The Second Wave.

The possibility of increased capitalization and higher return on equity is luring more mutual insurance companies into the demutualization tide.

Since 1998, several big life insurers in the United States and Canada have used demutualization to help transform their financial structures and results. Three more are set to take the plunge this year.

Prudential Insurance Company of America, Phoenix Home Life Mutual Insurance Co. and Principal Financial Group are all well along in plans to switch to stock ownership. Their conversions will continue what is already a remarkable transformation of the life industry and will reduce the market share of mutual companies. Credit Suisse First Boston reported in October that only 16% of the assets in the U.S. life insurance industry will be held in mutuals after the three conversions, down from 37% in 1998. The new stock companies will add about $25 billion of market value to the publicly traded sector, the report said. Eight North American life insurers that have demutualized since November 1998 have added about $45 billion in market capitalization.

Those conversions began with MONY Group (formerly Mutual Life Insurance Company of New York). MONY was followed in April 1999 by StanCorp Financial Group (formerly Standard Insurance Co.), Portland, Ore.; and three Canadian insurers: Clarica Life Insurance (formerly Mutual Life Insurance Company of Canada), Waterloo, Ont., in July 1999; Manufacturers Life Insurance Co., now part of Toronto-based Manulife Financial Group, in September 1999; and Canada Life Assurance Co., Toronto, in October 1999. In January 2000, Boston-based John Hancock Life Insurance Co. restructured under a new holding company, John Hancock Financial Services. In March 2000, Sun Life Assurance Company of Canada demutualized, and it now operates under the Sun Life Financial Group. Finally, Metropolitan Life Insurance Co. became MetLife Inc. in April 2000.

Better Financial Performance

Access to capital for growing the company has been the main force driving the conversions, and a statistical study in the 2000 life/health edition of A.M. Best's Aggregates and Averages shows that stock-based life/health insurers have performed better than mutuals. From 1990 through 1999, stock companies bettered mutuals in average annual return on revenue, 3.34% to 2.03%; return on assets, 0.87% to 0.5%; and return on equity, 14.13% to 9.77%.

Investors rewarded this performance, particularly for newly demutualized insurers. According to the Credit Suisse report, stock prices of the six insurers that have demutualized since July 1999 collectively rose 127.8% through Oct. 6, 2000, compared with a 15.8% decline in the Standard & Poor's Life/Health Insurance Index and a 0.8% increase in the S&P 500 Index.

Of the three mutuals that intend to tap into that kind of bonanza this year, Newark, N.J.-based Prudential seems to be the farthest along, but it may still have the farthest to go. The company announced its intention to convert more than three years ago--February 1998--but New Jersey did not have a demutualization statute at the time. The state passed its law later that year, but Prudential has had a lot of work to do since then, including completion of the costly settlement of its market-conduct lawsuit from 1996.

Not until December 2000 did Prudential's board of directors adopt a reorganization plan. On March 14, the company submitted the plan to the New Jersey Department of Banking and Insurance. When Commissioner Karen L. Suter deems the application complete, Prudential will mail information and voting materials to about 11 million policyholders. Under state law, at least 1 million will have to vote, and conversion must be approved by at least two-thirds of those who vote.

Prudential expected to submit its plan in mid-February; begin mailings to policyholders in April and have its public hearing in mid-June. The commissioner would then be in a position to approve the plan by Labor Day. Then Prudential begins its "road show," in which management would call on institutional investors with the help of one or more investment banks to drum up support for its initial public offering of stock. The IPO would be sometime in the fourth quarter.

Phoenix Home Life, based in Hartford, Conn., but domiciled in East Greenbush, N.Y., is on a much faster track. It announced its intention to demutualize in April 2000, and its board of directors adopted a plan of conversion in December. Its public hearing was slated for mid-March, with the New York State Insurance Department presiding. The rest of the timetable called for a closing of policyholder voting on April 2, with most votes expected by mail. Final approval by the department would follow Spokeswoman Alice Ericson said the company would try to hold its IPO before the end of June. But she added: "We'll take market conditions into account, and any other factors, before we decide to go." She said the company is not releasing who will handle its IPO.

