Finance Committee on May 1st, 2012

[The Chair, Conservative, James Rajotte]

I call this meeting to order. Could I have our colleagues' and guests' attention, please?

Thank you.

This is the 55th meeting of the Standing Committee on Finance, our orders of the day pursuant to Standing Order 108(2) being a briefing for the committee on demutualization.

I want to thank our witnesses for joining us here today at this meeting.

First of all, we have officials from the Department of Finance. We have Mr. Jeremy Rudin, ADM, financial sector policy branch. Thank you, Mr. Rudin. We're seeing you twice in two days. Thank you so much for being with us.

We have Mr. James Wu, chief, financial institutions division, financial sector policy branch.

We have Michèle Legault, senior project leader, financial institutions division, also from the financial sector policy branch.

We have the president of the Canadian Association of Mutual Insurance Companies, Mr. Normand Lafrenière.

Welcome, Mr. Lafrenière.

We have, from the Economical Insurance Group, Ms. Karen Gavan. Welcome to you as well.

We have, from Kings Mutual Insurance Company, the president and CEO, Mr. Dan Lister.

We'll start with officials from the Department of Finance and we'll work our way down the table. Then we'll have questions from all of the members.

We'll start with Mr. Rudin, for your presentation, please.

[Jeremy Rudin, Assistant Deputy Minister, Financial Sector Policy Branch, Department of Finance]

Thank you, Mr. Chairman. Thanks also for your invitation to speak to the committee on the topic of demutualization for federally regulated property and casualty insurance companies, or P and C companies, as we will refer to them for short.

In my remarks I will begin by providing the committee with a bit of history on the government's actions with regard to demutualization in general, and then describe our most recent activities that are relevant to the P and C sector.

Demutualization, as many of you will know, is a process by which a company that is governed in the first instance by its mutual policyholders decides to convert into a company that's going to be governed by its shareholders, so a joint stock company essentially. Since the 1990s, the federal legislation that governs insurance companies has contemplated the demutualization of insurance companies in general, both life companies, and P and C companies.

In particular, the Insurance Companies Act authorizes the Minister of Finance to approve a demutualization, provided that such demutualization takes place in accordance with the relevant regulations, and these regulations set the terms and conditions that govern an acceptable demutualization.

In the late 1990s with the legislation in place, the government announced its intention to develop a demutualization regime that would enable mutual life insurance companies to convert to joint stock companies, if they wished to do so. In anticipation of that new regime, what were at the time Canada's four large mutual life insurance companies—Clarica Life, which was then called Mutual Life, Manulife, Sun Life, and Canada Life—all announced intentions to develop demutualization plans. All of those companies acted on those plans, and in addition we saw the demutualization of Unity Life.

Let's talk about recent actions.

In the last year or so, we have seen for the first time an interest in P&C companies demutualizing.

In response, Budget 2011 announced that it would develop a demutualization framework that would provide, for companies that choose to demutualize, an orderly and transparent process and ensure that policyholders are treated fairly and equitably.

Budget 2011 also strengthened the demutualization provisions of the Insurance Companies Act to prevent companies from indirectly demutualizing.

The development of a demutualization framework is a careful exercise that must be aligned with the long-term best interests of the financial system, including the interests of the P&C insurance sector.

Because a company can only demutualize once, it is important to get the framework right in the first instance. The framework must also be workable for all P&C companies that may wish to demutualize in the future.

On June 30, 2011, the government launched public consultations on the Department of Finance’s website, together with a press release. The consultations closed on July 31, 2011. Over 80 submissions were received. A summary of the submissions has been posted on the Department of Finance’s website.

That concludes my opening remarks.

I understand, Mr. Chairman, that we'll open the floor to questions after everyone has spoken. Is that right?

[The Chair, Conservative, James Rajotte]

That's correct, Mr. Rudin. Thank you very much.

[Jeremy Rudin]

I would be happy to answer any questions at that time.

[The Chair, Conservative, James Rajotte]

Thank you very much for your opening presentation.

We'll now hear from the Canadian Association of Mutual Insurance Companies, please.

[Normand Lafrenière, President, Canadian Association of Mutual Insurance Companies]

Thank you, Mr. Chairman and members of the committee, for your invitation to appear before you today.

CAMIC is a trade association for property and casualty mutual insurers—the insurers of home, auto, farm, and commercial assets. The association represents the large majority of domestic and foreign mutual insurers doing business in Canada. This includes eight federally supervised Canadian-owned mutual insurance companies.

You will find our list of members in appendix 1 of the document that was given to you. In 2011, CAMIC members had in excess of $5 billion in gross premium written, which represents 11% of the non-government Canadian insurance market.

