Mutuality seems to be dying as Equitable and Bradford and Bingley relinquish it and the water regulator rejects Kelda’s proposition. Perhaps not surprisingly – mutuals suffer from the problems of too little capital – or too much. Is there a possibility of a sustainable constitution for a mutual business?
The days of mutual businesses seem to be drawing to a close. The “for sale” sign has gone up outside the offices of the Equitable Life. When Bradford and Bingley hands out windfall shares to its members, only one large building society – Nationwide – will remain, and that only because it has so consistently underperformed its competitors. Against the flow, the water industry has come up with proposals for mutualisation, only to see them denounced by bishops and rejected by regulators.
And yet mutuals are not disappearing because they have themselves failed as businesses. As with all companies, there are good and bad. Opponents of mutuals can point to the dismal decline of the Coop, once Britain’s largest food retailer. But supporters can describe how mutual building societies persistently ran rings round banks in retail financial services. And of all the life assurers, Equitable and Standard Life are the most admired.
Mutual organisation is dying because of two main problems. One is capital structure. Mutuals either have too little capital, or too much. Smaller life companies like NPI are disappearing because they don’t have enough capital. The most successful mutual companies ceased to be mutuals because they had so much capital that they were unable to resist the pressure to hand out the money to their current membership. Once carpetbaggers got the idea that windfalls were there for the taking, the pressure became irresistible. Hence the conversion of building societies, the sale of Scottish Widows – and the still precarious future of mutuality at Standard Life.
Equitable managed this balance between too little capital and too much better than any other mutual company, paying out profits to customers rather than building up hidden reserves, and offering competitive rates with adequate, but barely adequate, capital backing. But the trouble with walking a tightrope is that one gust of wind is enough to blow you off. Their defeat in the House of Lords over guaranteed annuities proved enough to tip the business into the void.
The second problem is the legitimacy of the mutual governance structure. The boards of mutuals are self-perpetuating, and often arrogant in their attitude to members. The same is true of many public companies, of course, and the rituals of the annual general meeting and the re-election of directors are as empty in public companies as they are in mutuals. But for public companies, the possible nemesis of a hostile takeover bid is always in the mind of managers and board. Mutual companies are free of this threat.
Are these problems intractable, or could mutual companies find a structure which would give them continued life and perhaps even allow the establishment of new mutual businesses?
There is a niche for customer focused mutual businesses. There are specific customer needs that a competitive market does not provide for or does not provide for well – because the customers alone have knowledge that is specific to the businesses, because there are community as well as individual benefits from the activity, because the service is a local monopoly, or simply because the competitive market has missed an opportunity.
That is how many railways and water companies, insurance businesses and building societies, schools and hospitals, came into being; why tennis clubs are organised on mutual lines, and the customer corporation is perhaps the best way of managing these activities even now.
If a sustainable model of a mutual organisation could be devised, it could offer a coherent choice of structure to the members, and customers, of Standard Life. It might also provide an appropriate vehicle for a whole range of activities, from water supply to roads to health, that today lie on the boundary between public and private sector. Sensible members of a mutual should not want to run the business activity themselves. They should want to subcontract that to competent professionals.
Identifying the role that mutuals can fill defines many aspects of their constitution. They need to be established for a specific public purpose and effectively confined to these purposes. That means they need to be protected from conversion, but also prohibited from accumulating surpluses and from diversification beyond their primary objectives. Their goodwill should be the respect of their communities rather than a marketable asset.
And what of the problem of capital structure? Such companies are the ideal recipients of sub investment grade debt. In effect, this means that the management is left alone unless things go wrong, at which point the capital markets intervene, sort things out, and hand the business back. The spread between the cost of that money and over investment grade bonds is the margin that pays investors to take on that risk and that responsibility.
In the nineteenth century, the equity of railways and water companies were very different securities from modern shares. They were low grade, high return, fixed interest securities: what we today call junk bonds. It is a model we could look back to with profit.