Upon conversion, the company will be renamed Phoenix Life Insurance Co. and will become a wholly owned subsidiary of a new publicly traded holding company, The Phoenix Cos. Inc. The company specializes in wealth management for high-income clients.

Principal, based in Des Moines, Iowa, is not as far along as Phoenix Home Life. It converted in July 1998 to a mutual holding company structure after 119 years as a mutual, but in August 2000 its board of directors authorized development of a plan of full demutualization. Spokesman Jeff Rader said the board hopes to approve a plan by the end of June.

A Different Approach

Rader said the demutualization process in Iowa differs from the process in New Jersey and New York in that once the board adopts a plan, its next step is to mail ballots to policyholders. The company needs two-thirds approval of policyholders who vote. A special member meeting would occur before a public hearing set up by the Department of Insurance. Approval by Commissioner Therese M. Vaughan would complete the process and clear the way for an IPO.

The plan would determine what kinds of policyholders would qualify for dissemination of stock, Rader said.

Principal's intent to fully demutualize may serve as the best illustration of the limits and shortcomings of the mutual holding company structure, which may have fallen out of favor. Credit Suisse said in its report that the pace of mutual holding company conversions has slowed significantly due to two factors-selected regulatory and consumer-advocate opposition and the weak performance in 1998 and 1999 of the stock of the AmerUs Life Group, the Des Moines, Iowa-based holding company resulting from the mutual holding company restructuring in June 1996 of American Mutual Life Insurance Co. AmerUs was the first mutual to convert to the mutual holding company structure. It fully demutualized in September 2000, becoming AmerUs Group Co.

J. Barry Griswell, Principal's president and chief executive officer, said the mutual holding company structure significantly helped his company, particularly in its $1.4 billion acquisition of BT Australia. "Without MHC, we wouldn't have been able to make it," he said. "We couldn't have raised debt to finance that purchase without it. It has been a very useful structure." It also provided Principal the necessary structure to form a banking subsidiary, he said.

The holding company gave Principal the ability to "unstack" its subsidiaries. Under a mutual structure, every subsidiary has to be "under" the life company, but with a mutual holding company, subsidiaries can be parallel to the life company Griswell said. "If the subsidiary is under the life company, you run into some nonlife restrictions and other things that are problematic for the company in trying to expand and go outside the United States," he said.

As a result of the mutual holding company structure, Principal was able to issue a $665 million debt offering to finance the BT Australia purchase. Principal is the largest life insurer to use the mutual holding company structure. But Principal has concluded that the environment has changed to the detriment of the mutual holding company format. "When we went into the holding-company structure, we anticipated it would be more widely accepted than it was, that more states would adopt it," Griswell said. "Some large states haven't approved it." Even more important, he said, is that with passage of the Gramm-Leach-Bliley Financial Modernization Act in 1999, companies need "full access" to capital markets to take part in the "essential consolidation" of the financial-services business, both domestically and globally. The mutual holding company structure constrains that access because the holding company must retain more than half of all stock.

Principal's flagship business is administration of 401(k) plans. According to the April/May issue of CFO Magazine, more employers choose Principal for its 401(k) offerings than any other bank, mutual fund or insurer in the United States. Most are small to midsize employers. Griswell said the company has aspirations to be a global retirement-services organization, and becoming a stock company will provide the capital.

"We've been very aggressive in our acquisition and expansion," he said. "In addition to Australia, we've entered India with a small mutual fund, Brazil with a small pension company, and Japan in a joint venture with ING. We're also participating in Hong Kong and Mexico, and we have an institutional asset-management office in London." He said Principal will be "digesting" in the next 12 to 18 months and plans no significant activity.

