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Insurance companies are major financial institutions with considerable assets. In the past, they were largely restricted to selling insurance products, but since the passage of the Financial Modernization Act (aka Gramm-Leach-Bliley Act (GLB), Financial Services Reform Act of 1999) in November, 1999, insurance companies are expanding their offerings to include stocks and mutual funds, and other financial services and products. The Financial Modernization Act has accelerated consolidation, where larger companies are buying up smaller companies, and has allowed convergence—banks, brokerages, and insurers can now sell a wide variety of financial products that, before the Act, were restricted according to the financial institution. For instance, banks can now sell insurance and insurers can sell mutual funds.
However, most of these combinations that sell different lines of insurance must be organized as holding companies and firewalls must be set up between the different companies within a holding company so that funds are not transferred among the companies.
Multiple-line insurers sell multiple lines of insurance, such as liability, fire, and automobile insurance. However, because of the public’s interest in maintaining the solvency of insurers, state laws prevent an insurance company or other financial institution from selling both life, and property and liability insurance—those that do are organized as holding companies, which have both a life insurance company and a property and liability company.
The most important distinction among insurance companies is that they are either stock insurance companies, which are owned by stockholders, or mutual insurance companies, which are nonprofit corporations owned by the policyowners.
A stock company is a corporation with stockholders that participate in the gains and losses of the corporation. Like other stockholders, they have the right to vote and to elect the board of directors. The stock company’s charter specifies what types of insurance that it will sell.
Most stock companies sell property and liability policies; some states all stock companies to sell life and health insurance as well. A stock company cannot issue an assessable policy, which is a policy that permits the insurer to charge additional premiums if losses are excessive. Stockholders bear the losses, but they also have the potential to gain through dividends or share price increases.
Mutual insurers are corporation owned by the policyowners, who elects the board of directors. The board of directors appoints the executives who run the mutual company.
Policyowners may either receive a dividend or get an advance reduction in premiums. Life insurers will generally pay a dividend only if the mortality experience has been better than anticipated, in which case, the dividends are a return of premium and are not taxable.
Mutual insurer types: assessment mutual, advance premium mutual, factory mutual, fraternal mutual.
An assessment mutual has the right to charge more premiums if losses have been greater than expected; few insurers, limited geography and number of policies.
Advance premium mutuals are like an assessment mutual in that the company is owned by the policyowners, but the advance premium mutual cannot charge assessments if losses were greater than expected, but pays for excessive losses out of its surplus, which is the difference between its assets and its liabilities. To cover losses, the advance premium mutual charges a greater premium than is necessary to cover its losses—hence, its name—and returns excess to the policyowner at the end of the period as a dividend. Many life insurers are organized as advance premium mutuals.
The factory mutual is a commercial property insurer that insures only those sites that meet its rigid safety and construction qualifications—what risk managers call a highly protected risk (HPR). The factory mutual, so called because it insures mostly factories and other industrial sites, inspects all sites regularly, and offers loss control services to reduce risk. The loss control information has been garnered from over a century of investigating losses on the properties of the insured. The factory mutual even sends teams to investigate losses on noninsured sites to learn more about how losses take place. By selecting those insureds that meet its qualifications, and follows its advice, it can generally offer lower rates than would otherwise be possible.
Perpetual mutuals, which provided mainly homeowner’s insurance, now has only historical significance since the last one dissolved in 2004. Perpetual mutuals charged a single premium or a lump sum that covered a long period of time. The money was invested to cover losses. If an insured canceled his policy, part of the premium was returned.
Fraternal insurers are mutual companies that provide life and health insurance to members of a social or religious organization, such as the Knights of Columbus or the Aid Association for Lutherans.
A reciprocal exchange is a private unincorporated mutual insurer that consists of members who insure each other. Each member insures every other member—hence, the name. A reciprocal exchange, constituting only a small part of the insurance market, mostly provides property insurance, particularly auto insurance.
