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.

Mutualization (or mutualisation) describes the opposite process, wherein a public company is converted into a mutual company.

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 Types of demutualizations
3 See also
4 References
5 External links

[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.

[edit] Types of demutualizations

There are three general methods in which a company might demutualize, full demutualization, sponsored demutualization, and into a mutual holding company (MHC). In any type of insurance company demutualization, all policies remain in force.

In a full demutualization, the mutual completely converts to a stock company, and passes on its own (newly issued) stock, cash, and/or policy credits to the members or policyholders. No attempt is made to preserve mutuality in any form.

A sponsored demutualization is similar; the mutual is fully demutualized and its policyholders or members are compensated. The difference is that the mutuality is essentially bought by a stock corporation. Instead of receiving stock in the formerly mutual company, stock in the new parent company is granted instead.

A mutual holding company is a hybrid concept, part stock company and part mutual company. Technically, the members still own over 50% of the company as a whole. Because of this, they are generally not significantly compensated for what would otherwise be viewed as loss of property. (This is also why many jurisdictions, including Canada,^[1] disallow the formation of MHCs.) The core participants are isolated into a special segement of the company, still viewed as "mutual". The rest is a stock company. This part of the business might be publicly traded, or held as a wholly owned subsidiary until such time that the organization should choose to go public.

Some MHC demutualizations have been planned as the first of a two-stage process. The second stage would be full demutualization once the transition pains into MHC status are complete. In other cases, the MHC is the final stage.

Note that some mutual companies, such as Nationwide and the MassMutual, own stock companies and are listed on a stock exchange. These are not MHCs, however; they are simply mutual companies which have majority control over one or more stock companies. Other mutual companies may own some of another company's stock, but as simply an asset, not something they actually control. Finally, many mutual companies, including Nationwide and MassMutual, have wholly owned subsidiaries. The subsidiaries may technically be stock companies, but the mutual owns all the stock. For example, the New York Life Insurance and Annuity Corporation (NYLIAC) is a wholly owned subsidiary of the New York Life Insurance Company (NYLIC). A person may purchase an insurance policy from either company, but only those who own participating policies from NYLIC are mutual members. Other policyholders are customers.