DEFINITION of 'Mutual Insurance Company'

An insurance company that is owned by policyholders. The sole purpose of a mutual insurance company is to provide insurance coverage for its members and policyholders, and its members are given the right to select management. Federal law rather than state law determines whether an insurer can be classified as a mutual insurance company.

BREAKING DOWN 'Mutual Insurance Company'

Mutual insurance companies exist in order to ensure that the benefits promised to policyholders are able to be provided long-term. Because they are not traded on stock exchanges, mutual insurance companies can avoid the pressure of reaching short-term profit targets. Members of a mutual insurance company have the right to excess premiums, meaning that if losses and expenses are less than the amount of premiums paid into the company the members would receive either a dividend payment or a reduction in premiums. In general, the goal of the mutual insurance company is to provide its members insurance coverage at or near cost, since any dividends paid back to members represent excess premium payments.

Large companies can form a mutual insurance company as a form of self-insurance, either by teaming divisions with separate budgets or by teaming up with other similar companies. For example, a group of physicians may decide that they can get better insurance coverage and lower premiums by pooling funds to cover their similar risk type.

Mutual insurance companies derive a large portion of their funding from member premiums, which can make it difficult to raise funds in order to acquire companies if the need to expand rises. When a mutual insurance company switches from member-owned to being traded on the stock market, this is called “demutualization.” This shift may result in policyholders gaining shares in the newly floated company. Because they are not publicly traded it can be more difficult for policyholders to determine how financially solvent a mutual insurance company is, or how it calculates dividends it sends back to its members.

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