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What is Demutualization?

2017-01-19T17:46:13+00:00

The term 'Demutualization' is included in the Corporate Finance edition of the Financial Dictionary. Get yours now on mazon in ebook or paperback format. Read more here...

Demutualization is the decision undertaken by the members of a mutual corporation to convert their company into one which shareholders own instead. This means that the members and users of the mutual company give up their rights of use in exchange for stock shares in the new usually publically traded company.

Such mutual companies were originally established in order to offer specific services to their members. They are able to provide said services for the least expensive price possible to their members. This is because they are not forced to earn profits, as with publically traded or for profit corporations. Instead, their goals are to remain at least financially stable and solvent, to offer member benefits, and to return any profits that remain after they pay expenses to their member owners.

This has been a practice most common with insurance companies in recent years. A number of mutual insurers that could not earn sufficient returns on their investments, or which faced limited possibilities in acquisitions and mergers on their own, chose this path. They evolved into companies which were publically traded stock corporations. It has aided insurance companies in raising much-needed fresh capital. It also helped them to become more competitive in the domestic marketplace.

The question remains is this a good strategy for the mutual insurance company owners? They already enjoy the rights to elect the members of the board of directors. They also have some voice in the way the firms operate. All premiums which the owners pay go towards the insurance company’s bottom line. If there is a profit, then a portion of those premiums are returned as dividends. This is not the case for those life insurance policy holders who own term life insurance only.

The insurance companies pay out these dividends once they determine what money remains after key expenses. Among these costs they look at are policy expenses, mortality payouts, and administration costs. Interestingly enough, mutual companies do not have to disclose to their owners how they come up with their dividends.

There are several important reasons why firms elect to pursue a demutualization. They are usually first and foremost interested in gaining greater access to additional capital. With this fresh infusion of substantial amounts of cash they can raise by selling shares, they are able to pursue mergers and acquisitions. The mutual insurance companies have found that laws which permit the mega banks and publically traded insurance companies to offer similar services have created huge amounts of pressure to compete effectively in the marketplace for financial services. At least on paper and on balance sheets, additional money a company obtains from its IPO initial public offering provides them with a healthier and more powerful firm.

The process of demutualization can require in the range of 18 to 24 months. Before the insurer can affect conversion, they will invest significant amounts of time to fashion a draft proposal. This has to first be approved by the board of directors of the firm. Next this proposal has to be turned in to the state’s insurance department for review. The firm will also want to run meetings giving out information in the state where their head office is based. Policy holders must be informed with regards to their rights to vote yes or no on the final proposal.

Those policy holders which have a right to participate in the process are usually allowed to choose one of three benefits. They can request shares of stock in the publically traded company, a cash payout, or an enhancement to their existing policy. Finally, after the policy holders approve the demutualization process, it is up to the department insurance of the state to review the plan. They must give final approval to the decision for demutualization to commence.

The term 'Demutualization' is included in the Corporate Finance edition of the Financial Dictionary. You can get your copy on mazon in Kindle or Paperback version. See more details here.