The Wealth Effect of Demutualization: Evidence From the U.S. Property-Liability and Life Insurance Industries

ABSTRACT This study examines the wealth effect of demutualization initial public offerings (IPOs) by investigating underpricing and postconversion long-run stock performance. Our results suggest that there is more "money left on the table" for demutualized insurers than for non-demutualized insurers. We show that higher underpricing for demutualized firms can be explained by greater market demand, market sentiment, and the size of the offering. Further, contrary to previous research reporting an average underperformance of industrial IPOs, we show that demutualization IPOs outperform non-IPO firms with comparable size and book-to-market ratios and non-demutualized insurers. We present evidence that the outperformance in stock returns is mainly attributable to improvement in post-demutualization operating performance and demand at the time of the IPOs. The combined results of underpricing and long-term performance suggest that the wealth of policyholders who choose stock rather than cash or policy credits is not harmed by demutualization. Stockholders who purchase demutualized company shares either during or after the IPO have earned superior returns. Our findings are consistent with the efficiency improvement hypothesis. INTRODUCTION Demutualization refers to the conversion of a mutual insurer to a stock company. It has become a very timely research topic given the conversions of several large life insurance companies (e.g., Metropolitan Life Insurance Company [MetLife], John Hancock Financial Services Inc., and Prudential Financial Group) and recent developments in the MetLife policyholders' class action lawsuit. (1) A number of studies have examined demutualization in the U.S. property-liability and life insurance industries. (2) Mayers and Smith (1986) present evidence that mutualization (stock to mutual conversion) is efficiency-enhancing by examining a number of variables around the time of conversion. Jeng, Lai, and McNamara (2007) use data envelopment analysis to investigate whether demutualized insurers improve operating efficiency after conversion. They do not find evidence that efficiency improves after conversion. (3) Viswanathan and Cummins (2003) focus on the motivation for a mutual company to demutualize. They suggest that the demand for capital and the opportunity to control free cash flow problems are the reasons for demutualization. The focus of previous demutualization studies is mainly on the impact of demutualization on the insurers' efficiency and profitability. Less is known about the wealth effect of demutualization on policyholders who become stockholders through the demutualization process and other stakeholders as well. This article examines the wealth effect of demutualization initial public offerings (IPOs) in the U.S. property-liability and life insurance industries. During the demutualization process, policyholders are given choices among cash, stock, or policy credits in exchange for their ownership rights. It should be noted that many eligible policyholders choose to become stockholders because eligible policyholders who are not required to receive cash or policy credits automatically receive stock unless they elect to receive cash. (4) A careful examination of the wealth effect is important because it directly examines the bottom line (wealth) of policyholders who become stockholders through the demutualization process. (5) In our analysis, we focus on two questions concerning demutualization IPOs. Ritter and Welch (2002) show that IPO underpricing persists over time and that the average IPO underpricing in the United States between 1980 and 2001 was over 18 percent for industrial firms. Rock (1986), Tinic (1988), Hughes and Thakor (1992), and Welch (1992) suggest that the underpricing may be related to information asymmetry whereas Benveniste and Spindt (1989) and Hanley (1993) suggested that the underpricing is related to the market demand. …