The argument for remutualising Australia

As the last of the big four banks to offload its underperforming life insurance operations, the recent Westpac sale to TAL follows NAB (sold to Nippon Life), Commonwealth Bank (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. His theory gained widespread support in the 1980s and 1990s 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. 

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Even before the reputational fallout from the Adele Ferguson-inspired Four Corners programme ‘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 required huge amounts of capital and were also 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 2000s Friedman’s shareholder primacy theory started to face criticism. The final recommendations of the 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 a Forbes magazine article this year, 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 environmental, social or governance (ESG) – but rather Peter Drucker’s dictum of ‘customer primacy’.

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

Can you imagine a world 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 co-operative 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 Global Financial Crisis (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 1990s, almost all the large life insurers in Australia were mutuals. Today, PPS Mutual is the only life insurance provider left in Australia who offer life insurance products with a profit share and distribute the profits to its members.

DEMUTUALISATION AND THE DESTRUCTION OF VALUE

Demutualising 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: the demutualisation of life insurers in the 1990s 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 approved product list’s (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 experience of AMP (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, its shares were listed on the Australian and New Zealand stock exchanges at $36 and in the excitement of the day, spiked at $45. Today they are trading at $1.08.  Even though AMP has returned capital and paid dividends along the way, the destruction of value has been enormous.

Fortunately, we have come full circle with the ill-conceived bancassurance model. The big four banks have all but divested their life insurance and financial advice operations, with the Australian Securities and Investments Commission (ASIC) remediation process for customers attesting to the misalignment of shareholder and customer interests and the poor outcomes for customers. 

It is a positive development that the life operations of the big banks (including BT Life which will soon be in the hands of TAL) are now owned by other insurers. Consumers, advisers, the new insurer owners, the banks themselves and the financial services industry should benefit.

2021 – WHAT STILL NEEDS TO BE ADDRESSED?

Firstly, insurers need to start treating their existing loyal clients as well as their new clients. They should start by passing back premium reductions to existing customers not just new customers. If the industry can become more customer-centric, there is the opportunity for sustainable 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 the Australian Prudential Regulation Authority (APRA) had to intervene in the design and pricing of individual disability income insurance (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 customer retention by increasing premiums in smaller increments across a longer span of time. Short-sighted insurer practices like front-loaded discounts in conjunction with dramatic one-off premium increases are contributing to high lapse rates and unsustainability.

Lastly, the industry needs to build confidence, trust, and a viable adviser network. 

Advisers are under significant margin pressure with reductions to commissions and huge red tape and compliance obligations. The way advisers have adjusted their businesses to these industry challenges and COVID-19 is a testament to their resilience.  

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 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, 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 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.  

Michael Pillemer is chief executive of PPS Mutual.