All property/casualty insurers perform the same basic function: selling insurance policies to customers. However, some are organized as stock companies while others operate as mutual companies. There are key differences between the two types of organizations. Each has advantages and disadvantages for insurance buyers.
The main difference between a stock insurer and a mutual insurer is the form of ownership. A stock insurance company is owned by its shareholders. It may be privately held or publicly traded. A stock insurer distributes profits to shareholders in the form of dividends. Alternatively, it may utilize profits to pay off debt or reinvest them in the company.
A mutual insurance company is owned by its policyholders. Surplus may be distributed to policyholders in the form of dividends or retained by the insurer in exchange for reductions in future premiums.
Earnings and Investments
Both stock and mutual insurance companies earn income by collecting premiums from policyholders. If the premiums an insurer collects exceed the money it pays out for losses and expenses, the insurer earns an underwriting profit. If losses and expenses exceed the premiums collected, the insurer sustains an underwriting loss.
Stock and mutual companies also earn income from investments. However, their investing strategies often differ. Stock companies' primary mission is to earn profits for shareholders. Because they are subject to scrutiny by investors, stock companies tend to focus more than mutuals on short-term results. Stock insurers are also likely to invest in higher-yielding (and riskier) assets than mutual companies.
Mutual insurers' mission is to maintain capital to meet the needs of policyholders. Policyholders are generally less concerned about insurers' financial performance than investors of stock companies. Consequently, mutual insurers focus on long-term results. They are more likely than stock insurers to invest in conservative, low-yield assets.
In addition to premiums and investments, stock companies have a third source of income: the proceeds of stock sales. When a stock insurer needs money, it can issue more shares of stock. A mutual insurer doesn't have this option since it is not owned by stockholders. If a mutual insurer needs money, it must borrow the funds or increase rates.
Policyholders of a stock company have no say in the company's management unless they are also investors. At a mutual insurer, policyholders are owners of the company, so they elect the company's board of directors. Policyholders may have some influence over the types of insurance products the company offers. They also receive dividends from company profits.
One advantage of a stock insurer for policyholders is stability. Because a stock insurer has more options for raising funds, it may be better able than a mutual insurer to overcome financial difficulties.
A major disadvantage of the mutual company organization is the firm's reliance on policy premiums as a source of income. A mutual insurer that is unable to raise funds may be forced out of business or declared insolvent. If the company is sold, policyholders may receive a portion of the proceeds from the sale. A mutual insurer that is financially impaired can become a stock company through a process called demutualization.
Generally, a mutual insurer can demutualize only with the approval of policyholders, the firm's board of directors, and the state insurance regulator. Mutual companies have three basic options for converting to a stock company.
- Full Demutualization. This involves a complete switch from a mutual insurer to a stock company. Policyholders receive cash, policy credits, or shares in the newly created stock company.
- Sponsored Demutualization. Policyholders do not receive any compensation other than the right to purchase stock in the new corporation. Shares of stock not purchased by policyholders may be sold to investors in a stock offering.
- Mutual Holding Company. This option is not available in all states. A mutual holding company is created along with a stock subsidiary that is majority-owned by the holding company. Policyholders receive an ownership interest in the holding company but not the stock subsidiary. The subsidiary takes control of the insurance policies.
Most Are Stock Companies
In recent years, many mutual insurers have converted to stock companies due to financial pressures. Consequently, the vast majority of US insurers are stock companies. According to the National Association of Insurance Commissioners, stock insurers held about 78% of the total cash and invested assets maintained by US insurers at the end of 2013. Only 18% of those assets were held by mutual insurers.