Regulations Provide Process for Mutual P&Cs to Demutualize

On February 28, 2015, the Department of Finance issued draft regulations under the Insurance Companies Act (Canada) providing the process to enable federally regulated mutual property and casualty insurance companies (Mutual P&Cs) to demutualize. Demutualization is the process of converting a mutual company into a company with common shares. Two different sets of regulations have been issued: the Mutual Property and Casualty Insurance Company Having Only Mutual Policyholders Conversion Regulations, for Mutual P&Cs that have only mutual policyholders; and the Mutual Property and Casualty Insurance Company with Non-mutual Policyholders Conversion Regulations, for Mutual P&Cs that have both mutual policyholders and non-mutual policyholders (collectively, Regulations).

Regulations to Be Finalized After Comment Period Ends on March 30, 2015 

The Regulations constitute the final step in a process set in motion in 2010 at the request of one of the largest Mutual P&Cs in Canada, Economical Insurance. Interested persons are permitted to make representations on the draft Regulations to the Department of Finance during a comment period that ends on March 30, 2015. Following the comment period, the Regulations will come into force on the date they are published in the Canada Gazette, Part II. Once they come into force, the Regulations will provide seven Mutual P&Cs — Economical Insurance, Gore Mutual, Portage La Prairie Mutual, North Waterloo Farmers Mutual, Saskatchewan Mutual, The Kings Mutual and Wawanesa — with the option to demutualize. Regulations permitting demutualization of federally regulated life insurance companies, in contrast, were issued in 1999, following which four large mutual life insurance companies — Canada Life, Manulife, Sun Life and Clarica Life (formerly Mutual Life) — demutualized.

Principal Issues: Who Is Entitled to Vote and Who Is Entitled to Demutualization Benefits

Creating a framework to permit Mutual P&Cs to demutualize has been somewhat controversial. The principal issues are who is entitled to vote on whether a Mutual P&C should demutualize and who is entitled to the benefits of demutualization. The Department of Finance received over 80 submissions as part of its 2011 consultation process on the P&C demutualization framework. The Regulations seek to provide a framework that will treat policyholders fairly and equitably through an orderly and transparent demutualization process.

Apportionment of Benefits and Valuation

In the case of a Mutual P&C with only mutual policyholders, the board of directors will present to policyholders a conversion proposal developed by the company that sets out how the benefits of demutualization will be distributed, as part of a process that is similar to that provided for life insurance companies. In the case of a Mutual P&C with both mutual and non-mutual policyholders, however, the process is unique and more complex, with the apportionment of benefits to be determined by negotiation between court-appointed counsel and court-appointed and supervised policyholder committees representing the two types of eligible policyholders. The basis for apportioning benefits in each case must take into account at least the following four factors in respect of each eligible policyholder: (1) his or her obligations, rights and benefits; (2) the premiums paid by him or her; (3) the length of time he or she has held a policy with the company; and (4) the historical growth of the company’s surplus account.

Valuation by Independent Expert and Opinion of Independent Actuary

The Regulations require a Mutual P&C seeking to demutualize to obtain a valuation by an independent valuation expert and the opinion of an independent actuary that the estimated and proposed apportionment of benefits is “fair and equitable to the eligible policyholders.” A summary of the valuation and opinion must be provided to the eligible policyholders who are entitled to vote on the conversion proposal and to receive benefits in respect of the conversion when the company seeks their vote to approve the conversion proposal.

Conversion Proposal Disclosure Requirements

The Regulations require the conversion proposal to disclose certain information about the value of the company and the methods used and assumptions made in estimating the value. The conversion proposal must set out the eligibility date for determining who is an eligible policyholder and must include a statement identifying any persons other than eligible policyholders who are to receive benefits in respect of the conversion. A detailed description of the benefits to be provided to the eligible policyholders and other specified persons, and of the method used to apportion the value of the company among them, must be included. The conversion proposal must indicate the basis on which any variable amount of benefits will be calculated; any fixed, minimum or maximum amount of benefits to be provided to eligible policyholders and other specified persons; the rationale for choosing the method for determining and allocating the benefits; and the aggregate value of the benefits.

