Myth #11: Does Mutual Really Matter? Yes and No
- David H. Kinder, RFC®, ChFC®, CLU®
- Dec 3, 2019
- 6 min read
Updated: Jan 18, 2023
A common refrain heard throughout the mutual company sales forces is "mutual matters". This obviously serves these companies' agenda to really sell more of their contracts. What IS "Mutual"? (Besides consent, of course.)
Mutual is simply a business entity. Investopedia gives us a great definition:
What Is a Mutual Company?
A mutual company is a private firm that is owned by its customers or policyholders. The company's customers are also its owners. As such, they are entitled to receive a share of the profits generated by the mutual company.
The distribution of profits is typically made in the form of dividends paid on a pro rata basis, based on the amount of business each customer conducts with the mutual company. Alternately, some mutual companies choose to use their profits to reduce members' premiums.
A mutual company is sometimes referred to as a cooperative.
How a Mutual Company Works
The mutual company structure is commonly found in the insurance industry and sometimes in savings and loans associations. Many banking trusts and community banks in the U.S., as well as credit unions in Canada, also are structured as mutual companies.
The first mutual insurance company was formed in England in the 17th century. The word mutual was probably adopted to reflect the fact that the policyholder, or customer, was also the insurer, or part owner.
KEY TAKEAWAYS
A mutual company is owned by its customers, who share in the profits.
They are most often insurance companies.
Each policyholder is entitled to a share of the profits, paid as a dividend or a reduced premium price.
The first insurance company in the U.S. was a mutual company, The Philadelphia Contributionship for the Insurance of Houses from Loss by Fire. It was founded in 1752 by none other than Benjamin Franklin.
Most institutions that are structured as mutual companies are private entities rather than publicly traded companies. In recent decades, many mutual companies in the U.S. and Canada have opted to change from a mutual structure to a joint stock corporate structure, a process known as demutualization. As part of this process, policyholders get a one-time award of stock in the newly-created joint stock corporation.
There is little substantive difference between the two corporate structures. A joint stock corporation is generally seen as more focused on short-term profit while a mutual company may prioritize strong cash reserves in case of unusual claims levels.
Advantages of a Mutual Company
A major selling point of mutual insurance companies is its shared ownership structure. Policyholders get some of the cost of their premiums back in the form of dividends or reduced premium prices.
IMPORTANT: Many mutual companies have changed to a joint stock corporate structure. This process is called demutualization.
For example, Lawyers' Mutual Insurance Co., a California-based company, recently paid a 10% dividend to its shareholders. It has paid dividends for 23 consecutive years.
As suggested by the name of that company, mutual companies often are specialized. They were formed by and for a group of professionals who often have common needs.
Mutuality is simply a business legal entity. It's similar to a corporation, LLC, partnership, sole proprietorship... whatever. The reason that it gets so much attention, is because they USE that term to help these companies and agents sell their policies.
Insurance companies are NOT the only forms of "mutuality" out there. Credit Unions certainly are as they are "mutually owned" by their membership. Their ownership benefits are generally lower loan rates and higher savings rates (called "dividends" rather than interest). Is it absolutely imperative that you buy your life insurance from a mutual company? If you are buying a PARTICIPATING WHOLE LIFE policy... and you are buying it for its performance and other features... YES!
What does "Participating" mean? It means that the earnings in the policy participate in the profitability of the company each year in the form of dividends. Non-participating policies do NOT participate in the profitability each year with dividends. In my experience, most non-par policies are typically from non-mutual companies, much smaller in size, and are purchased primarily for death benefits only.
Mutual insurance companies will declare a dividend each year to be paid to policy holders based on three major factors:
Performance of the general investment account of the insurance company
Favorable Mortality Experience (death claims)
New Sales Revenues generated each year.
Is it "bad" to buy a life insurance contract from a "stock" company? Absolutely not! However, you won't be participating in the company's profitability through dividends. That's for the stockholders of the stock company.
But let's make the distinction: Most stock companies don't offer a participating whole life policy. They offer various forms of Universal Life insurance contracts. The most popular offerings from these companies are Indexed Universal Life Insurance. These contracts offer the chance to earn interest based on an underlying stock market index without being directly invested in the index itself (subject to cap, fees, spreads, etc.; see policy for details). The way these policies will earn interest will be a key consideration, if purchasing for policy performance. Just like with any other company, you'll want to consider the financial strength and stability of the company through ratings agencies. One very clear positive of buying a policy through a stock company, is that the policy is typically far more "transparent" (with many more disclosures) than with the "black box" of whole life. You will know exactly how interest is calculated and how it is credited to your policy.
By contrast, whole life insurance dividends are NOT a rate of return, but the dividends are distributed to policyholders based on cash values, health rating classification, length of time the policy is in force, etc. It's all proprietary to the company, but generally that's how it goes.
"But stock companies are greedy because they have to generate short-term profits for their shareholders rather than doing what's right for policyholders."
More kool-aid propaganda. Stock companies have to invest in a general investment account in the same way that mutual companies do. They are just as regulated by state and federal agencies as the mutual companies are.
Mutual vs. Stock Insurance Companies: An Overview
Insurance companies are classified as either stock or mutual depending on the ownership structure of the organization. There are also some exceptions, such as Blue Cross/Blue Shield and fraternal groups which have yet a different structure. Still, stock and mutual companies are by far the most prevalent ways that insurance companies organize themselves.
Worldwide, there are more mutual insurance companies, but in the U.S., stock insurance companies outnumber mutual insurers.
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Key Differences
Like stock companies, mutual companies have to abide by state insurance regulations and are covered by state guaranty funds in the event of insolvency. However, many people feel mutual insurers are a better choice since the company’s priority is to serve the policyholders who own the company. With a mutual company, they feel there is no conflict between the short-term financial demands of investors and the long-term interests of policyholders.
While mutual insurance policyholders have the right to vote on the company’s management, many people don’t, and the average policyholder really doesn’t know what makes sense for the company. Policyholders also have less influence than institutional investors, who can accumulate significant ownership in a company.
Sometimes pressure from investors can be a good thing, forcing management to justify expenses, make changes, and maintain a competitive position in the market. The Boston Globe newspaper has run illuminating investigations questioning executive compensation and spending practices at Mass Mutual and Liberty Mutual, showing excesses occur at mutual companies.
Once established, a mutual insurance company raises capital by issuing debt or borrowing from policyholders. The debt must be repaid from operating profits. Operating profits are also needed to help finance future growth, maintain a reserve against future liabilities, offset rates or premiums, and maintain industry ratings, among other needs. Stock companies have more flexibility and greater access to capital. They can raise money by selling debt and issuing additional shares of stock.
One big difference between mutual vs stock insurance companies (besides transparency as already discussed) is that underwriting tends to be a bit more favorable for stock companies. Why? Well, maybe they ARE focused on some short-term profits, so they make a bit more underwriting concessions than mutual companies do! I'm not saying that "mutual is bad". I like ALL the mutual companies out there. And I'm not saying that "stock companies are better". There are plenty of good stock companies out there.
I'm simply saying that there is generally far more propaganda than facts behind this mentality.
UPDATE April 13, 2022: There is a mutual company that has chosen to demutualize. It is becoming a problem. You can read my thoughts about that company in this link below. I will say this: a company that demutualizes does run the risk of having a run on reserves... IF they are not continuing to honor the commitment of ongoing dividends. Does that mean stock is better? Depends on the policy and strategy being used. I happen to like limited pay whole life policies. Very few (if any) stock companies offer such plans. So we'll simply move these policyholders to a new company that does intend on their long-term tradition of paying dividends.
