Making It Mutual: Insurance and mutuality

5^th April 2013

Look to the mutual insurance industry for a ‘responsible capitalism’, urges Martin Shaw, Chief Executive of the Association of Financial Mutuals

Insurance, at its heart, is a mutual concept: a group of people coming together to solve a shared problem – an uncertain risk of a large loss occurring in specified circumstances – which is solved by exchanging the potential of a large loss for a (comparatively) small premium.

Self-help mutual societies can be traced back to the craft guilds of the Middle Ages, and the oldest known society is the Incorporation of Carters in Leith that claimed to have been founded in 1555. The first Act of Parliament to define a friendly society was in 1793 (‘A society of good fellowship for the purpose of raising from time to time, by voluntary contributions, a stock or fund for the mutual relief and maintenance of all and every member thereof, in old age, sickness, and infirmity, or for the relief of widows and orphans of deceased members’). With the era of industrialisation, people became more aware of the need to secure their financial position – hence insurers were routinely established as self-help mutuals in the nineteenth century, and by 1910 there were 26,877 mutual societies in the UK. [1]

Before widespread demutualisation in the last twenty years, mutual insurers and friendly societies held over 50% of the UK insurance market. Today they account for less than £1 in every £12 paid in insurance premiums. This article explores the impact – on consumers and on markets – of an insurance industry dominated by plcs, and explores what difference a stronger mutual sector might make.

Responsible capitalism?

For the last 40 years, the received wisdom has been that the capitalist model is the right and proper method to run markets. There are lots of reasons why this dogma has limitations, particularly in financial services. Chief among these is the false notion that the free-flow of capital can ensure that supply and demand are optimised.

Capitalism in its current form demands that the interest of managers and those of their customers are different. Inevitably, therefore, a simple supply and demand curve cannot adequately predict the future behaviours of either buyers or sellers. For example, buyers suffer from very low purchasing power and incomplete information; sellers’ efficiency is constrained by the need to pay shareholders.

Shareholder-owned organisations operate for the benefit of shareholders. Management is focused on maintaining the share price in the short term and on maximising the dividend. The quarterly reporting cycle and return on equity expectations become a ruthless benchmark of success.
Shareholders have the loosest of incentives to demand meaningful change, which partly explains why the shareholder spring came to nothing. According to McKinsey, the average equity holding in the US is now around seven months. [2] Indeed, high speed online trading, where the trader holds each equity for seconds at a time, today accounts for 70%of trading. [3]

So, if the average institutional shareholder shifts their investments every few months, what incentives do they have for seeking decision making for the long-term? Why would you challenge strategy, remuneration, or management performance if you knew your interest was purely transitory?

The term ‘responsible capitalism’ is not a new one, [4] but has been recently adopted by many UK politicians as a reaction to the excesses of business and their contribution to the 2008 financial crisis and the recession. Responsible capitalism imagines a business model that recognises that. As well as financial success, businesses should strive to achieve social value too, or as Vince Cable recently put it, “careful husbandry over long timescales”. [5]

Responsible capitalism is however only part of the solution to making markets work for society in general. Until you change the incentives and priorities, it is very difficult to expect big businesses to be more responsible, as the story of demutualisation in insurance demonstrates.

Demutualisation in insurance has made mutuals more compelling

Much has been written about the impact of demutualisation on the building society sector, and of the failure of those firms that converted to banks, such as Northern Rock, Bradford and Bingley and Halifax. Rather less has been written about the trend towards demutualisation in insurance, though the effects have been just as pronounced.

In 1997 over 50% of the UK insurance market was mutual. At its lowest point in 2007, this market had collapsed to under 5%, albeit with a recovery since to around 7.5%. This wholesale dismantling of the mutual insurance sector was facilitated by government and regulatory bias, whether intended or not, towards the plc business model, which forced many of the largest mutuals to convert in order to obtain the external capital needed to maintain growth.
However, in most cases this has produced anything but a stable basis for future growth. The majority of demutualised insurers either failed or merged with bigger organisations. Clerical Medical was absorbed into HBOS, following demutualisation in 1996 and Scottish Provident was closed and split up in 2000, to name just two examples. Norwich Union, which is perhaps the largest flotation, has found life as a FTSE 100 company tough, and its share price is now around half its float level.

