Mutuals suffer identity crisis

Access to capital is the usual reason given for mutuals rushing to list, but there is a far more serious flaw in their structure.

Mutuality, the belief that financial services companies should be owned by their customers rather than outside shareholders, took another knock on Friday when Equitable Life, Britain's oldest mutual life insurance society, closed its doors to new business after 238 years.

Mutuality, the belief that financial services companies should be owned by their customers rather than outside shareholders, took another knock on Friday when Equitable Life, Britain's oldest mutual life insurance society, closed its doors to new business after 238 years.

As everything from the AA to South Africa's Old Mutual opted for sale or flotation in the last few years, pressure has mounted on the dwindling band of committed mutuals to prove that being customer-owned is not just an empty ideal, but has a benefit that can be felt in customers' wallets. However, as Equitable Life's near-demise proves, just handing back more of your profits to customers is not necessarily the answer. Equitable's experience clearly shows the pitfalls for a mutual of not having built up enough reserves in the good times to cover unforeseen problems.

But the whole debacle has exposed a far more serious flaw in the mutual structure than lack of access to the public capital markets, which is the usual explanation why mutuals have been rushing to list. That is the fact that all customers are not equal and the ability of a mutual to manage conflicts between different interest groups within its customer base is limited in the extreme.

With hindsight, Equitable should never have sold the guaranteed annuities that precipitated the downfall of the society. They were effectively asking policyholders to write an unlimited interest-rate option in favour of one particular group.

But having written them, the society was unable to persuade holders of those guarantees to waive their rights even though exercising them in full was going to precipitate a situation where the firm was unable to carry on writing new business and everyone lost out. The guaranteed annuity holders who took their case to the House of Lords, won the argument but in the process undermined the finances of their own business so the only way it could carry on was if it were bought. As we now know even the Prudential could not justify paying the cost of rescuing the business.

It is a situation with which Don Cruickshank, chairman of the London Stock Exchange, will have some sympathy. The LSE has only partially shed its mutual status and as a result is in thrall to what he calls fuzzy governance - perpetual confusion about who the Stock Exchange is run for and to whom its board is responsible.

As a result conflicts abound - between big brokers and small brokers, between international brokers and those who are the European arms of American investment banks. A mutual has no mechanism for resolving those conflicts. Converting into a shareholder-owned company frequently appears to be adding a new level of conflict - i.e shareholders versus management and customers. But in reality it provides a clear hierarchy on which to focus. Shareholders just want to see their return maximised, so they will back any strategy which is in the interest of those customers who are more profitable, those employees, or the management team, who contribute more.

Lack of capital, or a fear that unless you list now, you will not be able to access capital markets when you need them, for example to fund an acquisition, is the usual reason mutuals advance for going public. Institutions like Nationwide and Standard Life may have more than enough capital to carry on with their current strategy.

But that does not mean they are immune from these conflicts or will find them easier to resolve than either Equitable Life or the LSE have to date.