Mutual Holding Companies in the U.S.

1. Introduction

Preparations have already begun on the financial reforms known as the Japanese Big Bang. The first step began with the revision of the Foreign Exchange and Trade Control Law in May 1997. This was followed by the partial revision of the Anti-Monopoly Law in June， which lifted the ban on holding companies in force throughout the postwar period. As a result， companies can choose to establish holding companies， under which they can organize subsidiaries. A holding company delegates all operational management functions to subsidiaries so that it can focus on the management of the overall group. Holding companies have certain advantages including the ability to arrange subsidiaries in parallel， and to facilitate business restructuring through M&A's. In addition， for the financial sector， the revision is expected to eventually allow financial holding companies to own banks， securities companies and insurance companies.

However， holding companies cannot be formed above mutual companies， which are a structure peculiar to insurance companies， because they are owned not by stockholders but by policyholders who act as members. A mutual company can use a holding company only by forming it downstream， or else converting into a stock company and establish a holding company upstream. Holding companies that are formed downstream are of limited use， while converting into a stock company is no simple matter.

Thus the structural constraints of mutual companies limits their available business choices compared to stock companies.

Meanwhile， the U.S. has recently allowed the formation of mutual holding companies， which are holding companies that enjoy the advantages of mutual companies. As they grow in number， mutual holding companies will become a keyword in the life insurance business.

In this paper， we look at the new development of mutual holding companies in the U.S. − what they are， and why they have become necessary.

2. The Life Insurance Crisis and Enhancement of Equity Capital

Following the failure of Nissan Life Insurance Company， concern has arisen as to the condition of other life insurers. The impact of the failure was all the more pronounced due to confidence in the life insurance business. A crisis also struck the life insurance industry in the U.S. in the early 1990s.

Against a backdrop of high interest rates and inflation in the early 1980s， financial institutions including banks and securities companies competed to excess by selling many new products with high interest rates. To stop the loss of customers to these products， life insurers offered their own products that guaranteed high interest rates from high-risk， high-return investments such as junk bonds and real estate. These high-risk investments， however， met their demise when the junk bond market crashed and real estate market slumped. From 1989 to 1991， almost 150 second-tier life insurance companies went bankrupt. Equitable Life Insurance Company， the fourth largest mutual company in admitted assets， fell in trouble and needed to obtain financing， it converted itself into a stock company.

The business crisis convinced life insurers that to ensure financial stability， they would need to enhance their equity capital. One measure was the introduction of RBC (risk based capital) rules， which evaluated a company's business condition based on the level of equity capital. This elevated equity capital into a high priority among life insurers. Another factor was that consumers， wary from the failures， looked at ratings to measure the ability of life insurers to pay before choosing a life insurer. The life insurance industry's efforts paid off as it managed to overcome the crisis.

Another factor encouraging the emphasis on equity capital has been the need to enhance competitiveness. From the mid 1990s， the traditional segmentation of the financial system has been blurring as banks have been allowed to sell annuities， as well as life insurance products in certain regions. The U.S. Congress has recently been debating financial system reforms to integrate the banking， securities and insurance businesses. Competition will thus increasingly transcend existing business boundaries. Life insurance stock companies are trying to bolster their customer services and corporate competitiveness by actively resorting to M&A strategy， a traditional reorganizing method in the U.S. However， this strategy rests on having sufficient equity capital.

In this way， U.S. life insurers were pressured to enhance their equity capital from two directions-bolstering services and competitiveness while maintaining financial stability.

However， mutual life insurance companies faced substantial limitations in enhancing their equity capital. Unlike stock companies， a mutual company cannot raise capital by issuing new stock. The alternative method of accumulating internal reserves out of annual earnings takes time and is unpredictable. To raise capital， mutual life insurers are limited to such means as issuing surplus notes. As a result， the only available alternative for mutual companies to enhance their equity capital with outside funds is to alter the company organization. As will be explained below， forming a stock company requires massive amounts of time and expense， and is not necessarily the best way to procure capital in a timely manner.

