Most life insurance companies are either stock or mutual companies. Fraternal benefit societies provide a small fraction of life insurance coverage, and the Department of Veterans Affairs also provides coverage for veterans under six different insurance programs and it oversees three other life insurance programs for members of the uniformed services. Among mutual and stock companies, the vast majority are stock companies—1,076, or 92 percent of the industry, in 2002.
A mutual company is a corporation that has no shareholders. The policyholders are the members of the corporation and they have membership rights. These rights derive from the insurance contract, the corporation’s bylaws and charter or articles of incorporation, state laws, and case law. These membership rights are similar to stock owners’ rights in a regular corporation and include:
- the right to contractual benefits, including dividends declared by the board of directors;
- the right to participate in corporate governance, usually by electing directors to oversee the operation of the company;
- the right to receive any remaining value if the corporation is liquidated or demutualized (i.e., converted to a stock company);
- the right to expect that the corporation will be run primarily for the benefit of the members;
- the right to bring legal action against the directors and officers for violating their fiduciary duties. Individual members cannot sell their rights to someone else and these membership rights terminate when a member cancels the policy or dies.
Stock life insurance companies are corporations that have shareholders, who may or may not be policyholders. In contrast with mutual policyholders, shareholders may generally sell their ownership interest in a stock company. The corporation is run primarily for the benefit of the shareholders, although its relationship with its customers must respect commercial laws and the need to compete in the marketplace.
Advantages and Disadvantages
Because a mutual company has no shareholders, there is no conflict of interest between shareholders and policyholders. This makes it possible to fulfill the company’s primary mission: to provide insurance at its cost. However, mutual companies still must make profits to remain afloat. Mutual companies need profits to maintain financial strength and to support future growth. In contrast with stock companies that can issue new shares of common stock to raise capital and expand their growth, mutual companies generally raise capital by retaining a portion of the premiums they receive in excess of the amount they expect to pay out to cover expenses and benefit payments. In general, however, mutual companies have a lower profit goal than stock companies, because they do not have to satisfy the demands of outside investors. Management can also tend to take a long-term view in running the business because they do not have to pay attention to daily fluctuations of a stock price. As a result, it is probably true that the net return on cash values has been somewhat higher and the net cost of insurance somewhat lower to mutual policyholders than to stock company policyholders, although this is not unquestionably so in all cases.
These advantages are offset by several disadvantages.
- Mutual companies have limited flexibility to raise capital and to merge with or acquire other companies because they cannot issue stock.
- Financial reporting is less flexible because all transactions are reflected on the parent’s books.
- Noninsurance subsidiaries may receive a valuation penalty for being associated with a heavily regulated parent.
- A mutual company’s identification as a life insurance company may hinder efforts to provide other comprehensive financial services (as compared to a stock company with subsidiaries in various financial services).
- Management performance is not subject to the same level of scrutiny as it is at stock companies, because there are no outside investors. In most cases, unhappy policyholders find it almost impossible to replace directors who are not fulfilling their duties. Policyholders have to rely on rating agencies to place constraints on management actions.
- Mutual companies may also have a higher tax burden than stock companies, although this has been a subject of debate.
From the insurance buyer’s point of view, the major distinction between mutual and stock companies originally was in the types of policies they issued. Stock companies originally issued “nonparticipating” policies where premiums, cash values, benefit levels, and dividends, if any, were guaranteed but fixed. Any investment performance above that assumed in setting the guaranteed cash values and dividends (if any) and any savings in expenses, mortality rates, and any of the other assumptions involved in pricing the policy (such as lapse rates and the like), went to the companies’ shareholders, not the policyholders.
In contrast, mutual companies issued “participating” policies where premiums, cash values, and benefit levels were also guaranteed at some level. However, if the company had favorable investment results or better than anticipated expense or mortality experience, or better experience with respect to the other factors involved in policy pricing, the benefits would be passed on to the policyholders through higher than projected dividends. Of course, if results were unfavorable, the dividends could fall below the projected dividend level, since dividends are not guaranteed.
So in general, policyholders in stock companies had a fixed and guaranteed and, therefore, known cost for the insurance. In contrast, mutual companies tended to charge somewhat higher premiums, all else being equal but gave the policyholders the opportunity to participate in the favorable experience of the company through higher than projected future dividend payments. As a result, the real cost over time to policyholders in mutual companies tended to be less than that for policyholders in stock companies.
Competition and innovation over time tended to blur the distinction between policies offered by mutual and stock companies. To compete, stock companies first started to offer interest-sensitive policies that paid higher dividends or, more frequently, credited higher cash value accumulations (rather than pay dividends) over time if the investment performance of the insurer’s general fund earned rates of return in excess of those rates assumed when setting the premiums. These types of policies evolved over time into the current-assumption policies where favorable experience with respect to virtually all variables used in the premium pricing decision (expenses, mortality rates, lapse rates, etc.) would be passed through to policyholders, generally in the form of higher credits to the accumulating cash value.
Similarly, mutual companies expanded their product offerings and began to offer current-assumption type policies similar to those offered by stock companies. Consequently, today, potential insurance buyers have a whole assortment of policies ranging from the traditional “non-par” (infrequently offered) to traditional dividend-paying “par” policies, “interest-sensitive” policies, “current assumption” policies, and to “flexible-premium current assumption” (universal life) policies offered by both stock and mutual companies.
Reproduced with permission. Copyright The National Underwriter Co. Division of ALM