Most Canadian mutual insurance companies were set up by farmers between 100 and 170 years ago, at a time when it was necessary for farmers to band together to self-insure, as conventional insurance was not available. A number of mutuals were formed for similar reasons by small merchants and businessmen. Their common solution was to form their own mutual insurance companies, whose role was to provide them with insurance products adapted to their needs and at cost.

Mutuals are controlled by the people they insure. The large majority of mutual insurers operate under the governance model of one member equals one vote.

The surplus residing in today's mutual P&C insurance industry is the result of the annual allocation of profits to surplus by many successive generations of policyholders. To operate, an insurance company needs a sizeable surplus.

Each year, the board of directors of the company decides what to do with the profits generated. The options are either to refund them to policyholders, to invest them in the community, or to transfer them to surplus.

The role of the surplus is to provide stable and secure insurance for the current and future generations of policyholders.

In the course of the many decades following their inception, mutual insurers reached economies of scale by opening their membership to others while remaining focused on their founding community’s needs. For instance, while farm mutual insurers now serve rural Canada as a whole, they continue to serve 75% of the farming community across Canada. They also contribute to the rural economy by creating a wide variety of jobs related to the P&C insurance companies: underwriting, inspection, claims settlement, accounting, marketing, and so on.

Also, consistent with their objective of delivering insurance at the lowest cost possible, over the years many mutual insurers resorted to merging with their neighbouring mutual companies. These mergers amongst mutual insurers allowed them to remain true to their mutual charters of incorporation while ensuring that their size would allow them to lower their cost structure.

Mutual insurers do not have access to outside capital. However, because they do not have shareholders demanding dividends and increasing share value, they invest their surplus funds conservatively and operate their company in a responsible manner. Not surprisingly, they meet very high capital test ratios.

When you become a member of a mutual, your entry is free. All you need to do is become a user of the services of the mutual. Policyholders may receive refunds in proportion to the level of business they do with the mutual, and they are invited to vote at the annual general meeting.

However, these privileges do not mean that the policyholder owns the company. It simply means that the policyholder controls the organization while he uses its services. For its part, the surplus of the company is owned by the company and is indivisible amongst policyholders, as no one can ascertain who contributed what to the surplus over many generations of policyholders.

We encourage the Department of Finance to consider seriously the issue of how to responsibly demutualize insurance companies in our sector.

If done improperly, through the allocation of surplus to current policyholders, rural Canada would be negatively affected. It would lose the presence of jobs and assets to the hands of larger North American and worldwide financial centres. The negative impact would also be felt in difficult market situations, where the market becomes more risk averse and many rural communities might become more highly dependent on their traditional local mutual insurance company to provide the insurance they need.

While CAMIC prefers the current situation, where no demutualization rules exist and companies grow organically and through mergers with other mutual insurers, CAMIC supports the Minister of Finance's decision to develop such rules. However, these rules must be fair to the many generations of policyholders who have built the surplus of that company for the long-term viability of the mutual.

You will find in appendix 2 our proposed demutualization regulations, which would meet those objectives.

CAMIC recommends the following: that the vote on demutualization be open to all policyholders; that such demutualization be considered only after the company made significant effort to merge with other mutual insurers; and that, if the demutualization is approved, the surplus of a demutualizing mutual insurance company be retained within the mutual community.

Quebec applies such rules to its provincially supervised co-operatives and financial co-operatives. The success of the co-operative system in Quebec is a testament to the effectiveness of these rules.

Thank you for your time, Mr. Chairman, and I welcome your questions.

[The Chair, Conservative, James Rajotte]

Thank you very much for your presentation.

We'll now hear from the Economical Insurance Group please.

[Karen Gavan, President and Chief Executive Officer, Economical Insurance Group]

Thank you, Mr. Chairman.

On behalf of Economical Insurance, I welcome the opportunity to speak with you today about demutualization of property and casualty insurance companies. We've provided the committee with a submission that we hope provides some useful background, so I'm not going to repeat that information. Instead, I'll focus on the need for regulations that allow mutual P and C companies the option to demutualize, why demutualization is right for Economical Insurance, what we believe should be central to the regulations, and how demutualization benefits the insurance industry, Canada's financial system, and in fact, all Canadians.

Economical Insurance is one of only 10 mutual P and C companies that fall under federal jurisdiction and will be impacted by these regulations. Economical Insurance has a long history and a proud tradition. We now offer a range of P and C insurance products to consumers and businesses in all provinces in Canada. We are successful, large, and have grown significantly in the past two decades.

In 2011 Economical Insurance was the 10th largest P and C company in Canada. However, despite our growth over the last decade, we slid from being the fifth largest in the year 2000. We are competing in a market that has changed profoundly over the last decade. We compete against large and growing Canadian stock companies, and Canadian operations of even larger multinationals. These companies have access to the capital markets to raise funds for growth. Mutual companies by their very nature lack that access.

