This is a copy of a post I wrote elsewhere in February 2008. It seems relevant in the current economic conditions. At the end of the lecture, the chair announced that the talk had been given under the Chatham House Rule – since everyone had been sitting there for an hour and a half, making notes on their laptops, that seemed to be more than a little hopeful. I have however tried to remove details of the speaker.
There was a lecture at the management school about the Standard Life demutualisation and share offer (IPO) of September 2006, and what had lead up to it. It was a fascinating account of the machinations of a large organisation going through a period of change and turmoil, and the effect this had on the firm, its staff and its customers.
A bit of Background…
SL was a mutual insurance company, owned by the investors in its “with-profits” fund. A with-profits is a kind of investment vehicle whereby the fund managers smooth out the growth of the funds (and savers’ investments), holding back gains in good years to cover for losses in bad years. They used to be very popular in the UK – a lot of pension funds are with-profits, and most endowment policies are too; these used to be the standard way which mortgage holders would pay off their loans – they’d take out an interest only mortgage, and simultaneously invest in an endowment policy to produce sufficient capital to pay off the debt at the end of the loan’s life.
The thing about with-profits is that they are very opaque, at best. It is very hard to tell how one’s investment is doing, because a lot of the capital gain is stored up and added as a “bonus” at the end of the product’s life. This works fine in rising markets, but badly in falling ones, when the annual capital gain is not sufficient to cover the investment. In the 1990s, and then again in the very early 2000s, the bearish markets meant that with-profits vehicles were not doing what they were supposed to do; there were no profits to share out – users got with-losses, instead.
In the UK in the early 2000s, this created a kind of “perfect storm” for with-profits funds. The markets were falling, so investments weren’t doing well; the Chancellor of the Exchequer dramatically changed the rules on reclaiming tax on dividends (arcane, but very important – suddenly a lot of investment vehicles, including pension funds [often with-profits], ISAs and PEPs, couldn’t reclaim the tax that companies had paid on their dividend distributions, effectively reducing the yield by 25% (and hence leading to a revaluation of the market – further downwards); and new accounting rules – FRS17, if you are interested – came in, meaning that any shortfalls on pension funds had to be shown, and made up.
These three things combined in a major way. The falling markets meant that a lot of pension funds had lower assets than their liabilities, and now because of FRS17, these liabilities had to be declared. (Previously, with-profits pensions and endowment funds could have relied on an actuarial assessment that the value of the fund was likely to rise to cover any shortfalls before they would fall due.) Plus the yield on investments was reduced. Actuaries value investments based on the yield, and when they looked at a lot of with-profits funds ,they found that there was insufficient capital to pay off mortgages, or that pension funds were effectively bust.
The funds reacted in some fairly typical ways. They stopped guaranteeing annual bonuses; they reduced the value of the fund available to investors; and they used a “market value adjustment” so that investors were effectively locked in – since if investors sold their investments, the fund managers would be selling into a falling market.
Some life assurance companies went bust – notably Equitable Life, which had tried to rescind on guarantees it had made to a particular group of investors – the legal arguments went to the House of Lords, who ruled in favour of those investors with guarantees (since this was a mutual fund, this decision was at the expense of all the other investors, who owned the mutual fund).
The regulators were paying a lot of attention to what was going on – after the Equitable debacle, they were all over with-profits funds; and they required the application of stringent liquidity rules, to ensure that funds would be able to meet their liabilities. To cope with this, the funds had to sell shares and buy gilts and corporate bonds – effectively, reduce the risk profile of their assets. But they were selling shares into a falling market – not a good place to be.
This was all played out against a backdrop of huge customer disappointment. Investors had high expectations: they were used to rising markets, and they had been sold products with promises (if not outright guarantees) that their mortgages would be covered with cash to spare, and they would retire with a large pot of money. Life assurance companies had to send out letters to thousands of investors telling them that actually this wasn’t going to happen. Customers left endowment funds and other with-profits vehicles as quickly as they could.
(All this has been my analysis of what was going on at the time… Now back to the lecture…)
Change and Demutualisation
So there was Standard Life. A mutual, it had fought off the wishes of some policy holders to demutualise at the height of the bull market in 2000, when they had hoped to profit greatly from the unrealised profits in the with-profits fund. The firm fought a very hard, high profile battle to keep their mutual status, holding lots of investors meetings, appealing to their caring, sharing side (rather than their greedy, give-it-to-me now side), the staff rallying around and doing their bit. They won, the demutualisers failing to get a simple majority of policy holders to sign up, let alone the 75% needed to demutualise. As a result, they had made promises to investors, too.
Then, in the depths of the bear market, with the new rules on valuation and the low-risk requirements for liquidity, the actuaries looked at the with-profits fund and saw it was also effectively bust. This was in December 2003. This was a huge turnaround: apparently, it was such a shock that the actuaries checked, rechecked, and rechecked their calculations – they just couldn’t believe that the fund had lost all its value. The regulator stepped in and set new liquidity requirements and a change to the risk profile of the fund.