The exchange is managed by an attorney-in-fact, which is usually a corporation, which manages the insurance operation, including marketing, paying losses, handling reinsurance, and collecting premiums. However, the members of the reciprocal exchange are the insurer—not the attorney-in-fact. The attorney-in-fact has no liability for losses; it is simply hired to manage the insurance operation.
A pure reciprocal exchange maintained separate accounts for each member, crediting each account with the members’ premiums and earnings, and debiting the account for losses and expenses. When a member canceled the insurance, he would receive what was in the account.
A modified reciprocal exchange does not maintain separate member accounts, but is run more as an advance premium mutual, which is managed by an attorney-in-fact.
One of the main effects of the Financial Modernization Act was to increase mergers among insurers—insurance companies either acquired other companies to expand their business, or were acquired. While a stock insurance company can easily engage in mergers, a mutual company cannot, so, to remain competitive with banks, brokerages, and other insurers, many mutual companies decided to demutualize—convert their legal organization from a mutual company to a stock company.
Demutualization requires the approval of the policyowners as well as the state insurance department. It generally takes 18 to 24 months to complete. Policyowners may receive stock or cash options, the value of which will be commensurate with the total amount of premiums paid by the policyowner. If stock is issued, how many shares of stock each policyholder will receive will depend on the stock’s initial public offering price.
However, many of the policyowners of former mutual companies were dissatisfied with the demutualization. The board of directors of many of these demutualizations have changed the policyowners' ownership rights into membership rights, with many policyholders receiving less than the value of their ownership rights in the process. Nonetheless, demutualizations will probably continue.
A stock company has much greater capital flexibility than a mutual. If a stock company needs more money to expand business, to form subsidiaries or holding companies, or needs to cover excessive losses, it can sell common and preferred stock or issue bonds. A mutual company can only rely on its surplus or premiums charged to its members.
A stock company could also issue stock options to its key employees, to attract and keep more talent. In addition, mutual companies have a limitation imposed by the Deficit Reduction Act of 1984 that limited the tax deduction of dividends.
There are 3 methods of demutualization.
Another form of demutualization that is legal only in Illinois and Pennsylvania is through the issuance of nontransferable subscription rights to the policyholders. Subscription rights give the policyholder the right to buy a specified number of shares in the new stock company for a specified price, but the subscription rights must be exercised when the stock is first offered to the public. The time period for the subscription rights is determined by state statute. The value of the subscription rights is commensurate with the policyholder’s ownership interest in the mutual company.
Because of state regulations, a mutual requires approvals from the state insurance department before it can demutualize. Demutualization is expensive, and generally takes from 18 to 24 months to complete. As an alternative, some states allow mutual companies to form holding companies, which can own and direct other companies. The mutual holding company gains the benefits of stock companies by buying them or forming them as subsidiaries, which can sell different lines of insurance, including life and property and liability insurance.
Often, the mutual holding company retains at least 51% ownership of any subsidiaries that issue stock so that the proceeds to do not have to be passed to policyholders of the mutual company—a clear disadvantage for the policyholders. Furthermore, the policyholders have no voting rights in the holding company, leaving the management of the company unaccountable to the policyholders.
Lloyd’s of London is not an insurance company, but a large insurance marketplace, where underwriters meet with buyers of insurance or their brokers to create an insurance agreement. The buyers and sellers—often referred to as Names—negotiate terms and price. The underwriting syndicates were restricted to individuals until recently. Now, corporations, including insurance companies, can become Names and sell insurance through Lloyd’s.
Each underwriting syndicate is a separate legal entity, and is responsible for all losses for the insurance that it sells. The General Insurance Standards Council of Lloyd’s audits each underwriter annually. All premiums for the 1st 3 years are paid into a premium trust fund. Losses and expenses are deducted from the fund. After 3 years, profits are distributed to the underwriters, or they are assessed a deficiency which they must pay.
The main types of insurance sold through Lloyd’s are automobile, aviation, marine, property and liability.
National Association of Mutual Insurance Companies (NAMIC) - an association of property insurers organized as mutual companies.
Green Tree Perpetual, the last perpetual mutual, ceases operations in 2004.
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