In February, 2015 the Department of Finance released the draft regulations dealing with the demutualization of Canadian property and casualty mutual insurance companies (“P&C insurers”). There are two sets of regulations: one dealing with mutual companies having only mutual policyholders and one dealing with mutual companies that have mutual policyholders and non-mutual policyholders. One is a mutual policyholder if he or she, either by the company’s by-laws or the terms of the policy, have a right to vote at meetings called by the company. All other policyholders are considered non-mutual policyholders or cash policyholders.

Some Background

Demutualization means a mutual company will convert into a typical stock company with shareholders. Mutual insurance companies that sell life insurance and annuities have been able to convert into a stock company since 1999. To date,  P&C insurers have been unable to demutualize as the governing legislation did not permit it. As a result of Economical Insurance’s decision in 2010 to demutualize, the Department of Finance has been under some pressure to pass the appropriate legislation permitting them to do so. Demutualization is no easy matter as “ownership” of a mutual company has never been clear.  This is relevant in a demutualization because the company has to deal with its surplus earnings that have accumulated over a number of years. Usually “owners” expect that they “own” the surplus and any value attributable to the company over and above the surplus.

Some take the position (as did Economical Insurance) that only those mutual policyholders that have a right to vote and that signed “premium notes” exposing them to some risk of a capital call, are the owners and that all others are simply customers. A problem may arise if there are only a very few voting policyholders (less than 1000 in Economical Insurance’s case) and hundreds of thousands of other policyholders. In such a case, the small number of voting policyholders stand to gain a windfall upon conversion if they are the only policyholders to share in the benefits. Apparently, in the case of P&C insurers, this will not happen if the draft regulations are passed in their present form. The industry was divided as to who should reap the benefits of a demutualization. The Department of Finance has decided that all policyholders, voting and non- voting, should share the benefits in a “fair and equitable” manner in the event that the board of directors determines it  is in the best interests of a mutual company  to demutualize.


Who is entitled to the benefit of the mutual company’s conversion?

  • All policyholders at the date that the company’s board recommends conversion into a stock company
  • The Department of Finance  did not decide how to split the benefits of conversion (i.e., division of the accumulated surplus and value of the company). For people who like to think in terms of stock companies, the accumulated surplus would be equivalent to the retained earnings and paid in capital reflected on a typical balance sheet. The value of the company in many cases exceeds the accumulated surplus given the profits that can be generated.

How are the conversion benefits split?

  • The draft regulations applicable to  a company with both types of policyholders require a committee of the voting policyholders to negotiate a  fair split with a committee of the non-voting policyholders.  Each committee is to be advised by independent counsel appointed by the courts and the usual actuarial, accounting, valuation, and other experts. In the event of a disagreement, the parties can refer the matter to the courts for resolution.
  • The draft regulations do specify that the conversion proposal must take into account at least the following factors:
    • the obligations, rights and benefits of the policyholders under the policy;
    • the premiums paid by the policyholder;
    • the length of time the policyholder held the policy; and
    • the historical growth of the company’s surplus account.
  • A conversion proposal will require an opinion by the actuary of the company and an opinion by an independent actuary that the proposal is “fair and equitable” to all the policyholders.
  • Yet to be determined is  what will be considered “fair and equitable” and the methods or principles to be followed in making that determination. There will be lots of room for debate as to what is “fair and equitable”. The conversion proposals made by the life mutual companies may not be helpful given the different nature of life policies when compared to the standard one-year policies issued by P&C insurers
  • Benefits do not necessarily mean the policyholder will be given shares in the converted company equal in value to his or her share of the value of the company. There are other ways to provide benefits, the most common of which is a “cash out” benefit.

Who needs to approve the conversion proposal?

  • The board of directors must decide if it is in the best interests of the mutual company to demutualize. The board will likely need to conclude that the company needs to have the ability to grow by raising more capital in order to compete in the Canadian market.
  • The voting (mutual) policyholders must decide whether to approve the board’s recommendation to demutualize and to proceed with the proposal. For companies with non-voting policyholders,  only the voting policyholders get to decide if the proposal goes forward after the two committees have agreed on how to split the surplus (benefits).  Two-thirds of those casting votes have to approve. (In the case of a company with non-voting policyholders, the policyholders must also decide whether to approve amendments to  the by-laws to permit non-voting policy holders to vote on the proposal).
  • The notice of the policyholders’ meeting and the materials to be sent to the voting policyholders prior to the meeting must be approved by the Superintendent of Financial Institutions.
  • If the proposal is approved by the voting policyholders, all the policyholders get to vote on the proposal at another meeting called for that purpose.  Again, the approval will require two-thirds of votes cast at the meeting.
  • Once approved by all the policyholders, the company needs to apply to the Minister of Finance for final approval.

Who can control the converted company?

  • The regulations provide that a converted company must be widely-held (no one having more than 10% of any class of shares) for at least two years after the conversion is implemented. This is to prevent a hostile takeover of the company shortly after conversion. This restriction also effectively prevents “sponsored demutualizations” in which an investor agrees to buy a controlling interest in the company as part of the process.

What will a conversion proposal look like?

  • The company will solicit expert opinions as to the value of the company to support the proposal.
  • The proposal will allocate that value among the “eligible policyholders” likely based on the factors mentioned above and other factors determined by the company and its actuaries. A proposal might allocate a “fixed” component of a company’s value  to all its policyholders regardless of the other allocation factors used. For example, 10% of a company’s value could be considered a fixed benefit to be shared by all policyholders. And, hypothetically, the remaining 90%  of value could be shared 30% based on tenure, 50% based on premiums paid and 10% based on risk exposure. These would be the “variable” benefits.
  • The proposal is usually implemented by delivering to the policyholders common shares of a new holding company in proportion to their share of the benefits. In return, the policyholders give up any “ownership rights” they may have had in the mutual company. Often cash will be paid to those policyholders resident outside of Canada to avoid complications with securities laws in foreign jurisdictions.
  • The proposal is often combined with an initial public offering of the shares and a listing on a stock exchange. This allows the company to raise cash for the “cash outs” and provides a market for the new shareholders to sell their shares.

The P&C insurance industry is consolidating in Canada and elsewhere. Once the draft regulations are finalized, Canadian P&C mutual companies will be able to participate in such consolidation if they so choose. The Department of Finance has given a 30 day time frame (from February 28th) for interested parties to comment on the draft regulations.