Thus mutual life insurers faced more restrictions in procuring equity capital than did insurers with a stock company organization. Mutual life insurers became concerned that with such restrictions， they would be forced to incur huge costs if they were unable to withstand the intensifying competition and business conditions deteriorated even temporarily. This is where the new form of company organization called the mutual holding company emerged.

3. What is a Mutual Holding Company?

(1)　Company Organization of Life Insurance Companies

There are two types of life insurance companies-stock companies and mutual companies. Stock companies are owned by the stockholders of the company. On the other hand， mutual companies are unique to the life insurance business， and in principle owned by policyholders. Thus for a mutual life insurer， the policyholders are not only customers but also owners (members) of the company.

In comparing the two types， stock companies have the advantage of being able to bolster their business foundation by raising capital through the issuance of new stock. On the other hand， mutual companies can minimize the cost of providing insurance because surpluses are distributed only to the policyholders/members. By law， it is possible for stock companies to be converted into mutual companies， and vice versa.

In Japan， 15 of the 44 life insurance companies are mutual companies， including all the major life insurers. In the U.S.， while only about 100 of the 1，700 life insurers are mutual companies， they are major companies who account for approximately 35 percent of life insurance in force. Unique to the life insurance business， mutual companies thus play an important role in both Japan and the U.S.

(2)　Characteristics of Mutual Holding Companies

Mutual holding companies are a new type of holding company based on mutual companies. The first insurance law allowing them appeared in 1995 in Iowa， and the first insurance company to convert to this organization was Iowa-based AmerUs Life.

The following characteristics of mutual holding companies can be observed from AmerUs Life Holdings Inc.

Policy rights remain at the converted stock life insurance company， while membership interests (voting and liquidation rights， etc.) are moved to the mutual holding company.
The stock life insurance company， which manages policy rights， conducts life insurance business.
The mutual holding company， which manages member interests， manages the group of subsidiaries including the stock life insurance company.
The mutual holding company initially owns 100 percent of its life insurance subsidiary (or of an intermediate holding company if one is created). Later， if stocks are issued to raise capital， the holding company must retain a majority stake.
After the organizational change， new policyholders become members of the mutual holding company.

4. Merits and Demerits of Mutual Holding Companies

(1)　Merits

To survive intense competition， life insurance companies must maintain and bolster their competitiveness by restructuring through M&A activity or by diversifying. The American approach holds that such efforts are ultimately linked to the protection of policyholders.

This is where equity capital becomes important. As already discussed， mutual companies are severely constrained in raising capital from outside sources. While one alternative is demutualization， this is not an easy step to take. Mutual companies must compensate for the loss of member interests after forming a stock company with stocks or cash. Since mutual companies have a wide variety of insurance products and policyholders， these calculations require huge amounts of time and cost. Moreover， since the new stock company will consist of many small stockholders， there is also the inherent problem of making the business foundation unstable

The mutual holding company solves these problems. Member interests are transferred to the mutual holding company， so there is no need to compensate member interests as in the case of demutualization. Thus the merits of demutualization can be enjoyed without incurring the time and expense. Simultaneously， the autonomy of policyholders (members) is maintained， a merit of mutual companies， while the mutual holding company enjoys the merit of stock companies in ease of raising capital. Moreover， the holding company contributes to greater organizational flexibility. Another advantage is that the acquisition of mutual companies is simplified.

On the other hand， mutual holding companies have the disadvantage of constraints in procuring capital compared to stock companies because they must hold a majority stake in their subsidiary life insurance company (or intermediate holding company). This is unavoidable from the standpoint of maintaining governance of the insurance company due to policyholders being members.

(2)　Debate Surrounding Mutual Holding Companies

The mutual holding company system is based on the breakthrough idea of separating policy rights from member interests， something that was impossible to do in the context of mutual companies. Despite the radical change in form of member interests of mutual companies， widespread support was obtained for this due to a basic consensus that policyholder (member) rights would not be compromised. Policy rights would be maintained by the stock life insurance company and thus protected as before. In addition， when the organizational change was accompanied by a public offering， possible conflicts of interest between stockholder dividends and policyholder dividends were avoided by taking measures to maintain dividend scales of existing policyholders.

