NIB yesterday became the first listed health insurer and its former members are no doubt delighted the shares closed at $1.18, a 38% premium to the 85c at which 100 million shares were sold to clients of JP Morgan last week.

However, former members of the Newcastle-based mutual should be outraged that JP Morgan has just transferred $36 million of their value to a small group of its institutional investors. This is how it was done.

As part of the demutualisation process, JP Morgan offered to sell shares on behalf of NIB customers who did not wish to receive shares. These were to be sold to JP Morgan clients by a “book build”, which is a kind of auction, except only JP Morgan clients can participate, and only JP Morgan knows how much demand there is. The range was 70-90c which the market is now saying was way under the odds.

About 10% of NIB’s 300,000 policyholders sold shares via the book build. This was a silly move and they would have been much better off retaining a slice of Australia’s 6th biggest insurer which has 6.6% of the market.

Additionally, JP Morgan placed $50 million worth of new shares at 85c via the book build, although most of the big holders are hiding behind nominee companies.

This placement is particularly outrageous as NIB says that it had $75 million of surplus capital at 30 June 2007 and plans capital initiatives to return cash to shareholders. NIB had no need for the $50 million, which only served to further dilute the vendors.

Coincidentally, the management term were allocated 550,000 shares at this same knock down price of 85c, so they actually had an incentive to keep the price as low as possible.

For providing this flawed service, JP Morgan will no doubt receive millions in fees, although no figure has been publicly disclosed.

Keith Lynch has been on the NIB board since 1982 and chairman since 2001. He’s got a lot to answer for and the 2006-07 annual report shows his pay has just rocketed from $141,000 to $187,000.

The management team shared $1.15 million in retention payments last financial year and CEO Mark Fitzgibbon saw his pay soar from $495,000 to $870,000.

This whole sorry saga demonstrates how mutuals can be captured by the insiders. NIB should have simply issued shares to its members and then offered a sale facility once they had been priced by the market. The sale facility should have allowed existing policyholders to buy from those wishing to sell.

Instead, JP Morgan, the management and some privileged insider institutions have needlessly enjoyed windfall gains. It’s a real shame the financial press can only trumpet this as a “successful float”, rather than exposing a completely flawed process.