Insurance regulations being introduced around the world, including Solvency II in the European Union, have encouraged some mutual insurers to consider new lines of business or operations in new territories in order to benefit from “the potential relief in regulatory capital calculations” that diversification can offer, says Willis Re, the reinsurance arm of Willis Group Holdings.
In its new report – Diversification Challenges and Opportunities for Mutuals – Navigating the pitfalls in pursuit of successful diversification – Willis Re says “risk diversification is of course fundamental to any insurer, regardless of whether they are a Mutual or not; the common principle being the pooling of funds from many policies to pay for losses incurred by the few. Clearly a well-diversified insurer has greater wherewithal to withstand a problem arising in one particular area of its operations.”
The Willis Re report says that there are both some challenges and opportunities specific to mutuals in their diversification.
“Mutuals tend to be specialised rather than generalist, and have the advantage over general insurers of a greater degree of focus and expertise in their particular field. This in turn can be leveraged to support better decision making, more informed underwriting and superior customer service, ultimately translating into better value for members. The disadvantage is that the mutual business model exposes them to geographic and homogeneous concentrations of risk, and with increased capital requirements under Solvency II or similar regulatory regimes there exists a prima facie case for diversification. However experience shows that diversification comes with other challenges and may not always be to the benefit of members.”
The report looks at three case studies where mutuals diversified. The first looks at doctor mutuals following the withdrawal of “virtually all” mainstream commercial carriers from the medical malpractice line in the late 1970s. The second examines energy and utilities such as AEGIS, OIL, NEIL and EIM, many of which were formed at a time when it was difficult to obtain insurance for energy and utility risks. The third focuses on U.S. professional liability (Errors and Omissions), following a capacity crisis in the U.S. professional liability market in the 1970s.
In considering whether and how to diversify, among the questions mutuals should ask themselves are the following:-
- What is the motivation for diversification? Is there a discrete and identifiable problem or gap in the market which needs to be resolved, or is the motivation primarily to achieve growth, economies of scale, rating agency approval or capital advantages etc.?
- Does the target customer group recognize and share our mutual values and uniqueness? If not, what do they have in common?
- Have opportunities to provide non-core products and/or services to existing policyholders been fully explored?
- As diversification proceeds, how is equity between members to be achieved in terms of pricing and affordability given different exposure characteristics and loss experience?
- What are the implications of pulling back or withdrawal?
Willis Re added that “while reinsurance alone cannot resolve all the issues facing mutuals in the face of diversification, it can offer significant benefits to in managing the process by recognising and reflecting upon the unique nature of the relationship between a mutual and their members’ capital.”
The full report is available online. (PDF)