Retaining and funding risk within a mutual framework presents several distinct advantages over opting for higher excesses on commercial insurance policies.
In this blog, we’ll explore the advantages of discretionary mutuals and why businesses may find them to be a more advantageous risk management solution.
The Mutual is a Separate Legal Entity
Central to the advantages of discretionary mutuals is their status as separate legal entities. This effectively moves the retained exposure from the members’ balance sheets to the mutual’s balance sheet. By doing so, members can mitigate their individual risk while leveraging the collective strength of the mutual.
Stability and Predictability of Results
One of the key benefits of discretionary mutuals lies in their ability to provide stability and predictability of results. Whilst a number of members can be expected to have a worse than average year, this is generally offset by other members having a better than average year, (with insurance covering the volatility of ‘unexpected claims).
The stability this generates manifests in a number of ways, including:
- Spread of Risk: By distributing risk across the membership enables the mutual to generate more stable results than its individual members are able to achieve.
- Collective Cap Advantage: When calculating some form of excess drop down or aggregate limit on retained claims, the collective cap the mutual is able to purchase this at is typically significantly lower than the sum of all separate individual member aggregate limits when purchased on the same basis.
Let’s look deeper into the specific advantages of discretionary mutuals:
Level of retained risk
The mutual is able to retain a higher level of risk than it would be prudent for any of its members to retain individually. This is due to the enhanced stability of the mutual pool, as well as the collective level of revenues available to fund the enhanced level of retained risk.
Scale efficiency
If the mutual is just being used to provide cover for the primary layer of risk (which is normally all of the ‘expected’ claims) then instead of the individual members entering the insurance marketplace one by one, a mutual enables its membership to harness their collective bulk buying power and enter the insurance marketplace as a single placement (larger placements typically attract lower rates than smaller placements).
Tax treatment of forward funding
Surpluses generated in the mutual are the benefits of mutual trading and are not subject to the application of corporation tax. This provides a highly efficient way for the mutual to accumulate substantial surpluses which can be accessed to smooth the impact of future claims or insurance market volatility.
Consolidation for “group” corporation tax purposes
When used in a group company setting (the membership being formed of two or more of the separate legal entities which are part of a corporate group), the mutual is able to be structured to support or preclude consolidation of the financial results of the mutual with that of the parent of the corporate group for accounting purposes, depending on which is the preferred outcome.
Funding obligations
Accounting standards can require provisioning, not only for known claims, but also for claims which have occurred but which have not yet been reported (IBNR), or where they have been advised but an insufficient reserve has been raised (IBNER). Whilst following these standards is also recommended best practice in a discretionary mutual, due to the discretionary basis of the cover provided this is not mandatory (as it is not a contract of indemnity).
Access to the support and expertise required
A mutual manager provides its membership with access to the skills, knowledge, systems and processes required to successfully retain and manage risk, which is available either as a one stop shop, or as a gap fill supporting existing in-house capabilities
