Markets brace for new breed of insurers

“It’s the coming of a new breed of financial institutions in Canada,” says Michel Nadeau, senior vice president, core portfolio, at the Caisse de dépôt et placement du Québec in Montreal.

The insurers – Mutual Life Assurance Co. of Canada, Sun Life Assurance Co. of Canada, Manufacturers Life Insurance Co., Canada Life Assurance Co. and Industrial Alliance Life Insurance Co. – want to switch from being companies owned by policyholders to being owned by shareholders. Doing so would give them more flexibility to raise capital and use common shares in acquisitions, for instance. Stock options can theoretically lure high-calibre employees, although current federal guidelines restrict these companies from handing out stock options until a year after demutualization.

In exchange for certain policyholder rights, the insurers must distribute 100% of a company’s book value to eligible policyholders, who then decide if they want to take their cut in shares or cash. Some estimate about two million Canadian policyholders will be given a total of $10 billion or so, with the rest handed out to foreign policyholders.

Steve Cawley, financial services analyst with Newcrest Capital Inc. in Toronto, says that as a rule in these kinds of offerings about 25% of policyholders will opt for cash. With the remaining 75% staying in retail hands, insurers will be looking for institutional investors to soak up that 25%, depending on such factors as the price of the stock and the state of the market at the time, Cawley says. “Because these are going to be indexed stocks, there is going to be a tremendous demand for them for both index players and closet index players.”

The Caisse’s Nadeau is one institutional investor who is keeping a close eye on demutualizing insurers for potential inclusion in the Caisse’s diverse portfolio. “I think the coming of a number of large financial institutions is something very positive for the Canadian equity market,” he says.

Traditionally, foreign investors have seen the Canadian market as resource heavy, even though that sector represents less than 20% of the Toronto Stock Exchange 300 composite index. Financial services, composed mainly of the banks and insurers Great-West Lifeco Inc. and Fairfax Financial Holdings Ltd., make up 22%.

But these weightings are expected to change once the demutualized insurers come on board. Nadeau estimates the financial services sector will represent about one-third of the benchmark index. Financial institutions represent 46% of Italy’s benchmark index, 40% in Spain, 27% in Germany and 39% in Switzerland, he says. “So Canada will become more comparable to European and other non-U.S. markets. I think this will also increase the perception of the Canadian equity market.”

The Caisse, Canada’s largest pension fund with net assets of $68.6 billion at Dec. 31, 1998, has about 22% of its overall investments in financial services. Adding demutualizing insurers to exchanges will also make the sector more exciting for large investors, says Nadeau.

“Your choice [now] is to underweight, or to overweight some large banks. So with demutualization, we will have at least a dozen large financial institutions. The game will be much more interesting for our financial service analysts and managers.”

The markets are expected to react well to the demutualized insurers, says Neil Parkinson, partner in the insurance practice of KPMG in Waterloo, Ont. Life insurance shares will be seen as high-quality, liquid stocks, the same as banks, which had a good run in the 1990s, he says.

As well, the reception to full demutualizations in places such as the U.S., Britain and Australia has been good. It also provides Canadian-based quality stocks for the portfolios of conservative RSP investors “who have had to chase smaller and perhaps lower-quality companies to fill their Canadian content quota,” says Parkinson.

Insurers will also all be potential takeover targets if and when the widely held rule is dropped. In a recent report, Tom MacKinnon, insurance analyst with Scotia Capital Markets, cites Mutual Life as “an attractive takeover candidate because of the size and strength of its Canadian distribution system.”

The potential for takeover has a way of increasing stock prices as investors anticipate a bidding war.

The demutualized life insurers will not get into the TSE 300 immediately. According to regulations, companies must first wait until the month end after the six-month anniversary of their listing date, says Richard Carleton, vice president, index and market data services for the TSE in Toronto. At that time, if the new company’s market capitalization is larger than the 150th company on the TSE 300, then the company automatically gains entrance, bumping out the company in 300th spot, he says. As of the end of May, No. 150 had a market cap of about $1 billion; Mutual Life is expected to have a market cap of $1.9 billion to $2.9 billion and Manulife of $9 billion-$12 billion.

Once the insurers go public, they’ll still have much work to do on the education front, says Ken Barnes, chairman of investor relations firm The Barnes Organization in Toronto. So far, the insurers have been busy trying to gain shareholder approval on demutualization and working on their respective prospectuses. But Barnes says they apparently have yet to understand the importance of selling their industry.

“I don’t think the street is ready for life insurance,” says Barnes. “It’s a new industry that’s not well understood and not well followed. [Winnipeg-based] Great-West Life, as a public company, was the only one out there to carry the banner as a public company and it did a very poor job. It had a very low profile of investor relations practice.”

Barnes says demutualized insurers will have to show investors they can increase their profitable areas of business and cut those that aren’t – a pruning exercise already in the works. “I see some rationalization taking place after the companies go public,” he says. “And investors love that – when companies cut costs and lay off people and rationalize and make themselves more efficient.”

It has only been for the past couple of years that mutual insurers have been under scrutiny and some don’t come out in the best light, says Barnes. Outside investors will have made up their minds about the companies’ strengths and weaknesses even before they’re listed. “That mindset on the part of investors has already begun, and they’re going to have to address that,” he says.