We cannot issue shares to raise capital to help expand our existing business or acquire others as many of our competitors can. In addition, mutual companies are expected to maintain higher levels of reserve funds than our stock competitors. That means we're not competing on a level playing field. To level the playing field, we need regulations that give mutuals the choice to demutualize.

After careful deliberation, and although regulations did not yet exist, our board of directors decided in 2010 that it was in the company's best interest to demutualize. It was the next logical step in our evolution and the right thing to do. Demutualization will allow us to gain access to equity capital, which will let us grow our core business. It will allow us to be a leader in the consolidation of the P and C industry in Canada. It will allow us the resources to develop our systems and risk management structures to remain competitive in a rapidly changing industry. It will help to protect our financial stability on the same terms as our non-mutual competitors.

Regulations do exist for Canadian mutual life insurance companies and they were used by a number of companies in the late 1990s. The result was larger, stronger, and more internationally competitive life companies that served more customers, employed more people, and added significant wealth to the Canadian economy.

We believe demutualization regulations used for life companies are a very good model and easily adapted for P and C mutuals. Mutual policyholders are the owners of the company. They are the only people with the right to vote and the right to receive distributions. Their ownership interests are at least as strong or stronger than those who receive benefits from the demutualization of the life companies.

We also believe the law is clear that the federal government cannot, without compensation, expropriate or transfer the property rights of mutual policyholders to others.

Finally, we believe the regulations for demutualization should create and maintain real choice for mutual P and C companies. Those who choose to demutualize should have a clear path to act on their decision. Those who choose not to demutualize should be protected, so that they can continue to serve their communities as they have done for decades. Just because there are regulations does not mean that all companies will choose to demutualize.

We are convinced that our position is right and fair, and that our approach is in the best interests of all concerned.

Let me leave you with this. The change we propose is good for Economical. It allows us to innovate and compete more successfully. It's good for customers. It gives them more choice and a financially stronger insurance provider. It's good for our communities. It allows us to grow and employ more Canadians. It means strength and stability for our industry and our financial sector, and that's good for all of us.

Thank you very much for the opportunity to speak to you today. I welcome any questions.

[The Chair, Conservative, James Rajotte]

Thank you, Ms. Gavan, for your presentation.

We'll now hear from Kings Mutual Insurance Company.

[Dan Lister, President and Chief Executive Officer, Kings Mutual Insurance Company]

Thank you, Mr. Chairman and members of the committee, for the opportunity to appear before you today. The matter of demutualization is of great importance to our industry, and specifically our company.

My name is Dan Lister and I'm the president and CEO of the Kings Mutual Insurance Company, based in the Annapolis Valley of Nova Scotia. We are a small mutual property and casualty insurer, established in 1904, writing throughout the Province of Nova Scotia. Like many other mutuals, a large portion of our volume is from rural, residential, and agricultural business.

For over 100 years, the mutual insurance industry has been a stabilizing force in the Canadian marketplace. Mutual P and C companies were formed due to the lack of insurance availability in the agricultural sector in rural Canada. The companies have been profitable and have built up their capital over many years, and continue to provide relevant products.

As a mutual, we require significant capital reserves to allow for fluctuations in the market cycle. These reserves should not be viewed as policyholder value. The reserves provide financial strength, policyholder security, and allow us to effectively compete in the existing marketplace.

Mutual P and C companies were not created to generate wealth for the policyholders, but to provide availability of insurance and security of assets. We are concerned that demutualization regulations will create an environment where successful mutual P and C companies with strong reserves are targeted because of their success. Our company exists for the policyholders, and we wish to protect their interests.

We are concerned that the compelling arguments for the continuation of the mutual insurance system may be reduced or overridden during the regulation process, to a clash of ideals on how to distribute the ownership and therefore the value. Instead, the regulations should create an environment where those companies wishing to demutualize must prove the value of the process to the majority of their policyholders.

If regulations create an opportunity to extract the wealth from mutual companies for benefit, then you will see the decimation of the mutual insurance industry in Canada. Companies will be demutualized and assimilated into stock companies, resulting in job losses and losses to the rural communities they serve.

We feel that a rash of demutualization could negatively impact the overall strength of the P and C sector. A reduction of the number of insurers will ultimately result in reduced competitiveness, availability of products, and loss of Canadian ownership in the industry. Enabling a process of demutualization that would not be in the best interest of the mutual sector would destroy this rich history and encourage greed to prevail. In fact, it would create the very environment that breathed life into the mutuals so many years ago.

