The argument for remutualising Australia

As the last of the big four banks to offload its underperforming life insurance operations, Westpac is reportedly soon to follow its peers in NAB (sold to Nippon Life), CBA (sold to AIA), and ANZ (sold to Zurich) in learning some hard lessons about the inverse nature of Milton Friedman’s ‘shareholder theory’ economic orthodoxy.

As a 20-year-old economics major, I was captivated by the simplicity of Friedman’s thinking which held that a company’s sole responsibility was to increase profits for shareholders.

Friedman contended that in a free market, pursuing shareholder outcomes would optimise goods and services, maximise employment and create wealth for deployment back into the economy for good use. His theory gained widespread support in the 1980’s and 1990’s as it was adopted by business schools and management consultants alike.

The problem for banks and their shareholder models is that they are not natural owners of life insurance companies.

Even before the reputational fallout from the Adele Ferguson-inspired Four Corners program “Money for Nothing” in 2016 and the Hayne Royal Commission in 2019, the banks were looking to offload their life operations. This was because they were sucking up huge amounts of capital and dragging down the banks’ ability to meet their return on equity hurdles.

Perhaps the banks’ Directors might have considered alternative economic theories. Not long after Friedman’s shareholder primacy model, American philosopher Edward Freeman put forward his ‘stakeholder’ approach. This model promoted the idea that a company’s responsibilities were to society and should be driven by purpose, values, and ethics – rather than just profits.

What went wrong?

In the 2000’s Friedman’s shareholder primacy theory started to come under sustained criticism. The final recommendations of the 2018 Hayne Royal Commission criticised many financial services companies for elevating the desire to make profits as their primary goal. In the words of Kenneth Hayne’s Interim Report: “Financial Services entities recognised that they sold services and products. Selling became their focus of attention. Too often it [profit maximisation and sales] became the sole focus of attention.”

In an article in Forbes magazine this year, author of ‘The Age of Agile’ and former director of the World Bank, Steve Denning, argues that requiring companies to satisfy the needs of all stakeholders is doomed to failure because of the lack of clarity of purpose and conflicting stakeholder goals. According to Denning there was always a better alternative to Friedman’s shareholder primacy theory – and it was not stakeholder theory or ESG – but rather Peter Drucker’s dictum of ‘customer primacy’.

Drucker, considered to be the father of modern management, contended that the purpose of a company is to serve its customers. Denning argues that this is even more relevant today with a strenuously competitive marketplace, new technologies and information at customers’ fingertips.

Can you imagine a world however where companies operate within the context of a capitalist / free market economy but where their primary purpose is to serve the customer? How novel would that be? Not so novel, it already exists.

The mutual model

Mutual and cooperative companies are owned by their customers with ‘customer primacy’ built into their constitutions. These companies do not have shareholders, so the many conflicts of interest that pervade shareholder-owned companies do not exist.

Some of the world’s oldest insurance companies are mutuals and this longevity has helped to build the reputation of the mutual model for being both sustainable and reliable. This is because mutuals look after policyholder interests first by providing products which cater to their needs, rather than selling products solely with profit in mind.

Profits earned by a mutual insurance company are distributed back to policyholders in the form of lower premiums or profit distributions. This mutual ownership structure, rather than public ownership, encourages mutuals to make decisions that deliver long-term benefits to their members.

Mutuality delivers a strong foundation on which to offer life insurance products because of the long-term nature of policy coverage. In contrast, shareholder companies encourage decision-making that delivers short-term benefits to shareholders over the longer-term needs of policyholders.

In the 10-year period following the GFC, global mutual life businesses performed strongly growing by 23% compared to 7% for the total life insurance industry. As a result, mutual life companies account for 22.5% of the total global life insurance market*.

Until they demutualised in the 1990’s, almost all the large life insurers in Australia were mutuals. It all started with a race for growth between AMP and National Mutual in the late 80’s. The race resulted in them writing so much capital guaranteed business that they depleted their reserves, therefore they decided to go to the markets to raise additional capital, in the process demutualising.

