GIM9020 - Mutual insurance: what is mutual insurance?

It is quite common for insurance to be carried on a mutual basis. There is a mutual element in all insurance, in that most of the funds contributed by policyholders are returned to them as claims payments. One of the purest form of mutual insurance is found in the P & I Clubs (Protection and Indemnity Clubs), which consist of groups of ship owners who agree that they will meet each others losses from storm damage and other causes. Each year the members of the club contribute (in proportion to the size of their fleets) whatever amount is needed to meet the losses insured by the club. This is usually in the form of an initial contribution followed by later “calls” if these are found to be needed after the year end.

More familiar is the mutual insurance company, the members of which will be its policyholders. If a mutual insurance company generates profits then it is the policyholders who are entitled to share in those profits. In practice this entitlement is unlikely to produce any visible benefit for the members of most mutual general insurers, as accumulated profits tend to be re- invested in the business, but this does not mean that the companies are not operating on a mutual basis. It is the entitlement to share in profits that matters, even if there are no actual distributions of profits for many years. On the other hand, the mere fact that a company has no shareholders (and may be referred to as “a mutual”) does not necessarily mean that it operates its business on a mutual basis.

The question of mutuality does not depend on the size of the insurance company or the number of its policyholders. A company may be a mutual insurer whether it has 200 or 2,000,000 policyholders. Indeed some very large insurance companies carry on their business on a mutual basis - even though many of their policyholders are probably quite oblivious of the fact.

Some insurers deny policyholders a right to participate in surplus until they have been members of the company for a qualifying period. Provided that such a provision does not operate in practice in such a way as to confine the benefits of membership to a minority of members it is consistent with Lord Wilberforce’s requirement for a “reasonable relationship”.

A mutual concern is not one that trades only with its members. Lord Macmillan’s description quoted above makes no reference to membership, but where business is conducted through the medium of a corporate structure, membership is significant. Unless the contributors to the fund control the company that owns it by being members with the right to vote, it is very unlikely that the company will carry on a mutual business. It follows that the ‘members’ must also, as a class, be identical to the contributors/participators, as a class. As policyholders, the contributors’ rights will be governed solely by their contract (or policy) with the company, whilst any surplus will belong firstly to the company, and will normally be distributable in accordance with the company’s constitution to the members by those who are in control of the company. Normally, in the case of an insurance company that purports to be carrying on mutual business policyholders will need to become voting members of the company in order to secure their entitlement to participate in surplus.

Islamic insurance – takaful

Takaful, which involves a number of “participants” sharing risk on a co-operative basis, is broadly similar in principle to conventional mutual insurance and is accepted by many Islamic scholars as not contravening the forbidden practices of gambling and paying interest. Some commercial arrangements may, however, involve sharing surplus above a certain figure with the operator or management company. This type of arrangement would not be mutual.