Insurance Structures to Enhance Risk Management and Profitability

Could restructuring your approach to insurance provide more resources to support risk management and mitigation activities at no extra cost?

One tried and tested method of achieving this is to integrate a Discretionary Mutual into your company’s risk transfer arrangements.

What is a Discretionary Mutual?

Discretionary Mutuals have been a feature of the UK risk transfer marketplace for well over one hundred years. They are currently used in industries ranging from health care, public sector bodies and education, to emerging sectors such as digital and cryptocurrencies.

The mutual is owned entirely by its membership and controlled through a board which is typically, if not entirely, drawn from within that membership. This ensures that the mutual has a clear focus on meeting the needs of its membership. A mutual will be run by the members for the members: it is an entirely symbiotic relationship with no external pressures from shareholders.

What advantages does a Discretionary Mutual generate?

The primary advantages include:

  • The mutual is domiciled onshore here in the UK.
    • This avoids the need to go offshore, which is where a lot of captives are based, and which can come with tax haven type reputational challenges.
  • The mutual has a solvency requirement, not the capitalisation requirement of an insurer.
    • The mutual simply needs access to sufficient funds to meet its obligations.
    • It is able to operate on a deposit and call basis.
    • It avoids the cost of capitalisation and the return on capital requirements which come with that.
  • A proportionate regulatory environment
    • The regulatory environment of a discretionary mutual is defined by the Companies Act and common law.
    • It falls outside the scope of the far more onerous obligations imposed by the FCA & PRA.
  • The mutual has no third-party shareholders to satisfy.
    • The mutual typically pitches its pricing at breakeven.
    • This avoids the conflict of interest which can arise between shareholders and policyholders.
  • Mutuals typically benefit from reduced frictional costs in the placement chain.
    • Members deal directly with their mutual, avoiding the fees and commissions which come with brokers and MGA’s.
  • The mutual harnesses the bulk buying leverage of its collective membership.
    • Rather than going into the insurance market one by one with traditional excess levels, they enter as a single placement with a sizeable deductible.
    • The base of the insurance placement typically attracts the bulk of premiums, and retaining this layer within the mutual normally generates a significant discount.
  • The mutual also brings with it a number of tax advantages, including:
    • Income into the mutual does not attract insurance tax (IPT typically adding 12% to the cost of commercial insurance)
    • Surpluses generated within the mutual do not attract corporation tax.

How does this enhance the role of risk managers?

The typical aim of the mutual is to retain all of the ‘expected’ claims whilst continuing to arrange insurance for the ‘unexpected’ claims (both on a per claim and accumulation basis). Through its pooling of risk and resources the mutual is able to retain a higher level of risk than would be prudent for any of its members to retain individually.

Members are therefore effectively spending their own money within the mutual retained layer, and this brings with it an inherently self-serving focus on risk management and risk mitigation. Improving risk quality and reducing the cost of claims has an immediate and direct impact on the level of pricing required by the mutual, and therefore increases the profitability of the company whilst also enhancing its reputation as an entity that manages its risk well. A natural consequence of this is an enhancement in the profile of the risk management role within any company.

How does this assist with the funding of risk improvement work?

With IPT consuming 12% of insurance expenditure, if brokers are earning a further 20% and if the insurer is targeting a 20% profit, in such circumstances less than half of the cost of commercial insurance cover actually remains available to fund the cost of claims.

None of these charges apply in the retained layer of a mutual. This increases the level of funding which is available (from within existing budgets) to fund risk improvement work with a view to further driving down the cost of claims – and in the process leaving further funds available to continue the process. After applying this process for a few years, the cost of risk management in the company will have decreased considerably – and its reputation will have correspondingly increased.

If you would like to explore how the introduction of a Discretionary Mutual into the risk transfer arrangements could benefit your organisation, or your sector, please get in contact with us.

Prospect is a multi-disciplinary practice with specialist expertise in the energy and environmental sectors with particular experience in the low carbon energy sector. The firm is made up of lawyers, engineers, insurance and risk management specialists, and finance experts.

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