The Benefits of Discretionary Mutuals Compared to Higher Deductibles and Self-Insurance
Article by David Gudopp.
When considering how to manage risk, businesses often weigh the option of self-insurance or increasing deductibles on commercial insurance. However, using a discretionary mutual can offer unique advantages that outshine these more traditional methods.
In this article, we’ll explore why a discretionary mutual could be a more strategic choice for managing risk compared to simply increasing excesses or relying on self-insurance.
A Separate Legal Structure for Risk Management
One of the key distinctions of a discretionary mutual is that it functions as a separate legal entity. By shifting the collective risk exposure from each member’s own financial statements to that of the mutual, businesses are able to share risk among the group, reducing the impact on any single organisation.
Greater Stability and Risk Balancing
Discretionary mutuals provide more predictable financial outcomes. While some members may experience higher-than-expected losses in a given period, others will likely fare better, allowing the mutual to balance out the overall risk. The insurance purchased by the mutual helps cover unpredictable claims, ensuring members are not solely exposed.
Some specific ways discretionary mutuals offer stability include:
- Risk Distribution: Mutuals distribute risk across all members, reducing volatility for each individual participant compared to when risk is managed in isolation.
- Aggregate Caps: Mutuals can typically negotiate a lower collective cap for excess drop-down or retained claims limits, leveraging the group’s size in the marketplace.
Why Discretionary Mutuals Are Effective
Let’s examine the practical advantages of discretionary mutuals in more detail:
Higher Risk Retention Capacity
A mutual has the financial flexibility to retain more risk than any individual member might feel comfortable holding. The pooled resources and steady flow of contributions from members provide a buffer that allows the mutual to assume higher levels of risk.
Bulk Purchasing Power
Instead of each member securing insurance individually, a mutual pools the purchasing needs of all members, allowing the group to obtain better pricing from insurers. Larger policy placements typically benefit from more favorable rates compared to smaller, piecemeal purchases.
Tax-Effective Risk Management
Any financial surplus accumulated within a mutual is considered mutual trading income, which is not subject to corporation tax. This enables the mutual to grow reserves efficiently, ensuring funds are available to cushion future market fluctuations or cover claims.
Flexibility in Corporate Structures
In cases where the mutual is composed of entities within a corporate group, it can be structured to either include or exclude the financial results of the mutual from the group’s consolidated accounts, depending on what’s most advantageous for the parent company.
Accounting for Future Claims
While accounting standards often require businesses to reserve for both known and unknown claims (such as IBNR or IBNER), mutuals have more flexibility. Although it’s good practice for mutuals to reserve funds for potential claims, it’s not a legal necessity, thanks to the discretionary nature of mutual coverage.
Expertise and Support
A mutual isn’t just about pooling risk—it’s about access to expertise. The mutual’s management team provides members with the specialised knowledge, systems, and support needed to handle risk effectively. This can be offered either as a full service or to supplement a member’s existing risk management capabilities.
David Gudopp
As the Head of Risk Mitigation and Transfer in our Insurance, Mutuals and Risk Management division, David will bring over 20 years of experience to the table. David’s focus is on providing clients with an independent assessment of their risk transfer arrangements and driving targeted outcomes.
Prospect Mutual Management is a multi-disciplinary practice with specialist expertise in the energy and environmental sectors with particular experience in the low carbon energy sector. The firm is made up of lawyers, engineers, insurance and risk management specialists, and finance experts.
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This article is not intended to constitute legal or other professional advice and it should not be relied on in any way.