In the first few months of 2004, SL went very quietly into the market and sold a large proportion of their equity holdings to meet the new liquidity requirements: they sold £7.5bn in five weeks. They managed to do this with no one realising what they were doing – which was kind of important, since if anyone had twigged, there would have been a run on the fund, much as that seen recently with Northern Rock. SL split the sales over several brokers, and only sold on days the market was rising so as not to prompt further falls. It is quite remarkable that they got away with it (and the discussion of how they did so makes the recent unwinding of futures positions by SocGen even more strange).
They also reviewed their strategy, and realised that they didn’t have sufficient capital to carry on: they need to raise more capital, or fold. It is not easy for a mutual company to raise capital, and the board decided to demutualise – a complete, and very public, turnaround from a couple of years earlier. The CEO resigned, and was replaced by Mr Crombie.
Customers – the owners – were very angry. The potential windfalls of a couple of years previously were much reduced. They would get shares, but not the apparently free money they might have got before. (Not really free, of course – they’d have been selling something they had owned; it was just now it was worth a lot less.)
The company had to change, too. It had been an expensive provider; now it had to slim down in preparation for the stockmarket listing. Strangely, it was actually helped by being a mutual: it could change its strategy relatively easily: not being a listed company, it could shrink.
SL was also help by a change in the regulation of pension products. In April 2006, the UK government changed how pensions were regulated, allowing investors to bring together all their pension holdings within one fund – previously, different pension pots were more or less kept separate. There was a boom in these new pension vehicle – self invested pension plans (SIPPs) – and Standard Life went for this new business ,and were very successful. The pricing structure on SIPPs was very different from traditional personal pension plans: the former pay management fees, whilst the company paid agents for the latter. With this new business, SL drastically changed its business model, and how it generated its revenue stream. The productivity of the organisation was increased four-fold.
Against this backdrop, the organisation had to convince the members of the with-profits fund to demutualise. They held many, many public meetings, and there was a lot of anger – pure hatred. Interestingly, the harshest critics were actually helpful to the firm. The lecturer described how at one meeting, a journalist leapt in with such hyperbole that others at the meeting became sympathetic to the board and the situation they found themselves in. Still, they needed very hard skins – the press were uniformly against them (partly because old SL had not needed the press, and had not cultivated good relationships with them – they had appeared instead aloof and arrogant); the CEO was told by the press not to take it personally, they needed to put a human side to the stories, as they printed apparently false allegations about the new red sports car he had bought as he planned to make thousands of staff redundant.
The company came to the market in July 2006. Markets were still falling. They had to convince institutional investors to buy their shares – mostly other pension funds. (This story is full of irony; it would make a great film.) There is a lot of negotiation in these situations, apparently: the new investors want the shares as cheaply as they can get them (they are looking for a profit), the new company wants as much cash for each share as it can get, whilst making sure the offer gets off the ground. It sounds like a game of brinksmanship: a lot of arm-twisting and horse trading goes on.
The issue was a success; the shares rose, supply was limited as the company went into the FTSE 100 index, and other fund managers needed to have it in their portfolios.
I was particularly interested by the impact on the staff. I was talking to someone today whose wife works for Standard Life, and has for many years; she still has the t-shirt she was given when SL was rallying support against the carpetbaggers in 2000 – “keep Standard Life mutual!”, it proclaims; she still expresses hatred for the board that broke its promises. From fifteen thousand staff before the crisis, the company now employs ten thousand – they reduced their headcount by more than a third, since many of the staff there now are new staff. It wasn’t clear how they had achieved this, and how the culture of the organisation had changed – how they had increased productivity, made their people more market-focused. It must have been a hard, wrenching business.
Apparently, one of the hardest tasks happened last year, when, as with many other companies, SL closed its final salary pension scheme: this was the last piece of the old organisation left, the last thing they could hold out to the staff – whatever happened, they had the promise of the pension scheme. But as FRS17 affected so many companies, that too had to go. It was a very symbolic event.
The new company is apparently flourishing; it has exceeded its performance targets and its shares have performed in line with the market generally- (that is, they have lost a lot of their value. The shares closed on 10th July 2006 at 242.5p (a premium on the 230p issue price); they went up to 349.5p on 18th May 2007, and they closed on Monday at 198p – down 18% on their first day closing.
After the talk, I found myself chatting to some friends who work at Standard Life – they are new Standard Lifers – and talking to one of the people who worked on the strategy review. This was interesting: he gave his take on the talk (which was that the source had been more open that he had before), and the state of the firm now – and how the staff felt. Then guy who gave the talk came and talked to his people, too; it isn’t often that I get to share a drink with a very senior member of a FTSE100 company. (OK, it had only happened once before!). He didn’t strike me a being a particularly good listener – although I can understand his lack of desire to chat after he had been on stage for a couple of hours. He probably just wanted a drink and to get away, like the rest of us.