- Seeks to ensure an equitable and transparent process through focus on the primary roles of boards and their advisors, court-appointed representatives and counsel, governance best practices and negotiated settlements with holders of non-mutual policies.
- Holders of non-mutual policies to also participate in demutualization proceeds on a negotiated basis.
- Lengthy and onerous process required for companies with both mutual and non-mutual policies.
- Companies required to be widely held for two years following demutualization.
Introduction and Commentary
Late last month, the Government of Canada published long-awaited proposed regulations to provide a framework for the demutualization of Canadian mutual property and casualty (P&C) insurance companies. The framework is intended to establish a transparent process for demutualization of P&C insurance companies, while ensuring that policyholders are treated fairly and equitably.
Release of the regulations follows a contentious consultation process that began in 2011 following a request from a large P&C mutual to develop such a demutualization framework. The Canadian regulatory regime already permits the demutualization of life insurance companies, and the largest life insurance companies demutualized many years ago. The new proposals consist of two separate regulations to be adopted under the Insurance Companies Act, namely the Mutual Property and Casualty Insurance Company Having Only Mutual Policyholders Conversion Regulations and the Mutual Property and Casualty Insurance Company With Non-Mutual Policyholders Conversion Regulations (the proposed regulations).
Both of the proposed regulations set out detailed procedures for the process of demutualization. As discussed below, the process is similar in many ways for both types of companies, but imposes significant additional steps on companies with non-mutual policyholders. The process for companies with only mutual policyholders is broadly similar to the process for life company demutualization.
Comments from stakeholders are being accepted by the Department of Finance for 30 days after publication. The regulations would come into force once published in Part II of the Canada Gazette.
Overall, the draft regulations reflect an attempt to make a highly contentious and potentially politically thorny process much more equitable and transparent through a focus on the primary role and responsibility of company boards and their external advisors, and court-appointed representatives and counsel, all following governance best practices. With respect to the central issue of whether, and if so, the extent to which, non-mutual policyholders would be entitled to vote on and share in the proceeds of demutualization, the process leaves the matter for companies to solve themselves through a negotiated process among court-appointed representatives and their court-appointed counsel. Entitlement to demutualization proceeds will no doubt be vigorously negotiated and this step will add significant complexity and lead-time to the process for affected companies.
Lastly, like the smaller life companies, demutualized companies will not be permitted, for two years following their conversion, to have a major shareholder, meaning a holder of more than 20% of any class of voting shares or more than 30% of any class of non-voting shares. This will effectively preclude companies from completing a "sponsored demutualization" in which they are immediately acquired by a friendly purchaser, and will instead force companies to demutualize by way of an initial public offering.
The Demutualization Process
INITIATION OF CONVERSION PROCESS
Under the regulations, the first step towards demutualization will be a decision by a P&C company's board of directors to initiate the process. In the case of companies with only mutual policyholders, the board would pass a resolution recommending conversion. All mutual policyholders of the company on the day on which the recommendation was made would be eligible to vote on demutualization, as would those who applied for a mutual policy prior to the resolution day and whose policy was issued within a specified period, and those with a lapsed policy that is reinstated during a certain timeframe.
The board resolution of a company with non-mutual policyholders would also have to set out certain information with regard to identifying which non-mutual policyholders would qualify as eligible to participate in the conversion proposal. At a minimum, non-mutual policyholders would have to have held their policies for one year prior to the date of the conversion resolution in order to qualify as eligible to vote. The board, in its judgment, may also elect to permit other non-mutual policyholders to vote and otherwise be "eligible non-mutual policy holders". Any such determination will require very careful and thoughtful consideration by such a board, in the exercise of its statutory fiduciary duty and duty of care.
The directors of a converting company would be able to terminate the conversion process at any time before letters patent of conversion were issued.
DEVELOPMENT OF CONVERSION PROPOSAL
In the case of a company with only mutual policyholders, the conversion proposal would be developed by the company itself before being put to a vote of eligible policyholders.
However, in respect of companies with non-mutual policyholders, the proposed regulations provide for a process that would include eligible mutual policyholders voting to negotiate a conversion proposal with eligible non-mutual policyholders and representative committees for both groups negotiating a conversion proposal, including, importantly, how the demutualization proceeds are to be shared. The basis for entitlement to demutualization benefits is to include, for each eligible mutual or non-mutual policyholder: (i) their obligation, rights and benefits; (ii) the premiums paid by them; (iii) the length of the time they have held a policy with the company; and (iv) the historical growth of the company's surplus account. The same criteria are to be applied to companies with only mutual policyholders. A court would appoint counsel for each of the two categories of policyholders and would appoint the members of each policyholder committee. The committees would also be able to retain outside experts, whose reasonable costs would be borne by the converting company. This innovative process of negotiation between court-appointed committees and their court-appointed counsel will add significant complexity and lead-time to a demutualization of such a company.
A conversion proposal would be considered approved by the two policyholder committees once at least two-thirds of the members of each committee agreed to its terms.
