Integrating a Mutual into the risk transfer arrangements of a group company has the potential to deliver significant cost and capital advantages, whilst also benefiting from a significantly more flexible regulatory environment than is offered through insurance or captives.
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Cut your insurance premium tax by 12% with a mutual
Placements via corporate insurance brokers with corporate insurance companies inherently bring with them a myriad of frictional costs, which materially erode the total cost of cover. This can result in scenarios where less than half of the cost of cover remains available to fund the cost of claims, the balance being redirected to costs such as Insurance premium tax (which currently consumes 12%), along with the commissions, fees and other sources of broker payments, through to the profit margin mandated by corporate insurer shareholders.
Passing ‘expected’ claims into a high frictional cost environment is unlikely to deliver high value outcomes.
‘Expected’ claims are the types of losses which are experienced on an annual basis. Whilst individually they are all fortuities, their frequency and repetition means that they are not ‘unexpected’.
How a mutual can transform your insurance costs
The most expensive part of any insurance placement is the primary layer, as this is where the bulk of claims activity is expected to take place.
The typical aim of a mutual is to retain all of the ‘expected’ claims (avoiding passing these into the insurance marketplace), whilst continuing to arrange insurance for the ‘unexpected’ claims (on both a per claim and accumulation (aggregate) basis).
If the members need to evidence insurance, the mutual can be structured as a Hybrid Mutual, the per claim insurance being purchased in the name of the members, enabling the members to evidence insurance, albeit with a large excess which is managed in their mutual. If advantageous, fronting arrangements could also be considered.
By capping the mutuals per claim and accumulation exposure with insurance placements, this enables the mutual to accurately quantify its worst case retained exposure, ensuring that this is within the risk appetite of the board of the mutual.
What is a Discretionary Mutual?
A mutual is owned entirely by its membership and controlled through a board which is drawn from within that membership. It is an entirely symbiotic environment, free of the conflicts of interest which come with third party shareholders, giving the mutual a singular focus of meeting members’ needs.
The cover offered within the mutual retention is on a discretionary basis. The decision whether to pay or not rests with the board of the mutual, meaning that the decision making process is entirely in-house, rather than being reliant on others.
Discretionary Mutuals have been a feature of the UK risk transfer marketplace for well over 100 years. One of the oldest examples is themdu.com/, with others having been around for decades, such as umal.co.uk/, and more recent examples including fric.org.uk/. They are used successfully by both the public and private sectors, and in a broad cross section of risk classes.
Group company mutuals - who benefits and how
In a group company setting, the membership of the mutual is comprised of two or more of the separate legal entities which reside within the overarching parent company. This ensures that Ownership and Control resides entirely within the group.
What are the primary benefits over traditional insurance and captives?
The key advantages offered by a Discretionary Mutual include:
- Domicile – whilst many captives are domiciled offshore, with the reputational challenges that can entail, a Discretionary Mutual is domiciled onshore here in the UK.
- Capitalisation – the mutual comes with the flexibility of a solvency requirement, not the capitalisation requirement of an insurance company or a captive. Typically this requirement can be met solely from the operational revenues of the mutual, but it gives the mutual the option to operate on a deposit and call basis, if this is seen as advantageous (whereby the mutual calls up sufficient income to fund the expected level of claims, only calling up the remainder (to the insurance attachment) if and when it becomes required).
- Regulatory environment – the operating environment for a Discretionary mutual is based on the Companies Act and common law. It falls outside the scope of the far more onerous and constricting regulatory regime overseen by the FCA (or their overseas equivalents for captives).
- A Discretionary mutual is highly tax efficient:
- Income into the mutual is not subject to the application of insurance tax.
- Surpluses generated within the mutual are not subject to the application of corporation tax.
- The mutual has complete control of claims within its retention (claims outside the scope of the wording will not contribute to erosion of the aggregate attachment). The mutual is able to grant cover to any exposure which it is willing to fund.
A Discretionary Mutual provides you with options in the way which risk is retained, managed and funded which are simply not available in the insurance area.
“Group” treatment for corporation tax
In a group company setting, being limited by guarantee means that the mutual will not have share capital, and therefore it will not be capable of being a member of a “group” for corporation tax purposes. If it is thought that it will or might be advantageous for the mutual to be a member of a “group” of UK resident companies for one or more corporation tax purposes, then consideration should be given to the mutual having share capital instead of being limited by guarantee.
How to use surpluses to benefit your business
Surpluses generated within the mutual must be used for the benefit of members, or as agreed by them. The typical aim of a mutual is to provide cost effective risk transfer, rather than the generation of profits, with pricing typically pitched at breakeven. However where surpluses are generated, these can either be:
- Retained within the mutual to act as a stabilisation / fighting fund.
- Used to subsidise or fully fund the cost of risk management initiatives.
- Rebated back to members as a discount on the following renewal
- Returned to members as a pure surplus distribution
- or any combination of the above, as is deemed appropriate by the Board of the mutual.
Sourcing the knowledge and expertise required to design, build and operate the mutual
The knowledge and expertise to design, build launch and operate the mutual can be acquired through the appointment of a mutual manager with the requisite skills, expertise and track record, such as Prospect Mutual Management.
The manager provides their reports and guidance to the board of the mutual (without requiring a seat on that board), and takes their instructions from them.
These can either be provided as a full service suite, or if you have existing capabilities which you wish to maintain, they can be provided as a gap fill and overlay solution.
How to implement a mutual in four steps
Each group will choose the pathway and timeline which meets its needs, but this typically comprises the following four stepping stones:
- Preliminary Assessment (typically a one month process);
Aimed at creating the prima-facie business case for progression of the mutual. - Feasibility Study (typically a 3-6 month process);
Aimed at creating a fully supported and costed business plan for deployment of the mutual. - Build and Launch (typically a 3-6 month process);
Putting in place the legal documents, people, systems and processes required to support day one of trading in the mutual. - Operate;
Management of the operational mutual, monitoring performance and undertaking the adjustments necessary to meet members’ evolving needs from their mutual.
Previous deployments have ranged from a one step process completed in under two months, to multi-stage processes taking over 12 months to complete.
Conclusion
We would welcome the opportunity to have a discussion with you, with a view to agreeing a pathway to explore, validate and value what introducing a Discretionary Mutual into the risk transfer arrangements of your organisation could deliver.
