At Definity, the future is for stockholders, not policyholders

When Economical Mutual Insurance Co. decided to go through the exhaustive process of becoming a public company, it set up a communications program for its policyholders called “Join in Our Future.” And that future turned out to be bright: For much of its young life, the new Definity Financial Corp. DFY-T has been one of the best-performing financial stocks in the S&P/TSX Composite Index.

The “join” part? Not so much.

Policyholders of the company – the next best thing to owners, in a mutual-company structure – negotiated to receive 20 per cent of Definity when it went public after a rigorous, decade-long process of “demutualization.”

But in the end, they were primarily paid out in cash, not stock. So, they ended up with about 7 per cent of Definity – even though they asked for nearly twice as many shares. And that means they’ve missed out on a lot of upside over the past two years.

To be clear, Economical/Definity did what it said it could do in the lengthy conversion plan that it provided to all of its policyholders.

Canada’s major life insurers demutualized more than two decades ago, but no property-and-casualty insurers like Economical had done the same. One complication for the company was that federal regulators determined that all of the company’s policyholders, not just the smaller, 878-member group of mutual policyholders, deserved a piece of the pie.

The resulting negotiations involved committees representing both sets of policyholders, a lengthy offering document detailing the stock conversion, and a vote in which the plan solidly passed.

The new Definity didn’t promise that the policyholders would receive their cut in shares of stock. Definity sent out an election form where the policyholders could request all stock, all cash, or some of both. The offering document said the ultimate mix of cash and stock would depend on discussions between Definity and its underwriters. And if policyholders requested more shares than Definity wanted to issue to them, Definity would substitute cash instead.

And that’s what happened. Even though Definity sold more than 73 million shares to the public, it decided to provide a little more than eight million shares to the policyholders. That suggests there was more than enough stock to go around.

Policyholders who requested they get their payment all in shares instead received about half cash and half stock, according to a policyholder document seen by The Globe and Mail.

Shareholders could have taken the cash and bought Definity shares on the open market, of course. But there’s little chance an individual retail investor would have been able to get the $22-per-share offering price – the stock jumped 24 per cent on the first day of trading, to $27.17.

Also, the cash payment to policyholders was likely treated as a taxable dividend, while the share payment likely allowed policyholders to defer taxes as capital gains. That tax penalty left cash-receiving policyholders even less consideration.

The Definity IPO was a smashing success. Securities filings show that in early November, 2021, the company said the lower end of its proposed pricing range implied a company worth a little under $2-billion. By the time the company increased the offering price and sold extra shares as part of an “over-allotment,” the company was worth more than $2.5-billion. By the end of the first day of trading, it was worth more than $3.1-billion. And by the end of 2021, more than $3.5-billion.

In its first year as a public company, Definity’s total return of nearly 70 per cent surpassed all other Composite financial stocks by more than 25 percentage points, according to S&P Global Market Intelligence.

Former policyholders owned 7.1 per cent of the company’s shares, worth about $250-million at the end of 2021. By that point, a one-fifth portion of Definity was worth $700-million. (Unfortunately for policyholders, the Economical/Definity conversion plan also said the 20 per cent given to them would be based on the value of the company “prior to the completion of the IPO,” so it didn’t include the value of nearly 16 million shares sold as part of the over-allotment.)

According to disclosures in the SEDI system for insider share ownership, the company’s executives and board members owned Definity shares as early as the IPO day.

This may surprise readers of the fine print in the federal government’s regulations for the conversion of mutual companies into stock corporations. There, it says a company converting from mutual to a stock corporation cannot “issue or provide shares, share options or rights to acquire shares” to directors and officers before its listing on a stock exchange, or for one year after.

Definity spokesman Mathieu Genest says Definity’s directors and executives “own shares because they purchased them with their own funds from the IPO underwriters or bought them subsequently over a stock exchange.” (Records show Definity chief executive officer Rowan Saunders acquired shares at the $22 offer price.)

And disclosures in Definity’s proxy circular to shareholders, which show Definity executives receiving share-based awards in 2021, prior to the IPO, do not mean they received shares, Mr. Genest says. They are “allocations of notional units” that didn’t have the word “share” in their names until after the IPO, he said, and they can be settled in cash. “These grants are not shares, options to acquire shares or rights to acquire shares.”

Mr. Genest says many policyholders asked for cash, not stock: And he contests a description of the policyholders as “owners” of the mutual company, saying that while they had governance rights at Economical, they couldn’t sell or transfer their policies, and they hadn’t invested extra capital for those voting rights. “They are not owners as most people would think about that concept.”

And, he says, Definity “is pleased that the strong investor demand meant that the company was able to attract quality investors to create a supportive, robust shareholder base – critical to our success … as a newly listed company and to the execution of our strategy going forward.”

It’s those new shareholders, in other words, who are joining in Definity’s future – and reaping most of the stock’s gains – as the company has adroitly left its old policyholders behind.