoted a large amount of resources to informing its public about the process every step of the way. "We spent a lot of time communicating with policyholders, agents, boards, employees, retirees, regulators, rating agencies, etc., so that no one was surprised about what was happening, when it happened and the aftermath of what happens," he said.

The First to Leap

For Liberty Mutual Group, forming a mutual holding company was also the right choice. In 2001, the company became the first major property/casualty insurer in the United States to make the conversion. Not only did restructuring its status from mutual ownership to a mutual holding company give the company room to grow, it also allowed Boston-based Liberty Mutual to issue shares of common stock and make the company stronger financially, thereby bolstering its promise to policyholders.

"While we are strong believers in the benefits of mutuality, we believed that a conversion to a mutual holding company was essential for several reasons, primary being our previous structure--several unconsolidated mutuals--was increasingly unwieldy and inflexible; and if we were to continue to be a leader in what had become a global business, then we needed greater flexibility to raise capital and to continue our M&A activity," said Laurance Yahia, senior vice president and director of corporate finance.

The mutual-holding-company structure enabled Liberty Mutual to combine its significant insurance companies--Liberty Mutual Insurance Co., Liberty Mutual Fire Insurance Co. and Employers Insurance Company of Wausau--under a single holding company. In addition, its reorganization changed the company's legal structure to bring it into alignment with the reality of its existing operational structure, said Yahia. "The result is a more streamlined, efficient governance and administrative process, while preserving the separate identities and brands of the companies within the Liberty Mutual Group," Yahia said.

In the future, the most successful companies in the increasingly competitive insurance industry will be those with the scale, capital and financial strength to compete in a mature market with fewer and larger competitors, said Yahia. "While Liberty Mutual was financially strong before converting to a mutual holding company, our former mutual insurance company structure provided limited means to raise capital and acquire or merge with other companies," he said.

An example of Liberty Mutual's new flexibility and access to capital is its pending acquisition of Prudential Financial's personal lines business. "We will acquire Prudential's operations by using debt issued through our holding company, and we will contribute the companies we acquire to our insurance operations, resulting in a net surplus increase that is approximately equal to the net assets of the acquired companies," said Yahia. Public company competitors have long used this transaction process, which had been unavailable to Liberty Mutual because of its mutual insurance company structure, he added.

Liberty's conversion was based on a 1998 Massachusetts law that allows mutual insurers to convert into a "hybrid" format that retains mutual ownership while providing the structural flexibility enjoyed by stock companies.

Flexibility Is Key

Millers First Insurance Cos., formerly Millers Mutual Insurance Association, is another company that said flexibility was a key driver in its decision to convert. The company, based in Alton, Ill., restructured earlier this year. "A mutual holding company seemed like the best alternative for us with favorable laws in Illinois and the ability to add some flexibility over the long term, such as affiliations and business partnerships," said George Milnor, chief executive officer. In addition, he said the opportunity to raise capital in the future was another value added.

MMG Insurance Co., which formed a mutual holding company in March 2002 after receiving a 94% approval vote by its policyholders, values flexibility and control. "In addition to adding more flexibility, the biggest advantage for us is our ability to retain our mutuality, which allows us to continue to make long-term business decisions for our policyholders," said Larry Shaw, president. Presque Isle, Maine-based MMG serves insureds in Maine, New Hampshire and Vermont. "Going a full demutualization really does bring about ownership from outside parties, and we wanted to have the company continue to be controlled by policyholders," Shaw said.

MMG began its conversion process knowing that increasing its surplus organically wasn't going to provide enough capital to ensure long-term growth, so it recognized that potentially, raising capital was going to be part of its future, Shaw said. Also, the company sees the new structure as a vehicle for business growth. "We see good growth opportunities in business that we will be able to get appropriate rates for and apply solid underwriting discipline to," he said.

Opposing Points of View

Despite some companies' successes, not all industry observers favor the mutual-holding-company structure.

For years, critics have held that mutual-holding-company proceeds from the sale of a stock-based company's stock accrue to the mutual holding company and not to the participating policyholders. In addition, critics debate over the divided attention of management between the interests of the mutual holding company's policyholders and the stock-based company's stockholders.

