A new age dawns for mutual insurance

“Insurance is a caring industry,” says Shaun Tarbuck of the International Cooperative and Mutual Insurance Federation (ICMIF). “It is there to look after people in their time of need.”

The basic principle of insurance – pooling risk for mutual benefit – is fundamentally people-centred and co-operative. Yet as the 20th century drew to a close, this principle was diluted. Insurance, like other financial industries, lost its way.

Starting in the 1980s, the mutual and co-operative insurance sector was decimated by a wave of demutualisations. Large insurers such as Prudential and Sun Life converted to joint stock companies, giving shares, dividends and cash payouts to policyholders.

By 1999, the mutual sector had shrunk so much, researchers at reinsurer Swiss Re asked whether mutual insurance companies were an endangered species.

It was by no means clear what benefit demutualisation offered to customers. Critics said insurance companies were no longer being run for the benefit of their customers, but to make profits for investors.

And they had a point. In 2005, research by two American professors of finance, Joseph Meador and Lal C. Chugh, demonstrated extraordinary returns on equity for investors in the demutualised insurers. More importantly, they showed fundamental changes in the nature of the business undertook by these new joint-stock insurers.

“Our findings clearly demonstrate a revolutionary change in the behaviour and strategies of the newly demutualised firms,” they said.

“Change is both extensive and widespread. The firms substantially increased their returns on equity and returns on assets.

“Second, the firms increased their revenue nearly 2.6-fold over the three years following conversion. Third, they accomplished dramatic changes in product composition, moving from the traditional life insurance business to wealth and pension fund management.

“The fourth change … was the adoption of riskier investment portfolios, adding more and lower-rated debt securities. Finally, the firms repositioned capital structures in favour of more long-term debt.”

So these newly demutualised insurers delivered extraordinary returns by vastly increasing the risk of their investment portfolios, not by improving underwriting.

At the time, this was not regarded as a bad thing – as long as returns were good, few saw any danger. The professors concluded: “Our research confirms that demutualisation has unlocked substantial value previously lying dormant in the mutuals. It has promoted innovation and operating efficiencies. In addition, demutualisation of life insurance companies has enhanced the allocative efficiency of the capital markets and therefore can be viewed as socially desirable.”

What was left of the mutual insurance sector was sidelined, and with it the principle of sharing risk for mutual benefit. Insurance had become simply another type of investment banking.

But the 2007-8 financial crisis changed all that. We think of it as primarily a crisis of banking, but it was in some respects just as much a crisis of insurance. In the US, “monoline” insurance companies provided insurance guarantees on residential mortgage-backed securities: when the value of these securities collapsed as the subprime mortgage crisis broke, many of the monolines bled to death.

Insurance giant AIG, which issued guarantees in the form of credit default swaps to major banks, was bailed out by the US government after Lehman Brothers collapsed.

In addition to these high-profile failures, the insurance sector as a whole was hit hard by the collapse in asset values. Large life insurers were badly affected by falling asset values in their investment portfolios.   

Since the financial crisis, returns on investment have become so poor, insurers have to focus on making underwriting profit rather than relying on investment income. In short, they are having to return to their roots. But for underwriting to be a reliable income source, they must attract customers. So just as in banking, customer service has become the new mantra, and insurance is rediscovering the primary importance of meeting customers’ needs.

And this creates a golden opportunity for mutuals.

Mutual insurers that do not have to satisfy the demands of external investors can give better value to customers, keeping premiums low while honouring claims in full. In a new report, reinsurer Swiss Re notes that as a sector, mutual insurers have loss ratios about 4% higher than other insurers – an “efficiency premium” that derives directly from the fact that they do not have to maximise profits. Large mutuals in highly competitive general insurance sectors particularly benefit from this efficiency premium.

Mutual insurers also appear more resilient. The mutual sector weathered the financial crisis better than other insurers. Swiss Re says that mutuals are generally well capitalised, maintain good reserve levels and avoid excessive risks in their investment portfolios.

But giving better value to customers and being more resilient are not enough. And despite fierce price competition driven by the proliferation of price comparison websites, price is far from being the only consideration for today’s concerned customers.

Added-value services, and a socially responsible philosophy, are increasingly important.

Mr Tarbuck says he has seen a structural change in the industry since the crisis. “Customers are more informed and more selective,” he says. “They are not just looking for a good insurance provider – they want to know that their insurance provider is a good corporate citizen.”

There is already evidence that mutuals are benefiting from customers’ change in attitude. Premiums for mutual insurers grew by 15.8% between 2007 and 2014, compared with only 2.8% across the insurance industry as a whole.

Much of this was in 2008 and 2009, when there appears to have been a “flight to quality” among insurance customers similar to that which benefited building societies at this time. But the resurgence of mutual insurance is still continuing, albeit slowly. Mutuals’ share of the market has grown from 24% in 2007 to 26% today.

A recent Bain & Company survey quoted in Swiss Re’s report shows that customer loyalty scores for mutuals, as measured by Net Promoter Score (NPS), were more than double those of multinational stock-based insurers. It seems that customers trust mutuals enough to want to stay with them.

Interestingly, the strength of mutual insurance appears to be a global phenomenon, with mutual life insurers doing well in Eastern Europe, the Middle East and Africa, and non-life insurers doing well in Latin America and the Caribbean. The international growth of mutual insurance is particularly impressive as 45% of countries do not permit mutual insurance. Breaking down these regulatory obstacles would give further impetus to mutual insurance worldwide.

Regulation is a growing concern. Since the crisis, Solvency II regulations have tightened capital requirements and governance standards for insurance companies, the corollary to Basel III regulations for banks. The Swiss Re report says that these requirements could put some mutuals, especially smaller ones with a narrow regional or business line focus, at a competitive disadvantage.

This could encourage a new wave of regulatory-driven consolidation among smaller mutuals. It is to be hoped that regulators will ensure the regulatory burden on smaller mutuals does not become excessive. The purpose of regulation is to make insurance companies more resilient, not drive them to the wall.

And, of course, there are other headwinds. Since the crisis, smaller insurers – including many mutuals – have been hurt by persistently low interest rates on their cash balances, while larger insurers have been partly insulated by central bank policies such as quantitative easing that have propped up asset prices. Again, this tends to push insurers towards consolidation.

On the bright side, technological developments that encourage risk pooling and sharing are likely to help the mutual sector.

And there is an important social implication here. The report says that by enabling people to share risk capital to cover potential adverse developments that might affect individuals in a network, mutuals can offer an important safety net for the less fortunate or poorer in society.

This is becoming increasingly important as governments in many parts of the world retreat from social insurance provision. New mutuals and co-operatives are needed to fill the gap that they leave.

The financial crisis exposed the weaknesses in the investor-led joint-stock model. As the pendulum swings back towards sharing of risk and supporting those in need, a new era of mutualism is beginning to take shape.