Demutualization Process and Approval Requirements for Mutual P&Cs with Only Mutual Policyholders

For Mutual P&Cs that have only mutual policyholders, the board of directions must pass a resolution recommending conversion and the company must prepare a conversion proposal. The Superintendent of Financial Institutions (Superintendent) will review the conversion proposal and other required documentation and, if satisfied, will authorize the converting company to send a notice of special meeting to the eligible policyholders to vote on the conversion proposal. Along with the notice of special meeting and conversion proposal, the company must send to policyholders a description of the advantages and disadvantages of the proposed conversion to the converting company and its policyholders; a description of the alternatives to conversion that the directors of the converting company have considered; and the reasons why, in their opinion, the conversion is in the best interests of the company and its policyholders. The eligible policyholders must vote to approve the conversion proposal.

Demutualization Process and Approval Requirements for Mutual P&Cs with Both Mutual and Non-Mutual Policyholders

For Mutual P&Cs with both mutual and non-mutual policyholders, the process for demutualization consists of a more complex four-step negotiated process.

First, the board of directors must pass a resolution recommending conversion and determining who the eligible policyholders are.

Second, the mutual policyholders must vote on whether to proceed to the next stage in the process, which is to negotiate a conversion proposal with the eligible non-mutual policyholders. The Regulations require that non-mutual policyholders who have held an insurance policy for at least a 12-month period ending on the date of the board’s decision to recommend demutualization be considered eligible non-mutual policyholders.

Third, the committee for the mutual policyholders and the committee for the non-mutual policyholders, each composed of court-appointed committee members and represented by court-appointed counsel, must negotiate the conversion proposal that identifies who is to receive benefits from the conversion. The conversion proposal is considered approved when two-thirds of the members of each committee agree to its terms. The Mutual P&C has one year from the appointment of the policyholder committees in which to submit a conversion proposal, opinions of actuaries and other required documentation to the Superintendent for review. The process terminates if the required time period is not met. Once the Superintendent is satisfied with such documentation, the Superintendent will authorize the company to send a notice of special meeting to the eligible mutual policyholders. Among other things, the company must send to policyholders, together with the notice of special meeting and conversion proposal, a description of the advantages and disadvantages of the proposed conversion, the alternatives to conversion that the directors have considered and the directors’ opinion of the reasons why the conversion is in the best interests of the company and its policyholders.

At the fourth and final stage, the eligible mutual policyholders must vote to amend the by-laws to allow the eligible non-mutual policyholders to vote. The company must then obtain the Superintendent’s authorization to send a notice of special meeting to all eligible mutual and non-mutual policyholders, and then all eligible policyholders must vote to approve the conversion proposal.

Approval of the Minister of Finance

In both cases, in order for the conversion to proceed, the company must seek the approval of the Minister of Finance for the conversion within three months of the policyholder vote approving the conversion. The process is completed when the Minister, on the recommendation of the Superintendent, approves the demutualization and issues letters patent of conversion to the converting company. The board of directors of the converting company may pass a resolution terminating the conversion process at any time before the letters patent of conversion are issued.

Two-Year Freeze on Acquisitions of Demutualized P&Cs

The Regulations provide that the Minister of Finance may approve a proposed acquisition of a converted company within the first two years of its demutualization only if the proposed acquisition would not result in the converted company having a major shareholder holding more than 20% of any class of voting shares or more than 30% of any class of non-voting shares, other than in the case of an acquisition of a distressed Mutual P&C. This requirement for demutualized companies to be widely held for two years is intended to “give companies time to adjust to their new corporate structure and to limit the risk of takeover of recently demutualized companies.” This is expected to mean that a so-called sponsored demutualization structure will not be possible. Accordingly, demutualization may be less attractive to small Mutual P&Cs that do not wish to become public companies.