REQUIRED CONTENTS OF A CONVERSION PROPOSAL
A conversion proposal, either developed by the company in the case of a company with only mutual policyholders or negotiated by policyholder committees in the case of a company with non-mutual policyholders, would have to contain certain information specified by the regulations, including (i) a report setting out an estimated value of the converting company and the method used and any assumptions made in estimating the value; (ii) a detailed description of the benefits to be provided to eligible policyholders and any other persons to be provided with benefits in respect of the conversion, and of the method to be used to apportion the value of the converting company among them; and (iii) a description of the mechanisms proposed to effect an initial issuance of shares, including a copy of the proposed by-law authorizing the issuance of shares.
SPECIAL MEETING (COMPANIES WITH ONLY MUTUAL POLICYHOLDERS)
In the case of a company with only mutual policyholders, the converting company would have to submit an application to the Superintendent for authorization to send eligible policyholders notice of a special meeting to approve the conversion proposal within one year of passing the resolution to propose conversion.
The application to the Superintendent would have to include certain information, including: (i) the conversion proposal; (ii) an opinion prepared by the company's actuary and an opinion prepared by an independent actuary stating that the benefits to be provided to eligible policyholders are fair and equitable and that the financial strength of the converting company and the security of its policyholders will not be materially adversely affected by conversion; (iii) an opinion prepared by an independent valuator stating that the method and assumptions used to estimate the company's value were appropriate and that the estimated value reasonably reflected prevailing market conditions as of the day the value was estimated; (iv) financial statements for the company's most recently completed financial year; (v) a detailed description of any significant transaction contemplated in connection with the conversion; and (vi) a copy of the prospectus if the converted company is required to file such a prospectus in respect of its issuance of shares to eligible policyholders.
Once the Superintendent's authorization has been received, the company must send policyholders notice of the special meeting. The notice must include, among other things (i) a description of the steps taken in the conversion process; (ii) the conversion proposal; (iii) a description of the advantages and disadvantages of the proposed conversion to the converting company and its policyholders; (iv) a description of the alternatives to conversion considered by the directors, along with the reasons why the conversion is in the best interests of the company and its policyholders; (v) a description of the form, amount and estimated market value or range of market values of the benefits to be provided as a result of the conversion to the eligible policyholder to whom the notice is sent; (vi) a description of any right of policyholders to vote after the conversion, as policyholders or shareholders of the converted company; (vii) summaries of the actuarial and other financial opinions submitted to the Superintendent; and (viii) the financial statements required to be submitted to the Superintendent.
Within 30 days after the approval of a conversion proposal by eligible policyholders, a notice would have to be sent to policyholders informing them of the approval and indicating the company intended to seek Ministerial approval for the conversion.
SPECIAL MEETING (COMPANIES WITH NON-MUTUAL POLICYHOLDERS)
Prior to seeking authorization to send a notice of special meeting to all eligible policyholders, companies with non-mutual policyholders would first need authorization to send eligible mutual policyholders notice of a special meeting to vote on whether to amend the company's by-laws to permit all eligible non-mutual policyholders to vote on the conversion proposal.
The information required to obtain the Superintendent's authorization would be similar to the information companies with only mutual policyholders would send the Superintendent in order for authorization to convene a special meeting. Importantly, the conversion proposal would be required to be submitted to the Superintendent within one year after the court appoints the members of the policyholder committees. Once authorization was received, a notice would have to be sent to all eligible mutual policyholders, containing information similar to the information described above and required to be sent to eligible policyholders in the notice of a special meeting in respect of companies with only mutual policyholders.
Once the company's by-laws were amended to allow for eligible non-mutual policyholders to vote on the conversion proposal, the notice process would be repeated. To obtain the Superintendent's authorization to send a notice of a special meeting to all policyholders, the company would have to provide certain additional information, including a copy of the by-laws indicating that amendments had been made to permit all eligible non-mutual policyholders to vote on the conversion proposal.
With the Superintendent's authorization, the company would then be able to send notice to all eligible (mutual and non-mutual) policyholders, with similar disclosure requirements as the notice previously sent only to mutual policyholders.
An application for Ministerial approval, to be made within three months of approval of the conversion, would have to contain certain information, including (i) the conversion proposal; (ii) the proposed letters patent of conversion and any by-laws, amendments to by-laws or repeals of by-laws that are necessary to implement the conversion; and (iii) the special resolutions of eligible policyholders.
Meanwhile, subject to an exception for financial difficulty, the regulations would limit the instances in which the Ministerial approval required under the Insurance Companies Act for a person to acquire a significant interest in any class of shares of a company would be given during a company's first two years as a converted company, so as to ensure companies were widely held and to limit the risk of a takeover of recently demutualized companies. The same public holding requirements were imposed on the smaller mutual life companies at the time of their demutualization and similarly the government has determined that demutualized P&C companies require the same protection. For two years, they will not be permitted to have a "major shareholder", which is defined under the Insurance Companies Act as a holder of more than 20% of any class of voting shares or more than 30% of any class of non-voting shares. This will effectively preclude companies from completing a "sponsored demutualization" in which they are immediately acquired by a friendly purchaser, and will instead force companies to demutualize by way of an initial public offering.