Learning objectives
1.7 Mutual and proprietary supply
Financial services organizations present themselves in two forms as far as owner- ship is concerned: mutual and proprietary. In simple terms, proprietary companies are owned by shareholders while mutual suppliers are owned by their customers.
However, this is indeed an oversimplification and, in the UK, a review of the gov- ernance of mutual insurance companies carried out by Paul Myners (2004) found the precise definition of mutuality a rather more complex issue.
A substantive body of literature exists which sets out to compare the operations of, and outcomes associated with, proprietary and mutual forms of supply. A par- ticular area of focus has been the relative expenses and payouts associated with life insurance firms. Of particular note are the studies carried out by Armitage and Kirk (1994), Draper and McKenzie (1996), Genetay (1999), Hardwick and Letza (2000) and Ward (2002). These and other studies concern the merits and demerits of mutual and proprietary forms. Underlying many of these studies is the presumption that the form of ownership is independently implicated in corporate performance. This is based upon a view that there is an inherent conflict of interest between the inter- ests of shareholders and those of consumers. Therefore, mutuals may be at liberty to concentrate more effectively on meeting the needs of consumers.
Supporters of the mutual form point to the tangible performance benefits of mutuality as well as its philosophical advantages. Fundamental to the former is the argument that the absence of the need to pay a dividend results in tangible benefits
to customers. Analysis by the Building Societies Association (2001) in the UK indi- cates that building societies (mutuals) display lower operating cost ratios, lower rates of interest charged to borrowers and higher rates of interest paid to depositors than do the so-called mortgage banks that had previously operated under the mutual form. Analysis performed by the International Co-operative and Mutual Insurers Federation (ICMIF) compares and contrasts the performance of mutual with proprietary organizations. The analysis is based upon a sample of 105 insur- ance companies operating in 11 European countries (ICMIF, 2003). The sample includes both life and general insurance companies, and is based upon performance data covering the period from 1995 to 2001. The measures of performance assessed by the study include:
● growth in new premium income
● expense ratios
● claims ratios
● investment returns
● solvency.
The report’s authors conclude that mutuals outperform their proprietary counter- parts on almost all measures of performance studied. In addition to the tangible per- formance advantages claimed for mutual providers there is the philosophical advantage. The argument centres on the claimed absence of conflict between the interests of customers and shareholders. Mutuals claim that their single-minded focus on the consumer is embedded in their culture, and this results in a range of corporate behaviours that engender consumer trust.
Supporters of the proprietary form point to the powerful influence of sharehold- ers, especially institutional shareholders with their substantial voting power, in exerting pressure on boards of directors to perform. The argument runs that the members of mutual organizations lack the power required to bring due influ- ence to bear on boards of directors, and that this results in the potential for under- performance and, possibly, the abuse of power. At worst, the CEO could run the firm like some form of personal fiefdom. Indeed, critics of mutuality will often cite the difficulties of Edinburgh-based Equitable Life as an example of how the gover- nance shortcomings of mutuals can have a devastating impact upon consumer interests.
There is also a view that proprietaries enjoy high levels of consumer trust.
Research conducted by the Citigate Group shows that mutuals featured only twice in the top-20 trusted investment brands; Standard Life at number 11 and Royal London at number 20. Interestingly, the brands positioned as numbers 1, 2 and 4 (Halifax, Norwich Union and Scottish Widows) were all mutuals until compara- tively recently. Critics of this piece of research argue that it confuses familiarity with trust. Undoubtedly, there is reason to believe that consumers do tend to view being a well-known household name as implying trustworthiness. Research carried out by the Financial Services Consumer Panel in the UK appears to bear out the point that consumers use brand presence as a proxy for trustworthiness. Thus, because proprietaries are large organizations with substantial marketing communi- cations budgets, they appear to enjoy a greater degree of consumer trust than do mutuals which, because of their size, are unable to invest in brand-building to
the same degree. There is no doubt that branding is becoming increasingly important in financial services, and the creation of global power brands is likely only to be achieved by major proprietary concerns. The recent attempt by Aviva to spend £17bn acquiring Prudential is clear evidence of intent to create a major global insurance brand. Attractive synergies are to be seen between the two, and Prudential’s strength in Asia and the USA would complement Aviva’s position in Europe.
