Money: ScotAm tries to kick habit

Nic Cicutti weighs up the pros and cons of Abbey National's offer

Abbey National, the former building society turned financial services giant, yesterday stunned the City with a takeover bid for Scottish Amicable, the Glasgow-based mutual life company.

More than a million ScotAm policyholders will have to decide between the rival merits of two completely different proposals for the future direction of the company they own.

What is the background to the bid?

We all know about building societies demutualising.

In the past five years, too, a number of insurance companies have merged, including Royal Insurance and Sun Alliance. Norwich Union also plans to float.

Competition and the need to rationalise have driven relatively inefficient firms together, while others are turning to the stock market to get funds to grow more quickly.

So where does this leave mutual insurers' policyholders?

They own the firms they are members of and have policies with, as long as the products they bought are with-profits policies, typically mortgages or pensions. This is because they have an interest in the underlying with- profits fund, built up over many years, from which their bonuses are paid. Therefore, when a mutual insurer is taken over, they are the ones to benefit.

Where does Scottish Amicable come in?

The firm is one of the UK's largest mutually-owned insurers. It was founded in 1826 and has total funds under management of more than pounds 14bn. It has about 1.4 million policyholders, of whom more than 1 million invest in its with-profits fund.

If it is so successful, why all the fuss?

The problem for ScotAm is that it is not as successful as its glossy brochures would like us to believe. In the past few years its performance has slipped in the league tables of life companies. The charts on this page give an idea. Once upon a time ScotAm was in the top five or six life offices in terms of its payouts to policyholders; in the past year or so it has fallen among the bottom performers.

Why is this?

Put simply, the company is in a cleft stick. It is forced by rules strictly enforced by one of its regulators, the Department of Trade and Industry, to set aside enough funds in non-speculative investments to meet policyholders' reasonable expectations. But at the same time, it cannot invest this in the equity markets, which could give it better returns. Other companies have a larger share of their funds in shares than ScotAm, enjoying better performance.

So what is ScotAm doing about this?

The company thought it had hit upon a clever wheeze. It announced two weeks ago that it was planning a two-stage de-mutualisation and flotation process, lasting three to five years. The deal is complicated, but involves an injection of pounds 350m from an outside firm, Swiss Re, to bolster the with- profits fund, ensuring better returns for policyholders. A further pounds 45m would be poured in by another firm, Securitas, linked to Swiss Re, to finance new business growth on ScotAm's part. This would fatten ScotAm for a flotation worth up to pounds 1.5bn. In return for this cash, Securitas would own a slice of the profits from the new flow of business in the next few years.

What do policyholders get out of it?

Well, they would get an immediate pounds 75m paid as bonuses into their policies if they vote in favour of the two-stage process, beginning with de-mutualisation in May. When the company floats in a few years', they would receive a further chunk of money, pounds 200m-pounds 400m, once again paid in bonuses.

ScotAm calculates that in cash terms, someone with a pounds 30,000 sum assured policy maturing this year might get pounds 1,500. This decreases the longer the policy is from maturity, because the bonus would be expected to earn extra interest. In five years, an extra amount might be added.

These figures are a bit suspect in that the pounds 1,500 related to an actual maturity value in April of about pounds 210,000 and few of us have policies that large. So it pays to think in terms of bonuses much smaller than that.

Still, it's better than a kick in the head. Why not vote for it straight away?

Because Abbey National has come in with a belter. It says it wants to pay at least pounds 400m upfront, worth more than five times the above amount per policyholder. The money would be paid in cash or Abbey shares. It would also pump up to pounds 1bn into the with-profits fund to boost its performance. But unlike the ScotAm deal, there is no more on the table in a few years' time.

So what happens next?

ScotAm's board says the Abbey offer is no good and it will still put its deal to the vote. This is by no means certain. It is possible that it may reconsider. Policyholders should wait until more details of ScotAm's and Abbey National's proposals before committing themselves. They should demand that ScotAm explain in detail why it does not wish to accept Abbey's offer. It may be that ScotAm puts its proposals to a vote anyway. By next week we should have a better picture but on the basis of current evidence, there may be other predators in the wings and it makes sense to vote against the ScotAm deal to see what else is on the table.

One last question: who is that strange man with the banana bandoleer in the picture?

He is Captain Chaos, a Sixties character dredged up by ScotAm for its last television campaign four or five years ago.