Bermuda: Mutual Companies

There has long been a significant number of mutual companies on the Bermuda register, particularly shipping mutuals, known as Protection and Indemnity (P&I) clubs, whose purpose is to obtain coverage for risks such as hull damage, strike loss, war risks, freight, demurrage and defence. In the early 1990’s there was a resurgence of interest in forming these companies. This appears, in part, to have been driven by tax and securities law advantages that were identified by several leading US law firms.

Over a century ago Mr. Justice Matthew described mutual insurance as "the most laudable and the most excellent way of effecting insurance".¹ These were high words of praise for one of the oldest forms of self-insurance, where the insureds are also the insurers inasmuch as they contribute to the funds required to meet the claims and other expenses of the company.

The mutual principle is an ancient one resting upon a fundamental concept of insurance, the sharing of risk. There are a number of historic accounts of mutual devices. For example, Chinese river merchants would average their losses by means of distributing their cargoes over a number of vessels and loading half their cargoes on each other’s vessels as a means of spreading the risk of loss.

The modern mutual insurance concept originated in England in 1696 with the creation of the first mutual fire insurer. The concept then migrated to the New World with the founding in 1752 of the Philadelphia Contributionship for the Insurance of Houses from Loss by Fire by none other than Benjamin Franklin. Subsequently, mutual insurance associations arose to provide membership to a group of persons bearing common risks. Unlike traditional insurance companies limited by shares, which are owned by investors who may have no other connection with the particular company, mutual insurance companies are owned by their policyholders. Mutual companies exist for the purpose of serving the insurance needs of their members, not to provide investment profits to uninsured investors.

In spite of the simplicity at the heart of the mutual principle, the modern mutual company is far from simplistic in organization. Typically, members are grouped according to risk, and there will be different rules for the different classes of the club. Mutual companies are also used for similar reasons by industry associations to provide coverage of risk.

A mutual company is defined in the Companies Act 1981 (the "Act") to mean "any company, other than a company limited by shares, or other company having a share capital, which is authorized to engage in or carry on as a principal object insurance or reinsurance business of all kinds on the mutual principle."

The Act also deems a mutual company to engage in or carry on insurance or reinsurance business on the mutual principle "where the members thereof who are exposed to some contingency associate themselves together by contributing by way of premiums on the basis that if the contemplated contingency befalls any member he shall receive a compensatory payment."

A mutual company must create and maintain a reserve fund (corresponding to share capital) of not less than the foreign currency equivalent of BD$250,000. The liability of the members is limited to premiums or the undischarged portion thereof due to the company by any member. The term "premiums" is defined in the Act to mean "the premiums, including retrospective premium adjustments or calls payable for insurance issued or effected by a mutual company to, for or on behalf of each member of the company and any capital contribution or other such assessment that is due under the bye-laws or any other contractual obligation with a member of the company."

However, liability for "calls" is somewhat open-ended, and careful structuring is needed to avoid effectively playing a game of "musical chairs" as members drop out forcing increased calls on those who remain.

When a mutual company is wound up, after its liabilities have been satisfied the person carrying out the winding up must either apportion the remaining assets in accordance with the bye-laws of the company or, if there is no provision in the bye-laws for such apportionment, then "in such a fair and equitable manner amongst the members of the company as such person may decide." This is to say that, unless the bye-laws otherwise provide, only remaining members may participate in the assets. Thus, former members who may have contributed to the reserve funds will be disadvantaged.

A mutual company is also required in its bye-laws to make provisions to establish the criteria by which membership in the company and eligibility for such membership is to be determined. Unless the bye-laws of the company provide otherwise, the following persons are deemed to be members of a mutual company:

In relation to (b) above, the reference to a risk of a person being indirectly insured by the company is to be taken as "a reference to that risk being covered by the company by reinsurance through one or more intermediaries."

Mutual companies are ideally adapted to industry groups of members/insureds who have a common business interest and a need for insurance cover in respect of a common range of risks, be they life or property in nature.² Indeed, such a form is used for major association captives such as that of the rail industry in the United States, or the franchisee benefits captive of a major fast food franchisor.

It is also possible, pursuant to a private Act of the Bermuda Legislature, to convert a joint stock company into a mutual company. This may be desirable for reasons having to do with securities, tax or other laws in effect in the jurisdiction(s) of the members of the mutual company.

There are many advantages to forming a mutual company, and these should be carefully considered with reference to professional advisers as necessary.