In the `yes they will, no they won't' wrangle about the merits of demutualisation, there are indications that investing a windfall payment can outweigh the benefits of a building society's rates. By Katharine Lewis
Last month, against all expectations, one of Britain's best-known building societies, Bradford & Bingley, finally succumbed to carpetbaggers and decided to convert to a bank.

Despite this, the country's remaining building societies continue to voice the dangers of demutualisation, saying remaining in a building society makes more financial sense for members than opting for a lump sum windfall payment.

But could the building society proponents be wrong? Research shows that keeping your savings or mortgage with a mutual in the long run does not necessarily save you more money than if you voted for the short term gain of a windfall.

Admittedly, interest rates at mutuals can often be more generous than at banks. But statistics indicate the money gained from investing a windfall payment over the long term can outweigh the money saved from better saving or borrowing interest rates provided by a building society that does not demutualise.

Moreover, after demutualisation, customers could move to a non-demutualised building society if they are concerned that saving or borrowing rates are falling at their demutualised building society.

Mutuals tend to have better interest rates because they have members (which are their account holders and policy holders) rather than shareholders.

Simon Ormston, assistant general manager at Staffordshire Building Society, says: "Mutuals reward the loyalty of their members by putting some of their annual profits towards improving the interest rates they offer on their products."

In comparison, the shareholders of banks and converted societies are not necessarily customers of the company so they are given dividends out of the company profits to reward them for their investment. Figures provided by Bradford & Bingley, prior to its demutualisation, illustrate the point.

Interest-only payments on a pounds 50,000 standard variable mortgage made over two years between 1996 and 1998 would come to pounds 11,428 for a Bradford & Bingley customer, pounds 11,892 for the Halifax (which has demutualised) and a hefty pounds 11,997 for Alliance & Leicester, also demutualised.

"This represents savings of pounds 464 and pounds 569 respectively for Bradford & Bingley customers before demutualisation," says Alis Marjoriebanks, spokeswoman for Bradford & Bingley.

For a customer paying into a mortgage over 20 years, this advantage could multiply many times. Although interest rates vary over time, taking Bradford & Bingley's rates as an industry average, mutual customers could save pounds 4,640 over Halifax customers over 20 years and pounds 5,690 over Alliance & Leicester customers, if they stayed with a mutual society.

Windfall payments for forthcoming building society conversions are expected to range from between pounds 250 (for Old Mutual) to pounds 3,000 for NPI policyholders. The average payout by Halifax on demutualisation was pounds 2,400. So the savings quoted above for a typical mortgage look attractive and support the idea of remaining a mutual.

But what if you turn the short-term gain of the windfall payment into the long-term opportunity of an investment in the stockmarket? Investing the windfall turns the pro-mutuality argument on its head because the gains from the investment are potentially greater than the savings made by staying with a mutual.

For example, when the wave of demutualisations began in 1997, many investment companies such as Fidelity and Commercial Union (now part of CGU) offered "windfall PEP" products, where investors could place their windfall shares into a tax-efficient fund, or they could put the proceeds of the sale of the shares into a tax-free managed fund instead.

Although these products are no longer available, current investors facing the "windfall" dilemma could do practically the same thing by putting windfall payments into an ISA.

Of course, the growth of the windfall within the ISA would depend on the fund's performance, so again is not guaranteed. Some funds invested in Japan or the emerging markets have delivered a negative return over the last few years. But the statistics for UK funds are compelling.

For example, a pounds 3,000 windfall investment in Virgin's UK Index Tracker made two years ago would now be worth pounds 4,305, representing tax-free growth of around 43 per cent. Even the average performing fund in the UK Growth & Income unit trust sector would return around 35 per cent over that period.

If that money were to be invested for a lot longer, the return on the original investment could be quite considerable. Data is not available for Virgin's fund going back 20 years, but the return from the FTSE All- Share over the last 20 years gives some indication. The index has risen by an astounding 958 per cent over that time. That means an initial investment of pounds 3,000 would now be worth pounds 28,740.

This makes the mutuality argument look weaker than ever.

But is this investment alternative realistic? Unfortunately, many of us don't have the self- control to save our money for 20 years without touching it. Research shows that most windfalls are spent, not invested.

At the Staffordshire, Mr Ormston says: "We have done a survey of Birmingham Midshires customers, who have just received windfalls after being taken over by the Halifax. It suggest that the majority of customers will spend at least part of their windfall money, and more than 50 per cent will spend all of it."

The average Birmingham Midshires windfall is expected to be around pounds 750.

So the question mutual members have to ask themselves, when it is their turn to vote for, or against, demutualisation, is whether they have faith in the stockmarket and the discipline to invest. If they do, then the potential gains from a windfall could outweigh the advantages of mutuality.

Expected windfalls

Birmingham Midshires (already paid out): Minimum pounds 400, average pounds 750 in cash or preference shares for one million savers and borrowers.

Old Mutual (mid-1999): Free shares worth minimum pounds 250, average of pounds 1,000 for 20,000 with profits policyholders

NPI (September 1999): Minimum pounds 300, average pounds 3,000 in cash or bonuses for 630,000 policyholders

Sun Life of Canada (end 1999): Free shares for 250,000 UK with profits policyholders, amount not known

Canada Life (end 1999/early 2000): Free shares for 70,000 UK with profits policyholders, amount not known

Bradford & Bingley (mid-2001): Free shares or cash to 2.5 million members to a probable value of pounds 1,000 each.