We request that deregulation ensures that any meeting to demutualize a company would require a significant majority of policyholders to establish a quorum, and that any vote to demutualize would require, at a minimum, a majority of those present. Under the current federal legislation, a quorum for a meeting is defined as the lesser of 500 policyholders, or 1% of the total number of policyholders. In the case of Kings Mutual, 110 people constitute a quorum. Therefore, as few as 56 people could, in essence, vote to demutualize the company, which represents one half of 1% of our policyholders. A small number of policyholders may then override the overall interests of the company. This is not a preferred governance model.

Additionally, any regulation will have to very seriously consider the distribution of the assets. P and C policies are on a term basis that is negotiated and renewed annually. A policyholder, unlike a shareholder, pays nothing to compensate a previous owner of the company when they become a policyholder. The accumulation of assets in the P and C sector is the result of a long line of past policyholders, not only those policyholders with a current policy in force. Therefore, we believe the time and the total premiums paid by a policyholder while insured with the company should be taken into account when determining any allocation of ownership.

As for those policyholders who assume additional risk by signing a premium note or purchasing a participating policy, I expect there are few alive who have had to respond to that demand. In the modern regulatory environment, with the oversight of the Office of the Superintendent of Financial Institutions and the support of the Property and Casualty Insurance Compensation Corporation, any exposure these policies would have is negligible. A major concern to us is any provision in the regulations that would provide an incentive to a small group of policyholders to encourage demutualization.

Finally, regulations should include restrictions so that no party can share in or be compensated for a policyholder's share of the demutualized value. This would stop individuals or organizations who are not policyholders from gaining financial benefits from the demutualization process.

Any process that leads to the demutualization of a P and C mutual company should be in the best interests of the company, as deemed by the board of directors of the company. It should not be the result of a process driven by outside interests. Our mutual industry has a long and proud tradition of neighbour helping neighbour, and we want to ensure that regulations based on the request of one company do not adversely or unintentionally impair our ability to operate.

Thank you.

[The Chair, Conservative, James Rajotte]

Thank you very much, Mr. Lister.

We'll begin members' questions, starting with Ms. Nash.

[Peggy Nash, NDP, Parkdale—High Park, ON]

Thank you, witnesses, and welcome to the finance committee.

Let me start with the Department of Finance.

Mr. Rudin, the briefs that you received during the consultation—I've not read this summary; I was unaware it was online—are these in the public domain?

[Jeremy Rudin]

We have published a summary and we're preparing to put the individual submissions on the website. To do that, we need to get permission from the individual submitters to share them. In some cases, submissions come from individuals who have based their submission on their specific circumstances, and we need to verify with those individuals whether they wish to share that part of the submission. If they do not, we have to come up with a redacted version. So that's in process.

[Peggy Nash, NDP, Parkdale—High Park, ON]

I understand there are some major groups opposed to demutualization, such as Desjardins and the Canadian Co-operative Association. Is that correct? Was it a mixture of opinion in support or opposition to demutualization?

[Jeremy Rudin]

I would say we got a wide range of submissions. I'm going to hesitate to report on specific submissions until they're posted, although a number of organizations have probably put their view in the public domain. I think there was quite a wide range, from both individuals and organizations, and you've heard a representation of this range in the remarks that followed mine.

[Peggy Nash, NDP, Parkdale—High Park, ON]

Ms. Gavan, Economical is a very old insurance company, and I've read that there are something like 700,000 cash policies with the company, but only about 943 are mutual policyholders. Prior to discussion about demutualization, how would I go about becoming a mutual policyholder with Economical?

[Karen Gavan]

Brokers were allowed to do applications if the applicant met the criteria. However, brokers felt that the mutual policies were very hard to sell for a number of reasons, primarily that mutual policyholders had to sign a legal promissory note called a “premium note.” That was a valid legal demand note that the board of directors could call on for an additional three times their annual premium in the event that the company needed cash to pay off claims.

[Peggy Nash, NDP, Parkdale—High Park, ON]

Has this ever happened in the history of the company?

[Karen Gavan]

Yes, it has.

[Peggy Nash, NDP, Parkdale—High Park, ON]

When did that happen?

[Karen Gavan]

In the 1930s.

[Peggy Nash, NDP, Parkdale—High Park, ON]

So it hasn't happened since the Great Depression.

Was OSFI overseeing the mutualized insurance industry at that point?

First, though, is the number of 943 mutual policyholders correct?

[Karen Gavan]

That's correct.

[Peggy Nash, NDP, Parkdale—High Park, ON]

If there should be a demutualization and there is a distribution, would it be to all of the cash policyholders, to the mutual policyholders, or would you reach back to recognize the investment of previous policyholders? How would that work?

[Karen Gavan]

We believe in a number of things. We believe that the mutual policyholders have sole ownership rights to the distribution of demutualization benefits.