Demutualisation and the destruction of value

Demutualising has had negative consequences for the life insurance ‘ecosystem’ in Australia. Most of the scandals involving life insurance in the Hayne Royal Commission can be traced back to two key developments: demutualisation of life insurers in the 1990’s and the introduction of the vertically integrated bancassurance model around the same time.

The banks failed to understand the long-term nature of profit emergence or life insurance distribution. People need banks and banks become used to being in a power relationship with their customers.

Prominent examples of the banks’ lack of understanding and complacency in relation to the distribution of life insurance products include the limited APL’s, volume bonuses to win business from non-aligned advisers and offering high front-loaded discounts.

AMP, which celebrated another new Chief Executive recently, is another example. The AMP experience (once the mighty Australian Mutual Provident Society) highlights that public listing and demutualising results in the customer’s best interests no longer being the key focus. Demutualisation involves the interests of ‘members’ as owners being separated from their contractual interests as policyholders.

When AMP demutualised in 1998, their shares were listed on the Australian and New Zealand stock exchanges and in the excitement of the day, spiked at $36. Today they are trading at $1.08

Fortunately, we have come full circle with the ill-conceived bancassurance model. The big 4 banks have all but divested their life insurance and financial advice operations, and the misalignment of shareholder and customer interests continues to have poor outcomes for customers as the ASIC remediation process for customers attests.

It is a positive development that the life operations of the big banks (with the exception of BT Life which is currently up for sale) are now owned by other insurers. Consumers, advisers, the new insurer owners, the banks themselves and the financial services industry as a whole should benefit.

2021- what still needs to be addressed?

Firstly, insurers should look to pass back their reductions to existing customers not just new customers. If the industry can become more sustainable, there is the opportunity for growth.

Secondly, insurers also need to ensure that they develop products which are both affordable and sustainable. It is an indictment on the industry that APRA had to intervene in the design and pricing of IDII products due to first mover reluctance on the part of insurers. Let’s not allow a similar situation to develop because insurers continue to chase market share by taking short-cuts in managing the quality of their risk pools.

Thirdly, insurers should look to improve sustainability by increasing premiums in smaller increments across a longer span of time. High lapse rates need to be addressed and front-loaded discounts contribute to these high rates as the focus is always on new customers, versus existing.

Lastly, the industry needs to build confidence, trust and a viable adviser network.
Advisers are under margin pressure with reductions to commissions and huge red tape and compliance obligations. Advisers are demonstrating their resilience however by the way they have adjusted their businesses to COVID-19 and many other industry challenges.

While I have no doubt that most professional advisers will ‘stand the test of time’, insurers must throw their full support behind the advice community (as they have done recently in supporting the ability for clients to choose how they pay for their life insurance advice as part of the 2022 Treasury ‘Quality of Advice’ Review).

At the end of the day, advisers are the bedrock of the life insurance industry.

Winding the clock back to the future

I believe there is an opportunity for shareholder life insurers to learn from the ‘customer primacy’ model of mutuals. The industry needs to eschew those dubious practices that are leading to high lapse rates and unsustainable pricing. There has never been a more important time to work towards building a strong and sustainable life insurance industry for all Australians.

Taking this one step further, while it’s a novel idea, it’s by no means unprecedented or impractical for insurers to consider going ‘back to the future’ and re-mutualising. Most changes in structure of this kind require the support of an existing mutual organisation but this would not necessarily be out of reach, with both MLC Life Insurance parent company Nippon Life and TAL owner Dai-Ichi Life operating as mutuals in their home market of Japan.

Remutualisation may be a long shot worth considering for many of Australia’s largest financial institutions that are facing a crossroads in their business model and a deficit of public trust.

*ICMIF Financial Insights, Nov 2020

Michael Pillemer is chief executive of specialist insurance company PPS Mutual