Demutualization

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The term demutualization (or demutualisation) describes the process by which mutual organizations or companies (mutuals) convert themselves to for-profit (or profit-making) public companies which distribute profits to their shareholders in the form of dividends.

Demutualization usually involves the sale or reorganization of a mutual, by its members, to or into a non-mutual company whose shares can be traded on a stock market. This maneuver generally improves the company's access to investment capital, and so increases its value as a viable business.

As a result of demutualization, members of a mutual usually receive a windfall payout. This payout usually takes the form of shares in the successor company, a cash payment, or a mixture of both. Under the Nixon administration, Internal Revenue Service findings claimed that cash payouts are fully taxable, and that distributed stock shares have a zero cost basis, a surprisingly unnuanced treatment of a rather complex transaction.

At demutualization, the restricted ownership rights of members are either dissolved or replaced by more conventional stock ownership and voting rights in the surviving company.

1 Examples
- 1.1 Security exchanges
- 1.2 Life insurers
2 See also
3 References

[edit] Examples

[edit] Security exchanges

The Chicago Mercantile Exchange became a shareholder-owned corporation in 2000 through a public offering. "The road to this initial public offering began in June 2000, when Exchange members voted overwhelmingly to transform the then not-for-profit, membership-owned organization into a for-profit, shareholder-owned corporation. On November 13, 2000, CME became the first U.S. financial exchange to demutualize into a shareholder-owned corporation" [1].

The Chicago Board of Trade is seeking approval from the SEC to do the same thing. "The CBOT presently is a self-governing, self-regulated Delaware not-for-profit, non-stock corporation that serves individuals and member firms." However, "the Board of Trade of the City of Chicago, Inc. (CBOT) has filed a Registration Statement on Form S-4, including a preliminary proxy statement and prospectus, regarding the restructuring transactions with the SEC" [2]. The Chicago Mercantile Exchange had its IPO on December 6, 2002.

[edit] Life insurers

Over 200 mutual life insurance companies have demutualized since 1930 and distributed more than $100 billion to policyowners. Demutualized life insurers include such well-known companies as Prudential, MetLife, John Hancock, Mutual of New York, Manufacturers Life, Sun Life, Principal, and Phoenix Mutual. At the end of 2005 there were less than 80 mutual life insurers in the United States.

Participating policyholders own the original mutual company by virtue of their contributions to its operating surplus in the form of premiums that exceed the actuarial cost of their policy coverage. These excess amounts function in a way analogous to the capital raised when a stock insurer makes an offering of its stock. But, of course, policies which mature (i.e. the insured person dies) surrender their participation rights which pass to the surviving members of the mutual organization. This "operating profit", along with investment income from the company's asset base are often paid as dividends to participating policyholders. Unlike stock dividends, insurance policy dividends are not subject to U.S. income tax.

During demutualization, voting rights, rights to future income dividends, and rights to future operating profits are reassigned. Some rights that would terminate at policy maturation become vested in company shares which will survive the policy from which they derive. Other rights to tax-sheltered dividends are converted into rights to taxable stock dividends. Policies still in force often retain partial voting or dividend rights too. Courts and state insurance regulators closely review demutualization plans for their fairness to the varied interests of all parties.

Tax consequences aside, participating policyholders who are able to take their windfall in the form of shares have generally made out quite well, as the reorganized business' increased value translates into an increased market price.