In Britain, steps have been taken to address the concerns regarding the governance of mutuals as a result of the Myners’ review. For example, the Association of Mutual Insurers was created in 2004, and one of its first tasks was to draft a code of conduct for the governance of its members. This code takes as its core the rules for governance set down by the FSA, which are proprietary-focused, with its explicit references to shareholders and shareholder interests. It adds additional requirements aimed at safeguarding the interests of both members (with ownership and voting rights) and policyholders (who do not enjoy membership rights).
Arguably, there is a role for both proprietary and mutual providers of financial services; both forms provide for the diversity necessary to solve the requirements of the marketplace as it continually evolves. The evidence does seem to support the view that demutualization has not necessarily been in the long-term interests of consumers as a totality. There have been short-term gains to directors in the form of share options, and windfall payouts to those with membership rights.
In practical terms, typical forms of mutual providers that are encountered are as follows:
● credit unions
● building societies
● mutual insurers
● co-operative insurers
● friendly societies.
Case study 1.2 provides an overview of how one mutual provider of financial services operates. Both mutual and proprietary forms of financial services supply are to be found in most parts of the world; however, there has been a trend of mutu- als converting to proprietary status, most notably in the English-speaking countries of North America, Australia and UK in recent years. Table 1.2 shows the composi- tion of the US insurance market in terms of ownership form.
Table 1.2 Life insurers doing business in the United States*
In business at year’s end 2002 2003
Stock 1,060 1019
Mutual 99 92
Other 12 12
Total 1171 1123
*Source: American Council of Life Insurers.
Police Mutual provides financial services to the police family. Originally that meant just serving officers, but as the police service has changed so has Police Mutual, and today membership of the Society is open to serving and retired police officers and police staff and their families (which includes partners, chil- dren, parents, and brothers and sisters). In essence, it operates as an affinity group-based organization and is a compelling example of how cost-effective and efficient such a model can be. In spite of what would appear to be its some- what limited market potential, Police Mutual has 176 000 members and man- ages funds of the order of £1.2 billion.
Police Mutual uses a form of governance that is based upon the delegate method, and has a President, Vice President and Chairman as well as an 80- strong delegate body drawn from the police service. The Society displays an array of significant relative competitive advantages that arise from its affinity- based model. Of particular note is the strength of real democratic involvement in the policy-making of the Society through its delegate conference, as well as the involvement in more operational decision-making through the role played by the Committee of Management. These structures, and their associated processes, facilitate the development of extremely close bonds and relationships between the Society and those it seeks to serve.
The strength of relationships between the Society and its membership is instrumental in supporting its core means of distribution. Its range of savings, investments, pensions, mortgages and insurance services are distributed largely on a direct-offer basis (the launch of an advice service aimed at retiring officers is the only variant from this model), and distribution is via a number of chan- nels, such as direct mail, on-line, phone-based and through a business develop- ment team, but also, uniquely, via a network of volunteers known as Authorized Officers (AOs). There are over a thousand AOs, the vast majority of whom are serving police officers, and they perform largely a communication role in displaying and distributing promotional material and directing people to Police Mutual’s head office if they have any queries. This role is unpaid and, as a consequence, Police Mutual has extremely low business acquisition costs.
Its cost–ratio benefits are reduced further by receiving the majority of its pre- mium contributions by payroll deduction.
The Society has an extremely good record with regard to persistency. In the last FSA survey, the industry 3-year average persistency level for regular pre- mium endowment plans was 84.9 per cent for direct-offer business; Police Mutual achieved persistency of 90.5 per cent. Industry average figures for other distribution methods are even lower, at 81.2 per cent for Independent Financial Advisers and 75.3 per cent in respect of company representatives.
A particular feature of Friendly Societies is their ability to ‘go beyond con- tract’. What this means is that their philosophy and style of mutuality permits them to provide benefits to members under certain circumstances that do not strictly accord with the terms and conditions of any specific policy contract.
Case study 1.2 Police Mutual Assurance Society Limited (Police Mutual)