Riding the demutualization wave: restructuring at the life insurance industry has exceeded expectations, and more is likely. (Life/Health).

The wave of demutualizations that has washed over the life insurance industry in recent years probably reached its peak in December with the successful completion of the long-awaited Prudential conversion. But we haven't seen the last of this phenomenon. Demutualization will continue to have an impact on the structure of the industry, through trends such as sponsored demutualizations and the consolidation of companies that have shed their mutual status.

In a sponsored demutualization, policyholders are issued shares of a larger, already-public life insurer into which their formerly mutual company is merged. Provident Mutual, which will be acquired by Nationwide Financial as soon as Provident goes public, is the most recent life company to take this alternative conversion route. Other companies-- particularly those that lack the size and breadth of operations to launch a successful initial public offering--may soon follow.

Already, too, with the sale of Clarica to Sun Life in Canada, we are beginning to see the first signs of consolidation activity among former mutuals. As public companies, these insurers are no longer impervious to the ongoing forces of consolidation, although most companies that demutualize have a period of time, generally three to five years, during which they are protected from hostile bids.

And let's not forget the big mutuals that continue to hold on to their mutual status--such as Northwestern Mutual, Massachusetts Mutual, New York Life and Guardian Life. Although these giants have resisted conversion so flu; they still could decide to go public. It is unlikely, however, that future demutualization activity will bring in anything like the huge influx of capital that resulted from the stampede to the equity markets from 1998 through 2001.

In 1998, Ernst &Young's prediction that impending demutualizations in the United States would bring in more than $50 billion seemed fairly aggressive. Looking back, however, we see that $55.3 billion was added to the capitalization of the industry through the conversion of four big mutuals--MONY ($1.9 billion), John Hancock ($11.9 billion), MetLife ($24.1 billion) and Prudential ($17.4 billion). Add the two Canadian insurers that went public during this period--Manulife ($13.4 billion) and Sun Financial ($9.1 billion)--and the total soars to $77.8 billion.

Capital on the New York Stock Exchange does not tell the whole story, of course. Two Canadian companies that converted--Canada Life and Clarica--are not listed in New York. Moreover, new capital represents more than just common shares. Prudential isolated its closed-block business by issuing $175 million of Class B shares after effectively securitizing most of that business's future profits. Both MetLife and Prudential issued mandatorily convertible securities, now worth about $2.1 billion and $760 million, respectively. Measured on this basis, the total capital raised as a result of demutualizations in the last four years is even more impressive--just more than $85 billion.

Initially, the market's positive reaction to the stock of newly demutualized companies was far from assured. In the summer of 2000, the shares were getting a cool reception, and the IPOs of most U.S. life insurers were priced below book value. Equity investors feared that prices would be depressed, long after issue, by the large numbers of life company shares coming on the market and the even larger number coming into policyholders' hands. Moreover, the returns posted by life insurers hardly compared with the kind of returns investors had been seeing on the tech side--at least before the technology meltdown.

What a difference 18 months makes. By the beginning of this year, all the new equity had been absorbed, and stock of financial-services companies--even with lackluster returns--looked much more appealing to investors. MetLife and John Hancock joined the S&P 500 Index, and Prudential probably will follow. Aggressive share-purchase programs by most companies kept the upward pressure on prices. The result of all these factors is a market capitalization that today is nearly double its value at issue.

How the market will treat life company shares going forward is far from certain. Analysts remain adamant about returns and are not pleased with the pace of cost reductions. Low interest rates and sagging stock-market performance are hammering variable and fixed products alike. Post-Sept. 11 conditions in some reinsurance markets have had an impact as well. But as the spotlight turns to sponsored demutalizations and acquisitions of the earliest converters, it's clear that mutuals and former mutuals will continue to play a role in the restructuring of the industry.

Robert W. Stein, a Best's Review columnist, is chairman of Global Financial Services for Ernst & Young, New York. He can be reached at [e-mail].