In what he describes as a political "hot potato," Martin Alderson Smith, senior managing director, mergers and acquisitions advisory group, for the U.S. private investment firm The Blackstone Group, said that some state legislatures view mutual holding companies as conversions that allow many benefits of demutualizing except they don't deliver value to policyholders. The New York Legislature, for example, has largely closed the door for any real mutual-holding-company conversions by New York-domiciled companies, said Alderson Smith.

Some insurers contend, however, that many of the merits achieved by demutualization, including benefit to policyholders, can be enjoyed by mutual holding companies, minus the time and expense associated with the sometimes costly demutualization process.

Since the first law allowing mutual holding companies came in 1995 in Iowa, about 28 other states in addition to the District of Columbia have followed suit and now have some type of mutual-holding-company legislation, either authorizing the creation of such companies or allowing businesses to retain their mutual heritage. In addition, mutual-holding-company legislation reached the federal level with a provision in the Gramm-Leach-Bliley Act of 1999 stating that companies domiciled in states that don't allow for mutual-holding-company structure can redomesticate to another state to create such a restructure, without any recourse against the company from its domiciled state.

Full Demutualization Unlikely

The debate over mutual holding companies hasn't shaken insurers' confidence about their decisions. "We'd make the same decision all over again if we had to," said United Heritage's Johnson, adding that the company has no future plans of collapsing its current structure into a full demutualization. "If we hadn't done this, we couldn't have accomplished our recent merger and not raised capital in the manner we did," he said. In addition, growth opportunities that go hand-in-hand with being a mutual holding company continue to give the company added strategic and financial flexibility.

Millers First is also opting not to reject its mutual-holding-company model in favor of demutualization. "The marketplace has not been in a favorable position for companies to go public," said Milnor, adding that the company will continue to enjoy the many benefits it's finding in being a mutual holding company.

Even in an improved equity market, it's difficult to tell whether or not insurers would consider moving to a full demutualization. "A favorable equity market would likely work to the advantage of companies in both a demutualization state and those in a mutual-holding-company state," said NAMIC's Dykstra.

For companies that may consider demutualizing, the question now is when is the best time, said Ernst & Young's Porrino. He said that the property/casualty industry is just coming off an "optimal time" for demutualizing. Dramatically increasing prices, a robust capital market and balance-sheet pressures from prior reserve inadequacies or insufficient capital to write as much business as companies can find were three key factors that made the past two years an ideal time for going public. "But it didn't happen for most companies," Porrino said.

The Future

Some commercial lines insurers will try to access capital markets once balance sheets are stabilized, Porrino said. "The issue is going to be whether or not capital markets will be favorable at that time and how long the cycle will stay hard," he said. In addition, he said there will be less push among personal lines companies to demutualize because their capital needs are smaller than those of their commercial lines counterparts. "I don't see anything financially that will drive a boom to demutualization for these companies; instead, it will be more a cultural than financial influence that drives that decision."

"The current environment may put some pressure on property/casualty companies because of extraordinary potential risks and claims," said Jon Koplovitz, managing director, mergers and acquisitions advisory group, for The Blackstone Group. Companies may need access to capital to boost reserves and can't bolster them enough just by raising premiums, he added.

"We see pressure on these companies to ensure they have adequate reserves, which may necessitate ready access to capital," said The Blackstone Group's Alderson Smith.

While there's been a "quieting" of companies moving to mutual holding companies, the pattern will likely continue. "Perhaps there's been less activity because of the harder insurance market and companies may be a little more profitable now than they were in the past, so restructuring alternatives aren't as important for whatever strategic growth plans they have," said Dykstra. Capital growth continues to spark insurers' interest, however. "We've seen an increased interest in surplus notes as a fairly easy way to raise capital, as opposed to restructuring organizations," he said.

see "States with Mutual-Holding-Company Legislation"

By Lori Chordas, senior associate editor, Best's Review: Lori.Chordas@ambest.com