16 November 2021

LV's demutualisation: what kind of capital(ism) do you want?

The impending demutualisation and sale of venerable UK life insurer LV has become one of the biggest insurance stories of the year. 

The planned acquisition by US private equity firm Bain Capital has been debated in parliament, rumours of secret deals and editorials about bungled communications have surfaced in the mainstream newspapers, and the noise is generally building ahead of the LV membership’s vote on 10 December. 

At the heart of the story lies the question of how mutual insurers access capital to support their growth, and whether the mutual business model can compete with non-mutual structures.

LV’s capital problems go back a while. When Solvency II came into effect in 2016, LV was revealed as satisfactorily, but not very well, capitalised. Its year-end solvency capital ratio of 136% was quite low for a mid-sized composite insurer, despite making use of mechanisms such as the matching and volatility adjustments, and management were under way with further ratio-boosting plans such as applying for an internal model.

In subsequent years, the ratio improved considerably, mostly as chunks of the non-life business were sold to Allianz in 2017 and 2019

Strengthening capital was a core argument for the Allianz disposals that netted LV £1.1bn ($1.5bn). That message is being repeated for the demutualisation and sale to Bain.

In its statement on the Bain plans, LV said: “The life and pensions market was becoming increasingly dominated by large insurers with access to capital. The scale of investment needed for LV to remain competitive meant there was insufficient capital to both ensure the interests of with-profits members were met and support the investment needed for the future growth of LV. Without investment, the new business franchise would lose market share and eventually become unviable.”

One of the concerns of the politicians and newspaper columnists is that LV has never elaborated why it needs more capital. 

“The board has swung from praising its capital strength to justifying its demutualisation within the space of a year,” notes the April report from The All-Party Parliamentary Group for Mutuals.

All LV has said is that it’s unfair for the with-profits policyholders to have to bear the risk of growing the business, and the deal with Bain is the best way of preserving with-profits policyholder benefits, while pursuing growth. 

LV’s management can expect much deeper probing of its business plans in the coming weeks. But if growing the business is the goal, then there is only one game in town: the sale of bulk annuities to defined-benefit pension schemes.

LV was rumoured to be entering this business in 2015, but it never followed through. Bulk annuities are without doubt a capital-intensive product, but it’s one that would suit a private equity firm, as insurers across the board are progressively shifting the investments backing annuities into private assets, of which Bain has plenty to offer.

Could LV have found other options to raise capital other than selling itself to Bain? The UK’s regulatory landscape has not been favourable to mutual insurers. Notably, the government failed to pass a law to allow mutuals to raise share capital, which some argue could have provided an alternative for LV.

Questions inevitably arise about whether mutuality is a sustainable option for UK life insurers. It does not hinder Royal London – the country’s largest mutual by a long chalk – and dozens of small firms with regional or sectoral niches. 

But it’s obvious by the number of significant demutualisatons over the years (Norwich Union, Standard Life, Scottish Widows) and the declining share of business in the UK conducted by mutuals (currently 10%) that something is not favouring the mutual model. Management greed is often cited, and it’s a factor that cannot be ignored, but government could try harder to level the playing field.

What is all the more surprising is watching the decline of the mutual at a time when consumer ownership of companies is as popular as ever.

Equity crowdfunding campaigns raised £332m in the UK in 2020, with thousands of individual investors willing to put their capital at risk in small and largely unprofitable firms.

Meanwhile, insurance technology firms are selling themselves on the “collective” risk-sharing aspects of their distribution platforms, showing that consumers still value the idea of mutuality, even if the products are actually underwritten by shareholder-backed firms. 

If a fake mutual can be successful, surely a real one could be too?

Christopher Cundy, editor

[email protected] 

Disclosure: the author is an LV policyholder