#126 | The Great Debate – Part 1 – Mutual Companies

As of this writing, Quick Take #4 – Voya & The End of an Era has been read over 2,000 times. I’m shocked, to put it mildly, that the article received as much attention as it did. I think one of the reasons why is that a lot of people viewed it as an opinion about the age-old question of stock companies vs. mutual companies. I got a lot of comments to the effect that I was doing mutual companies a favor with the article. That was not really my intent, although I can see why people took it that way. The message of Voya & The End of an Era is that the economics of writing life insurance policies require the willingness to tie up capital for a very long time and at an uncertain return, which means that mutual companies are fundamentally better suited to write life insurance than stock companies.

What gets people all hot and bothered about the debate over stock and mutual companies is not capital allocation, it’s whether one structure is better than the other for policyholders. Independent agents generally sell policies written by stock companies, captive agents generally sell policies written by mutual companies. That’s why this is such a loaded debate. Historically, I haven’t weighed in on the question but since the last article cracked open the door, I might as well walk through it. So here we go – and no one’s getting out without their feathers a little ruffled.

Mutual companies are built on the fundamental principle of mutuality. There are technical definitions of what mutuality means, but in a nutshell it’s the idea that the costs and benefits of coverage should accrue fairly to each individual policyholder. With true mutuality, there are no winners or losers amongst policyholders. The most obvious manifestation of this concept of fairness amongst policyholders is the participating nature of Whole Life, where the dividend slope in a company’s Whole Life product is literally its scheduled allocation of the overall gains available for distribution across the company, the total dividend. The fairness of the allocation is baked right into the bones of the product.

But there are less obvious implications for other products as well. Have you ever wondered why the Big 4 Mutuals don’t sell cheap term insurance? They definitely could. They have no shortage of capital or expertise. So why don’t they? Because term creates winners and losers amongst policyholders. It’s an open secret in the industry that the projected profit for a competitively priced Term product comes almost entirely from policyholders paying the exorbitant premiums to maintain coverage after the guarantee period. This is status quo for stock companies, but it is totally unacceptable for mutual companies because it is fundamentally not fair. The company loses money on 90% of policyholders and makes a killing on the remaining uninformed and unadvised 10% who continue paying after the guarantee period is over. Consequently, if you want to know what the fair price for term insurance is, then look at what the Big 4 Mutuals are charging. They generally don’t factor post-guarantee profits into their pricing. The same logic applies to other products with clear winners and losers like Guaranteed UL and Variable Annuities with Living Benefits. Those are almost exclusively the realm of stock companies, as we’ll see later.

The other important angle to mutuality is that the company is also part of the fairness equation. In Whole Life, gains aren’t just shared fairly across policyholders but also with the writing company. If there are no gains, there are no dividends. The company is only on the hook for the baseline guarantees in the policies, which are (ballpark) in the 1-1.5% range, if you want to think of it like a guaranteed minimum yield. And if it ever got the point where those guarantees were in play, the Big 4 Mutuals have a bunker full of capital to deal with it. That’s why they have bulletproof ratings. They design for fairness – both vertically and horizontally. Fairness means risk sharing. Risk sharing means stability. Stability means strength. See, don’t I sound just like a Northwestern Mutual agent?

So far, I’ve been speaking in generalities and, in general, it’s pretty hard to argue with the general theory of how a mutual company should work. The specifics of how mutual companies actually operate is quite a bit trickier. For example, I’ve been using the word “fair,” but what exactly does that mean? It’s not so easy. Being perfectly fair is impossible. Mutual companies don’t exist in a vacuum and responding to competitive pressures necessarily means that sometimes they have to make compromises on mutuality. A little lapse supported pricing to boost illustrated performance, a little foray into cheap term insurance to keep their agents happy, a little incorporation of short-term other business earnings into long-term dividend projections, you name it. Those are the little things that the Big 4 throw darts at each other about. But how do you explain other mutual companies that don’t even act like mutual companies? The ones that sell boatloads of cheap Guaranteed UL and Term insurance? The ones that have loaded up on VAs with Living Benefits? The ones that built their business on the back of aggressively illustrated Indexed UL? That doesn’t fit the mold. Whereas being a mutual company is a legal and regulatory distinction, managing the company to the concept of mutuality is not.

The core challenge of mutual companies is that there is no formal accountability for adhering to the concept of mutuality. The management of the company has the discretion to allocate capital and hue to mutuality to whatever degree they see fit with virtually no oversight, save state and federal regulators. Although policyholders ostensibly own the company, they have no practical way to band together to exert their influence. If a mutual company wants to spend its money executive perks, lavish offices, corporate jets, silly sideshow business ventures or bad acquisitions, who is going to stop them? If they want to grow sales above all because of a corporate ego trip and they’re willing to stick their policyholders with the bill, who is going to cry foul? If they want to load up the balance sheet with extremely risky products, who is going to call them out? Short of state regulators, the answer is no one.

No one, that is, except for themselves. Over the years, I’ve gotten to know most of the major life insurers pretty well and I can honestly tell you that, at least from my perspective, the Big 4 Mutuals do things differently. They talk the talk of mutuality, but they also walk the walk. It’s in their bones. It’s who they fundamentally are. A lot of life insurance companies aren’t exactly sure why they exist – the Big 4 know exactly why they exist, even if they all fall short of the purist theory of mutuality in their own ways. Corporately, Northwestern Mutual is the paragon of mutuality, despite the way some of their agents sell their policies and that swanky new office building in downtown Milwaukee. Both New York Life and Guardian operate primarily out of New York City, which is probably not the what a cost-conscious policyholder would choose. MassMutual got called out by the Boston Globe for its expenditures on helicopters, corporate jets and executive compensation. And all 4 spend exorbitant amounts of money supporting their agent field force in addition to speculative ventures like Haven Life for MassMutual, LearnVest for Northwestern and NYL Ventures for New York Life. In terms of expense structures, only Northwestern Mutual can honestly claim to be lean and mean. The rest have expense structures that look like, well, mutual companies.

But at their core, mutuality is still their shared operating system. It’s true and you can see it in the decisions they make. When was the last time you saw one of the Big 4 loading up the balance sheet with risky products? When was the last time you saw one of them hose a group of policyholders? When was the last time you saw any of them do something that wasn’t, at its core, their best attempt to be fair? I can’t think of an example. There is nothing to stop the Big 4 Mutuals from flying off the rails except for themselves and, fortunately, that seems to be enough.

The same can’t be said for the crop of mutual holding companies such as Pacific Life and Securian or smaller mutual companies like PennMutual. That group is a real mixed bag. In some cases, they operate like true mutual companies and stick to the knitting of mutuality. In others, they operate like stock companies. And in the worst cases, they combine the risk appetite of a stock company with the lack of accountability of a mutual company. How can you tell what kind of mutual you’re dealing with? Fortunately, it’s pretty easy. Product mix is the Occam’s Razor. Do participating policies make up the bulk of both the in-force block and new business sales? If so, then you’re dealing with a real mutual. If not, then you’re dealing with a mutual company that exists somewhere further down on the mutuality spectrum, ranging from squeaky clean to questionable at best. Know the companies you sell.

So, in short, if you sell a product issued by a real mutual company, you can be assured that your client is getting a fair deal. That is the core of mutuality. That’s what real mutual companies do. But is your client getting a good deal? No – that’s the domain of stock companies.