Moreover， members are assured that the mutual holding company， which has inherited member interests， continues to retain a controlling stake in the life insurance company.

Thus for practical purposes， no changes are made to member interests and policy rights. In addition， because the mutual holding company system facilitates outside financing for the insurance company， it is being well received for contributing to the competitiveness of insurance companies and leading to the enhanced protection of policyholders.

On the other hand， there is a view in Japan that mutual companies should not depart from the concept of mutual help of policyholders by using assets to move into unrelated businesses. However， this problem was not raised in the U.S. because despite being mutual companies， life insurers were free in principle to enter other lines of business through subsidiaries.

Thus the approach taken by life insurance companies in the U.S. has traditionally been that given the principle of market competition， taking measures to strengthen the business of life insurance companies would lead to the protection of policyholders.

Ratings agencies have taken a neutral stance on the mutual holding company system because the conversion is a means of raising capital and not the final objective， and thus does not directly affect the company's financial strength. They will reserve judgment on the conversion until it affects financing plans for M&A activities in the future.

5. Recent Trends

In the U.S.， since the insurance industry is regulated at the state level， the mutual holding company system has not been approved throughout the country. However， this year has seen a sharp increase in the number of states approving or starting to consider the system as it spreads across the nation. Of the states that contain the headquarters of major mutual life insurance companies with assets in excess of $1 billion， New Jersey alone has not passed or even deliberated on a law. Attention is now focused on New York， which is known to have the nation's strictest and most conservative insurance regulations. New York is currently considering whether to allow mutual holding companies. Since the state contains the nation's largest concentration of business and serves as headquarters of giants such as Metropolitan Life Insurance Co. and New York Life Insurance Co.， its influence is large. The consensus is that the state will enact a law， triggering a wave of conversions to mutual holding companies.

Presently， six companies have either converted into mutual holding companies or are in the process of doing so. While it began with small and mid-sized life insurance companies such as AmerUs Life， recently major life insurers such as Principal Mutual Life Insurance Co.， the nation's seventh largest in admitted assets， have been seeking approval.

Principal has attracted considerable attention throughout the nation not only for its size but because it is licensed by the state of New York. Although not under financial difficulty， the company believes that as competition intensifies with banks and other financial companies， a mutual company organization would not meet financing needs as well as a mutual holding company， which can raise capital whenever necessary. The alternative of demutualization was ruled out because as a stock company it would not only lose all benefits of being a mutual organization， but the transition would cost too much time and expense.

In any case， the application for conversion to a mutual holding company by a financially sound， major mutual company rated A+ by A.M. Best has sent ripples throughout the industry.

In the past， mutual companies such as Equitable Life Insurance Co. had converted their company organization because they were ailing and desperate to raise capital.

Today， conversion is being used as a strategic move to increase competitiveness.

No major mutual company in the U.S. can afford to be disinterested in the mutual holding company system any more. Future developments will be followed with keen interest.

6. Conclusion

As the baby boomer generation approaches retirement age， financial institutions in the U.S. are competing intensely for their retirement assets. Presently， the U.S. Congress is deliberating on financial reform bills， the outcome of which is expected to intensify competition among financial institutions. In line with this， the number of states adopting the mutual holding company system has risen sharply， and the application by a company with the stature of Principal to become a mutual holding company is worthy of note.

In Japan， the Insurance Deliberation Council issued a report in June 1997 stating that "Foreign trends regarding the mutual holding company system need to be carefully watched." Considering the differences between Japan and the U.S.， U.S. systems cannot be expected to immediately take root in Japan. But what is certain is the growing importance of offering policyholders a broad range of services that cut across existing business boundaries. In tackling the organizational aspects behind these issues， much can be gleaned from the mutual holding company system emerging in the U.S.

As globalization progresses and increases the need to harmonize with an international system， Japan should earnestly consider the implementation of mutual holding companies.

Mutual Holding Companies in the U.S.

Hironobu Murakami