So most shareholders of demutualised insurers have not benefitted from demutualisation in the way managers promised. But what about the policyholders? Customer research indicates that policyholders have generally seen falling standards of customer service, worse claims handling and higher complaints dissatisfaction. Consumer advocacy is also much lower than for mutuals. [6]

The largest windfall payment from a demutualised company was £6,000 from Scottish Widows in 2000. However, policyholders have been paying for it ever since. Before Scottish Widows demutualised, it was one of the insurance industry’s leading performers, at its peak paying out £107,941 in 1998 for a 25 year with-profits policy, based on premiums of £50 a month. This was around 20% better than the average for mutual insurers. In 2012 their average payout had collapsed to £28,071, one of the worst performers in the Money Marketing tables, and 34% less than the average mutual. Had Scottish Widows remained a mutual, one of its policyholders with a policy maturing on 1 January 2012 would have received a payout of £14,228 more, assuming the company had performed at the mutual average level. [7]

Amongst society at large, research undertaken for Association of Financial Mutuals (AFM) in 2012 showed a significant disparity between the levels of trust people have for financial mutual organisations, compared to their mistrust of financial plcs. [8]

Across all members of the public, financial mutuals enjoyed a net trust score of 32, compared to -5 for plcs (net trust score is the difference between those that trust and those that do not trust a company- hence a net score of -5 means more people mistrust plcs). Those who are members of a mutual also clearly see that as reinforcing general perceptions, as the net trust score is then more than 60.

It doesn’t need to be this way: other countries have had a more enlightened approach to encouraging a diversity of business models: mutual insurance market share across the EU stands currently at 26%, [9] and in that bastion of free markets, North America, mutuals hold 32% of the insurance market. [10] There is no reason to think that we can’t replicate that balance and dynamism of mutual models in the UK.

The mutual advantage

Mutuality brings with it multiple advantages, including the ability to focus on the interests of customers without the distraction of meeting shareholders expectations. That is not just a philosophical difference: it also translates into a financial and operational advantage. AFM has researched the impact of the ‘dividend drag’ in shareholder owned insurers. This indicates that the equivalent of 3p in every £1 of premiums is extracted from the balance sheet to cover the costs of dividends. The extra 3% retained within the business gives a mutual an enormous amount of freedom to manage the business, to the advantage of its customers:

• Mutuals typically take a more cautious, long-term approach to business: they are content to place customer money into less risky investments, or are prepared to accept a more reasonable level of profit over a longer period. During the financial crisis of recent years, mutuals did not suffer from the same kind of overexposure to bad debts or failed investments as financial PLCs did. A recent report on financial strength in the UK insurance sector showed that eight of the ten insurers with the highest level of free asset ratios were mutual.[11]
• Mutuals live longer: the average mutual insurer has been in business 119 years. Research by Geus suggests that average longevity of multinational, Fortune 500/ FTSE 100 companies is 40 to 50 years.[12] But as people get older, what does that mean for pensions or insurances, which can run for significantly longer than the provider?
  Mutuals can translate lower charges into higher levels of performance and better standards of service. PLC insurers generally do not now offer long-term savings products with low monthly premiums. Those that do typically charge significantly more than mutuals. Our analysis of comparative tables published by the Money Advice Service showed that the average charge by a mutual was 11% less than a plc for a typical savings endowment.

These lower charges make a crucial difference to the long-term value of the product: over 25 years the average return from a mutual with-products product was 27.5% higher than for non-mutual insurers, and 18% more than the typical unit trust fund. [13]

Back to the future for mutuals

Friendly societies and mutuals were once a cornerstone of financial services in the UK, and were the only way ordinary working people were able to plan ahead and protect themselves from the workhouse if they were unable or too old to work.

When the government decided to introduce National Insurance, it recognised that it could not manage a complex scheme of this nature itself. Instead the National Insurance Act of 1911 determined that friendly societies should administer state benefits on behalf of the government. This meant that it became a legal requirement for all insured workers to join a recognised institution such as a friendly society, and this remained the case until the National Health Service Act of 1948.

Today, there are similar reasons for believing that the government and mutuals should work together to tackle some of the social challenges we face today, that the government alone cannot solve. Thus, the introduction of public service mutuals seeks to ensure the staff of government departments become empowered to improve performance through a ‘John Lewis’ style employee-ownership structure.

This should result in major gains in productivity and presenteeism: AFM-sponsored research by Oxford University into the view of employees in the mutual insurance sector reveals that 90% of employees believe that the organisation is run in the interests of its customers and members, and only 4% disagreed that they are ‘proud of the ethical record and reputation of the business’. [14]

But there is more that can be done to extend the working relationship between the state and the financial mutual sector. Healthcare mutuals already serve millions of people, by providing services alongside the NHS;- for example, by offering private treatment when the NHS waiting list is too long. These services can work at a very low cost, and with the NHS likely to witness massive increases in demand over the next few years, mutuals may once again offer a lifeline to the state service.

Models of mutual insurance can offer a pioneering example as to what a ‘responsible capitalism’ might look like. An insurance industry that is more mutual would prove itself to be once again more dynamic and more responsive to the needs of its customers and the communities in which they live. It could also pave the way for other industries to follow suit and encourage a new national obsession with organisations that are more responsible and beneficial for society as a whole.

This article was originally published in ResPublica’s Making it Mutual: The ownership revolution that Britain needs, a collection of essays covering all areas of policy – energy, financial services, education, infrastructure, welfare, public services, competition – proposing entrepreneurial and innovative policy proposals for structural reform.