Years of Preparation

Manulife Financial fits well into Credit Suisse's profile of collective results of newly demutualized companies that have enjoyed strong growth. Since its IPO in September 1999, Manulife's capitalization has more than doubled. But Peter Rubenovitch, executive vice president and chief financial officer, said that success was not simply a result of demutualizing. Rather, the company started working on that success seven years ago, and the financial improvement can be traced across that time frame.

"These good results are heartening, but they reflect a business strategy," he said. They also reflect the company's necessary cultural change, which comes when employees know that their company has a quoted stock and that they are under scrutiny from stock analysts and by stockholders, he added.

To prepare for its demurualization, Manulife sold some two dozen noncore businesses, such as its entire business in the United Kingdom and its banking and trust business in Canada. It now runs a virtual bank and has no trust organizations.

"Some businesses were quite significant," Rubenovitch said. "Some we've held for many decades. But they lacked scale, were inconsistent with our financial objectives and were not compatible with our other core activities."

While it was divesting, Manulife also made three "very selective acquisitions," Rubenovitch said. One was the group life and health business from the liquidator of Confederation Life, which added scale to Manulife's businesses in Canada. Another was a merger with North American Life in 1996. It improved Manulife's scale in Canada and provided an entry into the variable-annuity business in the United States. The third came in Japan, a two-step process in which it first acquired the sales force of the 15th-largest insurer, Daihyaku Mutual, and then Daihyaku's in-force book of business.

The company is also "as proud of the deals we haven't done," Rubenovitch said. "Part of discipline is not paying too much for something."

Lastly, Manulife invested in businesses or started up businesses it thought were attractive. These include a 401(k) pension business for small and midsize firms and new operations in Vietnam, mainland China and Japan.

But while Manulife and the first wave of recently demutualized companies have made good business decisions, they also may have been lucky--the beneficiaries of a sector rotation in the stock markets that began about a year ago. At that time, investor sentiment shifted from speculative growth stocks to value stocks of the "old economy" with earnings--precisely the kind of company a life insurer is.

Rubenovitch agreed that there was no doubt that Manulife had benefited from "sector rotation from high-tech and dot-coms to companies that earn money," but he noted that the rise in its stock value "suggests favorable recognition" of its performance and that Manulife had generally outperformed its peers in that period.

Policyholders Seek Billions

The recent run-ups in stock valuations of recently demutualized life insurers have not gone unnoticed by policyholders of Massachusetts Mutual Life Insurance Co., Springfield, Mass. The company is one of a few large life insurers that have steadfastly defended the mutual structure and have publicly declared their intention to remain mutuals, including New York Life Insurance Co. and Northwestern Mutual Life Insurance Co.

A group of MassMutual policy owners has formed the MassMutual Owners Association, which they say is a nationwide organization. In a press release, the association prodded MassMutual to convert to stock ownership, a conversion it said would result in the distribution of $4 billion to policyholders. MassMutual opposes the demand, which the association has submitted to the board of directors.

The association is drumming up votes for the company's annual meeting on April 11 and expects a "very close" contest. If passed, the proposal would cause distribution of the estimated $4 billion in stock, cash and policy credits in exchange for policyholder voting rights and claims on earnings. But MassMutual would end up with greater financial resources, the association said.

"We have a win-win proposal," said John H. Jameison, executive director. "Policyowners believe it's only natural that MassMutual would want to demutualize and return their excess earnings to them. Most other large mutual insurance companies have already decided it's the right thing to do, which is why a wave of conversions is sweeping the country."

But Principal Financial Group's Griswell was reluctant to make such broad statements about the circumstances under which a life insurer should or should not demutualize.

"Each company is unique, so I don't know if you can generalize," he said. "For us, with our increased emphasis on asset management, accumulation and global reach, it seemed compelling we should move toward demutualization. But I think, too, that it has to do with how comfortable a management is with its structure."

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Capital and Surplus: Stock vs. Mutual companies

Stock life insurers have historically achieved greater growth in their capital bases than mutual life insurers have. This is particularly true for equity capital, since most of the Industry's major acquisitions in the past several years have been financed with stock.

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