Grassroots network, rooted in your community
How Cash Flow works for insurance companies
There is a strong network of purely mutual insurance companies operating in Ontario, commonly referred to as "the farm mutuals". These are community based property and casualty (P&C) insurance companies that are owned by their policyholders. There are no stockholders. Any surplus either remains in the company's surplus account or may be refunded to the policyholders - at the discretion of the policyholder directors.
Almost all of these companies are now over 100 years old. They have remained strong and stable throughout the years and have provided solid, reliable service to the communities in which they operate. Ontario's farm mutuals provide a broad range of insurance and financial products to participants.
The mutual companies cooperate with each other and are members of the Ontario Mutual Insurance Association. The Association was formed in 1882 and originally went by the name Purely Mutual Underwriters Association, and later Mutual Fire Underwriters Association. The Canadian Association of Mutual Insurance Companies networks mutuals across Canada.
Ontario's purely mutual insurance companies participate in what is called the Fire Mutuals Guarantee Fund. Formed in 1975, "the Fund" places the surplus of all member companies behind any one of the members. In the very unlikely event of the insolvency of one of the members, all other member mutuals would respond to 100% of current insurance claims, and policyholders would not lose any unused premiums already paid.
The mutuals also own their own reinsurance company. The Farm Mutual Reinsurance Plan Inc. was the first Canadian-owned reinsurance company when formed in 1959 and is one of a very few Canadian-owned reinsurers in existence today.
Purely mutual companies operate on a non-profit philosophy. There are no payments of dividends to stockholders. Expenses consist of claims payments plus administration expenses to operate the company. There are only two sources of income for a purely mutual insurance company - policyholder premiums and investment income from the investment of surplus funds. The simple goal is to provide for the needs of the owning policyholders while ensuring the mutual remains financially stable.
Here is a simple illustration that demonstrates the principles of a purely mutual insurance company.
Can you see how claims costs affect the amount of premium needed?
Can you see how changing the rate of flow of any of these four forces affects the water level?
The underlying principles of mutuals have not been of profit, but of cooperation and self help. This theme has endured for well over 100 years and continues to this day. In the beginning, the mutual policyholder was required to sign a premium note agreeing to assume certain liabilities of the company directly proportionate to the policyholder's limit of protection.
The general idea was to get a number of neighbours together for the purpose of sharing risk. Typically, buildings and chattels in those buildings were insured. When fire occurred, an assessment of whatever percentage was needed was levied, collected in due course, and paid over to the unfortunate one who had suffered the loss.
As the time passed, mutual companies were urged by regulators to adopt uniform methods to ensure safety of the company and justice to the individual policyholders. This gave rise to the adoption of a plan whereby companies would estimate future losses and cost of operation as a basis for rates. Under this system, levy on the premium note was only made when expenses exceeded the estimated cost for the year.
Gradually, mutual companies moved away from the assessment system in favour of collecting premiums in advance - however legislation required that the premium note remain in place for all policyholders of purely mutual companies until the formation of the Fire Mutuals Guarantee Fund in 1975.
The premium note was the financial backing of the mutual companies and served as a vital factor in their establishment and development. However, by the early 1970's it had become apparent that it would be in order to develop a better alternative. The result was the formation of the Fire Mutuals Guarantee Fund.
Again, through the theories of "strength in unity" and "neighbour helping neighbour" the mutuals entered an agreement whereby an open-ended fund was set up for the purpose of guaranteeing that all policyholders' outstanding claims and unearned premiums would be honoured in the event that any one of the mutuals could not honour its claims or outstanding policies. This fund is backed by each of the mutuals and the Farm Mutual Reinsurance Plan Inc., thereby placing the surplus of all member mutuals behind any one.
Mutual companies began sharing risks with each other in the 1930's through inter-company agreements. Any one company could share portions of risks in excess of its retention with neighbouring mutual companies.
In the mid-40's, this system was augmented by what was referred to as "The Supplemental Reinsurance Pool". This pool was operated by the secretary of the Mutual Fire Underwriters' Association and was a pooling arrangement that allowed a company to cede excess amounts of insurance to the pool for a pro-rata share of the premium.
After the Second World War, the mutuals were faced with the post-war boom. Property values were rapidly increasing and construction and development was at a record level in Ontario. The demand for higher limits of coverage was a challenge for the mutuals as the maximum amount of insurance they could retain on any risk was limited, depending on the size of the company.
By the mid-50's, the amount of time and money involved in the transaction of reinsurance led the mutuals to explore a more efficient alternative. This led to the formation of the Farm Mutual Reinsurance Plan Inc. It commenced operations in 1959 - the first Canadian-owned reinsurance company.
Under this new agreement, the mutuals were required to cede all of their reinsurance to the FMRP and were not permitted to assume business from any other company. The new reinsurance mechanism allowed the mutuals to eliminate much of the routine paperwork involved in reinsuring individual risks of the day.
In the subsequent years, the FMRP, a mutual company itself that is wholly owned by the pure mutuals within its membership and guided by directors elected from those mutuals, has developed into a highly sophisticated financial institution. Since 1959, through the protection provided by the FMRP, the policyholder-owned mutuals have been able to expand their product base to virtually any line of insurance required by mutual policyholders.