Our Demutual Friend
Sydney Morning Herald
Wednesday September 8, 1999
Floating would mean a change of priorities for the NRMA.
While the demutualisation and float proposal for NRMA Insurance Ltd has not been finalised, nor put to members - and won't be until later this year, as it must first go through a court approval process - pundits are talking up the stock anyway.
What's NRMA Ltd worth in a float? It was $4 billion in June; in July a broker valued it at $5 billion, and in the latest issue of Shares magazine, Eric Dodd, the CEO of the NRMA, reckons it's worth at least $6 billion or $7 billion. Since June its value seems to have risen by $1 billion a month.
Before that battle, however, there is the fight for seats on the board, with eight members of the 16-member board up for re-election in the ballot which closes on October 6. The fight is principally between the nine-member pro-float Members First faction led by the NRMA's president, Nicholas Whitlam, and the seven-member Motorist Action Group and Members Mutual factions, which want NRMA Insurance to remain a mutual.
Boiled down to its essential elements, the choice facing members is between a fistful of dollars at the float (how much each member will receive is still to be determined, but the average figure being floated by Whitlam is $3,000 in shares) and the option of remaining as a mutual and distributing the accumulated excess reserves in the form of lower insurance premiums or cash rebates to members.
The ill-fated 1994 prospectus, which tried to demutualise and float both the road service arm and NRMA Insurance and which said it looked at other options, opted for the full float model. The part float option now being put to members was rejected in 1994. That prospectus said that "selling off NRMA Insurance would effectively split the NRMA apart. The NRMA's strength lies in the value of both road service and insurance, with each benefiting the other. If they were to be separated, each would be weakened. The value of the combination is greater than its parts. Separating the two would mean splitting the staff of the NRMA, thereby destroying the very culture which has made the NRMA a success."
Obviously the NRMA board has discarded this view. So what are the relative strengths of rebates versus share allocations as a way of distributing the NRMA's excess reserves?
Peter Carroll, an actuary and MAG candidate, who has been a consultant to the insurance industry for 30 years, points out that shareholders pay income tax on dividends and capital gains. As with other demutualisations, some part of the NRMA shares to be issued if the float goes ahead will probably have a tax-free threshold - still to be determined - to reflect the current embedded value of the company. This means capital gains tax will be paid only on the difference between the sale price and that so-called cost threshold.
Rebates, Carroll says, are simpler, taking the form of premium discounts or lower road service fees and are tax-free to members. Unlike shares, they do not impact on pensioner income and assets tests.
The biggest effect to come from demutualisation will be on the management and board focus. With a mutual, the focus is on providing services, and being responsible, to members and communities.
In a floated corporate organisation, profit maximisation becomes the main objective and stakeholders, such as customers and employees, lose their voice as directors become single- mindedly focused on satisfying shareholders. Dodd, in his Shares interview, noted that, even before the float, he has set the pre-tax return on equity on all the businesses at 18 per cent. He reckons he is close to that with the $428.3 million pre-tax result just announced, although that figure includes $373 million of unrealised - that is based on market valuations at two points in time - profits which may not be repeated.
If unrealised investment returns drop dramatically as they have done in previous years, the only way to sustain this hurdle return figure is through rapid business growth or an increase in premiums. Alternatively, costs can be slashed. Or more likely a combination of all three.
Insurance analysts value insurance groups at around 15 times after tax profits. At a $6 billion valuation, that means the NRMA needs to make an after tax profit $400 million. At $7 billion it needs to make $466 million a year. For comparison, the 1999 pre-tax profit was $255 million. On a 15 multiple that would yield a value of $3.8 billion..
Carroll also makes the point that if rebates are paid, the customers or policy holders are rewarded for their loyalty. Dividends don't necessarily go to customers; they go to shareholders, and the two will not always be the same.
NRMA Ltd will become a minority shareholder in the floated organisation, receiving a dividend from its shareholdings. Minority shareholders, though, as we have seen recently with the GIO, don't have any clout. Also, GIO's demutualisation has not saved it from a hostile takeover by AMP. Its share price has now halved and its directors are being sued by minority shareholders. Dodd says it is important that the NRMA brand name remains strong and protected. No-one would disagree with him on that point.
© 1999 Sydney Morning Herald